U.S. stocks bounced between gain and loss on a couple different occasions Friday, ending the session slightly higher.   For the week, the broad market ended essentially flat, down just 0.4%. 

A strong regional manufacturing report offered the greatest boost to the market. a revised GDP reading that came in a bit higher than previously estimated may have helped a little too but the increase was mainly due to a downward revision on the inflation gauge tied to the report – nominal GDP was unchanged from the initial estimate, more on that below the jump.

The January existing home sales report kept the day’s gains to a minimum as sales posted the second-largest monthly decline on record; the largest decline occurred in the previous month.  

Financial and industrial shares led the broad market higher.  Bank stocks helped propel the financials after Barclays recommended buying shares of JP Morgan.  I don’t know, JP Morgan is one of the best-run banks out there but the fourth-quarter FDIC report on the industry didn’t paint a pretty picture for the industry.  The coverage ratio among insured banks slipped again last quarter to a level that is less than half where it was a few years ago when loan quality was strong – trouble lurks if loan quality fails to improve markedly, and quick.

Utility and consumer staples were the losers on the session, being the only two of the top 10 sectors to close lower on the session.

Market Activity for February 26, 2010

First Revision to Q4 GDP

The Commerce Department’s first revision to GDP, there will be one more coming next month but this should be a pretty true number, showed the economy grew at a 5.9% real annual rate last quarter.  The flash estimate, the advance look, had GDP up 5.7% when it was reported in late January.

So what changed? 

Well, the price deflator was revised down by 0.2 percentage point – the nominal reading (unadjusted for inflation) remained unchanged at 6.3%

The inventory segment was revised substantially higher as it showed stockpiles were reduced by just $16.9 billion, a reduction of $33.5 billion was estimated via the flash reading.  As a result, the inventory dynamic accounted for 3.88 percentage points of the 5.90% increase in GDP – previously thought to contribute 3.39 percentage points.  As we’ve talked about in the past, inventories don’t have to actually rise, they only need to fall at a reduced rate from the previous quarter to add to GDP.  Inventories were slashed by $139.2 billion in the third quarter so the $16.9 billion reduction offered a powerful boost. 

Also, within the private investment component of GDP, nonresidential structures fell 13.9% vs. the -15.4% initially estimated (subtracting 0.47 percentage point from the overall figure instead of the -0.52% previously estimated); equipment & software was revised substantially higher, showing an 18.2% jump vs. the 13.3% increase via the initial estimate (adding 1.09 percentage point to GDP vs. the 0.81 previously estimated).  Conversely, residential fixed investment was revised down to show an increase of 5.0% vs. the 5.7% increase initially estimated, but this didn’t hurt the private investment component or overall GDP too much as the housing sector accounts for about half of what it did a few years ago (adding 0.13 percentage point vs. the 0.14 previously thought).

Personal consumption, the largest component of GDP, was revised down to show an increase of just 1.7% from the initial estimate of 2.0% -- that means the contribution to overall growth was lower by 0.21 percentage points. 

Government consumption also weighed on the figure more than was originally estimated, but not because the federal government isn’t trying it’s best to boost things.  What people expecting public spending to boost the economy are forgetting is that state and local budgets are in a world of hurt, and they’re going to remain that way until we get policy that incentives business spending and production – necessary conditions to get hiring commitments rolling.  

The overall government component weighed on the GDP reading by a figure of 0.23 percentage point, surely not a big number but worth commenting.  State and local government spending fell 2.0% at an annual rate in the fourth quarter and this was with the federal government pumping huge amounts of cash to the states.  They’ve been using this money to plug budget gaps, so when the money transfers wane the state problems will really emerge.

Here are a few additional comments: 

The best news of the report was the jump in equipment & software.  This was due to a couple of factors. 

* Firms need to replace aging equipment and that’s what they are doing – managing capital expenditures to maintenance levels (they surely aren’t adding equipment, such as computers, because they’ve hired more people and they have no need to build more plants as plenty of excess capacity remains at existing facilities). 

