Daily Insight

U.S. stocks shook off two ugly housing reports to extend the recent winning streak to four sessions. A good headline personal income number helped traders look past the housing data. Even though the income figures are being propelled by government transfer payments, which can only be transitory in nature, the wage and salary component did register a nice increase and that offered stocks a little boost. Money was most focused toward mid and small capitalization indices as the broad large-cap market was only slightly higher.

Basic material, tech and energy shares led the advance. Financials were the worst-performing sector; health-care stocks slipped also as these were the only sectors of the major 10 that closed in negative territory.

Volume was extremely weak, which is always the case for the session prior to Christmas Eve, but even more so than is typical as just 740 million shares traded on the Big Board – something closer to 900 million has been the norm. Today is a holiday-shortened session and most traders are long gone so we’re likely to just go through the motions unless the day’s economic releases (jobless claims and durable goods orders) print readings that are far from expectations.

The U.S. dollar ended a six-day rally.

Market Activity for December 23, 2009
$80 Looks to be Back in Play

Crude-oil for January rose 3% to $76.67/barrel yesterday after the weekly energy report showed supplies fell more than expected. Crude stockpiles slid 4.84 million barrels last week, a fall of 1.6 million was expected, as consumption of gasoline rose 0.9% from the prior week to 9.05 million/day and distillate fuels (diesel and heating oil) rose 5.2% over the previous week – some of this was obviously due to colder weather, especially in the Northeast.

Not all of the decline in stockpiles was a result of increased demand, though it is nice to see gasoline consumption 2% higher than the ultra-weak levels of a year ago. While refinery utilization rose to 80%, this is still rock-bottom as 88% is the long-term average and 83% was viewed as the floor prior to the beating the economy’s taken over the past year. Also, oil imports fell another 0.8% in the latest week to 7.71 million barrels, the lowest level since September 2008 when Hurricanes Gustav and Ike punished the Gulf Coast and shut down the ports.

Mortgage Applications

The Mortgage Bankers Association reported that applications fell 10.7% in the week ended December 18, the first decline in four weeks. Both purchases and refinancing got clocked, down 11.6% on purchases and 10.1% for refis. The 30-year fixed rate mortgage rose to 4.92%.

The rate will move above 5.00% next week as Treasury yields have jumped, which means the Fannie and Freddie commitment rates also rose. Based on those moves the 30-year mortgage rate is going to 5.20% next week. This will be a nice little snapshot to show how housing will react to just marginally higher rates. It does not seem likely that a sustained move higher will present itself, in my opinion – not yet at least. But the housing market has become conditioned to 4.70-5.00% rates and thus the reaction will not be kind to 5.00%-plus, and higher, that is inevitable over time.

Personal Income and Spending

The Commerce Department reported that personal income rose 0.4% in November (a bit below the expected 0.5% increase), which marks the fifth-straight monthly increase. Over the past year, overall personal income is down 0.3% -- although that has been helped by a 15% rise in government transfer payments. Total compensation (which excludes rental, dividend, interest and proprietors income) is down 2.2% y/o/y, but off by 5.6% when we exclude transfer payments.

All of the components looked good in November. Compensation was up 0.3%, same for wage & salary. Proprietors income rose 1.2%, boosted by another huge bounce on the farm side – up 23.0%; non-farm proprietors income rose 0.5% for the month. Rental income added 0.6% in November. Interest income rose 0.2% and dividend income was higher by 0.9%. Government transfer payments rose 0.5%. On a year-over-year basis, rental income and government transfer payments are the only segments that are positive.

On this transfer payments situation, we have seen massive increases in both actual $ amounts (as the social safety net has become larger, we’ve seen two rounds of stimulus checks, and higher SS outlays due to an aging population) and as a percentage of personal income. The spike over the past year is largely due to the French-style extensions of unemployment benefits that now extend to as much as 99 weeks.


In summary, the 0.3% bounce in the wage & salary component was welcome news and let’s hope this is the start of something good. Even if firms are unlikely to add aggressively to payrolls (and aggressive additions is what it will take to move the unemployment rate meaningfully lower over the next year), some decent increases to existing workers’ paychecks is not out of the question. Still, the overall figures (total income and compensation) are looking better than would otherwise be the case due to the transfer payments. Such activity, government spending at these levels, is not sustainable and that does boost the risk that we face another disappointing trend a few months out. The “Gods of the Copybook Heading” will prevail as they always do. Bret Stephens of the WSJ Editorial Board brought this up earlier in the week and reflecting on Rudyard Kipling’s poetic reminder that common sense always prevails is all the more apropos today.

On the spending side, personal expenditures rose 0.5% (also below the expectation, which estimated a 0.7% increase) as outlays for goods rose 1.4% (holiday shopping) and service rose 0.4%. The cash savings rate held steady at 4.7%.

University of Michigan Confidence

The U of M consumer confidence reading for December was revised down to 72.5 from the preliminary print of 73.4 that was release two weeks ago. Still, this shows that confidence did improve from November’s weak 67.4.


The economic outlook reading (expectations six months out) was also revised down to 68.9 from 69.7.


New Home Sales

New home sales tumbled 11.3% in November (a 1.7% increase was expected) after a big downward revision for October (up just 1.8% vs. the 6.8% rise initially reported last month) to 355,000 units at a seasonally-adjusted annual rate. This is the lowest level since April and erases most of the bounce from the January low of 329,000 units. On a year-over-year basis, new home sales are down 9%.


This offers us a glimpse of what will occur when the tax credit expires. (Unlike existing home sales that are counted when a contract closes, new home sales are counted when a contract is signed. That is, while existing sales are effectively counting activity a month or two in the past when the purchase process began, the new home sales figure measures what actually occurred in the reporting month. Since buyers in November largely believed the credit had essentially expired – had to close by November 30 – this offers a glimpse of what things may look like without the subsidy.)

By region, sales were flat in the Northeast, up 21% in the Midwest, down 21% in the South (this region makes up over half of the new-home market) and off by 10% in the West (the West and South together make up 73% of the new-home market).

The median price actually rose 3.8% in November to $217,400, which was quite unhelpful.

The supply of new homes, as measured by the inventory-to-sales ratio (the number of months it takes to sell off existing supply at the current sales pace) rose to 7.9 from 7.2 in October.

Yesterday I mentioned that we should be careful in our expectations regarding the supply of homes when referring to the previously-owned home figures. The supply of existing homes fell substantially and has returned to a level that is pretty close to the longer-term average. However, when foreclosures begin to hit the market that supply number will rise again. But that’s not all as the market is likely to be hit by a double whammy – more houses hitting the market due to foreclosures along with a decline in sales. If what has occurred in new home sales shows up in existing (although unlikely to fully occur until the tax credit expires in April) then it will boost the inventory/sales ratio that much more.

Futures

Stock-index futures are higher this morning. We await the jobless claims and durable goods orders reports. Unless these numbers are much worse than expected, traders appear determined to push prices higher. We continue to hold above that 50% retracement level we’ve referred to over the past two days.


Merry Christmas!


Brent Vondera, Senior Analyst

Santa Claus Rally

In the past, the stock market has made modest gains in late December into the beginning of early January. Widely recognized as the Santa Claus rally, this time period has quite the track record. Since 1950, the S&P 500 has increased an average of 1.5% during the seven trading days that start with Christmas Eve and end with the first two days in January. Stocks have gone up during this period in 12 of the last 15 years.

Other interesting facts (complements of InvesTech Research):

• December is the best single month for stocks, with the S&P 500 index averaging a 1.6% gain. The first December after a bear market ends performs even better, averaging 3.1%.
  
• November through January has historically been the best three-month span for stocks. The average gain over the last four decades from Nov. 20 through the end of January has been 4.2%, or an annualized rate of 23%.
  

There are several factors that people theorize are responsible for the Santa Claus rally such as peak retail season (due to holiday shopping), tax considerations, upbeat year-end investment reports (many of which have “top stocks for the next year”), happiness around Wall Street, people investing their Christmas bonuses, and vacationing Wall Street workers.

A prudent investor knows the Santa Claus rally is not an opportunity to make a quick buck (because that would be market timing!), but it’s difficult to ignore all together. After all, the lack of a Santa Claus rally in recent years has signaled turmoil lies ahead. The market tanked in 2000 when there was no Santa Clause rally in 1999 and a late-year drop two years ago preceded a disastrous 2009.

Is Santa Claus coming to town this year?

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Peter J. Lazaroff, Investment Analyst

Economy or Quadruple Witching?

S&P 500: -13.10 (-1.18%)

Market participants scrambled for safety, pushing the dollar to the highest level in three months. On cue, stocks and commodities traded lower.

Several factors sparked fear in markets. Greece’s second credit rating downgrade this month certainly kept government debt concerns in focus. Also, initial jobless claims unexpectedly increased, reminding everyone that the road to recovery will be bumpy. The lack of jobs was one reason the Fed plans to keep interest rates low for an extended period.

A disappointing profit forecast global shipping company FedEx (FDX) also made market participants question the strength of the economic recovery. Many use FedEx’s earnings and projections as an indicator of the nation’s economic strength since the firm transports a wide range of business and consumer goods such as auto parts, real estate documents, and toys.

It was clear from FedEx’s earnings call that the company still lacks clarity on the end demand picture. The firm says the economy is approaching a turning point, but a full recovery appears a way off. In the long run, the firm sees strong demand in Asia and Latin America leading the way to global economic recovery.

Trading volume on the NYSE hit its highest level in nearly three months. One could argue that such volume is signs of conviction behind the selling effort, but it’s important to note that tomorrow is a quadruple witching day.

Quadruple witching is a day when contracts for stock index futures, stock index options, stock options and single stock futures all expire. This occurs on the third Friday in March, June, September, and December. The name may sound scary, but it simply means there is some extra volatility as large funds and traders cover any remaining open positions before they expire and settle on Saturday.



