U.S. stocks began the session substantially higher yesterday, all juiced by the latest manufacturing reading out of China (a  PMI reading that rose to 51.7 from 51.2 in July, yet still dangerously close to 50 -- the line of demarcation between expansion and contraction) and this renewed hope that the global recovery can remain above water.  I found it interesting how our market rallied harder than Asian bourses, and China’s Shanghai actually closed down. 

Then at 9:00 CDT the U.S. market was off to the races, which coincided with the release of a much better-than-expected U.S. manufacturing number.  Yesterday’s rally was the strongest since the 3.1% surge on July 7.

The acceleration in ISM from the prior month was confounding at first (considering the regional reports have weakened), but I think I see what’s going on, which we’ll get to below.  The August private payrolls estimate from ADP, which normally receives much attention but mattered little to traders yesterday, printed the first negative reading in seven months.

Industrials (up 3.85%), financials (+3.85%) and energy (+3.64%) led the broad market higher.  Telecoms (+1.62%) and consumer staples (+1.66%) were the laggards. 

The broad market remains in its general trading range of the past three months of roughly 1120-1050 on the S&P 500. The Dow Industrial Average has crossed the 10,200 mark 16 times now since mid May, ranging 10,500-10,000 with a quick spike to 10,700 three weeks back and a dip down to 9700 in early July.

Market Activity for September 1, 2010

Mortgage Apps

The Mortgage Bankers Association (MBA) reported that their applications index rose for a fifth-straight week, but the vital purchases figure remains very weak. 

The overall index was fueled by a 2.8% in refinancing activity (which currently accounts for 83% of all applications) and purchases increased just 1.8%. 

The purchases side isn’t that surprising, due to the tax credit pulling activity forward a few of months back and the state of the labor market.  (We’re hearing talk of Congress reinstating the tax credit – the circus continues.)  But refis were up just 2.8% even as the average contract interest rate on the 30-year mortgage fell again, down to a new record low of 4.43%.  We’re seeing the same people refi over and over as much of the market has been shut out – they neither have the equity that’s required to refi, nor the liquidity to boost their equity stake so they can get that lower rate. 

ADP Employment Change

The private-sector employment survey from Automatic Data Processing (one of the largest payroll outsourcing firms) estimated payrolls fell 10,000 in August (increase of 15k was expected), which is the first negative print from this measure since January.  ADP hasn’t been terribly accurate in predicting the official private-sector job results via the government’s report, but has been worthwhile to watch in terms of direction. 

ADP estimated that goods-producing industries shed 40,000 jobs last month (after a decline of 30,000 in July), led by a 33,000 decline in construction jobs – construction employment has plunged 2.275 million since peaking in January 2007.  Manufacturing employment slipped 6,000, according to ADP. 

Service-providing industries added 30,000 jobs (following a 67,000 increase in July).

In terms of firm size, large firms (500+ employees) added 1,000 positions in August after cutting by 4,000 in July; medium firms (50-499 employees) cut 5,000 positions after adding 21,000 in July; and small firms cut 6,000 jobs after adding 20,000 in July.

So I don’t know if Friday’s official jobs report will show private-sector jobs actually fell, the overall number will post its third-straight month of jobs losses due to Census firings, but the number is going to weak for sure.  And I wouldn’t be surprised to see a downward revision to the July employment figure as this is becoming a trend. 

ISM Manufacturing

The Institute for Supply Management (ISM) reported that manufacturing activity accelerated in August, defying the reduction in the rate of growth the regional reports have shown, with Philly (one of the key factory bases) and Dallas both moving to contraction mode. 

The ISM number came in at 56.3 for August after July’s 55.5 (the expectation was for a print of 52.8, and there were a lot of people out there thinking it would miss that estimate; instead, it beat even the most optimistic forecast within the consensus range).  Again, the expectation for a lower reading was completely reasonable due to the fact that the regionals weakened.  Also, the new orders index within ISM fell five points in July to 53.5 from 58.5 in June, which also had people thinking this would show up via a deceleration in August production and thus a lower overall ISM reading.

At first glance I found the figures within the report confounding.  How did production accelerate in August (the production and employment indexes drove the overall reading higher) even as new orders have fallen over the past two months?  But a closer look and the backlog of orders tells the story, I think.  That backlog index was hot back in May at 59.5 and remained robust in June at 57.0.  As a result, the production is playing catch up from the strong new orders as of April, May and June. 

Now though, with the backlog of orders declining (that measure has dropped from 59.5 in May to just 51.5 in August, and at this rate will be sub-50 by next reading) one can expect production to follow the deceleration in new orders and the overall reading will reflect the realities that the regional reports have shown. 

This latest reading on manufacturing has me questioning my prediction that all factory gauges will show substantial weakness by September.  Nevertheless, the internals of this ISM report, and what we’ve seen from the regional surveys, signals to me that the overall assessment remains intact; it may just be off by a month.   We shall see. 

Construction Spending

Outlays for construction projects fell 1% in July (double the rate expected), marking the third-straight month of decline -- down 23 of the past 26 months.  The June figure was revised down to show a 0.8% decline, previously estimated to have increased 0.1%.

Private-sector construction spending fell 0.8% as residential fell 2.6% in July, yet spending on commercial projects rose 0.8%.  Spending on home improvements fell 2.9% for the month, and wacked by 45.5% on a three-month annualized basis.

Public-sector spending fell 1.2% as outlays for residential work rose 0.3% but commercial was down 1.3%.

Have a great day!

Brent Vondera, Senior Analyst