U.S. stocks shrugged off escalating unrest in the Middle East to push higher and completely erase Friday’s losses as the Dow Industrials motored past 12K and the S&P 500 beyond 1300 (closing above these level for the first time since 2008) – risk back on, baby!.  (Chart below had to be drawn on a weekly basis, so it misses Mon. and Tues. rallies.)

Investors cheered the day’s earnings reports, Chinese manufacturing, news that the EU may soon release the latest effort to “fix” their debt problem, and maybe even the latest ruling on the health-care legislation.  Quickly on each of these:

* Yes, a look forward sees challenging profit comparisons ahead – something we’ve been talking about for a while as year-ago comps have been ultra-easy to beat and consumer spending outpaced incomes again in the fourth quarter – but that takes a backseat when optimism rolls. 

* The latest gauge of Chinese factory activity showed the sector remained in expansion mode. 

* The EU and IMF may agree on a sort of Brady-bond plan that leverages the credit ratings of the healthier economies and allows the troubled governments to roll their debt into 20-30 year maturities.   

* A U.S. District court ruled Monday that the entire health-care legislation is unconstitutional.

Basic material and energy share are on fire again, leading the market for a second-straight session.  Financial, energy, health care and tech also outperformed.  Utility and consumer staples lagged again, up half that of the broad market. 

The Dollar Index got smacked again, down to 77.06 by the close.  Next stop is the 76 handle; I peg 75 as the danger zone.  The index hit 75.88 in early November as the Fed promulgated QE2, which was also the time talk of currency wars hit its crescendo.  The Fed doesn’t seem to acknowledge the adverse consequences of its policy.  It’s ignoring the political uprisings that the policy is, at least partially, engendering via higher food prices and it is unwilling to accept the notion that further depreciation of the dollar will fuel international trade and capital flow troubles.  Nevertheless, the greenback should find support in the 75 handle as the euro will once again run into a wall.

And speaking of consequences, a story in yesterday’s WSJ touched on the flood of money that’s going into leveraged buyouts (financing corporate buyouts).    Investors continue to accept more risk as they seek higher returns and products that offer floating rates.  The article stated that $6 billion moved into these loan funds last quarter, double the previous quarterly record and the trend accelerated in January as $3.4 billion came in.  More demand means that private equity firms engage even more leverage. If something doesn’t derail it first, the Fed is undoubtedly inciting another asset bubble. Nothing has changed.

Market Activity for February 1, 2011

Sector Activity for February 1, 2011

Surrounded Again?

It seems surreal to watch stocks unfazed by developments in the Mideast.  Egypt’s political transition from Mubarak is unlikely to be smooth (the well-organized Muslim Brotherhood appears at the ready, just waiting to fill the vacuum ala Lebanon) and now Jordan’s King Abdullah has replaced his cabinet as he attempts to stem an escalation in uprisings there.  Both of these guys have either sustained or entered into peace treaties with Israel.  Egypt is to Israel’s south, Jordan to its east, a Hezbollah-controlled Lebanon to the north, Syria to the Northeast, and to the west…the Mediterranean Sea.  The market says no big deal, and I hope that consensus is right. 

ISM Manufacturing

The Institute for Supply Management’s nationwide manufacturing gauge for January came in at a hot 60.8 (beating the 58.0 expected), up from the 58.5 in December (a reading that was revised up from 57.0). 

New orders jumped 5.8 points to a rare reading of 67.8; backlog of orders rallied 11 points to 58.0 (follows four months of contraction); employment up 3 points to 61.7 (that’s a 38-year, yet factory payrolls are down over the past six month); and exports reversed two months of deceleration, fueling higher to 62.0.  Inventories were roughly unchanged at 52.4 and customer inventories rose 5.5 to 45.5, so more respondents were uncomfortable with the rise in stockpiles. 

And as manufacturing remains hot, prices continue to accelerate.  The ISM’s prices paid measure jumped 9 points to 81.5.  Over the past 30 years, such a level has only been hit 4.7% of the time outside of the circled timeframe when CPI averaged 8.5% per year. 

The employment index says it best.  These manufacturing surveys are measures of direction (how many more respondents are stating improvement) rather than degree of activity.  This is why these gauges are showing such huge numbers, yet factory utilization remains 6% below average and 10% below the previous expansion cycle – it’s a function of the deep contraction in 2008-09. 

Construction Spending

Construction spending slumped in December as both private and public-sector results declined for the first time since August.  Total spending fell 2.5% (expected to rise 0.1%) after November’s downwardly revised -0.2% (previously reported at +0.4%).

Residential activity led spending lower as private residential fell 4.4% and public spending slid 10.6%.  There was no word of weather playing havoc in these numbers from the Commerce Department. 

Government spending has been propping this sector up, but even the “mighty” government can’t keep the pace up forever.

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Have a great day!

Brent Vondera, Senior Analyst

St. Louis, MO

www.acrinv.com