* Second, the fourth quarter is generally a period in which spending on equipment jumps and this occurred with unusual effect at the end of 2009 as firms were chary with cash for most of the year and found they had unspent budgets in November and December, so engaged in the outlays. 

(S&P 500 companies saw their cash levels increase by 67% over the past year, largely helped by the big reduction in expenditures during most of 2009 (business investment fell the most since 1942 for all of 2009).  So, the money is there but they’ll need more certainty and less talk and action out of Washington that causes high levels of corporate caution for the nascent capital spending rebound to turn into a trend.)

In addition, the inventory dynamic that we’ve been waiting for came through big time in this report, accounting for 66% of the increase in GDP.  That’s all fine and good, but a couple of quarters out we’ll need end demand (final consumer and business demand) to take over from the inventory bounce or the recovery will fade.  

It’s important to note: The real final sales reading of the GDP report (which excludes the inventory component and thus illustrates the state of end demand) rose just 1.9%, which is weak for the beginning stages of a recovery from a deep recession.  This number averaged 4.1% following the previous-worst recessions of the postwar era.   I believe that this number is another indication that the economic bounce won’t be lasting, but we’ll see. 

Chicago PMI

The Chicago Purchasing Managers Index (factory activity within the region) accelerated to 62.6 in February (the expectation was for the reading to slip to 59.7) from 61.5 in January.  This February reading borders on the cusp of robust activity and has shown very nice progression over the past five months, back in September the reading remained mired in contraction mode with a reading of 46.0 (a reading above 50 marks expansion).

The Good: New orders slipped to 62.2 from 66.4, but this level is strong so the deceleration can’t be viewed as bad; order backlogs accelerated to 58.5 from 54.3 and supplier deliveries jumped to 62.6 from 55.3 (these are two areas we’ve been watching as indications of future factory employment growth, several months of increase shows firms are having difficulty keeping up with orders and will thus have a greater need to hire).

The Bad: Inventories fell to 42.4 from 48.7 (this reading should be moving to expansion mode); employment fell to 53.0 from 59.8 (maybe it’s incorrect to call this “bad” as it remained in expansion mode, but the official monthly jobs numbers show factory employment continues to contract so maybe we need to see this reading in the 60s to offer some evidence manufacturers are actually adding workers).

Existing Home Sales

Previously-owned home sales fell 7.2% in January to 5.05 million at a seasonally-adjusted annual rate (SAAR), economists had expected sales to increase (although I’m not sure why) by about 1% from the previous month. 

The January decline is the second-largest on record and follows the record decline of 16.2% in December.  Purchases fell in all regions, led by an 11% slump in the Northeast.  Sales fell 7.4% in the South, 6.9% in the Midwest and 5.2% in the West. 

The share of existing homes sold to first-time buyers fell to 40% from 43% in the prior month.  Distressed sales accounted for 38% of all homes sold, up from 32% in December.  

This data involves both single-family homes and condos & co-ops, but single-family units is the component that matters as it make up 88% of the total.  Single-family sales fell 6.9% last month after December’s 16.6% slide.  The spring/summer bounce in existing homes sales that got everyone so excited is proving to be extremely transitory as the figure appears to be headed back to the 13-year low hit in November 2008.  I’m not convinced this will occur as the tax credit will combine with warmer weather in March and April to provide a bounce, but it’s not looking too good, as the chart below illustrates. 

The supply of previously-owned homes, relative to the current pace of sales, rose to 7.6 months worth from 6.9 months in December – yet remains well-below the 23-year high of 11.0 hit in June 2008. 

The median price of an existing home fell 3.5% for the month to a new cycle-low of $163,600 from $169,600 – but about flat from the year-ago level of $164,200.  Needless to say, the 17% jump in prices during the first eight months of 2009 was completely due to government incentives and only delayed the inevitable.  As the high percentage of distressed sales shows, lower prices are needed to clear inventories – at least with the jobless rates hovering around 10%.

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900