In a repeat of Monday’s trading activity, the major stock indices gained ground in early trading yesterday, in fact spending most of the session in positive territory, only to give nearly all of it back in the final hour.  Better-than-expected results from two of the three data releases the market was most focused on helped to send stocks higher for most of the day, but following the FOMC statement (which we discuss below), the bond market extended its losses and that seemed to put some fear into the stock market. 

Telecoms, health-care, industrials and consumer staples were the session’s best performers.  Financials and energy were the worst. 

The CRB Index closed down slightly, essentially flat.  OJ futures weighed on the index as it appears Floridian citrus groves will avoid the feared damage from the cold snap.  Cotton, nickel and cocoa prices continued higher. 

The Treasury market has really sold off (prices down, yields up) and while rates were higher just eight months back, it does appear the market is testing the Fed – and it can overwhelm Fed buying if it wants to.  I still think we’ll see rates fall again before they eventually turn higher in a more secular manner, but what’s occurred is surely not going to help the housing market. 

What’s interesting is that Bernanke has given a couple of speeches since late August explaining that the Fed can’t do it all, that they’ll need some help from fiscal policy.  Well, agree or disagree, the Fed chairman is getting his favored Keynesian-style stimulus by way of the temporary payroll tax reduction.  But what it’s done is raise GDP forecasts, which has encouraged some slight normalization of rates – I don’t think this is a situation of the vigilantes pushing rates higher because of the deficit, not yet.  No matter the true cause, the bond market is really abusing the Fed, which wishes to push real interest rates lower in order to force households to spend more.   This may very well cause Bernanke to do something even more wild and crazy, such as those longer-term interest rates controls we’ve been talking about. 

Market Activity for December 14, 2010

NFIB

The National Federation of Independent Business reported that their small business optimism measure improved by 1.5 points to 93.2 for November – the fourth-straight month of improvement as the index slowly pulls out of recessionary readings.  This is the highest level since December 2007, which is when the recession officially began.

The results to the questions:  Plans to hire, business spending plans, expect a better economy and expect better sales all improved.  (The expectations measures have risen above readings that accompany recession, yet the more current readings – plans to hire and business spending plans -- remain at recessionary levels.)

Respondents’ answers to the questions on inventory satisfaction and positive earnings trends both fell – falling enough to more than wipe out the improvement in the previous month. 

So the overall index’s improvement by far lags that of past recoveries.  After spending the longest time in the measure’s 36-year history at or below the 90 mark, we now appear to be climbing out of those recessionary readings – a reading above 95 would mark such a move.  Based on the latest moves, while the deterioration within the inventory satisfaction and earnings trends figures are concerning, we should get back above that 95 mark within 2-3 months.  However, I’m not sure returning to the average reading of 100 is doable in this environment, and unfortunately the potential for economic shock is heightened to say the least.  One shock during this vulnerable period and you’ve got small business confidence on the slide again.

Retail Sales

The Commerce Department reported that retail sales rose a large 0.8% in November (expected to rise 0.6%) after surging 1.7% in October, a number that was revised up from the 1.2% that was previously reported.  Excluding autos, sales were up 1.2% after the 0.8% in October. Excluding auto, gasoline and building materials – the number that gets plugged into GDP – sales jumped 0.9% after the 0.5% in October.  

There was definitely a cold weather theme to the higher spending numbers over the past two reporting months.  The clothing and general merchandise segments were strong, up 2.7% and 1.3%, respectively.  Internet sales rallied 2.1% after the 0.8%

The weakness came from autos, furniture and electronics.  Auto sales were down 0.8% in November, but that followed two months of large gains.  Furniture is down pretty big over the past two months, and outside of a temporary boost when the tax credit was in play, has remained floored for 18 months.  Electronics sales drove overall consumer activity as it bounced from the trough hit in mid-2009.  Since then it’s been flat, which may be telling us something.  The segment has declined in three of the past four months.

