U.S. stocks caught a bid after two of the day’s three economic reports beat expectations, prior to these reports pre-market futures were substantially lower on another round of global growth concerns and the clocking the Nikkei took the night before – down another 3%..  Really, the best report of the day was the one that missed estimates, but even that showed factory activity continues to weaken; and in terms of the market’s relative happiness over the fact that consumer confidence and Case/Shiller beat expectations, it mattered little in reality as the former remains in recession territory and the latter was boosted by tax credit-induced home buying.  More on that later.

But the market reversed course yet again and went negative after release of the minutes from the last Fed meeting.  Those notes showed the Committee remains concerned about future growth, which is obvious since the current level of accommodation is unprecedented and they’re considering doing even more (a consideration that will turn to action this winter in my view, and I’ve got an additional comment on the ultimate objective of pumping more money into the system below).   Bernanke gave us the gist of those minutes via last week’s speech from Jackson Hole, and the symposium had a cloud of pessimism hovering over it even if the chairman blanketed growth concerns with a touch of hopeful optimism, so not to throw the stock market into a downward spiral to be sure.

The late-session decline was accompanied by a wild unexplainable bout of volatility in the waning minutes of trading; the broad market ended virtually unchanged as a result.  In fact, this entire market environment is pretty much unexplainable, but it would get kind of boring if I left it at that day in and day out.  Caution is the key.  We’ll emerge from this bizarre situation, but it’s going to take a while and will be met by additional hardship.

Six of the 10 major industry groups closed up yesterday, led by telecoms and financials – financials were the worst hit on Monday.  Tech shares led the decliners lower.

Market Activity for August 31, 2010

S&P Case/Shiller HPI

The Case/Shiller Home Price Index (CS) measured a 1.02% increase in June for the 20 cities the gauge tracks – that’s for the traditional measure on this index, which is not seasonally adjusted -- and up 4.23% over the past 12 months.  Eighteen cities posted an increase in price for the month, down ever-so slightly from 19 for May.

On a seasonally adjusted basis, home prices rose 0.28% in June.  Just nine cities posted an increase on a seasonally-adjusted basis, down from 15 in May.

The upper Midwest led the gains as Detroit home prices rose 2.49%, Minneapolis gained 2.48% and Chicago increased 2.46%.  The laggards were Las Vegas (which has yet to post a monthly increase during this housing market contraction cycle) and Phoenix as they saw prices fall 0.57% and 0.02%, respectively.  

Relative to the peak in CS, which was July 2006, Las Vegas home prices lead the declines as that market has plunged 56.5%.  Phoenix is next, wacked by 51.1%; Miami has been routed by 47.0%; Detroit home prices are down 44.4%; Tampa is lower by 41.9%; L.A prices are down 35.6%.   The best performers are Dallas, down just 4.8% from the peak; Denver is down 8.4% and Charlotte by 13.5%.

This is the final CS report that will be assisted by the tax credit-induced buying – the index is a moving three-month average so June results were being influenced by April and May home-buying activity.  Recall that existing home sales plunged 27.1% in July, the most on record (going back to 1968).  We’ll see where CS goes from here. 

Chicago PMI

The latest regional manufacturing survey, and the most important one as the Chicago region serves as the largest factory base, came in slightly below expectations.  As a result these regionals continue to show what has been the hottest aspect of this economy to be on the wane.

The Chicago Purchasing Managers Index came in at 56.7 for August, down from 62.3 and just short of the 57.0 expected.  A reading above 50 marks activity is expanding so a 56.7 is a good print.  The concern is that with other regionals also showing the rate of growth slowing it won’t be long before Chicago begins to flirt with 50 again, and that’s going to put the market at considerable unease.

The new orders index slid to a reading of 55.0 from 64.6 in July, the lowest level since the index was in contraction mode back in September 2009.  Order backlogs continue to look good at 56.2, down just a bit from the 57.6 in July, and the employment gauge remained at a solid 55.5 after 56.6 in July – although the payroll gains in the factory sector are hardly enough to offset weakness is other parts of the job market. 

The inventory index fell back to contraction mode, coming in at 46.5 from 50.8 in July – the inventory cycle, which has been a major catalyst to GDP over the past year, has pretty much run its course. 

Consumer Confidence

The most-watched gauge on consumer confidence improved in August, but current levels continue to illustrate that things are far from normal. 

The Conference Board’s reading came in at 53.5 after a 51.0 in July, which was revised up from the initial print of 50.4. 

The overall reading was boosted by a rebound in the Expectations gauge, respondents view of things six month out, as that measure rose to 72.5 from 67.5 in July – even with the bounce, this level shows consumers remain apprehension about the future and expectations will have trouble advancing without substantial job gains. 

The present situation measure fell back to 24.9, the lowest level since February when the reading was just barely above the cycle low of 20.20.

The jobs “plentiful” minus jobs “hard to get measure deteriorated to -41.9 from -40.7 in July.  Ultimately, overall consumer confidence isn’t going to get closer to normal levels until the unemployed believe the labor market has improved markedly and the employed become more sanguine that they’ll be able to keep their jobs. 

Guaranteed Liquidity Surge

The Fed remains confounded and continues to tackle the challenge of getting more money into the system.  They have purchased close to $2 trillion in mortgage backed securities, agency debt and Treasuries over the past year or so, yet the money hasn’t moved into the system as banks hoard cash (due the troubled loans on their books, regulatory issues and poor overall household credit quality).  And the demand for loans remains weak as business sales are lackluster and households seek to reduce debt loads.  As a result, there really is nothing the Fed can do to pump more liquidity into the system – getting it into the hands of consumers and the businesses that may need it.  Nevertheless, they will continue down the same road and we’ll see QE2 implemented this winter.

What we need is an efficacious response from fiscal policy.  Clearly, what we have gotten thus far has done nothing but delay the inevitable and set up a public debt situation that will be very tough to manage if the budget is not restructured in an expedient manner.  We often talk about tax policy as a way to get things going again.  Certainly, this will not cure our economic woes overnight, but it will ease the downside and allow for stronger growth when we emerge from this situation.  A reduction in the number of tax brackets from the current six to just two (10% and 25%), an elimination of the corporate tax, permanent current-year expensing allowances for business, and a cut in the dividend tax rate would get us on a path to success, in my view.

And it’s this last one that would deliver the liquidity to the system that the Fed desperately attempts to accomplish, yet is proving futile.  Instead of allowing the dividend income tax rate to surge to 39.6% (for the top income earners) from 15%, it should be cut to 10%.  S&P 500 companies currently sit on about $2 trillion in cash and excluding financial firms, the current cash position is about $1 trillion.  Cut this rate, which would result in an even more dramatic market reactions as it’s expected to rise, and firms will let go of this cash in the form of dividend payouts – investors will demand it and the share prices will shoot higher for the companies that comply with this demand.  As a result, you will see money pumped into the system in manner the Fed can only dream of in the current deleveraging environment. 

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900