U.S. stocks got off to a strong start Monday, but gave back all of those gains, and then some, by late afternoon as traders faded the rally. 

The early-session euphoria was fueled by the surprise news that China will allow their currency to float, albeit in a narrow range.  The broad market jumped 1.2% at the open, but slowly lost air by lunch and then slid into negative territory with less than an hour left in the session.

The decision to allow the yuan to float (as opposed to holding it at a fixed exchange rate to the dollar) could have many implications, but the one that seemed to get equity traders excited was the idea that it suggested the Chinese government believes the global expansion is self-sustaining – since the Chinese re-pegged to the dollar when the financial crisis began in earnest.  But as the day progressed, more saw the announcement as something meant to head off criticism at the upcoming G-20 meeting, a political ploy, than any meaningful intent to allow the yuan to appreciate.  And if the global economy runs into trouble again shortly, we’ll see them quickly renege and re-peg. 

Consumer discretionary shares were the session’s worst performing group – eight of the 10 majors fell yesterday.  Basic material and industrial shares were the only two groups able to hold onto earlier gains.

Market Activity for June 21, 2010

Rude Awakening

We’ve spent a lot of time talking about the current economic recovery and the likelihood that it will not prove long lasting.  There have been a lot of people that seem to be expecting the current recovery to emerge into a normal expansion -- which would mean higher levels of economic output for 5-8 years.  To the contrary, we’ve discussed that the economic recovery is far from normal this time and if not for massive government spending and an unprecedented level of monetary easing from the Fed the recession would have lasted longer. 

And here’s a question: When a contraction is halted by artificial means, has it truly ended?  It has in the sense of statistics but maybe not so much on the ground.

Surely the Fed had to be there as the lender of last resort when the financial crisis hit its crescendo, but they didn’t have to keep the emergency level of accommodation in place even to this day, and with no clear sign of removing it anytime soon.  And for Congress, our representatives could have taken a path of reduced tax rates (I’m talking everything: cap gains, dividends, corporate income, personal income, overseas earnings) but beyond that left the market to find equilibrium on its own. While this process would have been harsher, the contractionary cycle could have completed by now and thus the economy would be on more solid footing. Now what’s the Fed to do with their conventional powder spent if we do dip somewhat quickly into another recession?  Well, as we’ve been predicting, they’ll implement another round of quantitative easing, and this time it won’t be a $1.5 trillion program, but much more – thereby quite possibly creating even larger issues to deal with down the road.

Alas, fiscal and monetary stimuli can only do so much, and in fact such decisions can lead to, sorry to sound cliché, unintended consequences – the misallocation of capital and delaying the economic correction.  In fact we are receiving more data that supports the idea of an economic double-dip.  At the least we’re headed for a paltry level of growth that has no chance of propelling the level of job growth we need to escape current troubles. 

For instance, the Economic Cycle Research Institute (ECRI) releases a weekly leading economic indicators index and that reading has taken a turn for the worse over the past four weeks.  On Friday, we received the latest reading, which showed the index slid to a reading of -5.7 from a positive 8.9 just four weeks prior. 

Once this measure approaches a reading of -10, it has predicted every recession since 1970.  If this thing doesn’t turn quick, it’s going to signal economic trouble will ensue even faster than I had thought – and we all know my take hasn’t exactly been optimistic.  Such is the fantasy of government intervention – and they told us the Keynesian multiplier is 1.4 (one dollar of government spending produces $1.40 in economic growth); that so called multiplier is closer to 0.7. 

(I don’t have an arrow pointing to the 2001 period because it was a downturn, it does not fit the classical definition of recession because we never recorded two consecutive negative GDP readings.)

Today’s Data

After a couple of days without an economic release, we get back to it today with existing home sales (May), Richmond Fed (June) and ABC consumer confidence (week ended June 20).

Existing home sales for May should be another good report, but it’s lagging what current contract signing activity is showing.  Existing home sales are counted when the contract is closed, so this activity is a reflection of March and April signings – the tax credit expired (for signings) on April 30.  The June figure should show quite the deceleration in activity and starting with the July data, the figures will prove ugly.

Richmond will give us the third regional manufacturing report for the month of June.  We’re basically one and one, the Empire report was strong, but factory activity out of Philly was weaker.  My estimate remains unchanged, factory activity will show real deterioration by August/September.

We’re still waiting for the ABC confidence index to rise above levels seen in past recessions/downturns, which is also the case for the Conference Board’s survey of consumer confidence – the most watched measure.  

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900