Daily Insight

U.S. stocks slid yesterday as jobless claims jumped, China continues to make gestures toward reining in stimulus, and the White House proposed new bank regulations.

President Obama’s announcement yesterday morning, proposing new rules designed to restrict the size and activities of the largest banks, led to concerns over the sector’s profit potential.

The White House proposal, on its surface and if passed by Congress, would force financial institutions to spin off operations and change their regulatory status. Dang, and it was just over the past two years in which the government “encouraged” banks like JP Morgan and Bank of America to buy the troubled investment banks Bear Stearns and Merrill Lynch – both of which engage in the politically disparaged proprietary trading.

Let’s hope this is more a diversionary tactic on the heels of the health-care rebuke via the MA election than anything else because this proposal is ill-conceived and terribly timed.

First, you never, ever offer such a proposal without international cohesion – unless your goal is to deliberately put your own financial industry at a global disadvantage.

Second, this is about as poorly timed as it gets. Proprietary trading is one area that is helping to ease the losses on the traditional banking side of things – sky-high loan delinquency rates. You want to watch credit contract for a long time, implement this proposal now. (Also, this is a reminder of why I keep harping on the consequences of intense government intervention and waves of populism. Do not underestimate Washington’s ability to royally screw things up.)

Finally, firms will always employ an army of lawyers to find regulatory loopholes and this does nothing to tackle the “too big to fail” issue. If Goldman Sachs simply de-banks (recall they, like so many others, scrambled to become bank holding companies little more than a year ago so they could get in under the TARP and it’s bailout funds), their counterparties along with the rest of the universe will still see them as TBTF.

None of this may even matter. The banks have already easily identified the rather conspicuous loophole. The key phrase in the President’s proposal is “operations unrelated to serving clients.” Well, proprietary trading can be done through hedge funds in which clients may now be permitted to invest. One supposes even a bank’s own employees can be termed “customers.” It seems as if the weak regulations are by design, which gives credence to the charge that this is purely a political move.

If you’re going to get serious about this thing, you state that only traditional banks – engaging in only the most conservative of activities – are the sole institutions that have government backing and the safety net. The rest can do whatever they please, but it must be clearly stated that they do not have a government safety net. If they fail, they go down. When you explicitly state that investments are walking the tightrope without a net, the market will do the regulating. When the government gets involved with its backstops and safety nets risk will not be assessed properly.

Anyway, the announcement had wide-ranging effects on the market. It wasn’t only financial shares that got hit, basic material shares were by far the worst-performing sector for the session – got clocked by 4.3%. The group was already getting hammered over news that the Chinese are planning to remove some stimulus measures; they endured another leg down after the President’s press conference. Sudden regulatory changes may be seen as damaging the fragile, nascent and thus far slight global expansion and that’s why commodity-related stocks took the brunt of the hit.

The broad market’s decline was the largest since the 2.81% loss on October 30. Still, for all of the commenting from the press that yesterday’s activity was a bloodbath, it was not. The S&P 500 is up 68% from the March low. We’re considerably past the point of a correction in my view, the 2.95% lost over the last two sessions is child’s play – has everyone already forgotten what a bloodbath truly looks like? Of course they have, that’s what a zero interest-rate policy does. If Washington is going to play a game of chicken with the market by traveling down the path of populism, we will be reminded of what a real sell-off feels like.

Market Activity for January 21, 2010

Jobless Claims

The Labor Department reported that initial jobless claims rose 36,000 (expectations were for a 4K decline) to 482,000 in the week ended January 16. This moves the figure back above the 480K level for the first time in five weeks, just when it looked like claims would remain below 450K and on their way to 400K. The four-week average of initial claims rose 7,000 to 448,250 – the first increase in nearly five months.

