U.S. stocks closed flat as a weak GDP report (although in line with expectations) was offset by strong Chicago manufacturing activity.  The market was also able to shake off a couple of package-bomb shipments compliments of Yemen (it looks like the market won’t be adversely affected merely on attempt any longer; the action must be successful before it reacts) . 

Basic materials, consumer staples and utilities were the day’s top performers.  Health-care, financials and consumer discretionary shares the session’s losers.

The market escaped what can be another dangerous month in October (recall the broad market’s 8.76% rise in September, which also has an ugly history during times of economic vulnerability).  The month isn’t only famous for the 1987 crash but is involved Black Tuesday (October 29, 1929) and Black Thursday (October 24, 1929), not to mention the whole of October 2008.  The S&P 500 gained 3.69% for the month. 

The CRB (commodity index) rose back above that 300 mark Friday as the dollar weakened – a result of the coming QE2.  And dollar weakness isn’t only pushing commodity prices higher, but has driven the Japanese yen to an all-time closing high against the dollar.  The dollar/yen pair fell to 80.40 – a lower number means yen strength/dollar weakness.  The Fed’s activities are causing under-the-surface chaos all over the global economy – the Japanese are undoubtedly fuming.

Market Activity for October 29, 2010

Third-Quarter GDP (Advance)

The Commerce Department reported that Q3 GDP came in at 2.0% (right in line with expectations) after the 1.7% in the second quarter.  While it’s certainly good that the economy didn’t continue to decelerate, this level of activity is insufficient (by a mile) to kick the labor market into gear and what appears to be a waning inventory cycle means the fourth quarter reading is going to be weaker.

Personal consumption, inventories and business spending were the bright spots. 

Now, personal consumption is weak relative to past recovery phases but it is the largest component of GDP (70.4% to be exact) so it doesn’t take much for it to contribute most to the overall figure.  (Personal consumption generally spikes to average roughly 5% during the early stage of recovery but has averaged just 1.9% this time)

The lackluster results from the personal consumption component shows the troubles households are dealing with via debt loads and job-market weakness – and this is with government artificially boosting incomes as transfers payments account for a record 18.5% of personal income.  I’ll point out that this is going to change as the emergency unemployment benefits expire at the end of this month. 

Inventories helped GDP big time again last quarter, as the change in business stockpiles posted an increase of $116 billion after the $69 billion increase in the previous quarter.  As a result, the component accounted for 1.44 percentage points to GDP, which means the real final sales figure (measure of final demand) grew just 0.6%. 

This puts real final sales up an average 0.85% for this recovery – a number that usually ranges 4%-5%.  This is the weakest performance in at least the postwar era even with unprecedented levels of monetary and fiscal stimuli; if this doesn’t illustrate that the type of stimulus we’ve chosen is all wrong nothing will.

Business spending on equipment and software came in at half the pace of the previous quarter, but that previous reading was a hot one as it rose 24.8% at an annual rate.  In this latest reading, the figure increased 12.0%, which is still pretty good.  But as we talked about a few days back via the durable goods report, it appears spending is slowing substantially.  If this proves to be the case, we’ll get little help from business spending and inventories in the fourth quarter. 

Interesting to note, and part of GDP’s private investment component, was that spending on structures (commercial buildings) rose 3.9% in Q3, the first increase in two years.

Government also helped out, adding 0.68 percentage points to the GDP reading, as federal spending more than offset the decline on the state and local end. 

Residential investment (new homes) got crushed after the tax credit scheme lifted the figure in the previous quarter – it slid 29.1% at an annual rate after surging 25.7% in the previous quarter.

Net exports also weighed on GDP as imports overwhelmed export activity – imports jumped 17.4%, while exports were up just 5.0% (less than half the averages growth rate of the previous four quarters).

Unless something changes very quickly, the next GDP reading is going to come in closer to 1% than 2% as it will no longer be able to rely on the inventory dynamic and business spending looks to be pulling back rather quickly.  In addition, the government side will turn from tailwind to headwind over the next couple of quarters as the stimulus spending slows and thus federal activity will no longer offset big troubles on the state and local end. 

Chicago PMI

The Chicago Purchasing Managers Index showed factory activity remained hot in that region, coming in at a reading of 60.6 for October after the 60.4 in September – a reading above 50 marks expansion. 

Most of the internals looked strong too.  New orders jumped to 65.0 from 61.4; inventories rose to 54.9 from 49.5 (second-hottest reading we’ve seen in this recovery, a number than would normally give me some pause that stockpiles are getting ahead of things, but not with new order hot); employment improved to 54.6 from 53.4.

The only weakness was in the order backlog as that reading remained in slight contraction at 49.2 after September’s 49.1.  This means there isn’t much cushion to keep production going if new orders take a turn down.  However, thus far those new orders show no sign of weakening. 

Manufacturing activity remains remarkably upbeat, very strange to see these number while GDP figures come in so weak.  But these factory results are a function of the bounce back in business spending after firms slashed such outlays at a record pace in 2009.  We are seeing a weakening in business spending trends and it will show up in the manufacturing numbers if the trend continues. 

University of Michigan Sentiment

The revision to the UofM’s preliminary reading of consumer sentiment for October (that preliminary reading is released mid month) came in a bit lower, down to 67.7 from the 67.9 initially reported – this marks the lowest reading for the year. 

The gauge was driven lower by a meaningful 2.7 point downward revision to the expectations gauge (respondents’ view of their financial conditions a year out).  The current situation gauge was revised up by 3.6 points to 76.6. 

Here’s of historical look at these two aspects of the overall gauge.

We’ve got a mega week in front of us as the big events will be tomorrow’s election results, Wednesday’s FOMC meeting when we get specifics on QE2 and round it out Friday with the October jobs report. 

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900