U.S. stocks began Tuesday’s session lower, following a 3% decline in Shanghai overnight, and after the latest figures on small business, productivity and inventories were released the selling accelerated.

Bernanke came to the rescue though, by delivering an FOMC statement that further pledged the Fed will be there to provide all the easy money traders need to buoy stock prices – oh, if it were really that easy – as the broad market was able to pare most of the early-session losses directly after the announcement.  

Utility, telecom, consumer staple and health-care shares were the gainers on the session.  The other six major industry groups declined, led by tech and financials. 

As a result of the Fed’s latest statement, which we’ll get into below, the long-end of the Treasury curve rallied big time – the yield on the 10-year finished the session at 2.76% and is down to 2.72 this morning. 

And while we’re talking about the curve, yesterday’s $34 billion three-year auction was sweet (well, in terms of funding, not in terms of what it says for economic prospects) as demand was the second-highest in history, all for a yield of 0.84%. 

Market Activity for August 10, 2010

NFIB

The National Federation of Independent Business reported that its gauge of small business confidence remained pretty floored in July, falling to a reading 88.1 (just beating the 88.0 expectation) from 89.0 in June.  This reading was stuck below the 90 mark for longer than any time in its 34 year history until it bounced above that level to 92.2 in May. But that was good for only one month; never before has that occurred, a move above 90 only to slide right back down in the following report – it’s never occurred before basically because there was only one other period when the measure went below 90 to begin with, the 1980 recession. 

The segments of the report (the questions to respondents) that helped the overall reading from falling further were: Higher selling prices – up to a net -12% from -13%; expect higher sales -- up to -4% from -5%; inventory satisfaction -- rising to 0% from -1%; and good time to expand – ticked up to 5% from 6%.  But these improvements aren’t much to talk about as they remain at recessionary levels.

What hit the index hardest was a crushing net number via the expect a better economy question, which got slammed to -15% from -6% -- the lowest reading since the depths of the credit crisis, and I don’t think you need to pay attention to anything else with regard to future hiring plans. 

Plans to increase inventories also fell – down to a net -4% from -3%; easing of credit conditions fell to -14% from -13%; positive earnings trends fell to -33% from -32%. 

The one area that shows there are two different worlds on there in labor-market land was the rise in positions not able to fill component, up to 10% from 9% in June.  This number never went negative and while a reading of +10% is off of normal labor market conditions readings of roughly +20%, it shows that many, not all but many, skilled workers aren’t having a problem finding work.  Those who have really been crushed are the less skilled, who were finding relatively higher-paying work during the housing boom, but now must take lower wage positions as they don’t have the skills to fill the jobs that are needed.  (I should note: there are plenty of skilled trade workers who are having trouble because of very weak construction activity, but the above comments speak to the general universe of labor conditions.)

Second-Quarter Productivity

The measure of output per hour worked, the most important factor regarding profit growth, fell for the first time in six quarters as employee hours worked outpaced output.  Productivity fell 0.9% at an annual rate (expected to increase 0.2%) after posting huge readings in the prior five quarters (averaging nearly 6% at an annual rate during that run as output rebounded from very low levels yet hours worked declined as employers slashed jobs).  Note: the first two quarters of that five-quarter run resulted in a boost to productivity only because employee hours fell more than output had.  But in the final three quarters, output was rebounding and the productivity gains were real, if not extremely transitory.  

Anyway, for this latest reading output fell to 2.6% at an annual rate, down from 5.0% in Q1 and 6.7% in Q4 2009.  If this figure continues to slide at this rate -- that is, the rate of growth deteriorates to the same degree in the third quarter -- it all but says that even the tepid job growth we’ve seen is going to be extremely short-lived.  And for profits, you can expect the great news we’ve seen here over the past few quarters to run its course very quickly as well – which is what concerns us.

Wholesale Inventories

The Commerce Department reported that distributors’ inventories rose 0.1% in June (expected to rise 0.4%) and the vital sales figure fell 0.7%.  This marks the second-straight decline on the sales front.  We’ll wait for the business inventories report, to be released on Friday, as this figure includes stockpile changes and sales at the retail level.  But it appears the inventory cycle has pretty much reached its end, which means a major catalyst of GDP has faded away – inventory rebuilding accounted for 50-75% of GDP growth over the prior three quarters.

FOMC Statement

In the statement following the conclusion of yesterday’s FOMC meeting the Committee acknowledged that household spending remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit; that business spending is rising, but investment on structures remains weak and employers remain reluctant to add to payrolls; housing starts are at depressed levels; and bank lending continues to contract.  Thus, the pace of economic recovery is likely to be more modest than they had anticipated. 

So there is the assessment part of the statement and that final comment signals that when the minutes are released in four weeks the Fed will have again lowered their growth forecast. 

In terms of the famous phrase, that an exceptionally low levels of fed funds will remain in place for an extended period, it remains intact – and Hoenig remains the lone dissenter, wanting to pull the “extended period” from the phrase. 

On quantitative easing, the Committee stated that in order to help support the economic recovery they will reinvest principal pay downs of their mortgage-backed securities in longer-dated Treasury securities (concentrated in the 2-to10-year segment and TIPS).  They’ll continue to roll their holdings of maturing Treasury securities, which was already in play.  This is the QE-Lite, as many have termed it, in order to keep their balance sheet from shrinking – to prevent money from being drained from the system.

This is a bit more than I expected, as it didn’t seem likely to me that Bernanke would choose to do this prior to sending more of a signal first.  But overall, it doesn’t amount to much other than, again, keeping the balance sheet from shrinking.  Their statement on the economy remained a bit optimistic to me, even if they did signal they’ll be lowering the forecast.  In my view, reality will cause them to go big bang with regard to buying more Treasuries, maybe even corporate bonds, in the future. 

As we discussed yesterday, this will not keep GDP from either contracting or falling to such a low level that it may as well be a negative print (although it certainly assists  the government in financing debt at ultra-low rates) but it’s all they know and can do.  To ultimately pull us out of this funk, we need strong and consistent job growth and there is nothing the Fed can do to foster this as such efforts are in the hands of Congress and the WH – business needs incentives and the curtain of uncertainty to be pulled open.

Have a great day!

Brent Vondera, Senior Analyst