I entitled Wednesday’s letter Stocks Don’t; Like C-Note Oil.  Scratch that; I stand corrected.  Traders no longer appear to be concerned with crude above $100 and pump prices at the national average of $3.47 -- no problemo.  

U.S. stocks enjoyed their strongest rally this year on Thursday, but I’m not exactly sure what drove the upswing.  We did receive a very good initial jobless claims reading and another strong ISM report, but one can’t really say this data provided the impetus as futures were surging as early as 4:30am CT and actually eased back a bit after the claims number was released at 7:30.  Some are saying stocks rallied on this news that Venezuela’s Chavez is brokering a deal with Gadhafi (one of the various spellings) to step down.  I find the idea (not that Gadhafi is on the way out, but that Chavez is leading the charge and the market rallied on it) meritless as it’s more a sideshow than anything else, but people were talking about it as driving the market.  What, Chavez the diplomat?    Have we really turned that gullible? 

Anyway, industrials and health-care shares drove the broad market higher; financials, basic materials and tech also outperformed.  The relative losers were telecoms and utilities – the former barely closed in positive territory and the latter was up just 0.97%, little more than half that of the broad market. 

The gains helped the S&P 500 recover most of the overall losses of the previous two weeks, getting the index within 1% of the 20-month high hit on February 18. 

The CRB Index moved to a fresh post-crisis high as food prices were yesterday’s primary driver.  The Food and Agriculture Organization’s price index jumped another 2.2% in February to a new high (the measure began in 1990) – marking the eighth-straight monthly increase.  This is one of the major elements behind the unrest (or I should say the relative increase of Mideast unrest) and it’s got widespread complications for global growth and security, particularly if more radical groups fill the void. 

ECB President Trichet signaled he may raise their benchmark interest rate next month, but will continue to lend as much to euro-zone banks as they need for another three months – these banks remain dependent on the central banks as inter-banking lending has become expensive again.  He noted that the market should not expect a series of moves; this would just be a lifting of the emergency-policy stance.  The comments pushed the euro higher and the U.S. dollar even lower.

Market Activity for March 3, 2011

Sector Activity for March 3, 2011

ISM Service Sector

The Institute for Supply Management’s gauge of service-sector activity remained at a hot level in February, rising to 59.7 from the 59.4 in the January – the market expected a reading of 59.3.

This is a level that’s been hit just 5% of the time over the measure’s nearly 14-year history, and just as their manufacturing gauge is showing, illustrates quite the disconnect from actual GDP growth that’s running below the long-term average. 

The internals of the report were mostly strong with nearly all components remaining at solid-to-hot levels.  This means that the prices paid reading also moved higher.  As I stated on yesterday following the ISM manufacturing survey, either firms are going to boost prices in a significant manner or they’ll be forced to eat these costs. 

Same-Store Sales

The International Council of Shopping Centers (ICSC) reported that same-store sales rose 4.2% in February from the year-ago period, beating the +3.6% estimate.  The luxury (up 10.1%) and department store (up 5.7%) segments led the measure. 

The trifecta of holiday gift cards, the payroll tax reduction and a rising stock market (regarding the more affluent consumer) delivered the boost.  The March results may still enjoy three catalysts:  the payroll tax reduction (although the 35-cent increase in pump prices over the past month will curtail this a bit), a stock market that may continue to hold up or rise further, and those homebuyer tax credits that will roll in over the next two months (which will be needed for the year-ago comparison as last spring also benefited from these refunds) will drive activity. 

Lots of stimulus out there, what occurs when it’s gone? 

Jobless Claims

The Labor Department reported that initial jobless claims fell 20,000 last week to 368,000 (expected to rise to 395K) following a downwardly revised 388,000 in the previous week.  So this gives us the third week of sub-400K out of the last four weeks, and thus the first real sign that monthly job growth will accelerate over the next couple of months.  And if this does materialize, even though capacity utilization rates remain below average and units labor costs are in decline (two failed inflation indicators the Fed continues to obstinately rely on) this will put pressure on Bernanke to abandon any further QE plans. 

The four-week average fell 12,750 to 388,500, the first time it’s dropped below 400K since July 2008.

Continuing claims were mixed as the standard issue (which covers the initial 26 weeks of joblessness) fell 59,000 to 3.774 million, while emergency claims (which pick up from there to extend as long as 99 weeks) rose 56,600 to 4.503 million. 

So here come the jobs; this is what we’ve been waiting for, and what I’ve been waiting for as the early sign of pressure that confronts Bernanke to cease and desist his reckless behavior.  But the destruction that occurred in the labor market needs a long period of expansion to fully repair.  And I’m sorry but one cannot extrapolate the positive data we’re currently receiving because the Fed must eventually unwind the most aggressive monetary easing policy in its history.

Now, the totality of the unwind won’t occur real soon, but the beginnings of the policy reversal will if substantial job gains materialize and economic activity doesn’t fall off again near the back half of the year as the stimulus wears off.  But even before the unwind enters full effect, it’s going to hurt.  The stock market will anticipate the shift as will the bond market as the Fed is currently accounting for 70% of government-bond purchases – although one has a hard time arguing a prolonged spike in interest rates will take place if we find the economy cannot yet stand on its own.

Still, no matter how precarious the economic environment, the emergency level of monetary policy must end.  The time to stop using policy as an economic wheelchair is overdue, and when policymakers halt the sundry short-term stimuli that is when we find out what the economy and the market is really made of. 

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Have a great weekend!

Brent Vondera, Senior Analyst

Phone: 636-449-4900