Quick Hits

• Santa Claus’s Trade Infractions
  
  

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Peter J. Lazaroff, Investment Analyst

Exxon Mobil makes a splash in natural gas

Exxon Mobil (XOM) rarely makes major acquisitions. Today, the oil-giant announced the acquisition of XTO Energy for $31 billion, representing a 25% premium over XTO’s closing price on Friday.

Exxon played the last cycle better than any of the other oil majors. As energy prices rose during the last three years, Exxon patiently committed just 40% of earnings to capital investment while Shell, BP, and Chevron committed between 85% to 100%. Today’s deal is notable because it marks a change in strategy. Exxon’s move is a bet that gas demand is going to outpace oil and coal over the next decade, in part due to tighter emissions standards.

Staying true to their financial conservatism, Exxon is doing an all-stock deal rather than dipping into its healthy cash pile. At the end of the third quarter, XOM had a net cash position (cash less debt) of $2.9 billion. Meanwhile, the company converts roughly 10% of revenue to free cash flow meaning that the company may generate roughly $8 billion in free cash flow in the fourth quarter alone.

Some investors were disappointed Exxon didn’t offer a cash-stock combination, but this concern overlooks the fact that Exxon will assume about $10 billion of XTO’s debt. If you include XTO’s debt obligations in the cost of the acquisition, then Exxon is actually using cash to fund about one-fourth of the XTO purchase.

One could also argue that future share buybacks will reduce the new outstanding shares, effectively “paying” for the acquisition. Exxon has reduced total outstanding shares by 25% since the end of 2004 and has repurchased $17 billion in stock this year alone. I admit this is a bit of a stretch, but it’s worth considering.

Exxon’s acquisition is clearly a wager that depressed gas prices will improve in the coming years, but I wonder if there are any other factors at work.

How much does the Fed’s zero interest rate policy (ZIRP) play into these decisions?

Cash-rich corporations, like individual investors and savers, aren’t earning any return on their cash and equivalents. But until there is concrete evidence that the economic recovery is sustainable, businesses may be hesitant to add to capacity. As a result, mergers and acquisitions present a more attractive use of capital.

Does expected inflation create a greater sense of urgency for firms to put cash to use?

In Exxon’s case, higher inflation means higher natural gas prices and higher revenues. So it’s obvious that expectations for higher inflation would create a greater sense of urgency for an acquisition in this case. Still, it would also be in a non-energy firm’s best interest to purchase assets that can enhance growth if the firm believes that inflation will diminish their purchasing power in the future.


Quick Hits

• Fastest Food Inflation Since ’08 Riots Means Milk Costs 39% More Next Year
• Volcker: We Need to Think More Boldly

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Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks held onto most of the session’s early gains, fighting off a move into negative territory about midday to close higher for a third day in a row. The gains just barely erased pre-hump day losses – the S&P 500 closed fractionally higher for the week.

A well-balanced retail sales report and a higher-than-expected University of Michigan consumer confidence reading for December both helped to boost stocks. (This UofM confidence reading is a preliminary number, we’ll get the final reading later in the month. I’ll note that the trend over the past two months has been a downward revision. Plus the reading remains at past recessionary levels. So, the increase in stocks was likely all due to the retail sales reading.)

Utilities was the best-performing sector. Consumer discretionary and industrials were not that far behind. Tech and health-care were the only two of the major 10 groups that closed lower on the session.

Utility shares continue to enjoy a momentum trade that began in early November; what kicked it off were events that virtually happened in succession. First was the G-20 meeting at the end of October in which the members pledged to keep government stimulus plans in play, which was followed by the same pledge from APEC (Asian governments), followed by the Fed’s November 4 meeting and the FOMC’s statement that ZIRP will remain in place for an extended period. All of these comments showed that rock-bottom interest rate will remain in place – and there was some uncertainty in this regard by in mid-October – and that drove money into higher-dividend paying utility shares. The index that tracks utility shares is up 12% since November 4, double the move for the broad market.

Advancers beat decliners by a two-to-one margin. Volume was punk again as just 950 million shares traded on the NYSE Composite.

Market Activity for December 12, 2009
Retail Sales

The Commerce Department reported November retail sales rose 1.3% (double the expectation) after October’s 1.1% increase. That’s a strong two-month rise; it is unusual to see back-to-back 1%-plus readings. That said, the October reading was all auto-related (strip out autos and the figure was virtually unchanged, up just 0.01% -- as we commented on when it was released last month) and hardly an impressive report. However, this report for November was impressive, showing widespread gains – every major component with the exception of furniture and clothing was up nicely.

The ex-auto reading for November jumped 1.2%; excluding autos & gas, spending rose 0.6%; ex-autos, gas, and building materials (the figure that flows straight to the personal consumption reading of GDP) rose 0.5% - and is up 5.1% on a three-month annualized basis, which means we’re going to see Q4 GDP estimates boosted.

The caveat: this retail sales report was based upon a new sample – the sample is changed every 2 ½ years in an attempt to more closely reflect buying preferences. So, GDP estimates are being boosted and rightly so. We’ll see though if this new sample resulted in an overstatement of activity when the revision is released next month and more closely reflects what actually occurred rather than substantial estimations which are present in this first look.

Unless the spending figures are revised much lower, or the December reading is a complete flop, we can now expect a 3.0% GDP reading for Q4 even if the inventory segment doesn’t help out much. If inventories provide a good boost, we’ll probably see 4.0%.

This is what we’ve been talking about, even as my pessimism on several other fronts has surrounded these moments of optimism. A couple of months back we talked about the high possibility of above-average GDP readings for a couple of quarters, but the numbers won’t be as strong as they are historically coming out of a severe contraction, nor are they likely to be sustainable. (Recall, as we’ve explained, the economy has averaged growth of 7.8% in the year following the worst recessions in the post-WWII era – actually, to be specific this is true for the year following one quarter removed from the end of those recessions. So, if we are to get a couple of quarters of 4% growth it is still weak by comparison. We’ll take 4% though considering the headwinds the economy continues to face.)

By segment, autos were up 1.6%; electronics up 2.8% (boosted by post-Thanksgiving weekend door-buster sales, we’ll watch for follow through in December); building materials up 1.5% (I don’t believe this segment has a prayer at sustainability); food & beverage up 1.0%; health & personal care up 0.6%; gasoline stations up 6% (strange reading as this is not what the weekly energy reports have shown, some of it may be due to price increase, but most of that occurred in October); general merchandise up 0.8%. Again, furniture and clothing (each down 0.7%) were the only components to register a decline.

Import Prices

The Labor Department report November import prices jumped a higher-than-expected 1.7% -- up 3.7% year-over-year and the first positive y/o/y reading in 13 months. We have been expecting the inflation gauges to exhibit a pronounced change beginning in November, as the y/o/y comparisons become very easy -- heretofore, the year’s price-level readings have been matched against the highs in the inflation indices that resulted from that commodity-price spike back in the summer of 2008 -- $140/barrel oil etc. That has now changed.


I have begun to reassess my inflation expectations over the past couple of months, however. We should still expect relatively high y/o/y readings for a few months based on year-ago low levels, but banks are in bad shape (much more troubled than the market currently seems to acknowledge.) and if credit continues to contract a sustainable pick up by way of harmful levels of inflation could still be a another year to 18 months off. We’ll continue to keep a close eye on this story. The main point I want to get through here is while the inflation trade (commodities and commodity-related stocks) has proven a successful one for those who got in at the right entry point – had to be ahead of the momentum trade – I would caution against myopically charging at this trade right now.

Business Inventories

Business inventories rose 0.2% in October (a decline of 0.2% was expected, so this jibes with the larger-than-expected increase by way of that wholesale inventory figure on Wednesday) – this is the first increase in 14 months. Although, the increase was largely boosted by autos and thus still shows some clunker-cash boost. I bring up the clunker program because stockpile increases driven by this program don’t exactly offer the suggestion that firms are re-stocking as a result of a boost in confidence but rather via the large car sales that resulted in August – it’s fantasy to believe car sales will return to 14 million units at an annual pace, as occurred in August; something closer to 10 million is more likely and that means auto production can’t be leaned upon for too much longer. Excluding autos, business inventories fell 0.2%, down for the 13th month.

On the more positive side, business sales have increased for the fourth-straight month – up 1.1% in October. As a result, it shouldn’t be too long here before we see at least a mild trend higher in inventory levels.

The business inventory-to-sales ratio slipped to 1.3 months worth (the time it would take to sell off all stockpiles at the current sales pace) from 1.31 in September. This is a vast improvement from just nine months back when the reading hit 1.46 months worth. The inventory slashing of the two quarters that ended June 2009 were without precedent in the postwar era.


On a three-month annualized basis, business inventories are down $101.2 billion. That’s an improvement from -$174.1 billion in September and -$224.5 billion in August. All it takes is for stockpiles to fall at a slower rate in order to add to GDP. Again, based on the violent slashing of stockpiles earlier this year we should see some actual rebuilding. If we fail to see even a mild level of absolute re-stocking over the next couple of months, it will provide a clear signal that businesses remain very cautious and confidence has yet to improve.

Futures

U.S. stocks futures are up strong this morning, fueled by the news that Abu Dhabi will send Dubai a $10 billion check, $4.1 billion of which will be used to avoid defaulting on a bond payment that is due today. When this news was hitting the headlines around Thanksgiving we stated that December 14 will be the date to watch. That’s because Dubai World’s real-estate arm Nakheel has a bond coming due (Dubai World is the emirate’s corporate flagship). Well, what this shows is just another sign that things are not in the shape that equity markets world-wide appear to be pricing in. Another government bailout means that the global economy is far from out of the woods. Nevertheless, stocks look ready to revel.


