U.S. stocks bucked a three-session trend that saw early gains evaporate in the afternoon sessions.  Yesterday the opposite occurred as stocks began lower but reversed course to turn higher at approximately 10:00 CST – that’s POMO time for those not yet aware; yesterday’s Fed market-manipulating money injection was good for $6.8 billion. 

Investors do remain somewhat jittery about Europe and rising domestic interest rates too.  Those rates pulled back a bit yesterday, which helped to ease at least that concern. 

Further, the day’s economic data was a net positive.  Jobless claims, housing starts and the latest manufacturing data all beat expectations.  It was really the factory data though that offered some boost to sentiment.  The trend in jobless claims has certainly improved, but they remain stubbornly high.  Housing starts were stronger than estimated, but the level of activity remains unprecedentedly weak, and we hardly need more homes coming to market considering the massive supply glut.  Even the best release of the day, a quite strong manufacturing report out of the Philly area, carried with it disturbing cost pressures, which we get into below. 

Quarterly results from FedEx provided a key indication of the margin compression that’s occurring due to higher commodity input prices and Fed policy.  The company reported revenue rose 12%, but operating income was down 18%.  The firm explained that costs related to under-funded pensions and higher fuel costs were among the main contributors to the decline in profit. 

The Fed’s policy of continued monetary easing is meant to boost employment.  In reality, it may actual curtail job growth as firms seek to contain profit margin compression – ultra-low interest rates hit pension plans (which must invest most of their assets in fixed income assets) and Bernanke’s policy stance is a main contributor to the rise in energy prices.  The firm did raise their 2011 guidance, but explained that the guidance assumes stable fuel costs – big assumption. 

Seven of the 10 major industry groups outperformed the market, led by industrials, basic materials and utilities.   Financials (as the Fed considers cutting debit-card transaction fees by 80%), telecoms and tech weighed on the broad market’s advance.

Market Activity for December 16, 2010

Jobless Claims

The Labor Department reported that initial jobless claims fell 3,000 to 420,000 last week -- 5K below expectations.  The previous week’s reading was revised up for the 32^nd of the last 33 weeks.  Thus, if this trend continues next week we’ll find the number didn’t beat expectations at all as it will be revised higher.  The four-week average fell 5,250 to 422,750.

Continuing claims on the other hand, which lag initials by a couple of weeks, increased.  The standard issue of claims (first 26 weeks) rose 22,000 to 4.135 million and emergency-level of claims (that extend out to as long as 99 weeks) jumped 324,537  – although neither offset the declines from the previous week, so that’s good. 

Bottom line:

We continue to hold below the 450K level on initials, which is clearly an improvement in the trend.  However, we can’t seem to get to that 400K mark, which is key because a move to 350K is what corresponds to a normal labor-market recovery.  And continuing claims, while improving, remain at troubling levels.  The standard issue has declined from stratospheric levels, but remains near the peaks of the rough 1974 and 1980 & 1981-82 recessions. 

With the emergency level of claims very near 5 million, it shows that most of the decline in the standard issue of continuing claims is more about benefits expiring and rolling into emergency extensions than a function of job growth.  The long-term unemployment situation persists and some of this has to be related to those emergency-level of benefits themselves, simply because it raises the minimum wage for which someone is willing to work). 

Housing Starts

The Commerce Department reported that housing starts (beginning construction on residential real estate) rose 3.9% in November to 555,000 units at a seasonally-adjusted annual rate (SAAR) – 550K was expected.  The prior month’s reading was revised up to show starts fell 11.1% instead of the 11.7% initially printed last month – up to 534,000 from the 519,000 initially reported. 

We don’t really need more units coming to market but as you can see via the chart below, housing starts do remain floored. 

Philly Fed

The Federal Reserve Bank of Philadelphia’s gauge of factory activity remained hot in December, accelerating to a reading of 24.3 in December (blowing away the expectation of 15) from 22.5 in November – continuing the bounce from contraction a couple of months back. 

The new orders, unfilled orders, and average workweek all improved.  Yet the number of employees reading fell – factories are clearing increasing hours for current employees rather than adding to staff, as the past four job reports have shown. 

Further, the prices paid measure surged.  Prices paid minus prices received by manufacturers has widened to one of the largest differences on record – a level that has occurred only 2% of the time over the past 30 years.   It’s tough to see meaningful and consistent hiring in such as environment of margin compression.  Since firms have been reluctant to hire, they enjoy very wide margins; so there is room to compress, but the trend is not good and shouldn’t be ignored. 

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Have a great weekend!

Brent Vondera, Senior Analyst

Phone: 636-449-4900