U.S. stocks spent the entire session in negative territory, but it was still volatile below the cut line.  During the first couple hours of trading it looked as though the broad market would keep the losses to a minimum, particularly ahead of a holiday weekend.  But things changed after Korea and Spain re-entered the headlines. 

Comments from a North Korean General caused tensions on the Korean Peninsula to pressure stocks again.  The Korean General warned that even accidental conflict along the Demilitarized Zone will lead to “all-out war.”  This sent the market meaningfully lower for the first time of the session.  Stocks then managed to bounce...until additional news out of Spain hit.

Another Spanish savings bank, this one their largest with $235 billion in assets, reportedly began talks to merge with five other banks.   This is another coordinated effort by the Bank of Spain as these financials are in trouble, saddled with ailing real-estate loans.  And with Spain’s 20% jobless rate, there will be more to come.  This news was compounded by Fitch Ratings’ downgrade of Spanish government debt from AAA to AA+, which remains a joke of a rating itself.  Some viewed this as nothing more than catch up, as S&P downgraded Spain a month ago or so, but this latest downgrade may have been triggered by the breakdown of bilateral talks on public-sector wage reductions – labor strikes should begin any day now in Lisbon. 

Market Activity for May 28, 2010

Personal Income, Spending and Savings

The Commerce Department reported a good personal income and spending report, although the market may not like it.  Personal income for April looked good across the board, the most balanced income report we’ve seen in a very long time.  Overall, personal income rose 0.4% for the month – right in line with the expectation.

The private-sector components looked really good.  Compensation was up 0.4%, as was the wages & salaries figure; proprietor’s income rose 1.3%, boosted by a large 14.6% on the farm side, but nonfarm was up 0.9%; rental income chilled out a bit, rising 0.2% after six months of fairly big gains; personal income from assets rose 1.1%, after three months of decline – interest income fell 0.2%, but dividend income rose 4.1%; government transfer payment actually fell (first decline since October), as unemployment insurance slid 14.5% -- this was likely due to the emergency extensions expiring (those who used up their traditional 26 weeks of benefits were thrown off the dole, but that will change by the time the June report is released as Congress has passed another extension to those benefits). 

On the spending side, activity was flat (no change from March) – the expectation was for an increase of 0.3%.   The purchase of durable goods fell slightly after big increases in the prior two months (new home buyers using those tax credits).  Non-durable goods fell 0.5%, spending on these items, anything not meant to last at least three years, were also up big in the previous two months.  Purchases of services rose 0.25%.

While a short-term mindset of the market may not like the April spending results, this is exactly what needs to occur – sorry to say, we need more of this in order to get things right again.  The cash savings rate rose for the first time in four months, hitting 3.6% after falling to 3.1% in March.  

As we’ve been discussing, this measure of savings will trend toward the 5.0% range (and my view is that it will likely get to 6.0%. which we hit briefly in 2009) as households will gradually except that it may be a while before they can count on their savings within the stock market rising in a consistent manner again.  In addition, the state of the labor market (which is looking better but it will have to continue its improvement for well over a year to gets households comfortable with lower cash levels) and high indebtedness will also require more cash savings. 

Chicago PMI

The Chicago Purchasing Managers Index, a measure of factory activity for the largest manufacturing region, slipped a bit to 59.7 for May from April’s red hot 63.8.  The report illustrates that manufacturing activity continues to hum, although it won’t surprise anyone that I have my concerns as we enter the final two quarters of the year.  Between Europe’s woes, China reining in their stimulus measures, U.S. stimulus waning and auto production that may have gotten ahead of sale prospects manufacturing will see things weaken. 

But this report showed none of that is play right now.  Nearly every sub-index continued to post solid-to-strong numbers.  The one disappointment was the employment index, which fell back to contraction mode.

Misallocation

I’ve been wondering what kind of lobbying scheme the NAHB (National Association of Home Builders) will come up with now that the tax credit has expired.  We saw both the NAHB and NAR (National Association of Realtors) go apoplectic when the credit was set to expire the first time and worked feverishly to get it extended. 

Well, last week I found out as a new bill is working its way through the House – it will be termed the Residential Construction Lending Act, a program within the Treasury Department.  It will guarantee loans to builders, as if we need more houses on the market right now.  Government intrusion into private markets has already delayed the housing recovery.  If this thing passes, it will result in a misallocation of resources and a deeper home supply glut that will make the conditions within this market even tougher.  As I continually repeat, never underestimate Washington’s ability to royally screw things up. 

Futures

Stock-index futures are substantially lower in pre-market trading.  Some are citing slower economic growth in China as the concern, a topic we’ve spent pretty much time touching on over the past few weeks. While their latest manufacturing report did show relative weakness, I wouldn’t rule out that the rising prospects of another summer war between Hamas/Hezbollah and Israel (which means a proxy battle between Iran and Israel) is what’s pushing markets lower.  With everything else that is going on, such an event would very likely bring the safety trade back into full effect.

Have a great day!

Brent Vondera, Senior Analyst