Well, I guess the way stocks ended the day yesterday was apropos for the quarter.  A decline in the back-half of the session turned into a slide in the final hour, despite a momentary rally from the day’s low.  For the quarter, stocks also fell in the back-half, sliding at the end despite a mid-June rally.  The difference is for the quarter the final session recorded the period’s nadir.

Stocks actually began yesterday’s session up a bit as traders were feeling a little juice in pre-market trading after hearing European banks borrowed $161.5 billion via the ECB’s three-month lending facility, below the roughly $200 billion expected.  This was all part of the refunding we talked about in Tuesday’s letter due to the ECB’s one-year refinancing facility being closed out. Although, an interest-rate strategist at BNP Paribas did mention that many of the banks that borrowed $540 billion via the one-year funding program from the European central bank did so not because they needed it but as an arbitrage opportunity – and much less arbitrage is to be had now that the facility is for a term of three months rather than one year.  So it’s possible that the lower-than-expected borrowing from the ECB may not be as positive as it seems -- yet another example of premature excitement I’m afraid.

It is inconceivable that the EU financial system has suddenly begun to heal, as the headlines suggested, when it is likely to get worse.  Nothing but solid-to-strong economic activity will heal the loans on their books, the bonds they hold and inter-bank lending rates.

Anyway, the feel-good sensation didn’t last as a much weaker-than-expected ADP employment report later weighed on sentiment -- we’ll touch on that below.  Offsetting the bad preliminary jobs report was another strong regional factory survey, but the market appears to be looking forward, concerning itself with what may unfold over the next several months rather than manufacturing activity for a month that has now ended.  Reality appears to have overcome easy money.

Market Activity for June 30, 2010

Quarterly Results

For the quarter the broad market, as measured by the S&P 500, fell 11.86%, ending a three-quarter streak; the Dow Industrial Average fell 9.97%; the NASDAQ Composite slid 12.04%; the S&P 400 (mid cap) lost 9.90%; the Russell 200 (small cap) declined 10.19%; the major international index was hit by 14.91% and Emerging Markets lost 9.14%.

In terms of sector, the best performers were consumer discretionary (-0.46%), utilities (-4.82%) and telecoms (-5.65%).  The worst performers were basic materials

(-15.72%), financials (-13.56%) and energy (-13.27%).

You can see value beginning to present itself in a number of areas, but when fear picks up value can be like a knife.  You’ve got to be willing to catch that knife at some point because prices can move right through intrinsic value levels (of course anyone’s intrinsic value is always subjective).  The P/E at which the market currently trades is attractive, but I doubt earnings are going to hold up as well as most seem to predict right now.  Again, value is beginning to present itself, but the economic weakness that appears to be coming is likely to drive the market multiple higher even as prices are lower and that must be factored into the valuation analysis.

Mortgage Apps

The Mortgage Bankers Association reported that its applications index rose 8.8% for the week ended June 25, after the prior week’s 5.9% decline.  Alas, the reading was boosted solely by refinancing activity as purchases dropped again – down in six of the seven weeks that followed the tax credit expiration of April 30.

Applications to refinance rose 12.6%, thanks to a 4.67% average rate on the 30-year fixed mortgage.  But purchases declined 3.3%, even with borrowing costs approaching the lowest level ever, which was hit in March 2009 at a rate of 4.61% for the 30-year fixed. 

Ultimately, we need strong and durable (consistent increases for 12-18 months) labor-market expansion to completely pull housing back into recovery mode.  Without solid sales figures the distressed properties that will continue to hit the market will drag prices lower – which will also help in ending this housing trouble (the market must find that price that clears supply), but it will take additional time. 

ADP Employment Change

The preliminary jobs report out of the ADP, one of the world’s largest payroll outsourcing companies, showed private sector jobs increased for a fifth-straight month in June.  However, the 13,000 increase estimated by ADP was well below the 60K expected.  The May figure was revised up to show private-sector job growth of 57K (up from the previously reported 55K).

According to ADP, goods-producing sectors cut 17,000 jobs.  The manufacturing sector added 16,000 positions, but construction continues to weigh on the job market as the sector cut 35,000 positions.  Service-providing sectors added 30,000, less the half the average pickup for the past three months. 

Small firms (<50 employees) cut 1,000 positions, after May’s 13,000 increase.  Medium firms (< 500) added 11,000, after increasing payrolls by 42,000 in May.  Large firms added 3,000, following the 2,000 increase for May. 

ADP has been under-estimating what occurs within the official government employment readings, but even if official private-sector payrolls come in at four times the level ADP has calculated it will still miss the estimate by half.  For the overall employment reading for June, which we’ll get tomorrow, payrolls are expected to decline 125,000 as census jobs begin to be pared.  The market expects an increase of 110,000 private-sector jobs, while census employment is expected to decline by 235,000.

Chicago PMI

The fourth and final major regional manufacturing report for June showed factory activity remains strong as the Chicago Purchasing Managers Index came in at 59.1 after 59.7 in May.  The result was right in line with expectations.

New orders, backlog of orders and supplier deliveries all decelerated but remained in expansion mode – new orders moved below 60 for the first time this year but the 59.1 print is a strong reading nonetheless.  The employment figure popped back to expansion mode after falling below the critical 50 mark in May. 

The only negative occurred within the inventory gauge, which fell back to contraction mode after three months of expansion.  Maybe this is another early signal the inventory cycle has run its course; we’ll need more data to confirm.

All in all, this is another strong report for manufacturing.  My view is it will roll over by September as waning Chinese growth and EU troubles hit export activity and the inventory cycle will have run its course by then if confidence in intermediate-term economic prospects does not improve.   We get the national look at manufacturing today via the ISM report.

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900