January 11, 2010
"We have the most potentially inflationary policy I have ever observed in a developed country," said Alan Meltzer, Fed historian.
Weekly percentage performance for the major indices
Based on last Friday’s official settlement...
INDU: 1.8%
SPX: 2.7%
COMPQ: 2.1%
RUT: 3.1%
Market
The markets started the year with a robust opening rally, albeit on light volume. Sentiment is at an extreme (see AAII chart below), the highest level since October 2007 when the S&P 500 peaked. Extremes in sentiment seem to typically precede corrections, although I haven’t seen any statistical analysis showing that there is a strong correlation between the two. My concern with waiting for a correction is that apparently the consensus is also looking for a correction. Remember what Bob Farrell from Merrill once said “When all the experts and forecasts agree – something else is going to happen.”
Market action was tilted towards economically sensitive groups as basic materials, energy, industrials and financials led the S&P 500. The lagging groups were telecommunications, utilities, and technology. Earnings reports won’t begin in earnest for a few weeks, with the exception of pre-announcements. In the meantime, barring any unusual events (think terrorist attacks, Treasury Secretary resignations, etc) speculation about the economy, trade shows and investment conferences will dominate the market news.
Economy
Actual Consensus Prior
ISM Index 55.9 55.3 53.6
Factor Orders 1.1% 0.5% 0.8%
Construction Spending -0.6% -0.5% -0.5%
ISM Services 50.1 50.5 48.7
Initial Claims 434K 439K 433K
Continuing Claims 4802K 4975K 4981K
Average Workweek 33.2 33.2 33.2
Nonfarm Payrolls -85K 0K 4K
Unemployment Rate 10.0% 10.0% 10.0%
Wholesale Inventories 1.5% -0.3% 0.6%
Consumer Credit -$17.5bil -$5.0bil -$4.2bil
The U.S. unexpectedly lost 85,000 jobs in December, supporting Federal Reserve forecasts that a labor market recovery will take time. Payrolls fell last month after a revision showed a gain of 4,000 in November, the first gain in almost two years. Payrolls in construction dropped almost twice as much in December as a month earlier. Manufacturing shed the fewest jobs last month since December 2007.
Wholesale inventories rose in November. This is important because inventories are a key in measuring the recovery. Inventories in November rose 1.5% vs. expectations of a decline of .3%; October was revised up from 0.3% to 0.6%. Unless final demand picks up in a sustainable way, an inventory led recovery will just be temporary.
Consumer credit fell by a greater than expected $17.5 billion in November vs. an expected decline of $5 billion and follows a revised $4.2 billion decline in October. It is the 13th month of the last 14 that has seen a reduction and is the biggest monthly drop ever! Total consumer credit outstanding now stands at $2.464 trillion, the lowest since July ‘07 and has fallen $117 billion from the record high in July ‘08. As the consumer continues to de-lever, the government continues to lever in an effort to ease the landing.
Healthcare
Discussions are shifting in the healthcare debate as the House and Senate attempt to hammer out the variations in their two bills. How to pay for the 10-year legislation, whose price tag topped $1 trillion in the House, may be the biggest fight. Either way, despite the assurances of everyone involved, this plan is going to be expensive. The Senate plan calls for a 40% tax on the high-end, employer-provided insurance plans. The House wants a 5.4% surtax on couples earning at least $1 million. Unions are against the Senate plan since their generous plans typically would trigger the tax.
Employment
Last week Gluskin Sheff put out the chart below looking at employment in a different manner. The chart shows the percentage of people employed versus the total population going back to 1984. For the first time the measure has fallen below 60%, to 58%. This comes at a time when population growth has slowed.
The enlightened must be happy that we are looking more and more like a European country every day.
More Employment
We all know how poor this decade has been for job creation. The chart below, courtesy of chartoftheday.com, shows just how bad the Zeroes were for job creation, the first decade on record where job growth was less than 20%. I’m sure the 30’s were just as bad, if not worse, but unfortunately reliable (I know, please no jokes) economic records don’t exist for that time period.
Retail Sales
According to research firm ShopperTrak, foot traffic in retail stores fell slightly and total spending rose a healthy 8.8% during Christmas week in the U.S. The increase came in spite of a severe storm in the Northeast which led to disappointing sales the Saturday before Christmas. "As expected, pent-up demand following the snowstorm on Super Saturday pushed consumers to spend heavily last week," said Bill Martin, co-founder of ShopperTrak.