It seems pretty evident that the retail sales bounce over the past couple of months would have been much weaker if not for the quick change in weather – a sudden change from warmer-than-normal to colder-than-normal (encouraging a rush to buy new winter attire).  Too, stock prices are certainly helping consumer activity.  I continue to harp on this because sales driven by jobs and income growth results in much more consistency rather than spending driven by the short-term whims of the market.   Just something to keep in mind. 

Producer Prices

The producer price index (PPI) rose 0.8% in November (expected to rise 0.6%) after the 0.4% increase in October.  On a year-over-year basis, PPI is up 3.5%.

Producer prices were driven by a 4.7% increase in the gasoline component, a 1.7% bounce in passenger cars, and a 0.5% rise in prescriptions. 

I wouldn’t worry about this reading until it returns to 5% on a y/o/y basis, although the y/o/y 12.8% rise in crude goods (materials used in the very initial stages of production) is likely signaling what’s to come for the overall index. 

That crude goods figure will show acceleration via the next report as commodity prices (as measured by the CRB Index) have rebounded by 6% in December – the CRB was down 5% in November.  Tough to determine the trend though as all it takes is some weaker economic data or policy tightening in China and commodity prices are likely to pull back again. 

Business Inventories

Business inventories came in lighter-than-expected, rising 0.7% for October (expected to increase 1.0%).   The miss was especially surprising after the strong-than-expected wholesale inventory report we received last week.  However, the report was actually better than the headline reading suggested as the sales data was strong – sales growth doubled that of the increase in stockpiles. 

The sales figure rose 1.4% -- this marks the first time in six months by which sales outpaced that of inventories, which was something very much needed for this inventory cycle. 

If the November and December inventory readings surprise to the upside, then it will combine with the stronger-than-expected retail sales data to give us at least a 2.8% print for Q4 GDP and offers a shot at something around 3.2%.  If it disappoints, then the retail data of October and November will offset the weaker inventory results to contain any downside. 

And while we’re on GDP, it was really the first half of 2011 we’ve been worried about for some time as I’ve been explaining that this recovery is much weaker than normal and may prove intensely shorter in duration than the normal cycle that lasts for several years (7 years on average regarding the last three expansions).  The one-year decline in payroll tax rates basically provides enough help to consumer spending that takes the double-dip risk off the table – again, assuming one of the potential shocks doesn’t come jumping out at us and/or consumers don’t decide to simply save most of the boost to their paychecks. 

FOMC

The Federal Open Market Committee (the policy-setting committee of the Federal Reserve) issued a statement that was identical to the one that followed the previous meeting.   That is:  According to the FOMC, economic recovery continues, but at a rate insufficient to bring down unemployment; household spending is increasing, but remains constrained by high joblessness, modest income growth, lower housing wealth and tight credit; business spending is rising but at a slower pace than earlier in the year; and employers remain reluctant to hire.

The fed funds target of zero-0.25% obviously remained in place and the $600 billion in new QE and the additional $300 billion from mortgage-security pay downs will be reinvested into Treasuries – so they also stand pat on QE2. 

The main points from the Committee:  The economy remains constrained by high unemployment, progress towards their economic objectives remain disappointingly slow and underlying inflation continues to trend downward. 

On that last point, it is true only for the Fed’s ridiculous core inflation measure, which excludes such necessities as food and energy.  And they made no reference of higher commodity prices – which as the commodity-spike of 2008 showed, they will only do so when prices have spiked to exorbitant levels, such as $145/barrel oil.

While I personally believe the economic recovery is not self-sustaining, meaning that continued stimulus measures are buoying the recovery and masking serious issues,  I also believe that what the Fed continues to do will lead to even more trouble down the road; we should just allow things to play out at this point from the perspective of monetary policy.  But the Fed will continue to use the cover of currently nonexistent core inflation and very high joblessness as reasons to continue along their path of unprecedented easing measures.  

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900