U.S. stocks looked ready to end a two-day losing streak as a couple of takeovers, a better-than-expected retail sales report and an ease in concerns over Europe’s debt problems helped the market escape last week’s downward pressure.  But it was not to be as the broad market slid in the final 30 minutes of trading. 

Caterpillar and EMC Corp. both announced acquisitions; such actions almost always lead the market higher.  The retail sales data probably helped as well, although the news was offset by a plunge in New York-area manufacturing activity.  And as we talked about on Monday, EU ministers made some statements over the weekend that eased concern regarding the possibility of an Irish default, along with that of the other EU peripheral economies.  (I should note that concerns over Europe and Chinese interest-rate hikes are flowing again this morning, so the ebbing of the worries didn’t last very long.)

Four of the 10 major industry groups gained round, led by financials and utility shares.  The six groups that fell for the session were led lower by basic materials and energy.

On the Treasury curve front, yields are not going in Bernanke’s direction.  Just as the Fed begins to roll out QE2, we’ve got the 10-year Treasury yield up 40 basis points over the past week (up a huge 17 bps yesterday alone and that move probably has something to do with the market’s late-day slide) and mortgage rates are going to pop to 4.45-4.50% for the upcoming reporting week – the week ended November 12.  At the current Fannie Mae Commitment Rate, we’re talking about a 30-year fixed rate mortgage approaching 4.70% when this week’s rate is released (which will be reported next week) -- insanely low from a historical perspective, but big trouble for this housing market. 

So one part of QE2 is working: pumping up stock prices, but the other certainly is not: keeping bond yields floored.  Despite the increasing criticism over what the Fed is doing (the latest being an open letter to Bernanke from a number of economists, analysts, policy wonks and hedge-fund managers), Bernanke is likely to remain determined to do whatever to push rates lower.

Market Activity for November 15, 2010

Retail Sales

The Commerce Department reported that retail sales remained hot in October thanks to auto sales; the measure jumped 1.2% (expected at a 0.7% increase) after a strong 0.7% in September (which was revised up from 0.6%).  Excluding auto sales, which have been fueled by fleet sales over the past couple of months, retail sales rose 0.4% after a 0.5% increase in September.  Excluding autos, gas and building materials (the figure that flows to the GDP report), activity wasn’t so strong as the reading rose 0.2% following a 0.4% increase in September.

The strongest aspects of the report were those autos, up a massive 5.0% (the segment accounted for 73% of the monthly increase in overall retail sales), building materials (up 1.9%), and gasoline station receipts (up 0.8%).

The weakest aspects were furniture, electronics and department stores (each down 0.7% for the month).  That reading for department stores corresponds with the weak same-store sales results from the International Council of Shopping Centers we received a week back.

Retail sales have rebounded nicely over the last three reporting months, up about 10% at an annual rate – this follows a three month period is which sales had declined.  Excluding autos, the increase in sales (up about 8% at an annual rate) has surely been a function of higher stock prices -- the S&P 500 has jumped 17% since July.  The results over the past three months were also helped by 136K/month in private payroll increases for the three-month stretch, although this hasn’t been enough to budge the unemployment rate.  

Empire Manufacturing

The latest from the manufacturing sector within the second Federal Reserve district (NY Fed Bank region) showed that the expectation wasn’t even in the ballpark as activity collapsed in November.  New orders got killed, unfilled orders hammered, and the average workweek reading clocked. 

The measure slid to a reading of -11.14 for November, the lowest level since April 2009 when the factory sector was coming out of its worst contraction since the 1980 recession, from 15.73 in October – the estimate was for the reading to come in at 14.00. 

New orders slid to -24.38 from 12.90 (sharpest drop since the 9/11 attack); unfilled orders plunged to -24.68 from -1.67; and the average workweek fell to -12.99 from 3.33 in October.  Two of these three hit the worst levels since February/March 2009; the average workweek, which lags a bit, is at its worst level since July 2009 when the labor market was getting pummeled.

This is the first regional factory reading for November, so everyone will be intensely focused on the Philly survey as the market tries to figure out if this is a one off or beginning a trend lower.  That may prove to be a rather generous comment since this is the second-largest monthly decline in the survey’s 10-year history – or a move that’s only occurred 1.75% of the time.   It appears that something larger, like the end to the inventory cycle is responsible. 

Business Inventories

And speaking of which, business inventories rose a strong 0.9% in September, and the August figure was revised higher to show an equal gain of 0.9%.  However, sales growth continues to underperform the rise in stockpiles - a situation that has been in place for five-straight months now.  As a result, some of this inventory increase may be involuntary. 

Again, we’ll wait for Philly and the other regional factory reports but it does appear that the inventory cycle is more than just winding down.  Nevertheless, the revision to third-quarter GDP should be higher thanks to these larger-than-expected inventory builds.  If there is a little involuntary build however, what the inventory cycle has giveth, it will taketh away regarding the next couple of GDP reports.

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900