Continuing claims fell 18,000 to 4.599. That’s for the standard sort, the benefits that are good for the first 26 weeks. When those are exhausted Emergency Unemployment Compensation (EUC) kicks in to provide up to another 73 weeks of benefits. That’s right, another 73 weeks. These claims surged 613,000 for the week ended January 2 – there’s a two-week lag to the EUC claims. Standard claims have declined 2.3 million since peaking out last June. However, EUC claims have more than offset this move as they have jumped 3.2 million.

The data continues to paint the same picture that it has for a couple of months. While the pace of job firings has eased greatly, hiring has not begun to occur and a very disturbing level of long-term unemployment continues to grip the workforce.

Last week we mentioned that EUC claims halted their march higher for the first time since May. This offered some evidence that jobs have begun to pick up, but we expressed the caveat that the data in the following weeks must confirm this. Well, obviously the move in EUC failed to confirm that dip. Instead, those claims rose by the most since the program’s implementation in July 2008.

Philly Fed

The Philadelphia Federal Reserve Bank’s gauge of factory activity in the third Fed district posted its fifth-straight month of expansion in January, although the reading did decelerate to 15.2 from 22.5 in December.

In terms of the sub-indices, the new orders index slipped to 3.2 from 8.3 in December (a reading above zero marks expansion). Unfilled orders and delivery times both accelerated – unfilled orders rose to 3.6 from 1.7 and delivery times rose to 6.6 from 4.1. (These are two areas we’ve been keeping a close eye on because if they spend several months in expansion mode it illustrates that factories are getting stretched and may be forced to add workers. Among the several regional manufacturing readings, these two components have moved to expansion mode for two months now.)
The average workweek reading slipped but remained in expansion mode, coming in at 4.2 for January after 6.3 in December. (This another area to watch as a signal for future factory employment growth as current workers hours must rise and become stretched before firms will increase payrolls.)

The inventory index remained in contraction mode, but just barely as the -1.6 reading for January is the best number since November 2007.

The worst aspect of the report was the differential between prices paid and prices recieved. Prices paid continues to hugely outweigh that of price received, the former came in at 33.2 and the latter rose to just 2.7. This is not good for manufacturing profit margins. While they will be able to absorb these costs due to the massive reduction in payrolls (higher worker productivity via the slashing of employees), this could become a problem when hiring begins. It may even cause manufacturers to further delay new hires.

The Call – Part II

Earlier in the week we talked about the official date for which the NBER (National Bureau of Economic Research, the official arbiter of business cycle dating) will call the recession ended. While this announcement is not expected for sometime (the NBER generally take a considerable period of time before they call the official date), I have guessed they will state the recession ended in June; the St. Louis Fed staff believe it will be July. Overall, it’s meaningless, but it is interesting to talk about.

I bring this topic up again because Invictus (a blogger than keeps a close eye on the business-cycle dating committee) states that the NBER has posted some comments on their website that seem to raise some uncertainties as to whether they’re even planning to call the recession ended in 2009. I found his comments intriguing so I went to the site to see read the post. There one finds that the NBER doesn’t seem so sure the recession has actually ended via the statement: “In both recessions and expansions, brief reversals in economic activity may occur – a recession may include a short period of expansion followed by further decline; and expansion may include a short period of contraction followed by further growth (my emphasis).”

I continue to believe they will call the recession ended in 2009, but these posted comments do cause some doubt – they certainly had some kind of message they meant to relay by the posting. It is unclear as to whether the NBER views the unprecedented fiscal and monetary stimulus that has been by far the main reasons most economic indicators have begun to move higher, or at least halt their significant decline, as an invalid reason to state that the business cycle has truly troughed. Maybe they will wait an extended period this go around to make the call in order to see how the economy reacts to the fade out of fiscal stimulus. They are making things very interesting.

Below are the key indicators the NBER watches to make their call. While employment has halted steep declines and real retail sales have at least stabilized, industrial production is the only indicator that has shown a clear upward trend.

Have a great weekend!

Brent Vondera, Senior Analyst