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

Daily Insight

U.S. stocks bounced below the cut line several times yesterday, hitting the day’s nadir about 45 minutes into the session, but pared nearly all of the session’s losses by the time of the close. Stocks moved to the day’s low point just after the latest consumer confidence and regional manufacturing activity readings were released – consumer confidence came in above expectations but remains very weak and the factory report out of the Richmond Fed missed the estimate by a wide margin.

But the Fed’s afternoon release of the minutes from the November 4 FOMC meeting seemed to foment a relative rally as they raised their growth estimates and lowered their jobless rate predictions. They also stated that the likelihood of excessive risk-taking from record-low interest rates is “relatively low.” That’s reassuring. Are we living in one big world of wishful thinking here or what?

Among the top 10 S&P 500 sectors, gains and declines were spilt in half. Five sectors lost ground on the session, led by financials, tech and basic material shares. Five sectors gained ground, led by telecoms (two days in a row), health-care and energy shares.

Yesterday’s $42 billion 5-yr auction, the final of $179 billion of issuance this week, was hugely successful. And why not, who wouldn’t love gobbling up 5-yrs at a yield of 2.15%. The bid-to-cover of 2.81 (a measure of demand) was the best since September and above the four-week average of 2.59. Indirect bidders (foreigners and global central banks) stepped up for some of this awesome yielding stuff too, accounting for 60.9%, above the average of 51.1%.

This demand is all a function of several factors: year-end balance sheet clean up, risk aversion, a view among some that we’re in a Japanese-style malaise, foreign central banks devaluing their currencies (by buying U.S. dollar assets) and you know that other thing – the Fed at zero, which means banks get money for nothing and their chics, I mean income, for free. A yield of 2.15% ain’t all bad when your cost of money is nothing.

The Treasury will issue all they can at these rock-bottom yields until…well, they can’t. Then they’ll be issuing massive amounts of debt at higher rates.

Market Activity for November 24, 2009

We’ve got a lot to talk about, I’ll try to make it as concise as possible without leaving the important stuff out.

Third-Quarter GDP Revision

The Commerce Department reported that third-quarter growth was revised down to 2.8% at a real annual rate, down from the initial estimate of 3.5%. Thus, the end to the “Great Recession” came in softer than previously thought.

Quickly, there are a lot of people believing in a powerful economic recovery simply because history shows the larger the collapse the greater the recovery. This time I don’t think past will be prologue. We’ll find out by way of the fourth quarter reading. It’s not unusual for the first positive GDP print coming out of a major contraction to be weak (weak defined as below normal – and normal is 3.4%). But just as was the case following the nasty 1958 recession, the rough 1974 recession and the harsh 1982 recession, the subsequent quarter following the end of those contractions (two quarters from the last negative GDP reading) posted a reading of at least 5.1%. In the year ended that first big GDP reading, growth averaged 7.8%. We won’t have to wait long to find out how this period compares to those in the past.

The areas that led to the downward revision to GDP were weaker-than estimated personal consumption due to lower than expected car sales, a smaller increase in gross private investment as non-residential structures declined more than previously estimated and residential construction rose less than estimated, a larger decline in inventories, and a widening in the trade deficit.

The first two reasons for the revision pretty much speak for themselves – less car sales occurred than was estimated during the first look at GDP and business-plant construction declined more than thought, while the bounce in home construction (the first in 15 quarters) was less than estimated.

The other two reasons need a little more explanation.

Inventories fell more than anticipated and thus the segment didn’t add as much to GDP as was the case when first reported. You may be asking yourself, if inventories fell, then how did they add to GDP? Logical question. The answer: inventories only need to fall at a reduced rate relative to the previous quarter to add to GDP. Since stockpiles were pared more than expected they added less to GDP – but they did fall at a reduced rate compared to the record level of slashing during the second quarter.

In terms of the trade figure, it is a function of net exports (exports minus imports). GDP = C + I + G + (X-M), or Consumption, Investment, Government, eXports –iMports. The September trade figures were not out when initial estimates to GDP were released, thus economists must guess on this reading. Well, despite the declining dollar (which had economists believing exports would get a boost), exports fell at a greater rate than did imports. Since the export number was less than expected, it subtracted more from GDP than previously thought.

Those are the main reasons for the downward revision. I’ll also note, the government consumption segment of GDP actually increased vs. what was reported via the initial estimate. Thus the private sector played even a lesser role in economic activity than previously thought.

The great crowding out has begun. Intense government involvement via deficit spending along with current actions, and future signals, of new banking regulations and higher tax rates will likely cause the business community to remain very cautious. As the government puts the clamps on risk-taking within the banking industry (while ironically telling banks to offer more loans to small business – fat chance of that happening under current guidelines) Washington is finding no problem accessing capital as banks lay low via risk-free Treasury security purchases (a topic we touched on when the latest Federal Reserve Flow of Funds report confirmed it). As a result, small business is essentially locked out. And when small business is largely locked out of the credit markets, you can forget about the most powerful engine of job creation humming anywhere near all cylinders. Thus, the jobless rate is likely to remain high for a considerable length of time and final demand will remain weak. Businesses see what is occurring and that’s precisely why they will remain cautious and keep business spending (another important economic engine) to a minimum.

S&P CaseShiller HPI

The S&P CaseShiller Home Price Index showed the year-over-year rate of decline continued to fall in September. Among the 20 major cities the index tracks, home prices fell 9.36% over the past 12 months (a bit more than the 9.10% expected but not big deal). That is down from an 11.30% y/o/y decline as of August. The monthly figure showed prices rose for a fourth-straight month, up 0.27% from August. That follows increases of 1.13%, 1.12% and 0.76% during the subsequent four months.

The numbers on the chart below are not median home prices, just index numbers.

I guess it is a bit undesirable that the monthly increase was substantially smaller than that of the previous three months. This may be a sign that the monthly increase in home prices is short-lived, even shorter than those skeptical about this housing recovery had thought.

Another sign of renewed erosion is the increase in cities that posted a monthly decline. In August only three of the 20 cities tracked posted price declines – they were Charlotte, Seattle, Las Vegas and Cleveland. In September nine of the 20 cities posted m/o/m price declines – NY, Boston, Charlotte, Seattle, Dallas, Portland, Tampa, Las Vegas and Cleveland.

Just three cities – LA, San Francisco and Chicago (which make up 30% of the overall CaseShiller index) – accounted for effectively all of the September monthly price increase.

Consumer Confidence

To no ones surprise, or at least it shouldn’t have been, the Conference Board’s gauge of consumer confidence remained depressed, coming in at 49.5 for November – up just slightly from October’s 48.7; that October print was revised up by one point. The consensus estimate had actually expected worse, a reading of 47.3 based upon the previous months initial reading of 47.7. So, on an expectations basis the number was better, up 0.8 from the previous month’s higher revision vs. an expected 0.4 point decline from the original previous month’s print of 47.7.

Nevertheless, it is difficult (actually inappropriate) to get excited about this reading simply because it beat the expectation as the reading remains at a level that’s commensurate with the low points hit during the worst recessions since 1967 – which is when the survey began.

The overall consumer confidence reading is a collection of respondents ‘ appraisals of current and expected (six months out) business conditions, current and expected employment conditions and expectations regarding household incomes six months out. Here are how a couple of these segments came in.

The present situation index made a new cycle low, posting 21.0 for November after October’s 21.1. For reference, during the market low back in March this figure fell to 21.9. The all-time low is 15.8, hit in December 1982.

The expectations reading (view of economic prospects six months out) improved to 68.5 from 67.0 in October. At least the reading seems to have left the cycle low of 27.3 hit in February (also the all-time low) in the dust.

