U.S stocks fell for the first day in five, but rebounded from deeper intraday losses thanks to a rally in the final half hour.  The session’s economic data didn’t help matters as initial jobless claims bounced back above the 450K mark and the latest trade data illustrates that net exports will again be a drag on GDP, and we hardly need anything else tugging it lower. 

On top of the less-than-desirable economic releases, particularly the claims data, the foreclosure mess continues to receive more press.  Thanks to that rally at the end, stocks held up very well considering the foreclosure probe is bringing attention to the fact that the banks are going to have another round of nasty on their hands.  Deterioration in the loan book via additional mortgage losses has been the main reason I believe the profit cycle will prove short-lived and begin to show cracks by the time Q4 earnings season rolls around.  This foreclosure mess is only going to exacerbate that issue.

Financials and basic material shares led the market lower – worst-performing groups for two days straight.  Telecoms, tech and consumer staples were the only three of the top 10 major groups to close higher.

Before that late-session rally, I was beginning to wonder if yesterday was the day that the music had stopped.   That is, how much longer can monetary easing push stocks higher before the market views such continued actions as a bearish signal?  The banks took a good beating as the foreclosure chaos grows and everyone should know what will happen to the industry’s efficiency ratio (expenses/revenue) as a result, which is already on the rise – not to mention the effect further roiling within the housing market will have on expenses.  If the banks are dragged down again, the rest of the market is likely to follow suit.   This may be the financial/economic shock that saps the Fed’s juice.  More on this below.

Market Activity for October 14, 2010

Further, the $13 billion 30-year auction was saved by the primary dealers (stuffed with Fed liquidity injections) or it would have been much worse – the PDs accounted for 59% of the auction, the most since early 2009.  For the first time in quite a while the high yield came in above that of the previous auction as traders refuse to chase prices further.  Then again, we’ve got Bernanke speaking at 8:15ET so maybe there was a little sidelines move ahead of the speech.   Still, one can’t ignore what occurred.

As most readers know, this is a phrase – “when the music stops” -- I’ve used a few times now.  The Fed can push people into riskier assets like stocks and high-yield corporate bonds, but (as Mohamed El-Erian recently commented) such price-driven behavior isn’t nearly as lasting as when investors are “pulled” into riskier assets based on fundamental attraction.  And there is another phrase:  “Never fight the Fed.”  Meaning, don’t bet against the central bank’s ability to drive stocks higher.  Well, this environment is different than any other in the postwar era, and while the music may play for a while longer (and one must keep in mind that the fourth-quarter in an off-year election cycle is generally good for stocks), we may find the Fed doesn’t have the juice it normally does – which is surely the case from an economic growth perspective.  Yesterday’s sell-off was hardly anything to worry about thanks to the late-session rally, but mid-day it sure felt like someone bumped into the turntable. 

Jobless Claims

The Labor Department reported that initial jobless claims rose 13,000 last week to 462,000 (expected at 445K) from the upwardly revised 449,000 (24 of 25^th week the reading has been revised higher).  So we still can’t get below that 450K mark, and as I keep saying sub-400K is what we need to signal meaningfully consistent job growth.  The four-week average of initial claims rose 2,250 to 459,000.

Continuing claims headed lower, as both the standard issue (those that last the first 26 weeks) and emergency claims (those that extend out to as long as 99 weeks) declined nicely.  Standard claims fell 112,000 to 4.399 million and emergency level of claims slid 340,100 to 4.781 million. 

The move in continuing claims last week more than offset the increase in the previous week, so that’s a good sign.  However, the heightened level of initial claims (and the fact that they can’t hold below 450K) shows very little net job creation.  The fact that initials remain high tells me that the decline in continuing claims is due more to benefits expiring than a substantial boost in hiring.

Trade Balance

The Commerce Department reported that the trade gap for August widened to $46.347 billion (expected at -$44B) after the -$42.583 billion that came in for July.   The widening occurred as imports bounced from the July decline, but exports were unable to follow through from the previous month’s increase.

Exports rose just 0.2% after a 2.0% bounce in July as capital goods were hit by a 3.7% slide in the capital goods segment, pushed lower by a 46.9% plunge in civilian aircraft.  The other components were up slightly in general, so the move in commercial aircraft made the weak export results look worse than they actually were – commercial aircraft is an extremely volatile component so you can’t read too much into it.  That said, the GDP reading doesn’t know the difference and the widening won’t help the Q3 number.

Imports rose 2.1% after a 2.1% decline in July as all components save aircraft and computer accessories increased.  Telecom equipment also fell, but only 0.1% so it was essentially flat. 

So the real trade gap, the number that adjusts for prices and is funneled into the GDP reading, is wider by 2% than the gap in the previous quarter.  Unless there is a large degree of narrowing (exports significantly outpace imports) when the September report is released then net exports will be a drag on Q3 GDP. 

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900