The major indices ended mixed on Friday with the S&P 500 and NASDAQ Composite up a bit, while the Dow Industrials closed down a touch. 

For the week, the Dow Industrials gained 0.7% (and has more than recouped the 438 points lost in the final three weeks of November to rebound by 485 points over the past three weeks); the S&P 500 added 0.3%; the NASDAQ Composite gained 0.2%.  Mid cap stocks gained 0.40% last week (and up 8.38% over the past three weeks).  Small cap stocks were up 0.50% when averaging the two major indices that track the asset class (up 10% over the past three weeks).

Basic materials, utilities and financials were the best-performing groups.  Telecoms, industrials and energy were the laggards – all three were down for the session. 

The CRB Index snapped a three-day losing streak, to make a new post-Lehman high.  The gains were driven by price of sugar, coffee, cotton and corn.  Aluminum, heating oil and cocoa (which has been on quite a run for the month) prices were the only of the 20 components to decline for the session.  Precious metals and crude oil were slightly higher -- $1378/oz gold, $29.18/oz silver and $88.51/barrel crude (wholesale gasoline hit $2.325/gallon, anything above $2.30 is enough to keep retail hovering at $3.00).  

As everyone knows by now, the House passed the extension of current tax rates.  Beyond keeping federal income tax rates on income from increasing, the plan also involves a   two percentage-point reduction in the payroll tax (brings the employee’s 6.2% social security tax rate down to 4.2% for one year), a 13-month extension of extended unemployment benefits, 100% expensing for business equipment purchases for one year, and exempts estates $5 million and under from the estate tax – 35% for those over $5 million.  President Obama wasted no time signing the legislation, which occurred Friday afternoon.

Market Activity for December 17, 2010

Europe

Last week we talked about EU ministers attempting to show some degree of unison and late last week they continued this strategy by agreeing to create a permanent debt-crisis mechanism.  There were no details, such as what are the parameters that would trigger this mechanism, what conditions would be placed on those defaulting governments and how they would keep them from getting into trouble again. 

More than anything, this is another attempt to window dress the debt situation, hoping that investors see headlines that EU ministers have agreed on a longer-term bailout fund – and in an environment with which bailouts have become so prevalent, they hope that the market ceases and desists in punishing the debt of peripheral economies.  But it’s not working.  Sure, the euro is largely holding ground, but you see trouble continuing to bubble up via higher government funding costs. 

In addition, we received news on Thursday that the ECB (European Central Bank) would be doubling its capital position. 

Where will they get these funds?   They’ll be funded by member countries – of course this means even more borrowed money as they have none to give.  Why does the ECB find it necessary to raise capital?  Because they know they’ll incur losses from all of the junk they’ve been buying via essentially bankrupt Eurozone governments – bonds they’ve had to buy in an attempt to stabilize EU bond markets and keep interest rates from truly blowing out, masking the problems in the EU to an even greater extent. 

ECRI WLI

The latest reading from the Economic Cycle Research Institute’s (ECRI) Weekly Leading Indicators (WLI) gauge showed continued improvement and has just about returned to zero. 

The WLI rose to -0.10 for the week ended December 10 from -1.40 in previous week, meaning the index fell at a 0.10% annualized rate in this latest week.  So, we’ve clawed  back from the dreaded -10.00 mark – a level that had predicted every recession since 1970, which is why we began reporting this number again since it first hit that level in mid July and remained there for nine-straight weeks.

The index has improved in perfect tandem with the latest rebound in the stock market that began in late August when Bernanke first signaled another round of QE was coming.  Since then the WLI rebound has most likely been fueled by rising stock prices and a more positively sloped yield curve – and that yield curve slope has really kicked in since late September as the Fed holds the fed funds rate at zero while the long-end of the curve has jumped. 

Here’s a shorter-term look at WLI, and the slope of the yield curve below it.  I’m concentrating on the most recent rebound, but the surge off of the December 2008 all-time low was also fueled by that which the Fed has most manipulated – stock prices and the yield curve. 

Over the past couple of readings though, other components of the index have surely begun to help – I can’t know for sure as the WLI is a proprietary measure, but all leading indicators have 8-10 essential components, so I can surmise that initial jobless claims, consumer confidence and the average workweek are those components that have also provided help.  While jobless claims and consumer confidence remain at troubling levels and the average workweek is rising but new hiring remains week, this is nonetheless improvement.  Thus, the increase in WLI over the past couple of weeks has been more organic, if you will, rather than simply being pushed higher due to unprecedentedly easy monetary policy. 

Nevertheless, the economy remains overly sensitive to changes in stock prices (particularly since home prices continue to weigh on household wealth) and if those prices turn down consumer spending is going with it.  So it’s good that other components of leading indicators are pointing up, but euphoria has to be contained as it doesn’t take much to buckle this very vulnerable economic state.   The Federal Reserve, via its extremely aggressive policy has stomped out prudence for the time being.  We’ll see before it’s all said and done, that prudence still has merit. 

Prudence means different things to different people.  It depends on many things: one’s objective, risk tolerance, age, and certainly one’s view of how the world works.  The Fed has a very powerful ability to lull traders and investors into thinking risks have cleared and a more normal market environment has emerged.  I believe that when you put everything together – a panoply of risks and structural difficulties that I’ve mentioned on many occasions but will spare time and space this time – a higher than normal degree of caution is plenty justified. 

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900