U.S. stocks wandered aimlessly the entire day…up, down, up, down -- you know the drill, eventually erasing the final rally in the waning 10 minutes of the session.  There is zero conviction right now as short-term traders just wait to see which direction we go -- headed to test that 1040 level on the S&P 500 or higher to the top end of the most recent range, about 1118. 

The economic data was not a help really.  Personal income and spending was offsetting as incomes came in a bit below expectations, while spending a bit higher.  Overall, I thought the report was a good one, as the gain in income outpace spending; it would be nice to see this play out for a while, but as we elude to below this is probably not the type of stuff traders would like to see – spend baby, spend. 

Energy and basic material stocks were the worst hit groups yesterday,  It was a divided session as five of the top 10 industry groups fell with five gaining ground.  Consumer staple and telecom shares were the out-performers.

Treasury securities continued to rally, making it four of the past five sessions, as the yield on the 10-year fell to 3.02% -- again – and the two-year looks headed below 0.60% -- a record low yield, even below the 2008 and 2009 lows.  And the rally continues today as the 10-year yield is down another five bps to 2.97% and the two-year just barely above that 0.60% mark at 0.617%...continued after the jump.

Market Activity for June 28, 2010

What’s going on here?  Are traders gearing up for that next round of QE we’ve been talking about?  (Certainly not officially announced I must add, but it’s more than a guess as all one needs to do is read Bernanke’s 2002 speech, Deflation: Making Sure “It” Doesn’t Happen Here – for those unwilling to read the entire speech, attention to the final paragraph is all that’s needed to get a clear view of what’s ahead)  Or is it simply the view that another round of economic trouble is around the corner?  The two, of course, go hand in hand because if the economy had the escape velocity to propel it into a durable expansion then additional QE wouldn’t be viewed as necessary by the central bank.  Maybe this is all just massive short-covering as all of those “steepener” trades, or shorting of longer-dated Treasury securities on the view those yields would rise. 

Whatever the reason, this is not market activity that suggests the recovery has durability.  That is, actually has the juice to turn into a full-fledged expansion.  These are certainly strange times, conventional market strategy doesn’t apply as would normally be the case.  On the other hand, employing strategies that are unconventionally can get one badly burned.  Keep it safe, and just be patient; survival is the key.  New opportunities will arise in time.

Personal Income and Spending

The Commerce Department reported that personal income rose a solid 0.4% in May (just shy of the 0.5% expected), mostly driven by the segments that really matter – total compensation and wages/salaries.  Compensation rose 0.4% in May, which follows the same increase for April; wages & salaries rose 0.5%, which also matches the April increase.  These areas were boosted in May by strong pickups within the goods-producing sector, up 1.0% for the month – manufacturing-sector income rallied 1.2% after 0.7% in April. 

Proprietors income rose 0.6%; personal income via assets increased 0.6% for the month, interest income fell 0.3% but dividend income bounced 2.8% (this marks two months of big gains after three-straight months a significant decline for dividends; government transfer payments rose just 0.1% as unemployment insurance declined for the second-straight month.

On a year-over-year basis personal income is up 1.7% and disposable income (after-tax) is up 1.6%. 

So the transfer payment boost is over and for now manufacturing activity is helping to boost incomes within that sector of the economy.  The question from here is how long does this strong factory activity last – my belief is that it will wane by September – and offset the drag from declining government payments, which as we’ve talked about a lot over the past few months is always only a transitory help to overall incomes, that’s all it can be.  So things are playing out, thus far, as we’ve expected in generally.  The transfer payments are no longer a help, and if factory activity soon feels the pressure from the inventory cycle pretty much running its course then all we’ve talked about for several months will be right on cue.

On the spending side, personal outlays rose 0.2% in May (better than the 0.1% expected) after April’s flat reading – unchanged from March.  So here we have some of the payback from the big spending increases of February and March.  February spending jumped 0.5% and March was up 0.6%. 

As we saw via the latest revision to GDP, real personal consumption rose 3.0% in Jan.-March, which is pretty strong activity.  If we get a normal reading of 0.2% in personal spending for June, we’re looking at the largest component (personal consumption) of GDP coming in a bit shy of that seen in the first quarter – and since Q1 GDP came in at a weak-for-a-recovery 2.7% the expected 3.5% growth for Q2 looks pretty unlikely.  If spending comes in flat for June, then we’re looking at serious market-moving weakness.  This level of overall economic growth is not the level of activity that is necessary to boost job growth in a manner that sends the jobless rate meaningfully lower. And that’s where the rubber hits the road.  As transfer payments continue to decline, unless strong job growth shows up, consumer activity will be weaker than normal.

GDP is currently overly dependent upon both personal expenditures (you may recall us talking about this accounting for 80% of GDP when the long-term average is 65%) and inventories.  As a result, we should see GDP readings begin to wane by the third quarter.  Frankly, I view a slowdown in consumer expenditures as a good thing because spending needs to chill for a while in order for households to get their financing is better shape – although this short-term thinking market may not appreciate such a scenario, and Mr. Market is not ready for sub 2.0% GDP readings. 

As a result of incomes handily outpacing spending, the savings rate increased to 4.0% from 3.8% in April.  We hit 6.4% on the cash savings rate (cash set aside as a percentage of disposable income) when the consumer went into hiding a year ago.  I think we’ll get there again over the next year, certainly 5% will occur as something in the 6% handle may not occur only because you’re getting paid zilch on deposits. This continued and necessary increase in the cash savings rate will have an adverse effect on intermediate-term spending and economic growth, but it will set up for better conditions from a long-term perspective. 

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900