According to CommScore, a 5% increase in online spending during the holidays brings with it a mixed message. Between Nov. 1 and Christmas Eve, U.S. consumers spent $27.1 billion on the internet, compared with $26.8 billion in the same period last year. But the amount in 2008 was down 3% from that of 2007. In addition, this year's per-person spending was less than last year's. "Online sales growth this year was driven by a continued increase in the number of people buying online," said Gian Fulgoni, ComScore's chairman.
According to Barron’s, 75% of retailers beat estimates during the holiday selling season. We won’t get all of the details until the companies report in late February. Most retailers keep a fiscal year end of January 31st.
Munis Galore
According to Thomson Reuters, in 2009 U.S. municipalities sold $409 billion in debt, the second-heaviest year ever. Several factors contributed to the sales, including investors' willingness to own bonds with some risk of default and lack of liquidity. The Federal Reserve's policy of low interest rates also likely drove investors into bonds as they yielded more than bank deposits and money-market funds. However, the Build America Bonds program is seen as the biggest contributor to the surge.
Corporate Issuance
Municipal issuers aren’t the only ones actively issuing debt. After a record 2009 for bond issuance, US corporations issued over $50 billion in new debt just last week.
I guess they’re trying to get deals done before the Fed comes to auction this week.
Commercial Real Estate
According to Trepp, commercial mortgages delinquent 30 days or more shot up to 6.1% last month, the highest rate since commercial mortgage-backed securities were first marketed. The rate for November was 5.7%. By the end of 2010, the rate of delinquent commercial mortgages likely will be in the range of 9% to 14%, according to Jefferies.
More Commercial Real Estate
Echoing what we have been saying in this note for the past 15 months, U.S. bank examiners concluded that losses on commercial real estate loans pose the biggest risk to U.S. banks this year, impacting smaller lenders more significantly. According to Bloomberg, regional banks are almost four times more concentrated in commercial property loans than the nation’s biggest lenders.
The failure of loans backing malls, hotels and apartments may impede the U.S. recovery as small- and medium-sized banks reduce lending and conserve capital to absorb losses. Tight credit could slow the cycle of investment and hiring required for sustained economic growth.
The default rate on commercial mortgages held by U.S. banks more than doubled to 3.4% in the third quarter, according to Real Estate Econometrics. Default rates in the first three quarters of 2009 have been the highest since 1993.
Oil
Interior Secretary Ken Salazar is expected to announce that his agency will require oil and natural-gas companies to clear more regulatory hurdles before they are allowed to drill on federal lands. Mr. Salazar's action is likely to make it more difficult for the U.S. Bureau of Land Management to fast-track the permitting of oil and gas projects on federal land.
According to the AP, the BLM manages more than 260 million acres of federal land, which represents a significant chunk of U.S. energy supplies. Domestic production from federal onshore oil and gas wells accounts for 11% of U.S. natural-gas supplies and 5% of the nation's oil.
In a letter to Mr. Salazar last week, the Industrial Energy Consumers of America, a lobbying group that represents manufacturers, credited the 2005 law easing drilling restrictions with reducing drilling-permit backlogs and boosting natural-gas production. "At a time when we should be working to enhance our energy supplies here at home, we believe it would be a mistake to pursue policies that would make it more expensive or difficult to access critical natural-gas resources," the group said.
Spokesmen for the Interior Department declined to comment Tuesday, except to say that Mr. Salazar would hold a teleconference Wednesday to announce "several initiatives to reform the onshore oil and gas leasing program" administered by the BLM.
Compare this to China, which is dramatically ramping up its domestic refining capacity to eliminate reliance on foreign refining. Their goal is to create a surplus in capacity so that they can export to refining constrained countries such as the US.
Meanwhile here in California we are paying over $3 per gallon and the average gallon of gasoline in the US is $2.70, the highest level in 15 months. The all time record was $4.11 in the summer of 2008. I have seen estimates that an additional $.10 in gasoline prices hits the American consumer by $14 billion.