Have a great day!


Brent Vondera, Senior Analyst

Afternoon Review

S&P 500: +4.06 (+0.37%)

The S&P 500 managed to finish the week with a small gain after better-than-expected retail sales and consumer confidence offset concerns regarding sovereign government debt. Also lifting sentiment was bullish data from China (larger-than-expected increase in industrial production and new lending) as well as a bullish 2010 forecast from J.P. Morgan.

November retail sales signal the holiday shopping season got off to a nice start, with strength in electronics and “nonstore” (i.e. internet) retailers. It appears consumers can continue to spend during the deleveraging process, but a challenging labor market and tightening credit should restrict the pace at which spending will rebound in 2010.

The U.S. Dollar Index again made gains along stocks, gaining 0.7% today and now up 3.1% since November 25.

During the past several months, stronger economic data caused risk aversion to fade, pushing stocks higher and the greenback lower. This trend may be changing, though, with the market increasing bets on interest rate hikes in 2010.

If the dollar continues to rally, we should see a shift in outperformance from the companies that derive a large portion of their revenues internationally to those that derive the most of their revenue domestically.

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Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks pared their early-session gains but spent the entire day in positive territory and, most importantly, closed on the plus side. The financial press pointed to a jobless claims report that showed initial claims remained below 500K, as the main reason behind the market’s advance. I’m not buying it though as the continuing claims number suggested that labor-market troubles continue to lurk.

A more likely impetus behind the advance was day’s other economic release, the October trade figures, which, beyond showing that energy demand remains very weak, did illustrate pretty good discretionary spending.

Another factor may have been near-record wides in the yield curve (274 basis points between the 2s and 10s– just shy of the 275 record – and 355 bps between 2 and 30 – close to the record wide of 368). This spells continued strong interest income for the banks, and boy do they need all the help they can get by the way the coverage ratio looks – provisions set aside are hugely inadequate for the level of non-performing loans. According to the FDIC, that coverage ratio sits at 60%; the 15-year average is 140%.

Consumer discretionary shares led the gains, which gives at least some credence to the thought that the trade numbers helped investor sentiment. Utilities, health-care and energy shares were the other out-performers. Financials and basic material shares were the losers on the session.

Small caps continue to lag the broad market, which is usually a sign that a rally has become winded. The smalls peaked on October 14, about six weeks before the S&P 500 hit its post-March lows high-point. Since mid-October, the smalls are down 4.5%, while the S&P 500 is about flat.

Market Activity for December 10, 2009
Jobless Claims

The Labor Department reported that initial jobless claims rose 17,000 last week, rising to 474,000 – the reading was expected to fall by 2,000. This ends a five-week streak of decline but the reading remains nicely below 500K so that’s something to take a little comfort in. The four-week average fell 7,750 to 473,750.

Continuing claims slid 303,000 to 5.157 million, but the decline is meaningless as EUC (Emergency Unemployment Compensation – the jobless are moved to this program when their standard 26 weeks of benefits run out) claims more than offset that move by jumping 327,729. This shows that the move lower in standard continuing claims is more about the expiration of benefits (see chart immediately below) rather than from some level of job creation occurring.

The claims numbers continue to exhibit that the pace of firings has substantially slowed (as exhibited by the initial claims readings – possibly confirmed by the third month below 500K), yet firms are not yet adding net jobs (illustrated by the jump in EUC).

Trade Balance

The trade deficit narrowed in October by 7.6% to $32.9 billion from $35.7 billion in September. Exports rose 2.6%, while imports increased just 0.4%. I can hear it now, there will be economists exhorting that the lower value of the dollar is the reason and thus we should applaud the erosion in our currency. (A lower dollar means that U.S. goods are cheaper to the rest of the world and hence exports outpace imports. However, this doesn’t exactly work out in the longer term as well as the text books teach us because a weaker dollar causes a higher price of oil over time – and with our restrictions on domestic energy production we import a lot of petroleum products; this segment makes up 30% of imports.)

The narrowing appeared to be more of a domestic energy demand problem – not a surprise as office vacancy rates are on the rise and less people are driving to work. And the decline in crude imports, down 12% for the month, was not a function of a decline in prices – the price/barrel was down just 1.1%. In terms of barrels, we imported 32 million less barrels for the month of October – a 19.2% drop from the year-ago level. From the year-ago period crude imports are down 38.5%, even as the price of crude us up 48%.

Many categories posted some pretty good monthly readings though. Capital goods exports rose 3.7% -- fueled by an 8.9% increase in semiconductors, a 10.8% jump in computer accessories and a 2.2% rise in telecom equipment. On the import side, consumer goods were up 2.8% -- boosted by an 8.5% in pharmaceuticals. While this is more of a necessity product, clothing imports rose 5.5%, so there was a decent move from the discretionary aspect of consumer purchases. Autos also climbed 2.6%.

Outside of the significant drop in energy demand that continues the 14-month trend lower, U.S. consumer demand for other goods has shown decent improvement from very low levels.

Around the World

Australia reported that payrolls rose for a third-straight month, up 31,200 for November. Adjusting for population, this amounts to a 450,000 increase in U.S. terms (and payrolls are up roughly 1.4 million past three months). Last week we saw that Canada – another commodity-rich nation, particularly with regard to energy – posted a 79,000 increase in payrolls last month. Adjusted for population that’s a 790,000 increase in U.S. terms. This continues the theme that the commodity-laden economies of the world continue to post the best results

These countries can thank the Federal Reserve as it is their zero-interest rate policy that has the U.S. dollar just 6.5% above its all-time low; the path of the dollar both directly and indirectly is a major determinant of the price of commodities. Too bad we don’t aggressively remove production restrictions on our own energy holdings. This would be the most direct and effective way to create high-paying manufacturing jobs here at home.

Futures

Stock-index futures are up strong this morning on the heels of a higher than expected industrial production reading out of China. The figure jumped 19.2% in November on a year-over-year – the November 2008 reading it’s being compared to marked the cycle low. Even so, this is a large increase.

The growth in Chinese production over the past couple of months is commensurate to levels seen during 2003-2007; a period of robust consumption. Production is being driven by what is largely still a command-and-control government structure and history has shown, on several occasions, that such a political-economic system can lead to big trouble. I do wonder where exactly China is going to find the consumer activity to absorb all of these goods with global jobless rates double the levels they were just two years ago. Unemployment rates are still pretty low in Asia, but the region doesn’t have the domestic consumption to absorb this level of production as Asians’ propensity to save remains very high.


Have a great weekend!


Brent Vondera, Senior Analyst

Afternoon Review

S&P 500: +6.40 (+0.58%)

An unexpected narrowing of the trade deficit and favorable components of the jobless claims report helped the S&P 500 finish higher despite global government debt concerns. Volume was lacking for most of the day as stocks traded sideways for most of the session.

It’s also worth noting that the broad-based gains were made in the face of a stronger dollar, bucking the recent trend. Dollar gains have most often led to selling in the stock market due to the drag of a stronger dollar on commodity prices and repatriated profits from multinationals.

Small cap stocks finished lower today and continue to lag behind larger capitalization stocks this quarter. This trend is typical of a rally that is entering a later, more mature phase. The high beta stocks often see some of the sharpest rallies off the market bottom start to slow down.


Quick Hits

• The dollar’s fall reflects a new role for reserves
  
  

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Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks bounced into positive territory on two separate occasions Wednesday after beginning the session lower on sovereign credit concerns. However, the final push above the cut line occurred in the final hour of trading so the numbers posted a resplendent green by the close.

A bounce in basic material and technology stocks led the market higher. A turn down in the U.S. dollar helped the commodity-related material shares. Technology shares seemed to get a boost from Hewlett-Packard shares as the company announced it will cancel its normal two-week holiday break for the sales staff (normally begins December 21) in order to spend the time closing deals – obviously this it the kind of alacrity investors like to see.

Advancers just edged out decliners on the NYSE Composite by a margin of 9-to-8. Volume was weak at just over one billion shares traded.

The 10–year Treasury auction, a re-opening of the November issue, was a bit weaker than we’ve seen as the yield was about 4 basis points above where the when issued was trading and the bid-to-cover of 2.62 was below the 2.80 average of the last four auctions – not concerning though. The weakest aspect of the auction was that just 32.9% went to indirect bidders (a gauge of foreign central bank demand), meaningfully lower than the recent average of 45.6%. Tomorrow we get a $13 billion 30-year re-open and we’ll see if the heightened concerns that a sovereign default will occur (troubles in Dubai and Greece have garnered the headlines but Spain and Italy have been included in the mix – frankly I could see Russia as the next default; Abu Dhabi will bail out Dubai and the EU will make sure one of their members doesn’t actually default) may make for a more difficult auction.

For the U.S. no one has to worry about default, but higher interest rates are bound to become an issue with all of this debt issuance. Those lending money for 10 and 30 years at 3.4% and 4.4%, respectively, is where the major risk lies. Then again, if the economy runs into trouble in short order (and lower coverage ratios even as non-performing loans continue to grow has me quite concerned about another wave of bank trouble), 3.4% for 10 years may not look all that bad.

This is a strange environment, a tough environment – one can see several situations affecting rates, in either direction. Still, this is no time to increase risk levels whether it be by becoming more aggressive on the equity side of things or extending out in an attempt to reach for a little more yield.


Mortgage Applications

The Mortgage Bankers Association reported their application index rose for a second-straight week, up 8.5%. This follows a 2.1% increase in the week ended November 27 and broke a string of six weeks of decline. Applications to purchase a home rose 4.0%, just about matching the previous week’s 4.1% rise. The difference this week was that refinancing activity picked up, jumping 11.1% after a very mild 1.7% rise in the previous week. The 30-year fixed-rate mortgage held below 5% for a sixth-straight week, averaging 4.88% for the week ended December 4.

