U.S. stocks ended lower on Friday but managed to close higher for the week, making it three in a row.  The broad market advanced 0.86% last week, with the Dow and NASDAQ Composite posting gains of 1.1% and 0.29%, respectively. 

Stocks struggled virtually all day as prices started to slide after a brief uptick during the first half-hour of trading.  It was the Indian central bank causing some concern among traders as they unexpectedly raised their benchmark interest rate.  This market appears to be too dependent on fiscal and monetary stimuli and any signs of the punch bowl being taken away are generally followed by selling.  Remember, it was Bernanke’s reiterated pledge to keep fed funds at an exceptionally low level that spurred Tuesday and Wednesday’s gains – those sessions made the week for the broad market. 

Basic material, energy and tech shares led S&P 500 lower.  Telecom and health-care shares were the only sectors out of the 10 majors that closed higher on the session. 

Market Activity for March 19, 2010

Smoot-Hawley Redux

Last week we discussed how the rhetoric between the U.S. and China is heating up.  On Sunday things moved to another level as China’s commerce minister cautioned the U.S. against citing the Chinese yuan’s peg to the dollar as a reason to impose trade sanctions -- the yuan has been pegged to the dollar since 1995, although at various values over this period.  China overtly threatened retaliation. 

This is becoming dangerous territory; the last thing the global economy needs right now is a trade war.   When the Smoot-Hawley Tariff Act was about to be signed into law in June of 1930, Henry Ford spent an evening with President Hoover trying to convince him to veto the bill, calling it “an economic stupidity.”  It appears pretty obvious that we’re dealing with intense economic stupidity from policy makers yet again.  Not only would an escalating trade war be dangerous, we ought not demand that China allow their currency to strengthen against the dollar for other reasons as well. 

First, you don’t go out and express these statements in the open, no country is going to respond well to being called out in public; you do this stuff in private meetings – we’re watching amateur hour. 

Second, if the Chinese allow the peg to roll down, meaning to strengthen the yuan against the greenback, then that means China has less of a need to buy Treasury securities – it seems this fight is horribly timed as Washington runs up huge budget deficits.  (Less demand for Treasury securities means higher interest rates.)

Frankly, I’m fine with interest rates rising.  The normalization of rates will force the housing market to clear and speed up households’ pay down of debt (this will be an economically damaging process but a necessary development; you counter it with aggressive across-the-board tax-rate reductions so to ease the economic weakness).  But current policy makers certainly don’t want interest rates to rise, and that’s the irony of their demands for a stronger yuan; if China were to cater to these demands they’ll be required to hold less dollars and hence demand less in dollar-denominated assets such as Treasury securities. 

Week’s Data

This week we get a number of important data releases.  We’ll be focused on new and existing home sales (February), durable goods (February) and of course jobless claims.

On the home sales front, surely the snowstorms played a role in activity last month but that doesn’t explain the seasonally–adjusted record monthly sales declines of December and January.  The new home sales figure has taken out the previous record low hit in March 2009 to make a new all-time low – so much for the bottom having been put in last year as so many predicted.  On previously-owned home sales, the December/January declines wiped out the gains made during the five months ended in November, yet they remain 11% above its multi-year low.  It appears that this data has bottomed and we won’t test that low mark but the market is extremely fragile.  Only strong and consistent job growth is going to bring the real estate market back.

On durable goods, we’ve talked about how the end-of-2009 jump in business spending was nice but it will have to be confirmed by durable increases in the following months – it is quite typical for business spending to rise at the end of the year as firms use up unspent capital expenditure budgets, and this was especially true in 2009 as firms remained chary with their cash for most of the year.  Well, we didn’t get that follow through in January as ex-transportation durable goods orders fell 1.0%; this ex-trans figure is the one to watch as it removes the extremely volatile commercial aircraft orders.   We’ll need a good number when this data is released on Wednesday.

On jobless claims, the importance here is that everything hinges on job growth -- housing, final demand (and hence consistent profit growth), loan quality and government revenues all rely on an improving labor market.   Initial jobless claims remain stuck above the 450K level, they need to fall below 400K in order to signal job growth is upon us, and the continuing claims data is literally off the chart.  This figure must improve over the next few weeks or people are really going to begin to doubt a jobs recovery. 

Futures

U.S. stock indices are substantially lower this morning as sovereign-debt concerns are flowing once again, primarily after German Chancellor Angela Merkel told investors not to expect this week’s European Union summit will deliver a package to help Greece tackle its deficit-funding issues. 

Of course, we have our own budget problems here in the U.S. as federal deficits are running at the highest levels (as a percentage of GDP) since WWII.  The fiscal troubles go beyond Washington as state and local budget gaps are in a world of hurt – and it’s going to get worse for the states as the stimulus package has helped to mask these problems.  Those direct payments will wane over the next year and if we don’t manage to achieve significant job growth (a huge increase in the tax base in what’s needed) state and local fiscal situations will deteriorate.  What passed last night will only make this situation worse. 

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900