U.S. stocks rallied even after the Federal Reserve reported that industrial production fell for the first time in 15 months in September – a move that is just more evidence that the market is consumed with how much Bernanke’s going to give it rather than fundamental improvement. 

Also confirming the move was more about the Fed than anything else was the fact that Treasuries rallied too – gettin’ in front of QE2.  Industrial production is a key data release and one the FOMC keeps close eye on; it trends lower and QE2 will be larger than previously believed.

Financials, utilities and health care led the rally.  (Citigroup reported earnings that beat expectations, but pretty much only because they released another $2 billion in loan-loss reserves; revenue fell 10% -- they better hope the loan book doesn’t exhibit any hiccups down the road, which is a complete pipedream in my view.)

Consumer discretionary was the only major industry group to close down for the session; industrials also substantially under-performed the market.  These are the two best performing groups YTD.

Touching on Euroland for a moment, I guess anyone thinking the European sovereign debt crisis (and the adjacent public-employee uprising situation) has improved just because it not in the headlines appears to be sadly mistaken.  First, the ECB (either directly via outright purchases or indirectly via accepting government bonds as loan collateral no matter the credit rating) is completely backstopping bonds auctions – so the demand seen in those auctions certainly has an artificial feel to it.  Second, even mild attempts to restructure entitlement and public-sector retirement programs are resulting in growing uprisings.  Strikes have now begun shutting down fuel supplies in France, and while this sort of thing is unlikely to continue for very long, we see that rolling strikes within EU member countries represents the economic setback Europe will endure in the short term in order to get things right for the long term.  Global growth will feel these effects. 

Market Activity for October 15, 2010

Industrial Production

The Federal Reserve reported that industrial production fell in September, the first decline in 15 months as the largest component of this index (manufacturing output) declined. 

Total industrial production fell 0.2% in September (expected to rise 0.2%) after a 0.2% increase in August, marking the first decline since June 2009.  Manufacturing production, which accounts for 78% of the index, slipped 0.2%; utility output slid 1.9% due to mild weather; mining output rose 0.7%, up big over the past three months as energy and metals prices have jumped. 

Manufacturing output is the one to key in on.  This is the third monthly decline for the segment over the past 15 months, but those prior two declines followed large increases.  This one follows a lackluster 0.1% increase in August as the manufacturing sector is clearly slowing – even as the ISM data continues to hold up (possibly due to the employment component that remains elevated, a component that lags production).  This latest from the Fed’s industrial production report shows manufacturing activity continues to wane – pretty much flat since May.  Motor vehicle production was the only durable goods segment that posted a production increase. 

This report on industrial production also involves capacity utilization rates within the three industries it tracks, I’ll just post the charts to show what these elements have been doing – notice how low manufacturing and utility utilization rates are compared to historic averages (the horizontal line represents the long-term average).  Mining is the only industry in which capacity utilization had matched the average, thanks to higher commodity prices.  This is something the Fed keeps close eye on as they don’t believe inflation can ramp higher until these figures runs hot.  So there is no reason to expect any tightening whatsoever until these figures surpass their longer-term averages.

TIC Flows (August)

The Treasury International Capital (TIC) flows showed big foreign demand for Treasuries remained in place during August and demand for corporate bonds and stocks remained strong but cooler than July’s hot pace.  Foreigners’ purchases of agency debt rose again, but off from big demand in July. 

Foreigners bought a net $117.2 billion in Treasury securities in August (second largest since records began in 1978) after buying a large $77.7 billion in July; purchases of corporate bonds increased $10 billion, following a big $14 billion in the previous month; foreigners bought a net $4.9 billion in U.S. stocks, after a $12.5 billion surge in July; and agency debt purchases rose $4.6 billion after $17.3 billion. 

The largest single-entity holders of marketable U.S. Treasury securities are China ($868.4 billion), Japan ($836.6 billion) and Bernanke – otherwise known as the Fed’s balance sheet -- ($830 billion).  U.S. pension funds, banks, mutual funds and households hold about $3 trillion. 

ECRI WLI

I didn’t have room to discuss the latest on the main leading indicator index we’ve been watching in Friday’s letter with all of the other data out, so here you go: 

The Economic Cycle Research Institute’s Weekly Leading Indicators index improved for a sixth-straight week as stock prices have clearly brought the measure back from the brink of -10, but it remains deep in negative territory.  The reading came in at -6.90 for the week ended October 8 (meaning the measure fell at a 6.9% annualized rate) from

-7.00 in the previous week.

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900