Most U.S. stock indices sold off yesterday after a brief uptick at the open, hitting the day’s nadir just before noon central time, but a late-day rally kept the losses to a minimum.  The Dow Industrials managed to close higher thanks to shares of Disney and Hewlett-Packard. 

The Dollar Index also reversed course, after spending the early morning hours lower, to close higher and stocks didn’t seem to like that move. 

Some cited a better-than-expected factory orders report as reason for the U.S. dollar’s rally, but the upturn began an hour before that figure was released so it looks like something else was in play – considerable weakness in the euro set in just prior to the U.S. market’s official open so maybe there were some European debt concerns returning a bit. 

And one does get the feel that the U.S. dollar is going to engage in another one of those European debt-related fear trades as the euro comes under pressure again.  If this scenario materializes, then it also means the Treasury market rallies again (yields turns back down).

Telecoms, utilities and health-care shares were the session’s top performers.  Energy, consumer discretionary and basic materials were the laggards.  Oil prices touched a 27-month high in very early trading, hitting that $92/barrel handle, but the move was stuffed by the rallying dollar; the price of crude backed off by $2.40 – and is down another buck this morning to $88.41.

The entire commodity complex, as measured by the CRB Index, sold off by its most in about seven weeks.  The move was led by declines in the prices of precious metals, energy and agricultural goods. 

Market Activity for January 4, 2011

Factory Orders

November factory orders rose 0.7%, according to the Commerce Department (much stronger than the 0.1% expected) after a 0.7% decline for October.  The increase was fueled by orders for nondurable goods, or those meant to last less than three years.  Durable goods orders slipped 0.3% in November after October’s 3.1% decline.

While durables fell for the month, it appears that they’ll be revised up big time when the December durable goods orders report is released – this is one of the main reasons to watch this factory orders report as it provides a strong indication on that durable goods revision.   This report had durable goods orders down just 0.3% in November, which was previously reported last month in the strictly durables report as having fallen 1.3%. 

Even with the improved revision, headline durable goods orders have made very little progress since April due to the decline in commercial aircraft (down 41% at an annualized rate since April) and motor vehicles & parts orders (down 24% at an annualized rate since July). 

But ex-transportation, which is really the key number to hone in on, has rebounded nicely (up 3.6% in November) after activity was flat in the March-October period.

FOMC Minutes

I think the market was pretty eager for the release of the December 14 FOMC meeting minutes as the Committee’s tone within the statement that immediately followed the meeting remained quite morose considering the improving data of late.  Some may have also been wondering if the FOMC would signal a reduction in QE2 because of the better-than-expected data, but I doubt such action was ever realistic simply because of the negative tone in the statement.  (Just to clarify for new readers, the “statement” is the brief comment that follows a Federal Open Market Committee meeting.  The “minutes” are the more broad notes from that meeting, which are released three weeks later.)

And indeed, the Committee showed no sign of reducing the $600 billion ($900 billion when adding in re-investments from paydowns) in additional bond purchases.  The members of the FOMC continued to cite an unwillingness among businesses to hire and also expressed worries over another round of declining home prices.  (The Fed has not talked about housing all that much, but we’ve talked about how this is a major concern of theirs, particularly what another round of price declines will do to banking-sector capitalization.)

Bottom line:  The members of the FOMC stated that improvement in the economy didn’t meet the thresholds for scaling back QE2.  And some members stated that their thresholds were quite high.  What this means in terms of an actual unemployment rate that makes these members comfortable is anyone’s guess.  We know that conventional economic wisdom believes the natural rate of unemployment is roughly 5.5-6.0%.  Surely, they wouldn’t wait that long – nor would they be able to as global market forces would demand them to reverse course by that time.  But say they have an 8.0% jobless rate in mind.  At the current rate of job growth, we’re talking another 18 months of market manipulating QE action. 

It will be very interesting to watch this play out.  QE2 (on its current schedule) will have run its course by June, at which point the market will be left to stand on its own.  By then it’s not only doubtful but hugely unlikely that the unemployment rate will make anywhere near the progress desired by the Fed.  And if we endure another round of 5-10% home price declines (and some expecting home prices to return to their long-term mean see another 20% decline in store) then there will be more QE to come. 

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900

www.acrinv.com