We saw the purchases index decline for six weeks that ended November 13 as potential buyers were uncertain as to whether the tax credit would be extended. Now that it has officially been extended to April 30 (and beyond just first-time buyers as those who have owned a home for five years will be offered a $6500 credit to buy a new or existing home) sales have picked up again. I continue to believe that the affect the credit has on sales will be less robust than it was back during the traditional buying season, but we will see. No matter how it turns out, the home-buyers tax credit will expire and at that point it is likely sales will retrench.

Wholesale Inventories

Distributors’ inventories rose for the first time in 14 months, increasing 0.3% in October from September’s 0.8% decline – the estimate was for a 0.5% decline. The increase was boosted by higher stockpiles of motor vehicles, nondurable goods (such as clothing) and petroleum products (recall the weekly energy reports we’ve been touching on in which very low demand has pushed crude and gasoline stockpiles higher – and yesterday’s report showed no sign of improvement has presented itself). Stockpiles of durable goods ex-autos were down 0.4% for the month. From the year-ago period, total wholesale inventories are down 13.5%

So while there is some evidence that this overall inventory rebuilding is a function of the affects from clunker cash sales and low energy demand, this does get the first month of the final quarter of 2009 off to a good start – we’ll need to see some inventory building in order to get the next GDP reading above 2.5% in my view, based on what we currently know for the quarter. (For clarity on the clunker-cash comments, auto inventories fell for eight straight months, but began to build again in September following the big August sales gain related to the clunker program.)

Even if a full-blown inventory dynamic does not ensue, this segment of the economy will at least add somewhat to GDP as the three-month annualized change has moved to -$27 billion from -$56.8 billion in the prior month – and all it takes is a slower rate of decline to add to GDP.

The sales data within the report showed its sixth month of increase, up 1.2% for October – down 9.6% from the year-ago period. This is a nice trend we’ve got going here and it will have to be maintained to keep factory production on an upward trajectory.

The inventory-to-sales ratio has come crashing lower, down to 1.16 months worth (this measures how long it would take to sell off all inventories based on the current sales pace) from 1.34 months worth in January – the cycle high.

This shows just how effectively the private sector adjusts to new economic realities. While it is an unpleasant process, to say the least, the adjustment occurs quickly and fosters an environment in which we can begin producing goods again, on a net basis of course. Again, sales will have to remain on the current glide path or firms will simply keep stockpiles at rock-bottom levels.

We’ll receive the broader business inventories report for October tomorrow.

The Un-stimulus

Everyone is talking about Britain’s decision to slap a 50% tax rate on bank bonuses above $41,000 – Chancellor of the Exchequer Alistair Darling explained to Parliament that this tax will be borne by the banks, not the employees. You’ve got to be kidding; are these people really this clueless?

But the big news is Britain’s decision to raise income tax rates on bank employees making over $240,000 -- a 10 percentage points increase to 50%. Add this to the national insurance tax and the London city income tax and you’re honing in on 55%. (The 50% tax on bonuses is only in effect until April 5, 2010 so banks will either defer bonuses or come up with some other way around this onerous tax, which is why the top income-tax rate hike is the larger issue.) Keep in mind that the financial services industry is the best thing London has going for it –for now at least. In many Asian financial centers, tax rates on incomes of similar size are set around 20%. What do you think is going to happen?

Now we have Prime Ministers Brown (Britain) and Sarkozy (France) in an Op/Ed this morning explaining how economies across the globe need to increase regulations and tax rates. These are about the only two things a Frenchman and a Brit can ever agree upon.

Well, Messrs Brown and Sarkozy, at least here in the U.S. we’re importing enough of your Western European socialism. Those Americans that will be looking for work or fighting to move up the economic ladder don’t need anymore of it, thank you.


Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks declined Tuesday as a number of issues caused investors to flee for a little bit of safety – Treasury securities and the dollar rallied – but the equity market’s move lower was a mild one. Stocks have traded sideways for seven weeks now, moving as low as 1035 on the S&P 500 and topping out at the 13-month high of 1110, but overall no where since October 14.

This latest bought of weakness all started off with Bernanke’s speech on Monday in which, among other things, he mentioned that the economy faces “formidable headwinds.” A decline in German industrial production, a credit rating downgrade of Greek debt (which highlights government deficit risks) and a decline in small-business optimism, all occurring yesterday, put additional pressure on stocks. The budget problems in Greece, which is hardly the only nation with issues right now, follows the troubles out of Dubai that surfaced in late November.

Energy, basic material and industrials shares – all early business-cycle plays – led the broad-market’s decline. All 10 of the major industry groups lost ground on the session.

As a result of the dollar’s climb, back up to the 76 handle on the Dollar Index, commodities sold off. Gold fell for a third-straight session, down 7% over this stretch, and oil is back down to $72/barrel after holding in the high $70s since mid October.

Outside of some geopolitical event or a sovereign default it is tough to imagine the dollar breaking its downward trend – especially as the Fed continues to signal their zero interest-rate policy will remain in place.


Market Activity for December 8, 2009
Too Big Too Fail Fix – Give Me a Break

The House Financial Services Committee voted 31-27 last week to approve legislation that would augment government authority to police large firms that pose risks to the economy. Debate on the House floor will begin this week to create a council of regulators that monitor financial industry risks and impose costs (funds that would bail out reckless firms) on the largest firms within the industry. The legislation would grant the Treasury Secretary, among others, the authority to dismantle healthy, well-capitalized firms whose size threatens the financial system. It also removes a 30-year ban on audits of monetary policy – it’s not clear to me whether this pertains to just the Fed’s balance sheet or interest-rate policy as well; this is a treacherous road if it includes the latter, the Fed has made large mistakes this decade but you can expect plenty more if Congress and the GAO are allowed to get involved.

If this is passed, we may all watch firms take on even greater risks over time as healthy firms will see their costs rise, effectively backstopping those that get themselves in trouble – this has a certain moral hazard problem attached as far as I’m concerned.

Giving the government the ability to dismantle healthy and well-capitalized financial firms carries its own problems -- more government involvement in the private sector has never been long-run helpful and its not going to be this time. Further, it will eventually have to be acknowledged that we wouldn’t have had a credit bubble, and thus this de-leveraging process that ensued, if the Fed would not have kept fed funds below the level of inflation (negative real fed funds) for three full years earlier in the decade. Firms wouldn’t have been lured, taunted and encouraged to take on stupid levels of leverage in the first place -- implement insanely low levels of interest rates and you’re going to get more debt and whacky 30-to-1 leverage, unless of course the economy is so crushed that both the supply of and demand for financing craters, as is currently the case.

Rather than going down this road, imposing costs on the industry at this time of distress and possibly encouraging reckless behavior down the road, what we need is to allow the market to determine interest rates (not the Fed) and the Federal Reserve need only be there as a lender of true last resort. If the period we’ve just been through doesn’t wake everyone up to this reality, the high-probability that current monetary policy will engender new problems should do it.

Another key point is when new costs are imposed on industry those costs are passed through to the consumer. If the government decides to add on new fees to the largest banks in the financial sector, and they’re already looking at imposing much higher costs on all banks via the FDIC funding agenda, then we’ll see consumers face higher financing costs. This will add another impediment to credit expansion and thus increases the velocity of the headwinds confronting the economy.

NFIB Small Business Economic Trends

The National Federation of Independent Business (the largest small-business organization) stated that their economic trends index fell in November to 88.3 from 89.1 – the lowest level in four months. The six-month average is 88.2. The cycle low of 81.0 was touched in March; the all-time low of 80.1 was hit in April 1980, but just four months later the index was back to 94 and never returned to the 80 handle until this latest recession.

The report showed that six of the index’s 10 components registered negative responses – the key gauge being the hiring figure, which decelerated to -3 from -1. The six-month avg. is -2. As we’ve been talking about, this report is another indication that small businesses will be slow to hire – small firms account for at least 60% of job creation.

Another key reading is the measure of capital spending plans, this is important as an increase in plant and equipment outlays is a major job producer. The gauge fell to 16% from 17% in October –- this matches the lowest point on record; the first time this low was put in was March. The six-month avg. is 17%.

The share of executives expecting better business conditions six months out dropped to 3% from 11% in October. The six-month avg. is 6%

The NFIB’s chief economist stated that “sales are not picking up, so survival requires continuous attention to costs – and labor costs loom large.” He also stated that reductions in stockpiles (the gauge of executives expecting to increase inventories was unchanged at -3; the all-time low of -13 was put in in March and the six-month avg. is -5) “sets the stage for support for new orders in future periods.” This is something we’ve talked a lot about, but firms must first gain confidence in the future.

“New” Stimulus

President Obama, in a speech at the Brookings Institute yesterday, unveiled some “new” ideas – many of which aren’t exactly new. The administration continues to rely on additional extensions to unemployment benefits, food stamps, this idea of providing $250 payments to seniors and veterans and subsidizing health insurance costs for the unemployed – none of which fires up economic activity or job growth, but they’ll seek to spend another $100 billion on these programs. Yes, jobless benefits are the countercyclical programs that put more money than would otherwise be the case in the pockets of the unemployed. But look, benefits already extend out to 99 weeks and each dollar spent by government simply takes a dollar away from the private sector -- either in future taxes or currently as funds are needed to finance this deficit spending.

He also explained that the administration will seek to add $70 billion to infrastructure spending.

However, Mr. Obama did offer some things that actually work. He stated that they would push to extend the higher current-year expensing on business equipment and bonus depreciation schedules through 2010 – such initiatives have a track record of incentivizing business-equipment spending as it allows a business to quickly recover the cost of major asset purchases. (Why does it take a 10% unemployment rate to drag policymakers toward implementing efficacious polices?)