The most important segment of this report is the jobs “plentiful” less jobs “hard to get” reading. This is the confidence index’s best indication of future consumer activity trends. The measure made a new cycle low of -46.6. The all-time low is -58.7, hit in December 1982.

The share of respondents stating jobs are “plentiful” fell to 3.2% from 3.5% in the previous month and those stating jobs are “hard to get” increased to 49.8% from 49.4%.

Policy makers who believe their efforts will stoke consumer activity, and confidence within the business community, are living a fantasy. Their response is actually causing additioanl longer-term damage. While it eases the difficulty in the short term, the aggressive increase in government involvement will prolong economic and labor-market weakness, as touched on above. It appears we’ll be waiting quite an extended period of time before the overall consumer confidence reading returns to its long-term average of 95.

As a side note, I found the survey’s question on home buying particularly interesting. Only 2% of respondents stated they planned on buying a home within six months, that’s the lowest level since October 1982. The two periods compare well in terms of joblessness as the early 1980s was the only other time in the post-WWII era in which the unemployment rate was north of 10%. However, the interest rate environment was quite different as the 30-yr fixed mortgage rate was also north of 10%; today it is south of 5%. You get my point.

FOMC Minutes

The Fed released their notes from the November 4 meeting. I won’t spend much time on this, just a couple of things. We already know they unanimously decided to keep rates at emergency levels for an extended period of time and yes, they talked about how they will remove all of this accommodation – no reason to touch on these specifics now as unwinding appears to be well off in the distance

The entertaining stuff was the growth and unemployment estimates they offered.

For 2010, the Fed Governors and Reserve Bank presidents raised their economic growth forecast for 2010 to a range of 2.5%-3.5% from 2.1%-3.3% and lowered their forecast of the unemployment rate to a range of 9.3%-9.7% from 9.5%-9.8%. For 2011 (that’s really stretching things), they predict GDP will range 3.4%-4.5% and the jobless rate to a range of 8.2%-8.6%. Oh, and their inflation projections were lowered too – which is probably appropriate over the next year at least with credit continuing to contract (I’m certainly reassessing my own views on this one). I’ve got to say though, expecting higher rates of growth and lower inflation does seem just a bit too convenient. We shall see how it turns out.

They also offered estimates for growth and unemployment for 2012. Ok, this is getting ridiculous – they’ll struggle to get their 2010 estimates even close. But I won’t leave you hanging: The economy will grow at 3.5%-4.8% in 2012 and the jobless rate will range 6.8%-7.5%, according to Bernanke & Co.

The top range of their central tendency estimate for inflation is 1.9% by 2012. Read between the lines and this says the FOMC believes rates can remain very low for two years still. Unless, unless they are forced to act to rescue the sinking dollar. Bernanke has actually spoken the word: dollar; and that is a big event for someone who normally seems to act as if he never contemplates the value of our currency. But he is paying attention now and with the greenback moving ever closer to the all-time low hit 19 months ago, the only way they’ll be able to keep rates ultra low for another two years is if the economy flat lines or even falls back into recession.


Have a great Thanksgiving!


Brent Vondera, Senior Analyst

All Hail Dividend Stocks!

Dividend stocks are all the rage in the Dow Jones newsroom, with Barron’s cover story (10 for the Money) and the Wall Street Journal (Shop for Dividends in This Aging Bull Market) both championing “safe” dividend paying stocks.

This should be no surprise. The Fed’s zero-interest-rate-policy (ZIRP) is forcing investors and savers out of money-market funds and CD as the yields of those cash equivalents are virtually zero. Meanwhile, longer-term bonds sport higher yields, but leave investors exposed to inflation.
The common thesis among news articles like the ones above is quite simple. Low-quality stocks have been driving the current rally, but high-quality stocks will drive the second phase of the rally. And if the rally fades, they offer downside protection through their income.

But before you start scouring the market for yield, remember that higher yield often involves higher risk.

Here are some of the tools Acropolis uses to evaluate a company’s dividend.

Dividend Yield (Dividends per Share/Share Price)
Low yield compared to industry peers is either:

1. A result of a high stock price that reflects the company’s impressive prospects and ability to make the dividend payment, or
2. The company cannot afford to pay a reasonable dividend because its business model is not a strong as its industry peers.
   

At the same time, however, a higher dividend yield can signal a sick company with a depressed share price.

Dividend Growth
A company that increases its dividend sends a powerful message about future prospects and performance. A history of steady or increasing dividend payments often signals financial well-being and shareholder value. Double-digit growth rates are preferred, but a growth rate that at least exceeds inflation is sufficient.

Of course, dividend growth shouldn’t come at all costs. We generally frown upon companies that rely on borrowings to finance dividend payments. Watch out for companies with a debt-to-equity ratio greater than 60% since debt levels can hamper a company’s ability to pay its dividend (see financial crisis of 2008).


Dividend Payout Ratio (Dividends/Net Income) or (Dividends per Share/EPS)
In general, a lower payout ratio signals a more secure the dividend because smaller dividends are easier to pay out. A high payout ratio often means there may not be enough cash to weather hard times or raise the dividend.

However, different industries have different payout trends. For example, retail stocks tend to have ratios less than 30% and telecom stocks tend to payout more than 70% of profits. As a result, a company’s payout ratio should be compared to that of its industry peers to determine if it is high or low.


Dividend Coverage Ratio (EPS/Dividends per Share )
Dividend coverage ratio gauges whether earnings are sufficient to cover dividend obligations. In general, a coverage ratio of 2 to 3 is considered safe.

In practice, the coverage ratio becomes a pressing indicator when coverage slips below about 1.5. If the ratio is under 1, then the company is using its retained earnings from last year to pay this year’s dividend.

If the coverage is too high, say above 5, then investors should question whether management is withholding excess earnings or not paying enough cash to shareholders.

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Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stock got off to a good start Monday, feeding off of strong pre-market futures trading as U.S. central bankers continue to signal monetary policy will remain at emergency levels of accommodation for…well, as long as they get away with it. Stocks then built upon that momentum after the October existing home sales data blew by expectations.

This is the third-straight Monday in which stocks got off to a bang. Two weeks ago we rallied as the G-20 meeting concluded with all members pledging to keep stimulus plans going. Last Monday stocks celebrated APEC’s (Asia Pacific Economic Cooperation) members’ comments that they would do the same. Yesterday, stocks were juiced by a statement from the president of the St. Louis Fed that the central bank should continue to buy mortgage-backed securities – and the way that housing is becoming conditioned to these low rates the Fed will likely have to get the 30-year mortgage rate down to 4.50%, or below, to keep that market going.

All 10 major sectors gained ground on the session. One would have thought basic material stocks to have led the rally, with the easy-money trade alive and well, but it was telecoms that propelled the session. It’s no coincidence that it was just Friday in which bond maven Bill Gross, via his monthly letter, recommended buying these shares because economic growth will mirror utility growth rates as Washington seeks to regulate anything and everything. The attractive yields on stocks such as Verizon and AT&T (nearly double that of the 10-year Treasury) obviously have something to do with the rally in these shares as well, with the Fed at zero.

Volume on the NYSE Composite came in under 940 million shares, 23% below the six-month daily average.

Market Activity for November 23, 2009
Commodity Prices and the Greenback

The CRB index (an index that tracks a basket of commodities) is closing in again on the post-crisis high (touched a month ago) as Fed officials continue to express that the central bank will need to remain very loose for a long time. Last week’s speeches by various Fed officials didn’t offer specifics but their easy-money opinions were evident and some of the formerly hawkish (in terms of their inflation concerns) FOMC members have become dovish – that’s an important point to be aware of. Comments became more specific though on Sunday night as St. Louis Fed Bank President James Bullard stated the Fed many keep rates aggressively low to 2012 and the mortgage-backed security purchases program should be extended. This sent commodity price higher Monday, with metals leading the charge. Gold hit a new closing high of $1,165/oz., aluminum hit $2,035/metric ton (well below the 2008 spike but back to 2005 levels when economic activity was robust), and copper is up to $310/lb.(closing in on levels hit when home construction was going gangbusters). Oil remains near $80/barrel even as fundamentals suggest something closer to $40 is appropriate – of course crude likely has some Iranian-lunatic premium priced in.