More on M3
Two weeks ago I showed a re-creation of the US M3, which estimated that annualized M3 growth had declined to zero. Now we see a similar trend in the Eurozone as their M3 surprisingly slipped in November. The European Central Bank said growth of the money supply in the Eurozone reversed course last month and turned negative, marking the first contraction on an annual basis. The M3 money supply declined 0.2% compared with November 2008. Many economists had expected a 0.4% increase.
Rosie-82 vs. 10
David Rosenberg, who has been and continues to be quite bearish, put out a table this week comparing August 1982 with 2009, arguing that 2009 isn’t the beginning of a new secular bull market but instead just another bear market rally. Here are some of the highlights.
1. Fed funds rate 18% and only one way to go (down) vs. 0% and only one way to go, up.
2. 10-year bond yield 15% and falling vs. 3.8% and rising
3. Monetary base $170 billion and rising vs. $2.2 trillion and stable to falling
4. Budget deficit-to-GDP ratio -3% and moving towards a surplus vs. -10% and steady or falling from here
5. Household debt-to-personal disposable income ratio 62% and rising vs. 123% and falling
6. Inflation rate 10% and falling vs. 0% and rising
7. Misery index at 16 and falling vs. 12 and rising
8. Labor force participation rate 64% and rising vs. 65% and falling
9. Tax rates (highest marginal) 69% and falling vs. 35% and rising
10. Union share of the job market 20% and falling vs. 12% and rising
11. Profit margins (room for expansion?) 6.0% vs. 10.0%
12. S&P 500 P/E ratio (1-year trailing) 8.0x vs. 20.0x
13. P/E ratio (10-year normalized in real terms) 7.0x vs. 23.0x
14. S&P 500 price-to-book ratio 1.0x vs. 2.2x
15. S&P 500 dividend yield 6.0% vs. 2.0%
16. Investor sentiment 10% bullish vs. 88% bullish
17. Baby boomer population Median age is 25, peak spending and investing years ahead (capital gains) vs. Median age is 52, retirement focus ahead (capital preservation)
The Usual Suspects
Recognize any of the suspects below? They’re being charged with mismanaging the economy, amongst other crimes.
The Fed’s Keeping the Pedal to the Metal
From Scott Lanman at Bloomberg:
“Federal Reserve officials last month debated increasing and extending asset purchases should the economy weaken, with a few favoring the move and one seeking a reduction, minutes of their last meeting showed. Policy makers also differed over whether risks are greater that inflation will speed up or slow down too much, the Fed’s Open Market Committee said. Some officials said “quite elevated” slack in the economy would damp prices, while others saw a risk of faster inflation from the Fed’s “extraordinary” stimulus. “
“To keep inflation expectations anchored, all participants agreed that monetary policy would need to be responsive to any significant improvement or worsening in the economic outlook and that the Federal Reserve would need to continue to clearly communicate its ability and intent to begin withdrawing monetary policy accommodation at the appropriate time and place,” the minutes said.
Policy makers in the Dec. 16 statement following their meeting said the labor market is stabilizing, while keeping a pledge to keep interest rates “exceptionally low” for an “extended period.” The Fed said most lending programs would expire as scheduled on Feb. 1 because of “improvements in the functioning of financial markets.”
One member said the Fed could reduce planned asset purchases because of improvement in financial markets and the economy, and “that it might become appropriate” to start reducing asset holdings “if the recovery gains strength over time,” according to the report. The Fed is buying $1.25 trillion of mortgage-backed securities issued by housing-finance companies Fannie Mae, Freddie Mac and federal agency Ginnie Mae.
Some officials said there was a risk that the end of Fed purchases and federal homebuyer tax credits may “undercut” improvements in the housing market. Under Bernanke, the Fed has cut interest rates almost to zero and pumped more than $1 trillion into the financial system to battle the worst recession since World War II.
Officials “generally thought the most likely outcome” was for economic growth to “gradually strengthen over the next two years,” helping reduce joblessness and slack. Still, the “weakness in labor markets continued to be an important concern,” the Fed said.
At the same time, Fed officials “noted that any tendency for dollar depreciation to put significant upward pressure on inflation would bear close watching,” the central bank said.
Conclusion
This week should give us a better view of investor appetite. Volume should begin picking up again as vacations end, bonuses are paid, and people reallocate for 2010.
Have a great week.
Ned
“One determined person can make a significant difference; a small group of determined people can change the course of history.”—Sonia Johnson,
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