Still, this program that is held over from the Bush years is only effective so long as other government decisions don’t smother its otherwise beneficial effects. I applaud him for offering something here that makes sense.

In all, any stimulus plan that is not simply a function of government getting out of the way of private industry only drags out the adjustment process, elongating economic weakness. Sure it may offer the appearance that improvement has arrived, but in actuality results in weaker levels of growth and more frequent business-cycle contractions. Capitalism is about creative destruction, tearing down old industries that no longer compete and replacing them with more innovative ones that provide for higher living standards in the future. It is also about washing out excesses. While the adjustment process is unpleasant, it does allow for a more fundamentally sound and longer-lasting recovery to ensue. We seem to be forgetting this.

Have a great day!


Brent Vondera, Senior Analyst

Afternoon Review

The S&P 500 closed out with its second straight loss and its fourth decline in eight sessions. Continuing the recent trend of correlation, the dollar rose as crude, gold and stocks all dropped.

In focus today was sovereign debt related news, including a downgrade in Dubai and Greece as well as a warning to the U.S. and U.K. None of these countries debt problems are new, but they give market participants a perfectly good reason to sell a top-heavy market.
--

Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks slipped a bit on Monday, led by a decline in financial shares after Fed Chairman Bernanke gave a speech explaining that credit continues to contract and suggested delinquency rates will remain elevated as he cited the employment situation several times. Interestingly, consumer discretionary shares were among the top-performing sectors. Telecoms and utility shares were the leaders on the session.

In one relatively short speech Chairman Bernanke dispelled any idea that the Fed is about to even mildly remove its unprecedented level of monetary easing (recall this was the topic yesterday) by stating that the economy faces formidable headwinds, has some way to go before a self-sustaining recovery is assured, and questioned whether growth will be strong enough to materially bring down the unemployment rate. As a result, the dollar dropped like a rock from its early-session gains and the price of gold came off if its lows.

Funny thing that occurred though was stocks turned lower about two hours after the Bernanke speech and the dollar bounced off of its speech-driven plunge. I call this funny because the trend that’s been in place has been stocks rally when the Fed makes negative remarks (and signals ZIRP’s life expectancy has increased) – this trend has signaled the easy-money trade remains in the game. However, this late-session move lower in stocks, and up from the day’s low point in terms of the dollar, may now indicate a little safety trade in back on. We’ll have to watch this week’s activity to confirm a new trend but for what its worth (which probably isn’t much) it felt like things changed a bit.

Volume turned back down yesterday after Friday’s more normal levels (only the second session out of the past 20 in which we broke the 1.2 billion mark) as activity came in below one billion.

Market Activity for December 7, 2009
Stimulus Rolls On, But Other Actions May Smother

As we were just talking about Friday’s trade in yesterday’s letter, specifically the concern that the Fed will remove their aggressive level of accommodation sooner than previously believe, the Chinese government came to the rescue. That government stated early Monday morning that they will maintain “moderately” loose monetary policy and “proactive” fiscal policies through 2010. This helped to ease pressures on pre-market futures trading and flowed into the trading session. Stocks were set to move much lower when I came in on Monday morning.

The market continues to depend on stimulus programs (I’m shifting back to the domestic front) because the data shows that this nascent recovery is weak, at least to this point. While things are lackluster right now even with stimulus efforts (literally more than half of the 2.8% increase in third-quarter GDP was due to clunker-cash driven auto assemblies and fed-induced ground-level interest rates and tax credits that helped home sales and thus a bump in home building) there are a lot of economists that believe the expansion will soon turn robust.

Historically, it is true, the deeper the contraction the stronger the expansion that follows. We’ll find out if the current environment will prove consistent with this history when the fourth-quarter GDP reading is released. The historical record shows that coming out of the deepest postwar recessions –1958, 1974 and 1982 – that two quarters after the final negative GDP print the economy began to surge at a 7.8% pace in the following year, on average. (That two-quarters-removed reading begins in the current quarter.) Yet I feel many people seem to be forgetting that expansions are generally helped by the Fed lowering rates and the increase in household debt levels that ensue. That expansion of credit allows for spending to offset general economic weakness. This time though, while the Fed has certainly floored interest rates, households are not in a position to increase debt loads -- not with the jobless rate in double-digit territory and consumers flush with debt; the two have never occurred simultaneously in the postwar era.

And there is another thing: the EPA slipped an “endangerment” finding on carbon dioxide in April and declared it a health hazard yesterday, which set the stage for President Obama to formally declare CO2 a dangerous pollutant. (Offers the president some bargaining power at the Smokenhagen conference) The promulgation is expected this week, as the WSJ reported yesterday. Yes, that’s right; CO2 will be considered a pollutant – you now must refrain from exhaling. Quiet though, we don’t want to alarm the plants.

What this means is that it doesn’t take passage of a cap-and-trade system (officially, the Waxman-Markey bill), this allows Washington the power to regulate all production in the U.S. – all without a vote. This will only increase uncertainty regarding future business costs and thus takes away another historical driver of expansions – business-investment spending.

It apparently isn’t enough that firms must attempt to manage their businesses unaware and trepidatious as to just how the health-care legislation will come down and to what extent tax rates will be increased. I guess Washington feels the private sector needs yet another burden to work around. The result will be a heightened level of business caution – and that caution will show itself in lower job growth and much less private-sector activity in general. (This is showing up in the monthly NFIB Small Business Confidence Survey, which is just out for November. The reading, which would normally begin to rise by this point remains stuck – we’ll touch on this reading in tomorrow’s letter.)

Of course, there are many among us that do not at all believe this is by accident or a complete ignorance as to just how our economy works, but rather by design. I’ve got to say, based upon the way that the current congressional leadership believes an increased government role in the economy will prove beneficial it’s pretty difficult to argue with them. Bottom line is that this all increases the headwinds that the early-stages of expansion must endure – these headwinds appear to be picking up speed.

Conference Board’s Employment Trends Index (ETI)

The Conference Board (a 90-year old independent economic research group) stated its ETI rose to 90.8 for November from October’s reading of 89.2. The reading is the highest since March, but remains nearly 10% below that of a year ago. A year ago the economy was shedding 650,000 jobs per month.
(The reading is well below that of a year ago probably because two of the indicators that comprise the index continue to pressure. These are: respondents who say jobs are “hard to get” and the number of people working part-time because they cannot find full-time work. The Conference Board doesn’t give the specifics on these readings, so I’m guessing here based upon other economic readings that suggest these two areas continue to fall. People saying jobs are “hard to get” continues to make new highs as shown by the consumer confidence survey and the monthly jobs report shows that the number of people working part-time for economic reasons remains at extreme elevations.)

The improving indicators were jobless claims, the number of temporary workers, industrial production, job openings and real manufacturing and trade sales. The index is released the Monday following a monthly jobs report.


Consumer Credit

The Federal Reserve reported that consumer credit contracted in October for the 10th month in a row, which extends the record (data goes back to 1943). The figure is being pressured by a significant decline in credit card lines. The drop in overall credit was well-below what was expected though, contracting just $3.5 billion vs. the $9.4 billion that was expected. The September data was revised up also, showing credit declined $8.8 billion instead of the $14.8 billion initially estimated.

Revolving credit (credit cards) continues to plunge -- down $7 billion, or 9.3% at an annual rate -- as lines are being slashed due to eroding credit quality and consumers cut back. Fitch Ratings stated that more consumers fell behind on credit-card payments in October and several banks reported their highest delinquency rates for 2009. Such is reality with 10% joblessness and 17.2% underemployment.

Non-revolving credit (basically car loans) rose $3.4 billion, or 2.6% at an annual rate. The average maturity on an auto loan stretched out to 64.4 months in October and the loan-to-value increased to 93%.

We’ll be without a major economic release until Wednesday. The big event of the week will be the October retail sales data that is due out on Friday.


Have a great day!


Brent Vondera, Senior Analyst

Afternoon Review

The S&P 500 finished a volatile session in red with the day’s market direction primarily dictated by the U.S. dollar and comments from Fed Chairman Ben Bernanke. Friday’s jobs report led some to believe that the Fed would need to raise interest rates sooner than later.

In a speech today, Bernanke said, “we are still looking at the extended period,” with regard to low interest rates. At first, stocks rallied on the phrase extended period, which in other words means the liquidity party isn’t over. However, the market seemed to pause and reflect on the “formidable headwinds,” Bernanke referred to such as a weak labor market and tight credit.

Financials were by far the weakest sector today, off 1.61%. Citigroup and Wells Fargo disagreement with the government over TARP repayment is getting much press. Also receiving attention is the fact that the total cost of TARP could be cut by $200 billion.

Telecom was the best performing sector, notching a 1.77% gain. Telecom stocks have gained 4.67% in the past five sessions. Utilities have gained 3.77% during the same time period.



Quick Hits

• An Iranian nuclear bomb, or the bombing of Iran?
• Companies Must Flex Spending Muscles

--

Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks closed higher on Friday, but a jobs report that was vastly more positive than expected did result in a session of pretty wild fluctuations as traders re-assess their estimates for the unwinding of the Fed’s unprecedented monetary easing stance.

Industrial, financial and tech shares led the gainers – seven of the top 10 major sectors rose on the session.

Basic material and energy stocks were the worst-performing sectors as the jobs report worried the dollar-carry traders (borrowing in dollars at rock-bottom rates and investing in virtually anything else). Concern that the Fed will end their zero-interest rate policy (ZIRP) sooner than previously thought will lead to some covering of those borrowed dollars – the dollar rallied as a result, and continues to this morning.