This is all the loose Fed/dollar-down trade – none of these prices appear to be justified base on supply/demand fundamentals. The trade had chilled out a bit, pretty much moving sideways, over the past three weeks but looks set to roll again in the near term. (Looking out a few months the trade is likely to pull back as the economy shows its legs remain wobbly, before resuming its uptrend.)

The dollar hit the 74 handle on the Dollar Index again yesterday, a sustained move below 75 is viewed as a sign the greenback will test the all-time closing low of $71.33 hit in April 2008. If you dozed off over the previous two sessions you missed the dollar rally. Policy makers, and I’m talking about the Fed not Washington as politicians want the dollar to keep falling, will not become concerned until the Dollar Index settles in at 74. This morning it has bounced a bit back to 75.21.


Existing Home Sales – The Last Hoorah? (for a while at least)

The National Association of Realtors (NAR) reported that previously-owned home jumped 10.1% last month to 6.1 million at a seasonally-adjusted annual rate (SAAR) from September’s downwardly revised 5.54 million. This blew by the expectation for a 2.3% rise to 5.7 million units. Single-family sales rose 9.7% to 5.33 million – the highest level since February 2007; condo/Co-ops sales rallied 13.2% to 770,000 SAAR – the highest reading since March 2007.

The median price of a single-family existing home fell 1.6% to $173,100 – off by 6.8% over the past 12 months and down 25% from the cycle peak hit in July 2006.

The supply figures continue to move in the right direction as the homes available for sale reading dropped to 3.00 million from 3.10 million. At the current sales pace it would take this inventory (inventory/sales) 6.8 months to sell off – that’s down from 10.6 months hit in November 2008. Anything over 6.0 months worth is traditionally viewed as a buyers market, but this is a major move lower by this measure of supply.

We must, however, be cognizant of the inauspicious reality that banks are holding back the foreclosure process – the rate of foreclosure is not keeping pace with the increase in 90-day delinquency rates. Thus, there is a shadow supply, as some have termed it, that has yet to hit the market. Last week, NAR stated that that the total of mortgages either 90-days late or in foreclosure hit four million through September, so it is pretty-darn likely we’ll see the supply figures rise meaningfully again over the next several months.

Is this the last housing market hoorah for a while? October’s sales data were undoubtedly fueled by a rush to get in before the first-time homebuyers tax credit expired (must close by November 30 and contract closings are taking 6-8 weeks), We now know that the credit has been extended through April, but that wasn’t made official until November, thus those looking to take advantage had to get in. This existing homes figure is based upon contract closings, thus these are contracts that were signed in August and early September. Keeping this in mind, the November reading should receive a boost from late-September/early October purchases, but the back-half of October probably saw an immediate sales halt.

We may soon be watching quite a reversal take place as the efficacy of the tax credit is unlikely to have the same powerful effect as it did during the traditional home-buying season and most have already taken the $8K lure. From there, it seems pretty clear to me that when the credit eventually expires home sales will endure another round of significant weakness.

Fed-induced rock-bottom interest rates are certainly helping the housing market as well, but the market still has to contend with a jobless rate north of 10% (a reading north of 7.5% is highly unusual in the U.S.) and supply that is currently held from the market but must eventually hit. Since the market has become conditioned to these rates, ever a slight increase in mortgage rates will do massive damage to housing. The Fed will do everything in its power to hold down rates but for how long and at what price?

Eighteen months back we believed housing would begin to recover in the spring of 2009 – meaning durable sales activity and a sustained increase in prices. That estimate appears to be correct at the present. Unfortunately, I now believe it will prove to be quite inaccurate, which will become evident over the next 12 months.

The housing market has two very serious pressures to deal with over the next year. One, prime fixed-rate mortgage delinquencies make up 54% of the quarterly increase in loans 90 days past due but not yet in foreclosure – that’s according to the Mortgage Bankers Association. This is a lot of supply that will be thrust onto the market, and unless the labor market bounces back quickly, which is unlikely, the problem will persist. Two, we have Alt-A and option ARM resets to get through – and this is likely a major concern within the Fed, undoubtedly one of the main reasons they’re holding their benchmark rate at zero.

Have a great day!


Brent Vondera, Senior Analyst

Thanksgiving Week

S&P 500: +14.86 (+1.36%)

A few fun Thanksgiving week facts about the Dow Jones Industrial Average:

1. Over the past 59 years, the DJIA averaged a gain of 0.76% during Thanksgiving week.
2. The DJIA has ended the Thanksgiving week higher in 38 of the last 59 years – roughly 64% of the time.
   

I will attempt to keep with the Thanksgiving theme for the rest of the week (no promises though). Here goes nothing…


Market’s got off to a nice start this week as investors piled back into the risk trade following St. Louis Fed President James Bullard’s dovish remarks on interest rates. Stock investors are thankful (for now) for extended easy money policy. They were also thankful for today’s lower-than-average volume, which probably helped enhance gains.

Telecom led the market higher as AT&T (T) received several upgrades, including a positive write-up in Barron’s. AT&T is thankful there is an App for that. Meanwhile, Sprint Nextel is expected to close its acquisition of Virgin Mobile USA on tomorrow. Sprint is thankful they are surviving against much bigger rivals AT&T and Verizon.

Health-insurance stocks were particularly strong after a JPMorgan Chase analyst pointed out that managed care companies trade at a 40% discount to the S&P 500. These shares are also gaining amid growing doubts regarding a public health plan option. Managed care companies are thankful for centrist Democrats who disapprove of a proposed government-sponsored health plan option.

Treasury prices remained low after the $44 billion two-year note auction, the first leg of this week’s record $118 billion government note sales. The U.S. government is thankful for demand from foreign investors.


Quick Hits

• How Overrated is Sentiment in Economics?
• Fed’s Bullard: Asset Buying Efforts Should Remain Active
  

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Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks closed lower for a third-straight session on Friday, but again pared about half of its early-session losses in the final two hours of trading. Stock got off to a poor start as overseas bourses closed their session lower. A huge earnings miss from Dell Inc.and a larger-than-expected loss from homebuilder D.R. Horton didn’t help matters.

Comments made by European Central Bank President Trichet on Thursday night, in which the central banker stated policy makers will gradually withdraw emergency cash, hurt stocks overseas and that again flowed into U.S. trading. The market is not even close to wanting to hear these types of comments. Nevertheless, it is exactly what central banks need to be doing. (Although, St. Louis Fed Bank President Bullard last night, stating he hopes the U.S. central banks will extend its mortgage-backed security purchase program has stock-index futures sharply higher this morning.)

The global economy is not in a position to stand on its own and resume anywhere near normal growth, but you’ve got to allow the market to continue to wash out excesses and the miscalculation of risk that occurred via the previous loose money campaign. The current prolonged period of aggressive monetary stimulus is beginning to create other problems and it’s just not the rock-bottom level of rates but also other liquidity measures to banks. Just like intense government involvement, it may make things appear better than they are in the short term but it prolongs the economic damage. We’re seeing evidence of monetary policy exacerbating credit contraction, greatly endangering credibility regarding currency stability and leading to early-stage asset bubbles particularly in Asia (specifically, investors borrowing cheap dollars, converting to other currencies and buying assets in those countries).

