The S&P 500 Index gained ground for a fourth-straight session, clearing the 1250 hurdle, and the Dow Industrials rose for the first session in three.  Closing above the pre-Lehman collapse of 1250 means we’ve erased the crisis-level of equity-market damage; the index is now just 20% below the October 9, 2007 all-time high of 1565. 

Good earnings results from the tech sector and an ICSC report that showed same-store retail sales rose 4.2% last week on a y/o/y basis helped to offset still brewing trouble in the Eurozone.  Oh, and we received a double-barrel shot from the Fed as they implemented two POMOs yesterday good for $10 billion – this is becoming quite the trend as Monday brought two money-pumping operations also, good for $14 billion; QE2 is rollin’.”

Financials, basic material and energy shares led the broad market higher.  The traditional areas of safety – consumer staples, health care and utilities – all closed lower. 

The CRB Index moved higher for a third session, led by the prices of coffee, cotton (all-time high), aluminum and copper (all-time high).  The energy complex also continued its advance; the levels on crude ($90.21/barrel) and wholesale gasoline ($2.42/gallon) are certainly unwelcome for the consumer.

While the market rallies as if we’ve left financial crisis in the dust, actions from the Federal Reserve suggest otherwise.  We know that they continue to keep the fed funds rates floored at virtual zero (for two years now), continue to engage in more quantitative easing, and yesterday decided to extend swap lines to the ECB -- along with the central banks of Japan, Canada and the UK.  These swaps allow the Fed to provide for all the U.S dollars European banks need.  Dollar liquidity tightens up when the European government debt their banks hold continues to decline in value. 

Market Activity for December 21, 2010

We’re in a Different Economic World, for a While at Least

Rates have backed off again, halting the roughly 80 basis point surge in the 10-year yield during the first three weeks of December.  Now, the rate on the 10 only hit about 3.55%, not even matching the highs of the year – in April the 10-year hit 4.00%.  After the latest bond rally (of the past five sessions), which resulted in the 10-year rate easing back to 3.30% as of yesterday, it’s tough to see such a level causing much havoc. 

Certainly, the current level isn’t problematic. It’s the fear that we’ll get to 4.00%, 4.50%, 5.00% when bonds endure subsequent rounds of selling.  I see many people argue that rates averaged 10% in the 1980s and roughly 7% in the 1990s, so why can’t we manage around 4.50%-5.00% this time?  I hear what they’re saying because I’ve argued the same in the past, although that was before the economy became conditioned to ultra-low rates, the jobless rate stood at 5%, and we began running insane levels of budget deficits. 

So, people cite that the household debt servicing/disposable income ratio has declined (and I bring this up because it was a big topic on CNBC yesterday morning).  But what does this ratio do when interest rates pick up again?  Certainly, most borrowers that can refinance their mortgage already have at very low interest rates, so that won’t affect the ratio when rates rise.  But higher rates will boost new borrowing when new entrants buy homes and engage in additional consumer credit – and if they don’t then we have a growth problem on our hands, which is the overall point. 

And when we look at household debt as a percentage of disposable income, or HH debt/DPI, then we see the leveraged situation remains pretty troubling. 

And comparing household debt relative to personal income less transfer receipts, the debt picture is even worse.  (Why look at PI less transfer receipts?   Because the degree of government assistance is not sustainable -- currently at a record high of 18.5% of total income; the long-term average is 13%.   Hence, there’s been a $500 billion boost to the consumer via government assistance.) 

It appears the household deleveraging process has some ways to go still.  And the longer it takes for substantial and durable job creation to arise, the longer the deleveraging process will take – unless that deleveraging continues to come from dispositions (debt ratios falling as borrowers default), which can occur quite rapidly.  But of course this would spell additional trouble for housing and the banks – another of my major concerns. 

And while we’re at least tangentially on the topic of the job market, does anyone find it interesting that mainstream analysts almost seem giddy that payroll growth remains tepid at best.  Day in and day I hear the reason to buy the stock market is because companies have cut costs to the core, and the vast majority of those cuts were delivered via payroll slashing.  

During the so-called “jobless recovery” of 2003 the lack of job creation was seen as the worst thing since the plague.  But why would job creation pick up quickly back then as the unemployment rate only peaked out at 6.3% (in line with the long-term average).  Yet today, we’re just shy of 10% unemployment (and above 9% for longer than any time in the postwar era) but the mainstream analysts views a “jobless recovery” as just peachy.  I find the shift in mindset very interesting because it’s so bizarre. 

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Have a great day!

Brent Vondera, Senior Analyst