U.S. stocks were moving lower yesterday morning after the situation in Egypt continued to take a turn for the worse – heavier rioting and journalists being rounded up and beaten in some cases.  However, a better-than-expected ISM gauge of service-sector activity followed by a retail sales report that beat helped the market recoup some of those losses. And then came the Bernanke bounce after the Fed chairman signaled QE may just be extended beyond June – it was a tacit statement, but that’s how it starts; and this is the second signal we’ve received in two weeks.  Stocks rallied a bit more on that news and then enjoyed another little push in the final hour.

Consumer discretionary shares led the broad market higher on that strong ISM number and retail sales (remember, January sales have become an extension of the holiday shopping season over the past decade due to the gift card).  Telecoms, consumer staples and basic materials also outperformed.  The only losing sector on the day was industrials

Bernanke was taking questions after his speech at the National Press Club and reiterated that he thinks QE is offering significant support to job creation (geez, that must mean there’d be no job growth without it considering the gains remain paltry).  Since he also repeated his view that it will be a very long time before employment is back to normal (and the Fed has a mandate to maximize employment)…well, you get the message.  Although, he’s likely to contend with a couple of dissenting votes, that won’t matter much.   And yes, he also repeated that monetary policy actions are pushing people into stocks – this is not an investor’s environment, it’s a gambler’s. 

The Dollar Index gained good ground yesterday after ECB President Trichet stomped on the speculation that the eurozone’s central bank would begin hiking rates soon, which was just one of the many wacky ideas we’ve heard of late.  Trichet stated that their current stance is “appropriate.”

The CRB Index slipped, led by the prices of sugar and cotton – a couple of the hottest components lately.  Higher prices on silver, gold and OJ kept the index’s loss pretty tight.

Market Activity for February 3, 2011

Sector Activity for February 3, 2011

Jobless Claims

The Labor Department reported that initial jobless claims slid 42,000 last week to 415,000 (a drop to 420K was expected), following the prior week’s 54,000 surge that pushed the figure back to 457,000.  The four-week average rose 1,000 to 430,500.

Continuing claims declined too as the standard issue (which covers the traditional first 26 weeks of benefits) declined 84,000 to 3.925 million and the emergency level of claims (that extend bennies out to as long as 99 weeks) fell 67,571 to 4.551 million.

So continuing claims made nice improvement, bringing the total number below 8.6 million for the first time in 21 months, but as you can see below they remain off the chart.

Bottom line:  Initial claims remain above the 400K level, which suggests there’s still too many net layoffs out there.  As we stated last week, based upon the labor-market bloodbath that occurred nearly two years back (the slashing of eight million payrolls, six million of which occurred in a blinding 11-month period), normal economic conditions would have initial claims down to the low 300K handle (as occurred 13 months following the deep 1981-82 recession, and maybe even to the 200K handle based on the level of destruction that occurred). 

Continuing claims are showing “improvement.”  But is it absolute improvement?  Are these long-term unemployed now finding jobs, or are their benefits simply expiring and now they’re left with neither income nor government benefits?  The 400K-plus reading in initial claims and relatively anemic payroll growth do not suggest the majority of these long-term unemployed are finding work. 

Productivity

U.S. productivity rose 2.6% at an annual rate last quarter (beating the 2.0% improvement that was expected) as output increased 4.5%, while hours worked advanced just 1.8%.

The productivity improvement is a good one, really anything over 2.5% is from a historical perspective.   But what’s behind it is the lack of payroll growth.  And I see productivity specifically within the manufacturing sector jumped 5.8% in the fourth quarter.  We know why factory-sector payrolls have been so soft, in fact down over the past six months.  As manufacturers watch input cost rise, they sure aren’t going to add to their largest cost component.  Instead they’ll squeeze as much output from existing workers in an attempt to absorb these costs.  Yes, Fed policy is working against the labor market. 

ISM Services

The Institute for Supply Management’s gauge of service-sector activity continued to accelerate in January, rising to a reading of 59.4 from 57.1 in December (the estimate was a slight increase to 57.2). 

This is a reading that’s only been hit on five previous occasions (four times during the previous expansion cycle and once in 1997).  Now, this survey only goes back to 1997, so not a long history.  Still, this is a level that’s only been surpassed 3.1% of the time. 

The business activity, new orders, and employment indices all accelerated to hot levels.  Inventories decelerated a bit, which makes sense as the inventory sentiment reading showed respondents are less comfortable with the level of stockpiles. Nevertheless, most sub-indices are pretty much on fire. 

So according to both ISM gauges (manufacturing and service), we’re in an environment that is producing robust levels of economic growth and jobs.  Yet GDP is trending at less than half the level of prior expansions from deep recession (even as the Fed has never stood so hard on the monetary-policy accelerator) and monthly payroll increases are running well below prior cycles.  Either GDP is about to explode and job creation to follow, or these ISM figures are sending inaccurate signals due to the nature of the recession we’ve exited.

Same-Store Sales (Thanks Ben!)

The January figures for year-over-year retail sales growth came in at 4.8%, whipping the 2.8% expected.  This gets the first quarter off to a great start with regard to the personal consumption component of GDP.  But there’s a downside, a payback effect.  Personal consumption will eventually revert back to the mean, declining from the current 70% of GDP to the long-term average of 65%.  The Fed’s continued monetary games can delay this event, as they have, but cannot permanently prevent it. 

So retailers can thank Mr. Bernanke for this as the rallying wealth effect (the more affluent consumer accounts for a significant percentage of total spending, possibly a majority) boosts activity.   However, periods of reckless monetary policy lead to unhappy endings – it’s shocking we need to be reminded of this reality.  When the market suffers its Bernank Attack, praise for the Fed chairman will shift to derision.  And the only thing that will save the FOMC members from a crazed-citizen rush on the Eccles Building is the fact that most of the public remains unaware of the connections between artificial asset prices and foolish monetary policy decisions.   As a result, they many just have the luxury of concentrating on just one “exit strategy.” 

Sign up to receive the Daily Insight and other Acropolis publications here.

Have a great weekend!

Brent Vondera, Senior Analyst

Phone: 636-449-4900