Energy, tech and financial shares led the market lower on Friday. The traditional areas of safety – health-care, utilities and consumer staples – were the only sectors out of the top 10 groups to close higher on the session.

For the week, the broad market ended essentially flat, down just 0.19%, as the final three sessions of the week erased Monday and Tuesday’s gains.

Market Activity for November 20, 2009
The Greenback

The dollar is getting hammered this morning, looking to move to that 74 handle on the Dollar Index again, due to the divergent statements between Trichet and Bullard. If the European Central Bank is really going to begin a mild tightening campaign (removing the emergency level of stimulus) and it’s just not talk, while our Fed is going to keep the pedal to the metal, possibly even expanding its quantitative easing campaign, the U.S.dollar will make a new low.

The greenback will find some support via Asian countries forced to buy dollars as the Chinese yuan continues to get de-valued against the currencies of its Asian neighbors (as it is pegged to the U.S. dollar). Thailand, South Korea, Vietnam et al., will seek to de-value their own currencies so not to lose too much export activity to the Chinese. This is all due to the Fed’s policy.direction. It’s a race to the bottom, and a trend of currency de-valuation is not a good sign for global growth. To the contrary, it is a recipe for turmoil. But this dollar support will prove temporary. The longer-term trend of the dollar is almost completely a function of monetary policy – it ultimately depends on how long they remain hooker loose.

Gold has made a new nominal dollar high this morning, up $20 to $1,166/oz (the inflation-adjusted high is roughly $2,200/oz., hit in 1980). The metal is up 59% since the S&P 500 hit its all-time high of 1565 on October 9, 2007.

The Fed and Independence

There’s a lot going on in Washington, which we’ve been talking about on a weekly basis – you can never separate economic developments from policy, and this is especially so today. The latest is this bill to make the Fed’s actions more transparent.

The House Financial Services Committee advanced a proposal to remove a 30-year ban on audits of monetary policy and engage in examinations of central bank actions.

There are many people in an uproar over this development as they believe the ideas in this bill will compromise the Fed’s independence from Congress. Well, welcome to the arena of concern; Fed independence, or lack thereof, appears to have been jeopardized for over a year now. I guess it takes intensely conspicuous acts to wake people up to the fact.

The reaction seems to be a bit carried away though as the process is in the earliest stages and the entire proposal is not all bad if it’s massaged a bit.

First, it is likely to be diluted as, if, it ends up flowing through the legislative process. It must first pass a vote in committee, then must be approved by both the House and the Senate, and then of course signed by the President.

Second, the Fed can inform Congress of its actions, such as emergency loans to specific banks and institutions, so long as there is a significant lag (say, 2-5 years). This is the case in terms of some other things the Fed does. We just cannot make the information immediately public as it may result in a run on specific banks, or develop into other situations that potentially cause widespread panic.

So that’s the part of the bill that isn’t all bad if a bit of common sense is incorporated. The very bad part of the bill is this idea that the GAO (Government Accountability Office, formerly known as the General Accounting Office) would be able to criticize or even have a role in determining monetary policy. This would paralyze the decision making process. (Some people may see action to paralyze the central bank as a good thing, frankly I’m not going to offer an opinion on this right now because things have not yet progresses to a point in which the opinion would seem anything other than outrageous – in time we’ll be able to discuss, I’m pretty confident of that.) Anyway, at this point in time, the Fed cannot be paralyzed and adding another set of players to the mix will probably do much more harm than good.

So we’ll see how it turns out. In general though, it sure doesn’t seem the Fed is nearly as independent from the political process as it should be. I’m frankly concerned that the Fed has been roped into monetizing the debt (keeping rates grounded and devaluing the dollar) as this makes it easier for the government to manage massive levels of deficit spending – the interest payments are lower than they otherwise would be and you’re paying debts back with dollars that are worth less. Of course, it leads to many problems down the road.

Week’s Data

We were without a data release on Friday but this week will be a big one even as it is cut short by Thanksgiving Day.

On Monday we’ll get existing home sales (October), the data is expected to show a 2.3% increase as first-time buyers rushed in during the first half of the month to get in before the tax credit deadline (that credit has been extended but as of October it was uncertain). If the number misses it will be a big market downer as it is abundantly clear the November reading is going to show decline.

On Tuesday we get the first revision to Q3 GDP and the CaseShiller Home Price Index (September). GDP is expected to be downwardly revised to show the economy expanded at a 2.9% real annual rate – originally estimated to have grown 3.5%. CaseShiller has a large lag to it (being September data) but is still heavily watched nonetheless. It should show prices rose for a fourth-straight month for the 20 cities the index tracks. The year-over-year reading should show prices declined at a reduced rate, which would extend upon the five-month trend. We’ll also get consumer confidence (November). The reading has been falling for three months and currently sits at a level that is the low point for every recession since 1967.

On Wednesday we get personal income and spending (October), durable goods (October) and initial jobless claims (pushed up to a Wednesday due to Thanksgiving). Personal income is expected to rise 0.2% after unchanged for September and spending is expected to rise 0.6%. Spending will be boosted by durables, which were driven by auto sales as they bounced off of September’s very weak car sales. Initial jobless claims are expected to fall 5K to 500K. If accurate, it will mark the first time the reading touches 500K since falling to 488K in early January. We’ll be watching for the increase in extended jobless claims as this will be the first week in which the latest French-style extension takes effect – up to 99 weeks of benefits now.



Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Weekly

Short-term yields continued their march downward this week mostly driven by comments from St. Louis Fed President James Bullard. Headlines read “Fed will not increase rates until early 2012”, but were pretty misleading if read without the rest of the speech.

Below is a graph of the current on-the-run 2-year since it was issued late last month. Yesterday the 2-year tested the all time lows of .649% set in late 2008.


The majority of the Fed President’s speech focused on monetary policy going forward, namely the status of quantitative easing and near zero fed funds. Bullard prefaced the quote that ran across the newswires by sighting that the Fed has waited 2.5-3 years from the end of the past two recessions to begin raising interest rates, which would give us an early 2012 initial interest rate hike if the Fed decided to follow similar protocol. Problem is, this is no normal recession and the Fed has chosen to fight the deflationary threat to the economy in non-traditional ways (i.e. QE).

Instead of waiting for an initial hike from current levels 2.5 years from now, a scenario where the Fed moves to more of an accommodative policy within a year while beginning to test the securities market with reverse repos to unwind the QE is more likely.
Early year-end profit taking may have been another factor pushing the short end lower this week. According to Bloomberg, 3-month bills traded as low as .005% on Thursday and stayed that low all day Friday, likely due to managers moving to the sidelines through the holiday season and year end. Stocks are down a little for the week so this seems like a logical thought at least.

The last time bills yielded below .05% was in the aftermath of the Lehman Brothers bankruptcy which forced The Reserve Fund (a major money market fund who held a concentrated position in commercial paper issued by Lehman) to break the buck. This forced an exodus of cash from mmkt funds into bills, sometimes accepting negative yields in order to do so. We are in same place now for a different reason. Now more than ever, the Fed’s liquidity is urging investors to love risk again by punishing them for hoarding cash.

Cliff J. Reynolds Jr., Investment Analyst

Daily Insight

U.S. stocks lost ground on Thursday, following a slide in overseas bourses. A bout of concern that stocks have gotten ahead of economic growth prospects (we’ve heard that one before only to see stocks resume rally mode) and an analyst’s downgrade of the semiconductor space resulted in some profit taking.

A round of economic data didn’t help matters as initial jobless claims refuse to fall below the 500K level and mortgage delinquencies and foreclosure rates continue to rise – although high jobless claims and terribly elevated foreclosure rates haven’t had an adverse effect on stocks thus far during this meteoric rise from the March depths; maybe something has changed as we close in on year end – we shall see.

