U.S. stocks closed lower on the final day of the third quarter as a much stronger-than-expected Chicago manufacturing reading wasn’t enough to offset renewed worries about European debt issues and the hit economic activity the entire euro-zone will endure due to necessary austerity measures. 

The Irish government announced its 2010 budget deficit will come in at a sky-high 32% of GDP – a function of continuous bailouts of the banking system, but even when banks are shored up they state the budget/GDP ratio will remain at an extreme elevation of 14%.  Concern also revolved around another member of the PIIGS, Spain, as growth concerns have the market wondering just how much fiscal improvement can truly be achieved. 

Energy, financial and telecom shares were the day’s outperformers – energy being the only group to actually close higher for the session.  Tech, industrials and consumer staples were the biggest losers.

Well, while the broad market ended mildly lower on Thursday, it was a big month for stocks.  A September to remember perhaps?  The S&P 500 rallied 8.95%; the best September performance for the broad market since 1939, as the media has exhorted with glee over the past few days.  The comparison does bug me a bit though as I often wonder if they’re aware that wasn’t exactly a year of fond memories – personally, I wouldn’t compare anything to that year with a smile on my face.  The broad market fell 5% and preceded a slide in the subsequent two years (down 15.09% and 17.86%).  More importantly, the deadliest war in history broke out in Europe in 1939.

A quarter to remember?  The broad market advanced 10.72% for the quarter.  That’s good, although just shy of being good enough to offset the second quarter’s 11.86% decline. 

For the quarter, telecoms led the way with their 19.11% advance.  This was followed by the 17.24% rally among basic material shares and 14.72% for consumer discretionary shares.  The laggards were health care, up just 8.22%, and financials, higher by 4.06%. 

Market Activity for September 30, 2010

Jobless Claims

The Labor Department reported that initial jobless claims fell 16,000 to 453,000 (460K was expected) in the week ended September 25.  So this erases the 16,000 increase in the prior week and returns us exactly to the level hit two weeks back.  The four-week average fell 3,750 to 458,000.

Continuing claims fell also as both the standard issue and emergency level of benefits moved nicely lower.  The standard issue (those that cover the first 26 weeks of benefits) fell 83,000 to 4.457 million; emergency claims (that extend out to as long as 99 weeks) slid 292,000 to 4.878 million.   These emergency claims have made great progress in erasing the roughly one million jump when they were reinstated at the end of July.

Overall, this is a pretty good report – at least in terms of the 450K-plus initial claims and the 9-10 million continuing claims world we now find ourselves.   While the slide in continuing claims appears to be good news on the surface, one has to surmise that the expiration of benefits is the reason continuing claims have trended lower of late – at least until we see substantial job improvement arise within the monthly payroll reports.

Chicago Purchasing Managers Index

The Chicago PMI unexpectedly jumped to 3.7 points in September to 60.4 from 56.7 in August -- the market expected factory activity to slow to a reading of 55.5.  This reading is completely at odds with the four previous regional manufacturing surveys we’ve received for the month.

The internals were mixed.  New orders and current production were hot as orders jumped to 61.4 from 55.0 in August and production surged to 64.3 from 57.6.  In addition, the inventories reading rose three points to 49.5 – smack dap at the long-term average.  However, the order backlogs, employment, and supplier deliveries readings all declined. 

The order backlog reading, which fell to the lowest level since November, is vital to watch right now because any weakness in new orders will very quickly flow to production as the backlog of orders has returned to contraction mode.  And since production has outpaced new orders for four-straight months I doubt we’ll see the backlog reading improve via the next report. 

As we talked about on Tuesday, the Chicago region is dominated by the auto industry and since the other factory gauges have waned – two slowed substantially and two remained in contraction mode for a second month – it appears that auto production kept the index elevated last month.   The thing that concerns me about that industry is the car makers made clear early this year that they would ramp production up to cover 12 million-plus in annual sales.  The problem is nine months into the year total vehicle sales have averaged just 11.25 million units at an annual rate.  This leads one to believe, particularly since the labor market picture shows little by way of monthly job growth, that the automakers will get caught (yet again) with too much supply as their sales estimates are overly optimistic – some things never change. 

Latest Revision to Q2 GDP

The BEA (Bureau of Economic Analysis within the Commerce Department) revised second-quarter GDP up to 1.7% (previously 1.6%) as personal consumption and inventory rebuilding was a bit higher than previously gauged.

Personal consumption came in at 2.2% at an annual rate, up from the 2.0% previously estimated.  Sorry to say, the higher revision helped the figure, but it’s still very weak – and considering Q2 spending was helped by massive levels of government transfer payments and up to $8,000 refunds from the homebuyers’ tax credit, the figure is even less impressive.  Normally coming out of recession we see prints of 5% plus from this segment of GDP, the best we’ve seen thus far in this four-quarters of recovery is 2.2%.

A bit more inventory rebuilding than previously estimated also delivered the higher revision. 

Summing up the quarter, it was the inventory cycle and strong business spending on equipment and software, which jumped 24.8% at an annual rate, that helped to offset big decline in trade and the lackluster personal consumption.  We will need business spending to remain strong because the inventory cycle appears to be reaching its end, the government spending spree (at least in terms of directly boosting near-term activity) is tapped, and the combination of high joblessness and household debt will continue to keep personal consumption at low levels.

Bottom line we’re just four quarters into the recovery and we’re already back to sub-2.0% growth – coming out of the previous worst recessions of postwar era GDP would normally be printing 7%-plus readings at this stage.  The fiscal and monetary stimulus has proved feckless. 

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900