U.S. stocks jumped yesterday, pushing the broad market to pre-May 6 flash crash levels and as close to the 20-month high since hitting that mark on the April 23.

Inspired by Monday night’s Bernanke speech in which he confirmed, as much as a central-bank chairman will, that additional asset purchases are coming, stocks began the session higher by 1.1%.  The market built on that momentum after the latest service-sector report came in at a better-than-expected reading and Chicago Fed Bank President Charles Evans basically called for the nuclear version of QE.

Evans suggests the full-scale manufacture of inflation as he painted the current economic conditions as “really extraordinary” circumstances.  While this sort of comment strikes a dire tone for economic and job growth prospects, it sends the message to traders to bid up all asset prices.  We’ll see if the Fed can get the S&P 500 back to pre-Lehman 1250.

Basic materials, industrials, financials and energy led the way.  Utilities and consumer staples were the laggards, but even these traditional areas of safety gained ground as all 10 major industry groups closed higher.

Volume was actually strong, for current standards, just 4% below the six-month average – heaviest activity since late July.

Market Activity for October 5, 2010

ISM Service

The Institute for Supply Management’s latest gauge of service-sector activity accelerated in September after showing substantial deterioration in August.  The reading came in at 53.2, following the 51.5 for August – 50 is the dividing line between expansion and contraction. 

What this means is that more respondents stated business activity improved in September than the previous month; the number of industries that reported growth in September rose to 11 (out of 18) from nine in August.

The new orders index rose 2.5 points to 54.9 – just below the historic average of 55.6 (note: this index only goes back to 1997, so not a lot of history).  The survey’s employment measure also accelerated last month, rising back from contraction mode in August – up two points to 50.2.

The reading on inventories fell back to contraction mode, down 6.5 points to 47.0.  Inventory sentiment remained elevated (you want this number to go lower), falling just a half point to 59.5 – a higher number means that more respondents were uncomfortable with inventory levels.  ISM listed the respondents’ comments:  “Not replenishing stock” and “Some of the inventory reduction is due to the seasonality of our business and some due to the softness of the current market.” 

The backlog of orders measure fell for a fourth-straight month, down 2.5 points to 48.5. 

The reading on export orders jumped from contraction mode in August as it surged 11.5 points to 58.0 – the highest reading since June 2007.  This illustrates what we’ve already known.  At least for multinational firms, the bulk of their sales are coming from overseas.  However, with Europe in the doldrums and the Asian countries heavily export dependent, the boost in overseas sales boost may not prove terribly long-lasting.  As much as people want to believe in “decoupling” (the idea that Asian and emerging market economies can withstand either very low growth or another dip to recession here in the U.S.), the theory was violently debunked during the previous recession.  If the American consumer goes into hiding, then Asian and emerging-market economies lose their juice.  

Bottom line: this is a good report even if backlog orders and inventories justify some caution – that caution being the measure will test contraction mode even as we round out 2010.  The new orders figure is holding up well, much better than what’s occurring in the ISM’s manufacturing survey.  Then again, it’s taken unprecedented levels of monetary (ultra-low rates and asset purchases) and fiscal policy (transfer payments, $800 billion in official stimulus and massive aid to the states) assistance just to keep the data from falling back to contraction mode.  And speaking of which, here comes more:

Bernanke to the Rescue, and Evans Suggests DEFCON 2

Monday night Federal Reserve Chairman Bernanke gave a speech in which he stated the belief that Federal Reserve asset purchases have helped the economy and additional buying could help more.  So there we have it, it’s a done deal, only a matter of time.

As we’ve talked about for a couple of years now, the official Fed statements and minutes that follow FOMC meetings have little meaning for those gauging the direction of monetary policy --- of course it’s only going in one direction these days, so we’re talking about the degree of that easing.  Instead, what you listen to are the speeches, and on QE2 Bernanke’s comments makes it three – a clear go signal.  On Friday it was NY Fed Bank President Dudley talking about the need for further accommodation.  On Monday it was the NY Fed’s executive VP Brian Stack who opined about the benefits of security purchases. 

So Bernanke makes it the trifecta and Evan’s comments brings defense readiness to level 2 – only outright purchases of corporate stocks and bonds would bring monetary policy to the ultimate DEFCON 1.  (What does the Fed know that those sounding the all-clear signal obviously don’t?  I think it’s another drop in home prices, the summary trouble for the banking-sector’s loan book, and the continued contraction of credit as a result.  The Fed fears a “liquidity trap” – the situation in which even floored interest rates can’t get credit going -- and they’re prepared to do whatever it takes to avoid it.  I’m afraid they’ll be pushing on a string like never before.)

And the Bank of Japan (BOJ) is getting into the game too (well at least for this round as they’ve had the monetary easing mechanism floored for 15 years with no good result) as they reduced their target benchmark interest rate to virtual zero (a range of zero-0.10%) and will set up a $60 billion fund to buy government bonds, along with “other” assets.  Those other assets are equity-market ETFs and REITs, so they have chosen to completely rig their market. 

The poor Japanese, they try so desperately to push the yen lower against the dollar, but keep running into the Bernanke road block as the race to the bottom continues.  At this pace it won’t be long before the entire BOJ staff commits coordinated harry carry. 

As hedge-fund manager David Tepper stated exactly 11 days ago when musing about additional QE: “everything” goes up – stocks, bonds, base metals and oil.  Of course, our currency goes down, which no one (at least those running the show) seems to care about right now.  Oh, and home prices, despite what the Fed believes, are unlikely to gain much traction anytime soon.  But in terms of financial assets, sure, “everything” may very well go up…until they don’t.  And when the Fed is propping up asset prices, when it distorts markets, things can get ugly when the music stops. To think that all of these monetary, and fiscal for that matter, actions aren’t going to be followed by a significant degree of unintended consequences is fantasy. 

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Have a great day!

Brent Vondera, Senior Analyst