Complacency Shaken, Central Banks are Cornered and the Data 

U.S. stocks began Thursday lower on concern over the European-debt situation, nothing new there, but market activity was normal for most of the day.  But then right around 1:30 CDT selling really began to pick up, sending the S&P 500 down 4% -- that’s when things began to break down. 

The slide kicked off automated sell orders as the market blew through technical support levels, traders began to panic and that’s when the fat finger enters the field -- a number of institutional trade errors occurred during the chaos along with apparently one whopper, which we’ll learn more about over the next couple of days.  

The Dow was down 998 points at its lowest level; the S&P 500 was down 100 points, or 8.5%.  But within 10 minutes of hitting the day’s nadir, the market spiked back, able to erase at least the panic-led losses to close down 3.24%.

Some of the wackiest trades -- such as Accenture evaporating for a few minutes as it collapsed from $40 to a penny, or what is supposed to be one of the most stable stocks, Proctor & Gamble, slid 36.5% in a matter of seconds -- occurred away from the NYSE.  Thanks to some market regulation for which I can’t remember the name, trading must move to where it can get done even if the NYSE sees a reason to pause, even if the bid makes no sense whatsoever.  So, it appears the specialists on the floor really do matter as they can rationally step back and pause when they see something that makes zero sense; so many have told us these specialists are obsolete – we know the automate-everything advocates are the ones who are obsolete; they are the fools that get everyone into trouble.  More below.

 Market Activity for May 6, 2010

Regardless of what triggered the run for the exits, and there are plenty of fingers pointing to high-frequency trading (algorithmic trading) – or lack thereof as these systems supposedly stopped trading and liquidity disappeared, it has shaken a level of complacency that was grossly unjustified in the current environment.  Some may remember the comment made in Monday’s letter: When risks lurk around many corners, it’s only a matter of time before some form jumps out and scares the complacency out of everyone.

That has happened. 

If you are to learn anything from what occurred yesterday it is this:  If you’re going to play the momentum trade, attempting to suck every little bit of additional gain under the belief that you’ll be smart and nimble enough to hit the exit, think again.  When chaos and fear rolls, liquidity dries up; you may not be able to get out at an appropriate level.  When the market goes chaotic don’t even try to exit, you may very well get burned. 

From the start of the session, the markets didn’t like that the ECB (the EU’s central bank) kept their benchmark rate at 1.00% and didn’t even consider purchasing government bonds during their latest meeting.  Traders want the ECB to get rates to zero and begin down the path of quantitative easing (bond purchases) that the U.S. and UK have traveled.  They resisted for now (although they are accepting Greek junk as collateral so in a roundabout way are bailing out EU banks), but things in Europe appear to be degrading to the point that Trichet & Co. will eventually have little choice. 

Such quantitative easing action from the ECB  is likely to calm the markets for a while, but it would likely lead (not initially, but lead) to a further run on the euro as currency traders will smell blood and the markets in general lose any faith they may still have in the European central bank. 

Cornered

The ECB is between a very large rock and a very hard place, just as our own Fed is smashed between.  Do nothing and investors flee risky assets; do something and it buoys the markets for now but leads to other serious problems down the road.  There’s only one way out of this rolling debt crisis: it involves time, patience and a lot of economic distress.  My belief is that this situation can be managed more properly by slashing public-sector spending and tax rates.  This won’t solve things overnight, but there is no immediate fix to the high debt levels of both households and government.   There’s a very loud argument that government’s can’t slash spending now, it will result in even more economic damage.  They forget that, at least in terms of the U.S., that corporations are sitting on massive amounts of cash.  They’ll deploy this cash, which will lead to jobs, if they believe some rational longer-term policy has returned. 

Back to the Till

Freddie Mac returned to the Treasury ATM yesterday as the Federal Housing Finance Agency submitted a request for another $10.6 billion.  (And banks are reducing provisions as if the housing market is in some kind of organic rebound, oh I don’t think this is going to end well -- refer to our April 13 letter Living on a Prayer.)  Freddie’s first-quarter loss came in at $8 billion, after a $6.5 billion loss in Q4.  This request for cash brings the Freddie rescue to $61 billion and the combined Fannie/Freddie bailout to roughly $120 billion; there will be more to come.   

Jobless Claims

Initial jobless claims fell for a third-straight week, falling 7,000 to 444,000 in the week ended May 1.  Initial claims have eased after hitting 480,000, again, in the week ended April 9 but remain stuck around this 450K level.  This data is unable to make it down to the 400K level (as we continue to explain this is a level that is always accompanied by consistent job growth, it’s not always strong growth but it is consistent).  The closest we got to 400 was 439K during the week of February 5, only to see it jump back to 486K two weeks later. 

The four-week average of initial claims fell 4,750 to 458,500.

Continuing claims for unemployment benefits rose about 95K as standard claims (those that last the traditional 26 weeks) fell 59K but Emergency Unemployment Compensation (EUC) claims rose 153K – these are the benefit extensions to the standard period of benefits.  These EUC claims have a two week lag to them, this latest data covers the week of April 17.  Congress has since passed another round of extensions, which had lapsed over the previous four reporting weeks.  I wouldn’t count out the strong possibility that EUC claims jump next week.  If they don’t, I think some mild degree of improvement has occurred. 

First-Quarter Productivity (Advance)

There was some concern ahead of this reading that the productivity measure would fail to meet prior expectations, but I’m not sure why considering the massive pace at which businesses slashed employees and the current, albeit mild, inventory rebuilding process that is underway.  That is, output continues to vastly outpace hours worked.

So, the reading on first-quarter productivity did not disappoint, coming in at 3.6% at an annual rate vs. expectations for a reading of 2.6%.  That said, the fourth-quarter reading was revised down to 6.3% from initially reported 6.9%, but when this measure has averaged 2.1% over the 25 years I don’t think that’s anything to get all worried about.

What you do worry about is that this pace of output per hour worked (which is what productivity measures) is not sustainable unless firms are going to refrain from hiring; and even then it’s not sustainable as high joblessness will curtail end demand.  In the previous quarter, output rose at a 4.4% annual rate, while hours worked rose only 0.8% -- hence the 3.6% increase. The healthy type of productivity comes from technological advances that allow output per hour worked to advance even as job creation occurs.  What we’re seeing right now, not that we have a technology problem, is that the vast majority of this surge in productivity is from massive payroll cuts. 

Chain Store Sales

The International Council of Shopping Centers’ (ICSC) tally of 31 retail chains reported that year-over-year same-store sales grew 0.8% in April after March’s 9.0% surge.  The April reading was held back by an Easter holiday that fell earlier on the calendar than it did in the previous year, which also caused the March surge.  I hear a lot of analysts stating that we need to combine these two months so to smooth out the results based on the Easter holiday, which is absolutely correct.  But funny, I didn’t hear any of this as so many seemed to get overly excited when the March number came out, it’s only now that the April figure was a dud that they want to average the two months – we talked about this last month. 

Anyway, combine the two months and same-store y/o/y sales rose a strong 4.9%.  Of course, this is off of the very depressed period of March/April 2009 when the consumer was in hiding.  Year-ago comparisons will become much tougher for retailers as we enter the fall.  

Have a great day! 

Brent Vondera, Senior Analyst

Phone: 636-449-4900