This concern over monetary policy was seen in the equity markets as stocks reversed course big time, moving to negative territory mid-morning after beginning the session higher by nearly 2%. The reversal shows that risk-trading strategies are more about easy money than economic fundamentals. In the final 90 minutes of trading the broad market recouped about a third of the day’s high-water mark.

While I wish the Fed would remove its emergency level of accommodation, gently bringing their benchmark rate to 0.75%-1.00%, the concern that the Fed is going to engage in a full-blown unwinding of their aggressive monetary easing is a premature concern. First, it is very normal for the unemployment rate to tick down before peaking. Second, once the jobless rate peaks, the average length of time with which the Fed begins to raise rates averages six months (shortest amount of time is one month, the longest is 22 months).

One thing is clear, if the dollar does trend higher on the belief the tightening is right around the corner, we’ll see just how directly the market’s upswing has been connected to the dollar carry trade by moves in the equity markets -- those shorting the buck will scurry to cover those positions and stocks will fall.

Volume on the NYSE Composite was the strongest in a month as 1.4 billion shares traded, roughly 16% above the six-month average – however, still below the norm of the 2004-2007 period.

Market Activity for December 4, 2009
November Jobs Report

So that was the lead up, let’s get to the specifics.

The Labor Department issued a big surprise as it announced payrolls declined just 11,000 in November. This is well-below the consensus estimate of a 123,000 decline. Since the prior month’s report we’ve talked about the monthly change moving to the statistically insignificant level of < 100,000/month, but this occurred much quicker than expected. However, I’ll note that during the 1982 job-market contraction jobs printed a month of just -6,000 only to see large monthly losses ensue in the following eight months. This is in no way an attempt to compare the 1982 recession and job contraction to the current environment. Back then, both tax rates and interest rates were in the process of tumbling. This go around we’ll have the opposite working as a headwinds to this recovery. But I use this period just because it also showed an especially long stretch of large monthly job losses and a month of ease in between.

The previous two months of losses were revised up big time, showing 159,000 fewer jobs were lost than previous calculated.

In terms of industry, the goods-producing industries shed 69,000 (the preliminary ADP report was pretty inaccurate as it predicted 88,000 were lost), a large improvement from the prior month’s loss of 113K – and much better than the three-month average of 92K. The construction segment shed just 27,000 positions (29th month of decline), and improvement from October’s 56K decline – the three-month average is -45K. The manufacturing sector cut 41,000 positions (24th month of decline), a decent improvement from the -51K in October – the three-month average is -44K.

The service-producing industries added 58,000 positions – this is strange considering the ISM service-sector index continues to show positions are being cut (ADP was way off, estimating 81,000 were eliminated). The revision to October service-sector employment also showed a gain (a pick up of 2,000 positions), a huge upward revision from -61,000 reported last month. Trade and transportation cut 34,000 positions, much better than the 60K loss in October – three-month average is -50K. Retail cut just 15,000, up from -44K in October – the three-month average is -33K.

Business services posted a big increase of 86,000 jobs and temporary employment (a key indicator of future jobs gains) jumped 52,000, which follows an upwardly revised 44K addition in October. This marks the third month of increase for temp. hiring. We want to see temporary hiring increase, as it is generally an indication that permanent hiring is not that far behind. However, with temp making up so much of the increase in business services, 65% of the increase, I do wonder if firms are relying more on temp work as the uncertainty regarding the future cost of hiring the next worker is high. We’ll just have to wait a few months to ultimately find out.

Education and health-care continued to keep the ball rolling, this segment never endured even a month of decline during this entire contraction, as the segment added 40,000 positions. This matches the prior month’s gain and in line with the three-month average of +39K.

The unemployment rate ticked down to 10.0% from 10.2% in October (it was expected to come in unchanged) – a result of the decline in the labor-force participation rate. That is, more people removed themselves from the labor force as they did not look for work during the four weeks of this November survey. When laid-off workers begin to feel better about things and come back in to look for work, the jobless rate will rise again. A tick down in the jobless rate prior to a cycle peak, as mentioned above, is evident in almost labor-market downturn. This is the second move lower for the current cycle, the first being in July when the jobless rate fell to 9.4% from 9.5%.

The U6 unemployment rate (the underemployed rate as it includes discouraged workers and those working part-time because they can’t find full-time work) fell for only the second time in 20 months. It remains extremely elevated as it settled at 17.2% in November (down from 17.5% in October). This number was re-calculated in 1994 and based on the former methodology it sits at 13.7% -- the record of 14.3% was hit in 1982.

The worst aspect of the jobs report was the jump in the average duration of unemployment, up to 28.5 weeks from the 26.9 in October. This jibes with what the jobless claims data is suggesting – the pace of firings has eased greatly, but hiring is not yet occurring. This is a very very normal event, firms do not begin to hire this soon in the recovery, but the large increase in this reading (up from what was already a record level) shows that some aspects of the labor market are actually a little worse.

The average weekly hours worked reading bounced off of its record low, up to 33.2 from 33.0. This is nice to see, as the number needs to hone in on 34.0 before meaningful jobs gains ensue. The average over the past decade is 33.8

For stocks, the market may, as appeared to be the case mid-session on Friday, begin to worry that the end of ZIRP is near – it’s kind of that what’s bad is good environment we’ve been in as bad means ZIRP lives and good reminds the easy-money trade that ZIRP will be laid to rest. But while I keep harping on what’s in store when ZIRP is removed, traders shouldn’t get too worried just yet that the Fed will remove aggressive levels of accommodation.

The excitement over the jobs report did seem a little amateur to me. Again, after the huge job losses over the past two years (especially over the last 12 months) one has to assume some mild payroll additions will show up soon. However, and I don’t enjoy stating this, the labor market is very likely to remain troubled for an extended period and it is not reasonable whatsoever to believe that the normal job rebound of 200K-350K in monthly job creation will present itself (credit contraction, uncertainty over future employment costs, plenty of room to still stretch existing workers, a lack of final demand and big time trouble within state and local budgets are all serious headwinds for job creation).

So let’s hope that the months ahead prove the economy is close to ending job-slashing mode, but I fear we won’t see much in terms of job growth.


Today is the 68th anni of the Pearl Harbor attack – America’s wake up call to the axis threat.

Have a great day!


Brent Vondera, Senior Analyst

Afternoon Review

S&P 500: +6.06(+0.55%)

For the third straight day, stocks set fresh 2009 highs but failed to sustain gains. Still, stocks managed to fight off a couple of dips into negative ground to close the session in the black.

The main news today was the much better-than-expected November employment report. U.S. nonfarm employment fell by 11,000 in November, the smallest lass since 2007 and much better than the expected drop of 125,000. In addition, previous months were revised to reflect fewer job losses. Accordingly, unemployment decreased to 10.0%, from the previous reading of 10.2%.

The employment data helped drive the Dollar Index to a 1.4% gain. In turn, the CRB Commodity Index dropped 1%, with gold falling 4%. Strength in the Dollar ultimately limited gains in equities as well.

The employment report also led to increased bets that the Federal Reserve will move off its zero-interest-rate-policy sooner than originally anticipated. There is some concern that raising rates too early would de-rail the nascent recovery, but it seems unlikely that rates would move higher than 1% in 2010 – a level that is still highly accommodative. The next scheduled meeting of the Federal Open Market Committee (FOMC) a few weeks from now will, as always, be worth watching for clues.
--

Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks ended a three day rally after the latest service-sector survey missed expectations by a wide margin and moved back to contraction mode. This brought back another round of the “economic recovery is faltering” concern (we’ve seen this many times only to see the market shake it off and rock on). There was probably a little pause among traders in play as well as they waited for this morning’s monthly jobs report.

Stocks did begin the session higher after the latest jobless claims data showed the previous week’s move below 500K on initial claims was for real and not an aberration. Unfortunately, what occurred within the continuing claims data showed the labor market remains conspicuously troubled – more on that below.

Utilities (two days in a row) and telecoms were the best-performing sectors, the only of the major 10 that posted gains on the session. Financials, basic material and energy shares led the declines.

The Treasury market declined -- quite unusual on a down day for stocks, although what’s abnormal seems to be the norm these days -- as the government stated it will sell $74 billion in notes and bonds next week. We continue to see strong demand for U.S. government debt so it shouldn’t be an issue. One does wonder how these auctions will go whenever it is that the Fed removes the emergency level of rates. For now banks are more than happy to buy up Treasury securities at nothing yields because they are borrowing from the Fed at zero and depositors at something barely more than that. However, when the ZIRP comes to an end, it seems these auctions may not go quite so swimmingly.

Market Activity for December 3, 2009
Jobless Claims

The Labor Department reported that initial jobless claims declined for a second-straight week, which pretty much confirms the big decline in the previous week was for real. Initial claims fell 5,000 to 457,000 in the week ended November 28, which follows the meaningful 39,000 decline in the week prior that pushed the figure below the 500K level for the first time since January. The current level of initial claims is the lowest since just before the chaos – mid-September 2008 – and finally has moved just below the peaks of the prior two recessions.

The four-week average of initial claims fell 14,250 to 481,250.

This data is a tale of two situations though as the continuing claims data rose 28,000 to 5.465 million.

This is the standard reading for continuing claims, a number that does not include the Emergency Unemployment Compensation (EUC) claims and its various extensions that elongate benefits from the traditional 26 weeks up to 99 weeks. EUC surged 265,300, the second-largest weekly jump since the program began in July 2008, to 3.85 million. When we add EUC and its various extensions (which total 597,688) to the standard continuing claims data, it is literally off the chart at 9.8 million.

So what does this data tell us? As we’ve been discussing, it shows that the level of firings has eased substantially, yet firms have not begun to hire. They will first have to see final demand push current payroll workloads to the stretching point, then add back in workers who have been idled (which is particularly the case within the manufacturing sector) before slowly beginning to hire new workers.

