Daily Insight

U.S. stocks struggled after a disappointing profit outlook from drug giant Pfizer and a key gauge of service-sector activity continues to show end demand remains weak.

Financial shares led the market’s decline, but health-care was the second-worst performing sector on the Pfizer news, which stated 2010 earnings would be below consensus estimates. The firm did record awesome revenue growth, up 34%, thanks to the Wyeth acquisition. The problem looking ahead is the potential in the pipeline; it will have to be enough to overcome blockbuster drugs that will be running off patent – but that is hardly a new uncertainty.

The best-performer sectors were tech and consumer discretionary, the only two of the 10 major groups up on the day.

Last week we spent a little time discussing the jump in Greek government bond yields as default risk was on the rise. Well, they aren’t actually going to default, at least as the word is technically defined, but it was becoming increasingly evident that it would take some sort of EU bailout to keep their long-term government bonds yields in single-digit territory.
But sentiment has changed quite dramatically over the past two sessions as those Greek yields on now on the decline after the EU endorsed that government’s latest program to get their deficit/GDP ratio down to 3% by 2013 from the current 13%.

Now, it is fantasy to believe this will occur. First, it would take an extraordinary level of economic growth over the next few years for that to be possible. Second, implementing austerity measures on the spending side will prove more than difficult. The Greeks are used to a large welfare state and to accomplish this goal they’ll need to slash entitlement programs. This is about as unrealistic as it comes. Greeks don’t participate in the peaceful demonstrations we’re used to here; they take a slightly more aggressive track. Greek yields will rise again.

We’re not going to escape a full-fledged round of sovereign default risks before the global economy ultimately completes its mending process. Spain, Portugal, Greece, Russia (where I’m expecting the actual default to occur, ala 1998) are all on the soaring-yield and rising debt-financing cost chopping block. I’ll tell you, public finances here in the U.S. don’t look all that much better; we are on a dangerous road. Thankfully, we continue to enjoy this lasting benefit due our history of leading the global economy and the deep and liquid markets that are a result. But we better get ourselves on a more sensible path, and do it quick.

Market Activity for February 3, 2010
Energy Report

The Energy Department reported that crude supplies rose 2.32 million barrels last week (a gain of just 400,000 was expected). The price of crude for March delivery actually held in there pretty well considering such a larger-than-expected build in supplies, but there is a heavy future inflation hedge that’s still in play and it is keeping oil prices in the mid-$70 range – hovering at $76 as I type.

Gasoline supplies slipped due to rock-bottom refining rates. Refineries operated at 77.7% of capacity last week, a number below 83% is considered the floor during downturns – it takes a major hurricane to push rates below where they are now.

The low refinery output reflects the fact that demand remains weak. Gasoline consumption averaged 8.64 million barrels per day, the lowest since 2004. Total fuel (gasoline, heating oil and diesel) demand averaged 18.8 million barrels per day last week, 2% lower than the year-ago period when the economy was in a world of hurt and 10.5% below the norm of 21 million barrels/week.

Fuel demand is an important indicator to watch, as it is shows what’s occurring on the ground. I think too many people in the market place today are ignoring this very accurate barometer.

Mortgage Applications

The Mortgage Bankers Association reported that their applications index jumped 21.0% in the week ended January 29, following a 10.9% decline in the previous week. Both aspects of the report fueled the rise as purchases rose 10.3% and refinancing activity increased 26.3 – those figures followed -3.3% and -15.1%, respectively.

The rate on the 30-year fixed mortgage averaged 5.01% for the week, virtually unchanged for three weeks now.


Preliminary Jobs Reports

The Challenger Jobs Cuts Survey (from the outplacement firm Challenger, Gray and Christmas) showed there were 71,482 announced firings in January, which is 70.4% below the year-ago period when the economy was shedding 690,000 jobs per month. This missed expectations for a 72% decline, but that’s not important – we all know the massive slashing of a year ago is out of the way. From here we need to concentrate on job increases and we’ll need 100-150K per month just to keep the unemployment rate steady at 10% and 300k-plus/month to get it meaningfully lower a year from now.

Challenger did show that layoff announcements came in at 71,482 last month, which is up from the 45,094 in December and the highest level since August.

In a separate report, the ADP Employment Change Survey showed just 22,000 payroll positions were shed in January, which is better than the -30,000 economists had expected the report to show. ADP captures only private-sector employment. For tomorrow’s official Labor Department reading on the January employment situation economists expect to see an increase of 15,000 payroll positions.

ADP estimated that goods-producing industries cut 60,000 positions (25K within the manufacturing sector and 35K within construction) and service-providing industries added 38,000. Those figures, if accurate, would prove a pretty good improvement from the December results when goods-producing companies cut 80,000 positions and service-providers cut 4,000.

ADP had small firms (defined as having less than 50 employees) cutting 12,000 jobs; medium firms (< 500 employees) added 9,000; and large firms cut 19,000.

ISM Non-Manufacturing

The Institute for Supply Management’s service-sector index rose just into expansion mode for January, rising to 50.5 from 49.8 in December – a reading above 50 marks expansion. The number did come in just shy of expectations, which had the figure rising to 51.0.

New order rose to 54.7 from 52.0 and employment rose to 44.6 from 43.6, but these were the only sub-indices of the report that showed improvement. Backlog of orders slipped to 45.5 from 48.0; inventories fell to 46.5 from 51.5; and supplier deliveries remained unchanged at 50.5

The breadth of the report deteriorated, as just four industries reported growth in January. This is down from seven in December.

What respondents said:

• “Business is better, but not robust.” (Agriculture, Forestry, Fishing & Hunting)
• “Some client capital spend plans have been delayed until the 2nd or 3rd quarter.” (Professional, Scientific & Technical Services)
• “Outstanding production month, highest since March 2009, but still lower than December 2008.” (Wholesale Trade)
• “Commodity prices are starting to rise. We will be trying to mitigate inflationary price trends through longer contracts and value engineering.” (Accommodation & Food Services)

We’re going to need something considerably more substantial than this to keep things going. The data continues to suggest that end demand remains lackluster.

Cisco and Futures

Cisco Systems reported some really good numbers last night, profits up 23% and revenue up 8%, and Chairman/CEO Chambers was very upbeat about business spending trends.

We’ve spent a lot of time talking about how firms are likely to hold business spending to maintenance (replacement) levels in this environment. Well, Cisco is a main beneficiary of this maintenance spending (networking components, remote access servers, routers that direct data and voice traffic, etc.) and their numbers showed it.

It’s important to keep in mind that this rise in capital expenditures must be confirmed by the rest of the tech industry and followed up by a good first-quarter. You’ve got to get away from the end of the year to get a clear picture of what’s going on here because unspent annual budgets get spent in December – and this scenario probably occurred like no other as businesses were scared to let go of cash for much of 2009.

The news from the tech giant is not helping futures, which are down meaningfully this morning.


Have a great day!

Brent Vondera, Senior Analyst