There was a pretty good flood into the short-end of the Treasury curve as the two-year note fell 4 basis points to yield 0.7%. The two-year yield hasn’t hit this level since we were in the middle of the storm in December 2008 – maybe fund managers have decided to begin booking equity-market gains and sit in Treasury securities to year end.

Still, the 1.34% decline in the broad market was hardly substantial considering the spike in prices over the past eight months; the rush into the Treasury market – the two-year yield has plunged 30 basis points since late October, the 10-year yield is down 20 bps over this four-week span – would normally put significant pressure on stocks, yet they are barely off recent highs. It’s a strange market environment for sure. The broad market was actually down 2% at the day’s nadir, but rallied in the final 90 minutes to erase a good deal of those losses.

Energy shares led the decline (down 2.07%) with financials and information technology not far behind. Traditional areas of safety, consumer staples and health-care, were the relative winners on the session – down 0.33% and 0.53%, respectively.

Market Activity for November 19, 2009
Initial Jobless Claims

The Labor Department reported that initial jobless claims held steady last week at 505,000 (in line with the expectations of 504K) from the upwardly revised reading of the prior week -- originally estimated at 502K, but revised up slightly to 505K. The four-week average of initial claims fell 6,500 to 514,000.

We’re still waiting for that move below the 500K level.

Continuing claims fell for a ninth-straight week, down 39,000 to 5.611 million in the week ended November 7 (there’s a one week lag between initial and continuing claims). However, as we’ve been talking about, jobless benefit extensions rose, more than offsetting the decline in standard continuing claims. As the unemployed see their traditional 26 weeks of benefits run out they are moved to Emergency Unemployment Compensation (EUC) and its several extensions. EUC rose 101,838 for the week and extended benefits (the various tiers to EUC) rose 17,170.

Extended benefits now run up to 99 weeks, as we discussed earlier in the week. This extremely wide social safety net (maybe more appropriate to term it a hammock) will, at the margin, keep the jobless rate high.

I’ve put this exhaustion rate chart up several times now. It is a monthly number so it hasn’t changed since last week, but I find it helpful to paint the picture. This is the exhaustion rate of standard (26 weeks) unemployment benefits. It continues to make new highs not only because the labor market is a wreck, but also because Congress continues to add extensions.


Philly Fed

The Philadelphia Federal Reserve Bank’s survey of manufacturing activity accelerated to 16.7 in November from 11.5 in the previous month – the estimate was for a move to 12.2. This is a big reading for Philly and is a bit contrary to that of Empire Manufacturing, which showed New York-area factory activity decelerated – these are the first looks at factory activity for November.

A couple of the sub-indices showed substantial improvement. New orders jumped to 14.8 from 6.2, great sign for next month’s activity; shipments soared to 15.7 from 3.3 – although this is a just a follow through of the prior month’s higher reading. The number of employees remained in contraction mode, but rose to -0.5 from -6.8; the average workweek moved to expansion for the first time since December 2007 – that’s when the NBER (official arbiter of business cycle expansions and contractions) stated the recession began.

However, while employees and average workweek improvements show the pace of firings declined, a couple of indicators on actual hirings moved deeper into contraction. Unfilled orders fell to -5.4 from -1.3. The delivery times readings fell to -12.7 from -9.3. These readings indicate that factories are not burdened with a degree of orders that current payroll counts cannot fill or deliver. It does not speak well for new hires because it shows they’re not needed.

Just as we’re watching for a meaningful move below 500K on initial jobless claims, we will keep a close on these two factory readings (unfilled orders and delivery times) for evidence that meaningful additions to payrolls are on the horizon.

The inventories index rose to -17.3 from -31.8 – a substantial improvement but shows firms are still destocking. A full-blown inventory dynamic is not yet upon us but GDP only needs for stockpiles to decline at a slower rate to boost the reading. The fact that this inventory reading is barely better than the average since the recession officially began (-17.3 vs. -20.4 average) illustrates that business confidence remains lackluster.

Mortgage Delinquencies

The chart above speaks for itself, but it does exclude the inventory of foreclosures. The number of mortgages either delinquent or in foreclosure is 14.11%.

Here is the delinquency breakdown:

Among fixed rate mortgages, the delinquency rates are as follows: 5.67% of prime loans; 24.57% of subprime; 13.90% of FHA

Among adjustable rate mortgages, the delinquency rates are as follows: 12.37% of prime loans; 28.23% of subprime; 14.36% of FHA

What we have seen over the past few months is that prime loans are beginning to drive foreclosures; at the beginning of this housing contraction, it was sub-prime leading foreclosure rates higher. This tells us it is not just about bad loans written and a lack of credit standards, but the highest jobless rate in 26 years is doing the damage.

This data screams of a significant increase in home supply. The number of loans 90 days late or in foreclosure is now over 4 million, according to the Mortgage Bankers Association. To put this number into perspective, there is currently 3.8 million new and previously occupied homes for sale.

Based on such a larger number of homes waiting to hit the market I fail to see how housing escapes another round of price decline, and the resultant increase in bank losses. Economists who expect a robust economic expansion to ensue appear to be living a fantasy.


Have a great weekend!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks stumbled, but just slightly, as the latest mortgage applications index and October housing starts showed that a new round of home-buying weakness is likely upon us. Concerns are also increasing over FHA-backed mortgage loans. The latest to express concern about the FHA is Robert Toll, CEO of home builder Toll Brothers, who referred to the situation as “a definite train wreck.”

The FHA’s required down payment is only 3.5% and these loans now make up 24% of the market, up from 3% in 2006, if memory serves -- we’re looking at a lot more mortgages going underwater. With 14.4% of FHA-backed loans at least 30 days late and 7.8% at least 90 days late (according to the Mortgage Bankers Assoc.), this will work as another incremental force keeping foreclosure rates heightened and another taxpayer bailout is coming. Book it, it’s a done deal.

However, this market is living in a keep-up-the-bad-work mindset. The broad market rallied late in the session to darn-near erase earlier-session losses. What’s bad is good in this bizarro environment because it signals an increase in ZIRP’s lifecycle – easy money continues to boost the appetite for risk.

Financials led the rally as billionaire John Paulson, president of the eponymous hedge fund, put a price target of $29.81 on Bank of America by 2011 – the stock currently trades at $16.35. Sounds like he either wants to juice his trade or believes the Fed will remain at or near zero for another two years.

Among the 10 major industry groups, health-care and telecoms were the only other sectors to close in positive territory. I found it interesting that basic material and energy stocks failed to close higher even as metals and energy prices gained ground. Also, the dollar nearly gave back all of its prior session gains, still these dollar-down trades couldn’t make it to the plus side.

Volume was weak again as barely more than one billion shares traded on the NYSE Composite – that’s roughly 18% below the six-month daily average.

Market Activity for November 18, 2009
Mortgage Applications

The Mortgage Bankers Association reported that its applications index fell 2.5% in the week ended November 13, even as the 30-year fixed-rate mortgage averaged 4.83% -- the lowest level since May.

The purchases index fell for a sixth-straight week as buyers were frozen, uncertain as to whether the tax credit would be extended or not. Now that that extension has been promulgated, it should unfreeze home sales in the coming weeks. Nevertheless, I wouldn’t expect quite the effect it had in the summer as we’re now past the traditional buying season and most of those who were able to take advantage of the credit probably have.

The purchases index is down to the lowest level since late 1997.

Refinancing activity slipped 1.4% after large bounces over the previous two weeks of 11.3% and 14.5%, respectively.