There is still a likelihood that monthly jobs gains, yes gains, may present themselves a few months out, but nothing substantial is likely to occur for quite some time. The fact that unemployment benefits have been extended to nearly two years (undoubtedly reduces the sense of urgency for segments of the workforce) and the signals from Washington that hiring the next worker is about to become more expensive are other reasons the jobless rate will remain high for an extended period of time.

ISM Non-Manufacturing

The Institute for Supply Management’s service-sector survey for November didn’t com in quite as good as their look at the manufacturing index (which we discussed on Tuesday). The reading moved back to contraction mode after spending two months just barely in expansion territory. The reading fell to 48.7 (51.5 was expected) after 50.6 in October as the business activity and supplier deliveries readings both put pressure on the overall index. The employment reading didn’t help much either as it was barely changed and remained well in contraction mode.

This is not a good sign for the nascent recovery, even the index’s rebound to expansion mode was hardly convincing as the move over 50 in the previous two months was negligible – 50.9 in September and 50.6 in October.

The highest unemployment rate in 26 years (and only the second time the jobless rate has hit this level in the post-WWII era) is putting the clamps on consumer activity. Further, the state of the labor market and household indebtedness is hurting business confidence as firms are less than optimistic a sustained rebound in consumer activity will present itself.

In terms of the sub-indices, the new orders figure remained in expansion mode, although it decelerated slightly to 55.1 from 55.6. However, the business activity reading (a measure of production – and of business confidence) fell back below 50 (49.6 after October’s 55.2) for the first time since July. The supplier deliveries reading fell to 48.5 from 50.5. The employment reading improved to 41.6 from 41.1, but as the number suggests shows the service sector continues to reduce payrolls.

The big aspect of this report that sticks out is that new orders remain in expansion mode (although a substantial recovery would have this reading in the 60s), while production moved back to contraction. This is yet another illustration that the inventory rebuilding process has yet to occur, retailers continue to draw down stockpiles. On the optimistic side, this means that we’re getting closer to production kicking up as inventory will eventually need to be boosted. The degree of near-term consumer activity will dictate the degree of inventory rebuilding.

Chain-Store Sales

Coinciding to the ISM number, the ICSC (International Council of Shopping Centers) showed that its chain-store sales figures fell 0.3% in November after two months of increase – a two-month bounce that followed 11 months of decline, exactly what ISM had shown. To clarify, chain-store sales are simply comparing results for same-store sales to the same period of a year ago.

The segments that showed sales increased last month were discounters (up 0.6%), drug stores (up 2.3%) and wholesale clubs (up 1.9%). The wholesale-club segment also offers an ex-fuel sales reading, which rose just 0.1% and ends what looked to have been an emerging trend of 4% year-over-year gains.

The segments that declined were apparel (down 0.4%), department stores (down 4.5%) and luxury (down 6.9%). Luxury has been completely hammered since the credit crisis went into full tilt 14 months ago. Last month’s 1.8% increase looked as though the segment had turned the corner, but apparently not.

The fact that same-store sales remain shaky, unable to trend higher even compared to the year-ago period when economic malaise was in full effect, vividly illustrates the state of the consumer.

Bernanke Confirmation

The Fed Chairman endured quite a raucous confirmation process yesterday (President Obama nominated Mr. Bernanke for a second term in August but Congress has to confirm and that may not come before Christmas) and it wasn’t just the normal circus that is usually on display when politicians find themselves in front of the cameras. There were actually legitimate policy criticisms exhorted.

Unfortunately, the bulk of the serious and informed questions centered around how the Fed was negligent in regulating excessive risk-taking within the financial industry. That is certainly a fair shot at Bernanke & Co., but the session seemed to almost completely ignore the specific policymaking errors -- the very damaging mistake of keeping short-term rates too low for too long in the period 2002-2005. And here we are again, even lower this time. We’ll see how it turns out. (I must qualify this statement by saying the Fed had no choice this go around, but they continue the emergency level of rates and signal ZIRP will remain in place for an extended period.)

But for that period earlier in the decade, if not for that very aggressive easing campaign (fed funds was below the rate of inflation for three full years, which means you’re going to get a lot more leverage among institutions and consumers, and the risk taking that results) the fuel that sparked the credit bubble would have never doused the financial system in the first place. That is what we really need to be focusing on.

And then there is this, a thought I’ve had for several years now: It’s not a stretch to ultimately blame this entire event on the 9/11 attacks; the Fed would have never gotten so aggressive absent that event.

This is not to take Greenspan and Bernanke off the hook, it was stupid as stupid can be to move fed funds all the way down to 1.00% especially as late as they did – didn’t get there until June 2003; the economy had already been in expansion mode for all of 2002, even if it was low growth of 2.0%. And they compounded the problem by leaving fed funds at 1.00% for an entire year, even as 2003 GDP grew at 3.8%, and didn’t get fed funds back above 3.00% until the summer of 2005. This is the key element that created the housing and overall credit bubble. But if we were not attacked by the scourge of the earth, or we had placed ourselves in a better position to thwart that attack, the heavy stock market decline the Fed was obviously focused upon would not have ensued (and I’m not referring to the 22% decline in the year following the bursting of the tech bubble, but the second leg tumble of 27% that was clearly driven by the 9/11 event and the economic uncertainty it created) – thus I really doubt the fuel that created this mess would have been released by the Fed.

Anyway, Bernanke will be confirmed, but not without a heck of a lot of justified criticism.

Jobs

Payrolls grew by 79,000 in Canada last month, marking the third month of increase out of the last four. Just as Australia has shown, the resource-rich economies are performing much better than the rest of the world – they can thank global central banks actions, specifically our Fed as the policy has put pressure on the dollar and driven commodity prices higher, for this help. We also live in a country that is resource rich, too bad that we set a vast majority of these resources off limits. It’s an act of insanity; we could be producing tons of high-paying manufacturing jobs if we would just think practically.

In about an hour we’ll receive our employment report for November. It is expected to show payrolls declined for a 23rd straight month. We will need to see the average workweek rise from the current all-time low and temporary hiring trend higher. Those will be the key signs that job losses will move to statistically insignificant levels and then to mild monthly job gains in the near future.

Have a great weekend!


Brent Vondera, Senior Analyst

Afternoon Review

S&P 500: -9.32 (-0.84%)

Stocks finished lower, ending a three-day winning streak, after spending most of the day in positive territory.

A surprising fall in initial jobless claims was offset by an unexpected decline in the service sector. Services are the largest portion of the U.S. economy. Meanwhile, retailers delivered uninspiring November same-store sales, which are sales at stores open at least a year.

Bank of America (BAC) lifted sentiment early in the session, with the company announcing it will repay its $45 billion TARP loan with $26.2 billion excess liquidity and $18.8 billion in proceeds from the sale of “common equivalent securities.” The financial sector was leading the market, but reversed course following downside fiscal 2010 guidance from Principal Financial Group (PFG).

In the bigger scheme of things, the Bank of America news is an encouraging sign as the financial climate is vastly improved from a year ago. Economic reports, though, paint an uneven story. Economic data is undoubtedly improving, but it is important to remember that the road to recovery will be a bumpy one.



Quick Hits

• Bernanke Doesn’t Rule Out Using Interest Rates to Control Asset Bubbles

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Peter J. Lazaroff, Investment Analyst

Daily Insight

The broad market managed to close the session fractionally higher as the day’s economic releases failed to provide much help; the market awaits tomorrow’s November jobs report. The NASDAQ Composite performed well as the utility and basic material stocks in the index (the leaders for the session) boosted the measure to a meaningful gain. These are the same sectors that kept the S&P 500 above the cut line.

Gold made another new high, which helped the commodity-related stocks post a third-straight day of gains. The basic material index is up 14% since October 31 as the Fed kept the ball rolling with their November 4 statement in which they stated ZIRP will remain in place for an extended period – there was some uncertainty prior to that meeting as to whether they would pull the “exceptionally low level of fed funds for an extended period” phrase. In the two weeks that followed, G-20 and APEC members pledged to keep stimulus measures intact and that kept the group on fire – up 86% since the March 9 lows. For comparison, the broad market is up 64% for the period.

Energy stocks weighed on the market after a very bearish weekly energy report.

The Fed released its Beige Book, the economic assessment from each of its 12 districts, which stated economic conditions improved. This helped the broad market pare late-morning losses. Although, a delving beyond the headline and into the text shows this is an improvement from low levels of activity, particularly so with regard to the real estate market – not that this is any revelation. The fact that the Fed keeps an emergency level of rates in play, unwilling to even gently boost fed funds to 0.75%-1.00%, speaks volumes as to what they truly believe.

Volume was vapid as just 985 million shares traded on the Big Board, 18% below the already low six-month average.

Market Activity for December 2, 2009
Weekly Energy Report

The price of crude oil slipped 2.2% to $76.65/barrel after the Energy Department reported that crude supplies rose 2.09 million barrels last week, expectations were for a build of just 400,000. Even worse, gasoline supplies surged 4 million barrels even as refinery operating rates slipped further to 79.7% (the long-term average is 88% and under normal circumstances 83% is considered rock bottom). This illustrates the sorry state of demand right now, which fell to 18.5 million barrels/day. This is 3% below even the year-ago level when the economy basically shut down. The average is 21 million barrels/day.

Mortgage Applications

The Mortgage Bankers Association reported that applications rose 2.1% in the week ended November 27 after a 4.5% decline in the previous week. Applications to purchase a home rose for a second-straight week, up 4.1% following the 9.6% increase during the previous week – this followed six weeks of decline. The promulgation to extend the tax credit has helped the purchases index rebound, although it remains at the lowest level in over a decade.

