The Korean conflict, European debt situation (as Spanish bonds are now getting clocked) and lending quotas in China combined to take stocks down Tuesday.  Better-than-expected economic data, on the whole, failed to offset these concerns.

The European debt situation continues to roll and will not ultimately be resolved until debt is eventually restructured – it’s just another market fantasy to believe that throwing debt on top of debt can solve this problem.  (It’s been a year -- the day after Thanksgiving 2009 -- when this sovereign debt crisis began to surface with Dubai.  And on the current course we’ll be dealing with it a year from now because government continues to kick the issue down the road.  They know there’s another banking crisis that awaits because of this public debt situation, and that’s why they don’t want to deal with it; eventually though, we must get on with it.

A report from Bloomberg News reported that China’s biggest banks are close to reaching annual lending quotas, at which point they’ll have to stop expanding their loan books – the Chinese appear to be more concerned with citizen uprising that result from escalating food prices than from reduced economic growth rates. 

On top of it all was the Korean conflict, which is unlikely to turn into something more substantial, but one hesitates to become too complacent as North Korean is headed by a madman who’s probably not long for this world. 

Telecom, utility and consumer-staple shares were the outperformers – although even these groups closed down for the day.  Energy and basic materials received the smack down as the dollar rallied -- a result of the run for safety.

Market Activity for November 23, 2010

GDP Revision

The first revision to third-quarter GDP showed a nice upward print, coming in at 2.5% at a real annual rate from the initial 2.0% reported a month ago and follows the 1.7% print for the second quarter.  So the economy grew at a 3.2% rate over the past year, a bit better than previously expected but less than half the rate recorded at this point in the cycle following the prior worst recessions of postwar-era (and this one was the worst).

So what drove the revision higher? 

Personal consumption rose 2.8%, instead of the 2.6% initially estimated – this added 0.23 percentage point to GDP.  

Net exports were revised up as well and as a result only subtracted 1.76 percentage points from GDP instead of the 2.01% points initially estimated.  Still, export activity has cooled big time, up just 6.3% at an annual rate, down from the double-digit increases of the previous few quarters. 

Finally, government spending came in higher than initially estimated.  Federal spending was slightly stronger and state and local spending was actually revised to show a 0.8% increase vs. the 0.2% decline.  This also mildly helped the revision.  We should enjoy this help while it lasts because states are in the process of substantially reducing outlays.

Business investment on equipment and software was better than expected – up 16.8% at an annual rate vs. the 12.0% increase initially estimated.  However, spending on structures was revised down substantially, off by 5.7% at an annual rate instead of the +3.9% initially estimated.  Thus, overall private investment was reduced a bit but I wanted to mention on the upward revision to spending on equipment and software, which is especially key for the economy right now. 

The increase in inventories came in a bit lighter than initially estimated, adding 1.30 percentage points to GDP instead of the 1.44% points estimated in the prior report.  Yet, inventories still accounted for more than half of the GDP increase.  This segment is likely to subtract from GDP for the current quarter – if it doesn’t it will begin to drag on it by the first quarter of 2011. 

Real final sales (which excludes inventories from the GDP increase and is a proxy for final demand) improved due to the diminished help from inventories.  The measure jumped to 1.2% from 0.6% initially report last month.  However, this measure averages 5-6% at this point in the cycle. 

Existing Home Sales

Previously-owned home sales fell 2.2% in October (a 1.1% drop was expected) to 4.43 million units at a seasonally-adjusted annual rate (SAAR).  Single-family sales fell 2.0% to 3.89 million and multi-family (condos/co-ops) fell 3.6% to 540,000.

The number of existing homes available for sale slipped 136,000 to 3.864 million – that’s for the official number, at the low end of the shadow supply range the figure is twice that.  The number of single family units fell 239,000 to 3.26 million.  These figures may be a bit deceiving due to the distressed properties taken off of the market due to the foreclosure fraud cases.

The months worth of supply ticked down to 10.5 months worth from 10.6 in September.  For single-family units, the level remained unchanged at 10.1 months worth.

The median price of a previously-owned home held pretty much steady, down just 0.6% to $170,500.  For single family units, the median price fell 0.7% to $171,100.  Prices are likely to slide again when distressed properties return to the market, they’ve been held back due to the latest foreclosure moratorium.  This will also bring sales back a bit as distressed-property sales have accounted for roughly 35% of all sales over the past several months.  But that shouldn’t show up for a couple of months still. 

Richmond Fed

The latest factory activity survey from the fifth Federal Reserve district came in at a better-than-expected reading of 9 for November – expected to come in at 6 – after October’s 5. 

The internals of the report looked good as all improved, with the exception of wages – still they remained in positive territory.

So this makes it two of three regionals that have improved from the prior month.  This is after the Empire reading got the month of November started off on a terrible note by plunging by the most since the 9/11 attack, and deep into negative territory.  But Philly and Richmond look pretty good. It’s clear the manufacturing sector has cooled, but is holding up much better than I had expected by this point. 

Fed Minutes

The big news from the latest FOMC minutes (notes from the last policy meeting) was that the Committee lowered their growth forecast, the third reduction in eight months by my count.  The minutes also revealed that FOMC members were divided on the efficacy of QE2 and its consequences, but we’ve known this via various speeches and Op/Eds so nothing new there. 

Another thing, which we talked about a few weeks back, was that Bernanke & Co. contemplated targeting interest rates on longer-term securities as they summoned an emergency meeting on October 15 – reminiscent of the interest-rate controls the Fed implemented during WWII to hold long-term Treasury yields down; during the 1940s they held the 25-year bond yield at 2.50% for a number of years.  They decided against this, for now, as it would mean buying even more than the considerable amount of Treasury securities they already own and plan to buy.  As of their latest actions they are now the single-largest holder of government bonds; that’s a lot of money printing – and it was just a few months back in which Bernanke testified before Congress stating they would never monetize the debt.

Anyway, on the reduced forecast, the Fed sees GDP ranging 3.0%-3.6% for 2011 (they’ll be lowering that one again by early 2011) after growing 2.5% for this year.  Their prior forecast was for a range of 3.5%-4.2%.  I’m not even sure they believe in these forecasts; it may just be an attempt to cheerlead, hoping it gets confidence rolling.

On the jobless rate, they see it ending 2011 at 9.0% (previous estimate was 8.5%) and don’t see it below 8% until 2013.  They also raised the long-run unemployment rate estimate to 6.0% from 5.3% -- meaning they see some structural damage has occurred in the labor market. 

I don’t think this has to be so.  While my views over the short term are pretty negative, the correct policy stance will allow the U.S. economy to escape this malaise and return to our long-term average of durable 3.3% real growth.  In fact, I believe this country’s potential is closer to 4.0%, but this would involve serious tax rate, trade, regulatory and entitlement reform.  Such growth would easily deliver the job growth needed to get us back below 6% unemployment within a reasonable amount of time.  For now though, let’s concentrate on getting down to 8% unemployment. 

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Happy Thanksgiving!

Brent Vondera, Senior Analyst

Phone: 636-449-4900