Consumer Price Index

The Labor Department reported the headline consumer price index (CPI) rose 0.3% in October (+0.2% was expected). The core rate, excludes food and energy, rose 0.2% (+0.1% was expected).

Year-over-year, headline CPI was down 0.2%, the slightest decline since y/o/y comparisons began posting negative readings in March. This will change to an increase when the November data is released. Even if CPI comes in unchanged for the month, the y/o/y figure will be up 1.5%. If the current monthly trend continues to December, the y/o/y figure will close in on 3%. The degree of increase in the headline y/o/y readings from there will depend upon the direction of the dollar and the rise in commodity prices.

The y/o/y reading on the core rate remained benign, 1.7% for October.

The main contributor to the October rise in headline CPI was the transportation segment (which consists of private and public vehicles and gasoline) – it accounted for 71% of the increase. The core rate was driven by new and used vehicle prices, accounting for 58% of CPI’s October increase when excluding food and energy.

Used vehicle prices, at least according to CPI, rose 3.4% last month and this component is up 31% at an annual rate over the last three months -- clearly a function of clunker cash. Thanks Congress!

Housing Starts

The Commerce Department reported that housing starts plunged 10.6% in October – which is pretty amazing considering starts remain on the mat, but this is necessary due to weak fundamentals. Builders broke ground on 529,000 units at an annual rate, the market was expecting a rise to 600,000 units. Overall housing starts are down 30.7% from the year ago period and 76% from the cycle peak hit in January 2006. (On the chart below, SAAR stands for seasonally adjusted at an annual rate.)

Construction starts on single family units fell 6.8% in October. The 476,000 in single family starts (at an annual rate) is 33% above the all-time low hit in February but even with this bounce the number remains 9% below the erstwhile record low, which was hit in 1981.

Multi-family starts slid 34.6% in October, which follows a 19% decline in September. The 53,000 in multi-family construction starts marks a new all-time low.

Housing construction permits, obviously an indication of future work, fell 4.0% last month -- down 24.3% from the year-ago period. It appears that boost third-quarter GDP receive from residential construction (the first in 15 months – sorry I think I stated 13 months in a letter earlier this week) was a one-and done event.

Bumpy Road – Not Just a Metaphor

We are in the process of $787 billion in deficit spending that is specifically slated as stimulus – traditional infrastructure projects, entitlements, health services, energy efficiency, etc. Something in the range of $45-$65 billion is earmarked to highway and transportation projects. So why exactly do I find myself dodging I-270 potholes on the way to and from work?

Recall our skepticism early this year regarding the claim that there are “shovel ready” projects. That is, the claim that money will be delivered directly to state and local governments which have projects ready and waiting, and thus immediately result in new work – a wonderfully conspicuous event for politicians as Americans would be able to see this activity as they go about their daily lives. Well, only the naïve believed this claim as there is an arduous, and well-known, appropriations process that stands in the way of immediate results. Still, one would think we’d get something to show for this, one of many budget busting, programs. Apparently, they can’t even resurface roads in a reasonable timeframe.


Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks refused to stay down yesterday, extending the latest winning streak to three days. After spending nearly the entire session below the flat line, the major indices rallied in the afternoon to eventually close the session slightly higher. The S&P 500 is within 1% of recouping half of its losses from the October 2007 record high of 1565 – 1120 on the S&P 500 marks that point from the closing low of 676 on March 9, 2009.

The market completely shook off a lackluster industrial production report and comments from Fed Chairman Bernanke the day before on the state of the economy, statements that had pre-market trading tracking lower. A rally in commodity-related basic material shares (up about 1%) led the broad market into positive territory.

Consumer discretionary shares were the biggest loser on the session (down 0.74%). Of the 10 major industry groups, six rose and four fell.

Volume was very weak as less than one billion shares traded on the NYSE Composite.

Market Activity for November 17, 2009
Producer Price Index (PPI)

The Labor Department reported that producer prices rose 0.3% in October (+0.5% was expected), after a 0.6% decline in September. Year-over-year the reading is down 1.9%. Excluding food and energy, what’s known as the core rate, PPI fell 0.6% for the month and is up just 0.7% year-over-year. So on the more headline numbers the data remains uneventful.

A look within the report gets a little more interesting. Over the past three months, PPI is up 7.4% at an annual rate. That’s up from +0.6% by the same meaure in September.

Total intermediate goods (those used in the middle stage of production) were up 0.3% in October and are higher by 9.7% annualized over the past three months (although mostly due to a large increase in August, which had clunker-cash auto assemblies written all over it). Core intermediate goods fell 0.5% in October, but are up 5.5% over the past three months at an annual rate. Crude materials (those used at the initial stage of production) were up 5.4% in October; the core rate was up just 0.5% after huge back to back gains in September and August of 3.6% and 6.0%, respectively. On a three month basis, total crude goods are up 31.5% and the core rate for crude goods is up 48.6% at an annual rate – albeit from pretty low levels.

So, there is evidence of underlying inflationary pressure. We’ll see how this materializes into higher headline PPI readings and later consumer price inflation. For sure much of these underlying pressures will be absorbed as the slashing of payrolls has worker productivity at elevated levels; nevertheless, we’ll certainly see PPI begin to post positive year-over-year numbers when the November reading is released. By December, it is likely y/o/y PPI will begin to run at 3.5%-4.0%. Not terribly concerning, but it is a significant turn from the trend of negative readings of the past year.

We’ll continue to watch credit. When it begins to expand again, that is when the unprecedented level of dollars the Fed has pumped into the system will result in much higher inflation readings.

Industrial Production and Capacity Utilization

The Federal Reserve released their monthly industrial production figure, which showed if not for the third-coldest October on record production would have ended a three-month streak – a bounce off of the most prolonged contraction in the post-WWII era.

Industrial production (IP) rose 0.1% last month (+0.4% was expected) after rising at a downwardly revised 0.6% in September – previously estimated to have risen 0.7%. There are three main components to this data: manufacturing, utility and mining production.

Manufacturing fell 0.1%, held back by a 1.7% decline in auto production after huge increases over the previous three months. There we had clunker-cash driven auto sales (and thus assemblies) driving the previous IP gains and now that that has run its course, we’re seeing the short-term effects of that program in this weak reading. Machinery orders did rise, up 0.2% for the month. Computer and electronics production fell 0.3%. Overall business-equipment production fell for an eighth month in 10 and is down 6.7% year-over-year – down 10.79% at an annual rate since peaking in March 2008. Production of construction supplied fell hard for a second-straight month, down 1.2% in October and down 17.0% over the past year.

Mining production fell 0.2%, a bit of a surprise at these commodity prices.

Utility production saved the month as the segment posted a 1.6% gain.

Capacity utilization (CU) inched up for the fourth-straight month, touching 70.7% -- the cycle low, also the all-time low (data goes back to 1967), of 68.3% was hit in June. The long-term average on this reading is 81.0%, so we’ve got a ways to go before a meaningful degree of hiring begins. Firms will increase current employees’ hours worked before adding to payrolls, as we’ve been talking about for some time now.

Manufacturing industry CU ran at 67.6% in October – the long-term average is 79.7%. Utility CU ran at 79.0% -- the long-term average is 87.6%. Mining CU ran at 83.5% -- the long-term average is 87.5%. It won’t take long for mining utilization to blow through the average if the dollar stays down and commodity prices high.

National Association of Home Builders (NAHB) Index

The NAHB showed confidence among homebuilders remained at depressed levels in November, unchanged from October at 17 – a reading below 50 illustrates most home builders view conditions as poor. High joblessness, lofty foreclosure rates (filings surpassed 300,000 for the eighth-straight month in October, according to RealtyTrac) and problems obtaining credit are all holding down sentiment.