Applications to refinance a mortgage rose just 1.7% (refis currently up 72% of the total mortgage apps index) even as the 30-year fixed mortgage rate fell below 4.8%. Have the vast majority of those who can refinance already done so? Likely.

Challenger Layoff Announcements

The Challenger Job Cuts Survey, compiled by executive outplacement firm Challenger, Gray and Christmas, showed that employers cut the fewest amount of jobs since the recession began nearly two years ago. Planned firing, which is what this measure gauges, fell 72% in November to 50,349 relative to the same month a year ago – down 9.6% from the previous month.

ADP Employment Change

The preliminary jobs report from business outsourcing solutions firm ADP estimated that payrolls declined 169,000 in November – the expectation for the official jobs report to be released on Friday is for a decline of 123,000.

ADP estimates that goods-producing payrolls fell 88,000 in November, 44,000 of which occurred within the manufacturing sector. That would be an improvement from the official October losses of 129,000 for construction and manufacturing jobs.

On the service-providing front, ADP expects payrolls to decline 81,000, which would be worse than last month’s 61,000 loss.

Small (defined as 1-49 employees) and medium (defined as 49-500 employees) sized firms are the two main job creators – small firms are the key engine. ADP had small firms shedding 68,000 jobs last month and mediums cutting 57,000. Large firms were expected to have eliminated 44,000. (The White House will be hosting some sort of jobs summit today, but they didn’t invite the National Federation of Independent Business (NFIB), which happens to be the largest small-business organization. Many look to the NFIB’s monthly survey in order to gauge the small business environment. It’s confounding how one can have a jobs summit without NFIB).

American small and medium-sized businesses need to be empowered. Surely they will wait for current employee work loads to be stretched before increasing payrolls, that is always the case coming out of recession, as it should be. But they also need to have confidence that hiring the next marginal worker is not going to be increasingly costly. They will be much slower to increase payrolls if they believe the probability is high that hiring the next worker will become intensely more expensive. When Washington signals that general regulations, health-care requirements and tax rates are all going to become more onerous, the jobless rate will remain high. On top of that, businesses know that that Fed cannot keep rates floored forever. When that tightening campaign ensues, an economy that is dealing with credit contraction (as opposed to the typical recession that is sparked by Fed-tightening and excessive inventories) the Fed tightening becomes increasingly acute. This understanding alone will keep firms cautious and that caution becomes heightened when the government sends the wrong signals.

As we mentioned following the October jobs report, monthly payroll losses will soon move to statistically insignificant levels of <100,000. And it shouldn’t be long before we see some mild monthly job increases – possibly just three months out. But monthly job gains must reach 150,000, and stick there, in order to slowly bring the unemployment rate lower. The odds of this occurring are remote based on the policy signals from Congress.


Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks rallied for a second-straight session on Tuesday, nearly erasing Friday’s Dubai-related losses. The latest reading on manufacturing activity showed the sector remained in expansion mode during November and pending home sales for October suggest that existing home sales will post another positive reading next month. The former missed expectations and the latter beat, in total they were enough to keep the pre-market momentum going.

(I can’t help but wonder if either of these readings would have engaged in any meaningful upswing, even from the depths hit earlier this year, without massive government support. Naturally, I can’t help but also imagine the paths these readings will take when Washington must remove its economic crutches – a level of spending and monetary easing that cannot have long lives without creating even greater problems down the road).

And speaking of problems created, the dollar got crushed yesterday, back down deep into the 74 handle on the Dollar Index – hence the old carry trade was alive and well and that kept the see, hear and speak of no risk environment in play.

All 10 of the major S&P 500 sectors gained ground on the session. Utility, telecom, basic material and energy shares led the rally. Financials were really the only true laggard, up just 0.1% for the day.

Volume was weak as less than 1.1 billion shares traded on the Big Board, 10% below even the lackluster six-month daily average of 1.2 billion shares.

Market Activity for December 1, 2009
ISM Manufacturing

The Institute for Supply Management’s manufacturing index showed that nationwide factory activity grew but at a slower pace than the previous month. ISM Manufacturing came in at 53.6 for November, a deceleration from October’s 55.7. This marks the fourth straight month of expansion. The reading did miss expectations for a print of 55.0.

The new orders, production and backlog of orders readings didn’t waiver too greatly. New orders accelerated to 60.3 from 58.5 and production slipped to 59.9 from 63.3 – although what occurs in new orders for the current month largely follows through via production in the month or two ahead, so we should expect factory activity certainly to remain in expansion mode for December.

The backlog of orders, one area we’ve been watching for early signs of a turn in manufacturing employment, fell slightly to 52.0 from 53.5. Along this same line, supplier deliveries slipped too, down to 55.7 from 56.9. Both remain in expansion mode as number above 50 illustrates, but these readings need to move closer to 60 (and sustain those levels for several months) in order to offer a sign that capacity utilization rates are expanding and thus firms will have to hire more workers to meet demand. At this rate, it will be quite a long time before factories feel stretched with regard to current payrolls and work loads – resource utilization rates are way to slack to believe otherwise.

The employment index also remained in expansion mode, for a second-straight month now, even though it declined to 50.8 from 53.1. However, this reading of expansion, even if tepid, is not showing up in the actual data as the monthly jobs report continues to show factory employment is being slashed – 61,000 factory jobs were cut in October, which is a bit more than the three-month average. We’ll see how November shapes up on Friday when the months employment data is released.

The inventory reading continues to show that firms have little confidence activity will continue to progress as the ISM’s inventory gauge fell to 41.3 from 46.9. This reading needs to hold in the upper 40s, the fact that fails to even after the record pace of inventory slashing that occurred a couple of quarters back is telling. Add in that the customers’ inventories reading hit a new low (this means factories believe their customers inventories are too low) and yet factories still have not boosted stockpiles, it shows just how weak confidence is. (When the customers’ inventories is below 45, the overall inventory reading is always either heading for 50 or beyond it – not this time as inventories reading remains low even customers’ inventories has averaged just 40 since June).

Surely GDP will continue to get a little help from this segment of the economy – all it takes is for stockpiles to fall at a slower rate than the previous quarter – but a full-blown inventory dynamic, in which actually restocking is taking place, has yet to occur.


Construction Spending

The Commerce Department reported that construction spending came in unchanged in October from a downwardly revised -1.6% in September (previously reported as an 0.8% increase last month). This number beat the estimate of what was expected to be a 0.5% decline, although that was based on the previous month’s believed 0.8% rise. Based on the big downward revision for September, the result actually missed expectations by a wide margin.

The reading continues to get hit by the commercial side of real estate as spending on non-residential buildings fell 1.5% -- the private-sector aspect of this segment fell 2.5% in October (down 20.6% y/o/y and 31.9% last three-months annualized). Public-sector commercial construction fell too, but just 0.4% for the month (actually up 3.7% y/o/y and down only 1.9% three-months annualized).

Residential construction is keeping total construction spending from really falling. Total residential construction rose 4.2% in October, fueled by a 4.4% increase on the private side – this was divided in half by actual new-home building and home improvements on existing homes. (Private home construction is down 23.6% y/o/y but up 11.1% three-months annualized) Public-sector home construction fell 2.4% for the month after a 4.1% increase in September (up 3.7% y/o/y and up 0.6% three-months annualized).

Pending Home Sales

This number was the big surprise for the day, rising 3.7% for October, blowing by the totally reasonable expectation of a 1.0% decline. The NAR (National Association of Realtors) has done an excellent job of informing buyers of the tax credit expiration (at least the expiration date of November 30 that was known back in October, it has since been extended) and thus I wouldn’t have thought any contract signings in the back half of October as it is taking at least six weeks to close – and the contracts had to close by November 30 to get the credit. But apparently the rush in the first two weeks of October was more than most people had estimated.

By region, pending sales (contract signings) rose 19.9% in the Northeast, 11.6% in the Midwest and 5.4% in South. Contract signings were down 11.2% in the West.

Based on the weekly mortgage applications report we get each Wednesday, November pending sales is going to take a hit. What this means for the next couple months worth of existing home sales (which are not counted until the contract is closed) is another good number for November, based on this October pending home sales reading, and then a substantial decline in December.

There is still a lot of government support out there, we’ll see if it can continue to offset the troubled labor-market conditions. Rock-bottom interest rates and tax credits that put $8,000 in home-buyers’ pockets are indeed juicy lures, but I’m not sure they’ll have the same effect as they have had over the past several months. And then, there is the reality that this government support must be taken away at some point. That’s probably when we see the next wave of housing market trouble.

Vehicle Sales

U.S. auto sales came in at 10.92 million at a seasonally-adjusted annual rate (SAAR) in November. This shows a bit of a bounce from the October reading, which printed 10.45 million, and is just barely higher than the very low readings of a year ago when the credit markets were in chaos. You can see by the chart below, the August bounce that was fomented by the clunker-cash program was largely a one-and-done event. Auto sales should remain well-below the 25-year average of 15 million units SAAR for an extended period as the jobless rate remains terribly elevated and households will have to reduce debt levels.

It’s not only about auto sales, but consumer spending in general. Think about it. The last (and only other) time the jobless rate moved above 10% in the post-war period was 1982-83. That jobless rate and economic contraction was a function of the Fed jacking rates above 15% -- fed funds averaged 12% for the four years that ran 1979-1983. This time, the jobless rate is going to test that 1982 record of 10.8% even as the Fed is at zero. We still have to get through the unwinding of this unprecedented level of monetary easing (whenever it does occur, and it will be a bit still because there may be another wave of this credit crisis to hit). I just don’t think enough people are thinking about the coming tightening campaign, even if it is off in the distance relative to the very short-term mindset that prevails in the current environment.


Have a great day!


Brent Vondera, Senior Analyst