U.S. stock-index futures were about flat early Monday morning, until STL Fed Bank President Bullard, via a CNBC interview, tacitly stated for the second-straight trading session that the Fed will remain aggressively accommodative for as long as they get away with it.  That’s all equity markets really need to hear, futures summarily jumped on the comment. 

But as the official trading session got underway, the broad market shed much of the early-session gains.  A mid-session bounce in the price of crude nearly sent stocks into negative territory (funny how that relationship has shifted now that we’re hovering around $100/barrel, stocks and oil had traded in tandem since the financial crisis hit), but energy prices eased off again and stocks bounced back. 

Telecom, utility, basic material and health-care shares led the broad market higher.  Tech, consumer staples and financials were the under-performing groups, but even these sectors did gain ground for the session. 

The day’s economic releases were mixed, as we discuss below, as if it matters.  This market pays less attention to the data, save the jobs report, then maybe any time in history as the Fed’s so in the game right now.  It’s almost to the point that when we get a big-bang monthly payroll reading I could see traders taking profits as they’d worry the Fed’s money-pumping days are coming to a close. 

And due to the abundance of Bernanke liquidity, the environment is more challenging for those focused on investing rather than trading.  Until very recently, momentum trading was the game -- so you saw stocks that make very little-to-zero sense from a valuation perspective continue to move higher, while the longer-term buying opportunities underperformed.  This situation has begun to shift lately, but only over the past month or so.  When the Fed is seen as backstopping losses, that’s the market you get, but it’s a dangerous market, one in which prices can vaporize very quickly.  At which point, value investing will pay off for those thinking multi-year rather than multi-day or week; this will become evident again when we find that the latest 25-30% of this move from the March 9, 2009 lows has been built on very shaking ground. 

Within the international scene, the Chinese government reduced its economic growth target to 7% (from 8%) for the period 2011-2015 in order to combat their growing inflation problem – surely one of the catalysts behind increased protests and uprisings that have now spread to China.  This does have implications for the U.S. economy as, in the current environment at least, our export growth is increasingly more dependent upon Asian activity. 

Market Activity for February 28, 2011

Sector Activity for February 28, 2011

Personal Income & Spending

Personal income jumped a strong 1.0% in January, whipping the expected 0.4% increase, as the payroll tax-rate reduction took effect.   (The payroll tax, which funds the Social Security program, was cut by two percentage points for all of 2011.)  Why economists’ estimates failed to factor this in, expecting just a 0.4% increase in personal income for the month is beyond me. 

The more intrinsic segments of income looked good too in January as wages & salaries gained 0.3% for the month, but the disposable income (after-tax income) figure illustrated that most January’s income gain was a result of the 2011 tax cut as that segment jumped 0.7% -- up 0.4% when adjusting for prices. 

(I’m all for lower tax rates, but only if they are made permanent – or as permanent as Washington can get.  The problem with a one-year tax rate reduction is that when it’s taken away after-tax income falls.  Households understand this and the result is an increased propensity to save that money – opposite the focus of the plan.  Milton Friedman illustrated this in his Permanent Income Hypothesis. 

Among other segments:  rental income remained strong, up 2.1% for the month and a fantastic 10.6% over the past 12 months; income from assets was up 0.5% as interest income gained just 0.2% but dividend income jumped 1.1%; government transfer payments declined 0.5%, just the fifth month of decline in 2 ½ years. 

Spending during January rose 0.2% in nominal terms and fell 0.1% when adjusting for inflation – the first decline in a year. 

While Keynesian economists certainly want this income to be spent, reality is that households have much to repair and it’s better from a longer-term perspective that they take some time to save this income increase.  (The charts below illustrate that debt levels remain grossly high, and when interest rates normalize they’ll choke the economy again -- debt servicing will jump to a level that kills consumption).

As a result of incomes vastly outpacing spending for the month, the cash savings rate rose to 5.8% from 5.4% in December. 

Chicago PMI

The Chicago Purchasing Managers Index, which tracks factory activity within the largest manufacturing region of the country, rose to a rarely seen level of 71.2 – a mark hit only 1.8% of the time in the measure’s 44-year history.  In fact, this is the first time Chicago PMI has hit a reading above 70 in which nominal GDP wasn’t running 9.6% on average -- today it’s below 4%, so something’s going on here. 

Now, the manufacturing sector accounts for less of the U.S. economy today than it did 30 years – the actual figure varies depending on how one measures it.  But it’s not like this situation suddenly changed on a dime, it’s been fairly constant for 15 years, yet the strong growth rates of the late 1990s never saw Chicago PMI hit a reading higher than 62.7 (besides the service-sector readings are posting number that don’t match with the weak GDP figures either).  I guess it’s simply a situation in which there are just too many other things dragging economic activity lower. 

Every segment of the report posted strong results, so no sign that activity within the Chicago region will wane any time soon.  Export activity is a large part of the regions factory activity, so it will be interesting to watch what occurs as China seeks to lower their growth rate, as they attempt to dampen inflationary pressures.

One has to believe though that unless other aspects of the economy start to come around, the manufacturing sector will have to begin to feel the drag too.  This is what I’ve surmised for five months now, yet factory activity carries on.  It can’t continue to levitate though unless other aspects of growth begin to take hold. 

Pending Home Sales

The National Association of Realtors (NAR) reported that pending home sales fell 2.8% in January following a 3.2% decline in December, a reading that was revised down from the +2.0% reported a month ago.  These pending contracts signal the direction of official sales when existing-home sales close a month or two hence. 

The decline in pending sales is no surprise as we’ve seen this setting up within the mortgage application readings – high frequency data that is released each week.  Apps to purchase a home have declined eight of the past 11 weeks.  What’s interesting is the rather large downward revision to the December reading that showed pending contracts were canceled.

What happened in December?  Mortgage rates jumped by 30 basis points as they approached 5%.  Certainly, a 5% mortgage rate is hardly some inhibiting cost of money from a historical perspective – the 20-year average rate for the 30-year fixed mortgage is 7.0%.  But in the current environment, in which the market has become conditioned to stupidly low rates and more appropriate credit standards take hold after a period of no standards, it appears that approaching the 5% mortgage is simply a level that this housing market cannot yet withstand.  At least without serious subsidies, such as the homebuyers’ tax credit. 

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900

St. Louis, MO