The NAHB also gauges buyer traffic and sales expectations for the next six months. The buyer traffic gauge was unchanged at 13 – the recent high is 17 and the all-time high is 60. The gauge of future sales rose two points to 28 – the recent high is 30 and the all-time high is 83.

For Some Reason I’m not Feeling Stimulated

Bloomberg News reported yesterday afternoon that the House is working on a “job creation” plan this year that will include money for highway construction (sorry, that creates work not jobs), tax credits for small businesses to hire more workers (one assumes this is the vaunted concept that first made the rounds this past summer – a $4,000 tax credit to be paid over two years; if members of Congress took the time to inform themselves of what it costs to hire a worker they’d understand how silly this $ amount is), and finally, drum roll please…another extension of jobless benefits (that would bring us to triple digits as current extensions run out at 99 weeks).

Bienvenue a l’aupair etat.


Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks shook off an ugly consumer confidence reading to close higher on Friday. The gain pushed the broad S&P 500 up by 2.26%, which follows a 3.20% move in the week prior – completely erasing the pullback of late October. The Dow Industrial Average added 2.46% for the week and the NASDAQ Composite rose 2.62%.

Consumer discretionary shares led Friday’s gains, which was pretty strange considering the latest consumer confidence reading – we’ll touch on those results below. It appears the consumer discretionary trade got a boost from Disney’s earnings that beat expectations on Thursday night. But the results were able to beat only because of massive cost cutting and a jump in fees from cable operators. The television division drove the number. Advertising and them parks continue to struggle, which is to be expected.

Technology shares also performed well, as did traditional areas of safety such as utility and consumer staples.

Small cap stocks also rose for the week, but have underperformed the large caps over the past four weeks, which may be a sign this rally is getting tired.

There’s certainly no indication the equity sprint is running out of steam this morning though as stock-index futures are up big. A pledge from Asian countries to maintain stimulus measures – pretty much a redux of the statements we got out of the G-20 a week ago – has provided more juice for the risk trade. Commodities continue to roll as gold has hit $1130/oz., oil’s closing in on $80/barrel again (even though fuel demand is weak) and copper hit a new 14-month high -- and is not all that far from the super-spike level of 2008.

The dollar, of course, is getting hammered back to the 74 handle on the Dollar Index as the Chinese government said they will not re-value the yuan (which we talked about last week) and is having a field day ripping on Fed policy over the past several years.

Forget the problems that ZIRP causes in an economically endogenous sense – higher commodity prices, the improper assessment of risk as investors scramble for yield, dropkicking the dollar and exacerbating the credit contraction as banks simply borrow at nothing and invest in Treasury securities instead of making loans. This Fed policy has enormous potential in creating international tensions, problems to which we won’t know the extent until they occur.

Instead of acknowledging this issue, along with the massive deficit spending and protectionist policies that are also damaging relationships, our policymakers are in Asia talking about climate change. You want to talk about misplaced priorities, this is a striking example. When we get to the end game, when the markets no longer rise simply because countries say they are going to keep their stimulus measures floored and the consequences of all of this short-minded stimulus must be paid, I’m betting we’re not going to find anyone who takes life seriously concerned about climate change (it’s interesting how the climate Malthusians no longer call it global warming).

Market Activity for November 13, 2009
Trade Balance

The Commerce Department reported that the September trade balance registered a deficit of $36.472 billion for the month, a widening from the -$30.849 billion difference in August. The real (inflation-adjusted) deficit widened to $41.71 billion, or 10.1%, from 37.86 billion.

There are a couple of quick takes from this: One, the punishment the dollar has endured isn’t helping to narrow the deficit – which is what all the academics tell us must happen; some people are not surprised they’re wrong. Two, since this is the trade data for the last month of the third quarter, it means a lower revision to the GDP reading – a widening of the trade figure subtracts from GDP.

A significant reason for the wider difference between exports and imports is the higher price of oil, this is one reason the “lower dollar is good for narrowing the trade balance” conventional wisdom is flawed – a lower dollar means an increase in the price of oil.

Indeed, the imported crude-oil number jumped to $4.06 billion for the month, or a 26.2% increase. (The trade deficit hit its historically wide levels back in 2006-mid/2008. Those wides in the trade figures were driven by Greenspan/Bernanke & Co. keeping rate too low for too long, which encouraged the credit expansion and thus the big import flows. Of course, the seven-fold increase in the price of oil (from $20 in 2002 to $140 by the summer of 2008) had something to do with this too. The dollar, which plunged 40% in value against a basket of other currencies during this period, drove that oil price. Again, so much the conventional wisdom – according to their beliefs the U.S should be running a huge trade surplus as a result of such dollar decline.

But back to this latest data, exports rose a healthy 2.9% for the month, but imports rose more, up 5.8%. Ex-petro, imports still rose 4.4% and this was fueled by the clunker-cash scheme (and you thought you had heard the last of that term) as auto parts and supplies imports jumped 11.5% -- automotive goods accounted for 18% of all imports in September.

The exports reading was boosted by a 45.7% increase for commercial aircraft after a 40% decline in the previous month – this volatility is not unusual. Exports of industrial machines and telecom equipment were also good.

Import Prices

Import prices rose 0.7% in October, up for three-straight months and seven of the past eight. No one seems to be paying much attention to this data, probably because the year-over-year reading is down 5.7% -- the 12th month of decline. But over the past six months, import prices are up 13.3% at an annual rate. The actual year-over-year reading is going to post a dramatic shift by the time of the December figures -- even if the number is flat over the next two months that reading will shift from -5.7% as of this data to +7.0% by the December reading.

University of Michigan Confidence

The U of M.’s headline consumer confidence reading for November fell back to 66.0 from 70.6, which brings the index back to where it stood in July. The Economic Conditions reading slipped to 69.6 from 73.7 (which was the highest level since April 2008). The Economic Outlook reading fell to 63.7 from 68.6.

This survey does not involve a specific question on consumers’ take of the job market environment, such as the more widely watched Conference Board’s confidence reading does. Thus, one may expect another decline in that survey, which is already at a level that matches the worst readings of prior recessions, going back to 1967.

The Week Ahead

This week will be a big one on the data front as we get retail sales (October), Empire and Philly Manufacturing (November), Industrial Production (October) and Housing Starts (October).

Today we’ll kick it off with one of the most watched numbers, retail sales for October. The reading should post fairly strong results, a number that has a good shot of beating the 0.9% increase that’s expected (+0.4% ex-autos and +0.2% ex-auto and gas).

This market is likely to get excited if the reading is as good as I think it will be as there’s a lot of wishful thinking rolling out there with regard to intermediate-term consumer activity trends. But the weather will have provided a fake out. Last month was the third-coldest October on record and that means it pushed forward fall and winter apparel sales. We’ll see how it turns out in about 30 minutes.


Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks remained in rally mode on Monday after a good retail sales report and Asian countries’ pledge to maintain stimulus spending. As a result, energy and basic material (commodity-related shares) led the advance.

The largest daily gains over the past couple of weeks have followed policymakers’ statements that aggressive monetary and spending policies will continue. For instance, the broad market jumped 1.92% the day following the latest Fed meeting in which the FOMC stated conditions warrant “exceptionally low levels of the federal funds rate for an extended period.” Then the S&P 500 rallied 2.22% a week ago Monday after the G-20 members agreed to continue stimulus spending. Now we have this 1.45% move yesterday, which immediately followed the pledge from APEC (Asia Pacific Economic Cooperation). The impetus for these rallies appears to be pretty obvious.

To be sure, the retail sales data had something to do with the rally. Or rather what it didn’t do, it didn’t damage the higher sentiment that was evident by pre-market futures trading. A number of segments within that report showed decent-to-solid growth, but the ex-autos number did miss expectations and the downward revision to the previous month was substantial. The overall reading easily surpassed expectations, but only because auto sales bounced from a very weak September reading -- the autos sales chart below tells it all.

