U.S. stocks gained ground for a third-straight session on Friday after a better-than-expected increase in wholesale inventories and Japan’s economy slowed less than expected.  The two events appeared to increase optimism that the global recovery has legs.

That inventory data received positive headlines, but the internals showed a different picture as the increase in stockpiles surpassed the rate of change in sales, which has persisted for three months now – a sign the inventory cycle is winding down.  On Japan, their growth is going to continue to be buoyed by Chinese economic activity, but I wouldn’t expect too much global help from that economy.

Energy, health-care and consumer discretionary shares led the broad market higher.  Energy stocks got a boost from a 3% increase in crude prices.  The climb in price, which is back to $77/barrel, was instigated by a Midwest pipeline leak that forced shutdown.

Utilities, tech and financials were the laggards.  The utility sector was the only major group to end lower for the session.

The broad market gained ground for a second-straight week -- up 3.75% and 0.46%, respectively.  The bounce nearly recouped the previous three weeks of decline, but it’s occurred on very soft volume -- 28% below the six-month average for this two-week stretch and 40% below that average with regard to Friday’s activity. 

The gains look set to continue this morning as the market is cheering the Basel Committee’s decision to give banks eight years to meet higher capital ratio requirements and China’s latest reading on industrial production showed that government continued to keep things humming.  For now, it looks like we may just retest that 10,700 mark on the Dow – a level we last hit on August 9 before sliding below the 10K mark for the fourth time over the past four months alone.

Market Activity for September 10, 2010

Wholesale Inventories

The Commerce Department reported that distributors’ inventories jumped 1.3% in July, easily exceeding the 0.4% expectation, after an upwardly revised 0.3% (up from 0.1% reported last month) for June.  The sales data bounced back after two months of decline (the first consecutive declines since the heart of the financial crisis in late-2008/early-2009) by increasing 0.6%. 

Despite the bounce in sales in July, they’ve been shy of the continued increase in stockpiles.  This has been occurring for three reporting months now, ending a 13-month streak in which sales outpaced activity on the inventory side.  This may signal the recent accumulation in stockpiles is relatively unintended, and even as inventory/sales ratios remain historically low, firms may become quite uncomfortable in coming months due to the sluggish pace of economic growth. 

We’ll receive additional insight via the business inventories reading for July on Tuesday (which will include retailers’ figures), but it appears, absent a rather large jump in the sales data over the ensuing few months, that the inventory cycle is coming to an end. 

Rising inventories are a good sign, if and only if they are accompanied by a commensurate increase in sales – someone please explain this to the financial press, which applauded the news.  And speaking of which…

Missing: Economic Perspicacity

One morning last week while driving in I heard one of the anchors on a financial news program state that he doesn’t understand how increased expensing allowances on capital equipment creates jobs.  I wasn’t going to comment on this, but since there was only one data release on Friday, why not?  Beyond that, we should give the administration kudos for acknowledging the effectiveness of such supply-side strategy even if they’ve driven us so treacherously down the current Keynesian road – a path riddled with a pathetic panoply of central planning initiatives – to be fair, Bush, in his final year, took this track as well. 

It really doesn’t take a genius to understand how such a program would create jobs, besides we have plenty of empirical evidence to back it up anyway -- namely when this sort of thing was put in place in the early 1980s and then again in the early 2000s.   When firms are incentivized to invest in capital equipment, its takes people to build that plant; it takes people to build that equipment, and that of course means jobs.  Further, you don’t go out and build a new plant without placing people in that facility to run it.  And finally, these capital investments make firms more productive, which drives profitability and when firms are more profitable (assuming it is not solely driven by massive cost cutting, which is the troubled situation we currently find ourselves) then they hire more employees, over time. 

Now, in the current environment there are many challenges and structural problems that only time can ultimately heal and that means even smart policy action may not be as efficacious as would otherwise be the case.  In addition, we have a bevy of other policies coming out of Washington that will certainly curtail the effectiveness of 100% current-year expensing allowances.  Thus, this proposal to incentivize businesses to spend more of their cash on capital outlays is unlikely to provide a large boost to activity, but it will help to ease the next round of economic weakness. 

For it to be most effective though, it must be accompanied by other pro-business proposals and it must be permanent.  It would also be helpful for the president to refrain from publically vilifying business as he has stepped up this sort of rhetoric over the past week.   You want jobs?   It kind of takes a friendly business environment to make that happen – I’ll check the textbooks on that one, but I think it’s a safe statement in the meantime. 

As for the majority of the financial press corps, their lack of economic understanding blocks them from delivering the correct message to the public. 

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900