U.S. stocks rallied Monday morning, closing in on that pre-Lehman mark of S&P 500 1250.  News that China refrained from raising interest rates, which was expected to occur, certainly helped stocks move higher.  However, momentum disappeared in the final hour as the broad market slid to wipe out virtually all of the earlier gains.  The NASDAQ Composite erased all of its early gains and them some to close in negative territory. 

That news out of China also propelled commodity prices higher as the CRB Index hit a new post-Lehman high – although still 13% below the level on 9/12/2008, the session before the weekend that Lehman went down.  Soft commodities (sugar, OJ, coffee, cotton) along with the metals (silver, copper and nickel) led the move. 

Energy, basic materials and utility shares were the best-performing groups.  Consumer discretionary, tech and financials all finished lower.

Long-end Treasury yields were up (price down) -- about five basis points in early trading yesterday on the 10-year, but those shorting T-securities got POMO’d as the bond market reversed course, yields down/prices up.  POMO stands for permanent open market operations, which is when the Fed outright buys Treasury securities.  They bought $8 billion in securities yesterday and another $35 billion to come over the next six sessions. 

Market Activity for December 13, 2010

European Ministers vs. the Market

European finance ministers convened over the weekend and have clearly decided to show some consensus as their next attempt to combat the market’s assault on sovereign debt.  Prior to this latest display of esprit de corps, we had German officials demanding that investors must take losses, if not right away then eventually, which was a much more stringent approach than the rest of the EU was taking. But now they’re in unison – the Germans, the French, the…well, the Germans and French are really all that matter -- as they state they’ll defend the currency at all costs. 

This means that investors will not be made to take losses as the EU’s strongest governments will continue to backstop everything.   This, in addition to the ECB’s recent ramp up of government bond purchases, will help for a spell.  Of course, government cannot backstop everything in perpetuity.  The Gods of the Copybook Heading, to borrow from Kipling, will eventually prevail as is always the case.  Investors will eventually have to take losses, the debt will be restructured and the euro will endure another round/rounds of assault. 

This Week’s Data

After a quiet Monday, with regard to economic releases, we get back to it this morning with NFIB’s small business confidence survey, retail sales, producer prices, business inventories and the latest FOMC meeting.

The NFIB’s survey will be a must watch as is the retail sale number.  We’ve been stuck around the 90 level on NFIB, a recessionary reading, for longer than any time in the measure’s 36-year history.  The October reading moved back above 90 to 91.7 and I think it will continue to make progress for a while.  I’m afraid we’ll struggle to get back to 100 (the longer term average) before moving back down again.  During the normal recovery the gauge approaches 105 – its peak of 107.5 was hit in 1983 and then again in 2004.

Retail sales for November are expected to rise a strong 0.6%, particularly strong after the outsized 1.2% increase for October – this data has been hot since August as it bounced off of significant weakness in the second quarter; to no surprise, spending turned down along with the stock market in Q2. 

Business inventories are expected to remain in expansion mode after last week’s good wholesale inventories reading.  The sales data is the key and we’ll watch for this segment of the report to outpace the increase in inventories.  Inventory rebuilding has outpaced that of sales growth for five-straight reporting months, which is unsustainable. 

Inventory rebuilding has accounted for more than half of the increase in GDP during this recovery, so it’s intensely important right now. 

And finally, the latest FOMC meeting comes to a close today and we’ll get the statement that accompanies the rate decision at 1:15 CST.  Obviously, there isn’t going to be a change to the fed funds rate (that can’t come until the Fed signals they’ll end QE, which has recently been ramped up); we’ll read that statement for evidence of further QE action.  I don’t think they’ll give us anything on this front; they’ll stand pat but may acknowledge the improvement in some of the data sets over the past six weeks via the statement. 

Things may get more interesting again in the coming weeks if longer-term Treasury yields continue to rise.  If so, I wouldn’t best again a return to interest-rate targeting (interest-rate price controls) regarding the long end, ala the Fed’s action back in the 1940s, namely because Bernanke remains very concerned about the housing market and the effect that even another 5% decline in prices would have on the banks – 27% of all mortgages have 5% or less of equity in the home (and much of the “less” is underwater) so a 5% decline means even more defaults.

Oh, they may also engage in explicit interest-rate targeting on the long end in order to halt losses on their current holdings.  The Fed must be incurring losses as the 2-year Treasury has backed up by 25 basis points (bps), the 5-year by 84 basis points and the 10-year by 80 bps – and all in just six weeks. 

And speaking of the Fed (or more germanely, the yield curve and stock prices), the Economic Cycle Research Institute’s (ECRI) Weekly Leading Indicators (WLI) index continues to improve and has all but returned to zero from the dreaded -10 mark as of September.

Since the measure has made most of its improvement beginning in September, the yield curve (spread between the yields on 2 and 10s) has widened by a massive 40 basis points and stocks are up 18% -- both are key components of any leading indicators index.  Surely, consumer spending has also helped, but this has also been fueled by stock gains.  Bernanke knows that if stocks take another move down, a number of indicators will start to print trouble again. 

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900