Advancers trounced decliners by an eight-to-one margin on the NYSE Composite. Volume was unimpressive as less than 1.1 billion shares changed hands.

Market Activity for November 16, 2009
Bernanke’s Dollar

Whoa! The Fed chairman not only mentioned but spent considerable time talking about the dollar, and the corresponding increase in commodity prices, in yesterday’s speech to the Economic Club of New York. Of course, he had to point out that he believes inflation will remain subdued for some time (and he may be right so long as credit continues to contract, but the moment it picks up so will the velocity of money and all of those dollars pumped into the system will cause prices to rise, and fast).

The Dollar Index spiked on the news, but quickly plunged back to where it was trading before the comments. The markets will require action, talk is not nearly sufficient to reverse the dollar down trade – but if this is a first step we’ll take it. Is this an early signal the Fed is thinking about a little ratcheting? Let’s think about that.

If mildly increasing fed funds shows the world that the Fed is somewhat serious about keeping the dollar from drowning in a sea of aggressive monetary easing, it will make their eventually unwinding of current policy much easier. Conversely, if they keep ZIRP in place and the dollar heads lower, commodity prices keep flying and traders continue to push stocks to valuations that do not appear to be commensurate with realities on the ground, then the Fed’s job in the months ahead will become all the more politically unsavory. The longer they wait, the more aggressive the tightening campaign will be and this will be very harsh on asset prices. I know I’m reaching here. It’s highly unlikely the Fed will move on rates before the unemployment rate peaks (and we’re at least six months from this occurring). But allow me to dream for a moment.

The market surely didn’t view his statements as anything but lip service as stocks kept chugging along and the Dollar Index moved down to the 74 handle and then to intraday lows. The dollar bounced off of that low mark but finished below the day’s average price – as you can see above.

Retail Sales

The Commerce Department reported that retail sales jumped 1.4% in October (+0.9% was expected) after a big downward revision to the previous month – down 2.3% vs. the -1.5% initially estimated.

The overall gain in retail sales for October was mostly due to a bounce in auto sales after a very weak September. (Of the $4.7 billion increase in sales, autos accounted for $4.0 billion.) But we did get good results from the apparel and general merchandise segments – there’s that colder weather event we talked about; last month marked the third-coldest October on record.

Excluding autos, retail sales rose 0.2% (following a downwardly revised 0.4% increase for September. The ex-auto reading was weighed down by a large 2.4% decline in building materials. Take out autos, building materials and gasoline (what’s known as core retail sales and the number that feeds directly into the personal consumption reading for GDP) and retail sales were up 0.5% for the month – that gets the fourth quarter off to a good start.

Quickly on that building materials decline, this is a pretty bad sign for residential home construction. Home building added to GDP last quarter for the first time in 13 quarters. The increase in this area will probably prove fleeting.

Autos (motor vehicles and parts) jumped 7.4% in October. Gas station receipts were flat after rising for two months in a row. The segment is down 15% year-over-year.

Clothing and general merchandise looked good as sales for those segments rose 0.4% and 0.8%, respectively. Eating, drinking (the segment that I often refer to as unfazed by high joblessness as a significant portion of this reading involves 20-somethings) jumped 1.2%.

Furniture, electronics, sporting goods, and again that building materials reading, were all down.

From a year-over-year perspective, overall retail sales are down 1.7% from the very weak October 2008.

Empire Manufacturing

New York-area manufacturing activity grew in November but at a reduced rate relative to October. The Empire Manufacturing index came in at 23.51 for the month (6.5 points below the expectation) after a 34.57 in October. A reading above zero marks expansion, so this is a good number even if it missed the forecast. (This differs from the ISM and Chicago manufacturing surveys in which a reading of 50 is dividing line between expansion and contraction.) That big reading for October (the best since 2004) seemed to be artificially boosted by auto assemblies following clunker cash.

In terms of the sub-indices, new orders fell to 16.66 from 30.82 in October. Delivery times fell to -2.63 from 3.90 in October – this shows firms are having no problems delivering orders even with the slashing of payrolls, not a particularly good sign for job gains. Employment fell to 1.32 from 10.39. However, these are the first back-to-back positive readings since the spring of 2008.

The two readings getting most attention right now – inventories and average workweek – were not helpful.

Inventories ticked up to -17.11 from -18.18, but remain well in contraction mode. We have yet to receive evidence that firms feel comfortable enough to boost stockpiles – and that means production remains lackluster.

The average workweek reading fell back to 5.26 after bouncing to 20.78 in October. We were waiting to see some extension to that previous reading, for sure current employees will have to see their hours worked increase dramatically before factories bring back those who have been laid off. It is good to see this reading in positive territory, but after the aggressive manner by which manufacturers have slashed payrolls, this measure needs to post a series of outsized gains in order to deliver an addition to factory employment anytime soon.


Business Inventories

The Commerce Department reported that business inventories fell 0.4% in September, the slowest rate in a year, showing what the latest GDP reading also illustrated – inventory slashing has ended. To be sure, stockpiles continue to be cut, firms have neither the confidence nor the demand to begin to rebuild, but this is an important first step. Auto inventories jumped in September, due to very weak sales for the month. Excluding auto, business inventories fell 0.6%.
The sales data attached to this report showed a decline of 0.3% after three-straight months of increase. The inventory-to-sales ratio held at 1.32 months worth of supply. This reading probably needs to fall back to 1.25 (near the record low) in order to get firms building stockpiles again in this environment.

Economists are watching for a build in ex-autos stockpiles as evidence the inventory dynamic has arrived – this is what will catalyze GDP for a couple of quarters. I’m guessing the first and second quarters of 2010. Many readers may notice I keep pushing this estimate forward. A couple of months back I had estimated the inventory dynamic would be in full swing by the fourth quarter. We’re still waiting for its arrival.



Have a great day!


Brent Vondera, Senior Analyst

Fixed Income Weekly

The process of money creation is complex. Flooding the market with cash to keep Fed Funds low is a very traditional way to stimulate an economy, and the Fed is all in on that front with Fed Funds at zero. They took it a step further this year and moved into longer assets to bring down longer term interest rates on things like mortgages. All of this buying has left banks flush with cash and rates low, hoping to spur lending and economic growth. Fed funds has been at 0-.25% for 11 months, they have purchased $300 billion in Treasuries notes, over $1 trillion in Agency MBS and over $100 billion in Agency debt in addition to $43 billion in TALF and billions more in other confusingly named programs. So why isn’t there any real growth?

The graphs below show the decline in credit since late 2008. The first graph shows Commercial Loans, the second shows Consumer Loans.

Banks are required to hold a certain amount of cash at the Fed, called required reserves. Excess reserves, cash that banks chooses to hold at the Fed in excess of the required amount, have grown since the Fed began pumping the system with cash. The reason for this is lack of demand for funds by both households and businesses – basically banks have nothing to do with all the liquidity. The graph below shows the level of reserves, both required and excess, that banks currently hold at the Fed.

True money creation is more than just Fed induced liquidity. Money creation will only happen if there is adequate demand for money, and right now there isn’t. Excess liquidity has a track record of producing high levels of inflation, but the lack of demand for loans is keeping inflation in check right now.

The public can ridicule banks all they want for not lending, but that is not the problem. Businesses are not expanding and households are still trying to repair the damage done to their home values and/or from their lost income. Stimulus, whether it is monetary or fiscal, still relies on true demand to foster a recovery, and risky asset rally that has been labeled an “economic recovery” has some difficult times ahead unless we get some.

Cliff J. Reynolds Jr., Investment Analyst