FMX | Connect – www.fmxconnect.com - (Reported 11/17/2010)
Excerpt from MARKET MUSINGS & DATA DECIPHERING
CAN YOU HANDLE THE TRUTH?
With 20-20 hindsight, it is now crystal clear as to what caused everyone to hyperventilate back in early September regarding the prospects of a sustainable recovery underpinned by the Federal Reserve and its well-advertised QE2 program. Not only the Fed, but also the mid-term election that promised to replace uncertainty with gridlock — it hasn’t turned out that way. Practically everyone believed that uncertainty had been swept away in the immediate aftermath of the November 2nd election and the November 3rd Federal Open Market Committee (FOMC) meeting, which is how the VIX index (a measure of volatility in the market) managed to recede all the way back to 18-and-change.
The bulls decided to hold their breath awaiting the holy grail of sustainable recovery and reflation. The stock market rallied spectacularly, as did commodities from corn, to crude, to cotton, to copper, in hopes that asset inflation would rear its lovely head. The U.S. dollar and the long Treasury bond both declined in value because of concerns (hope is more like it) that the Fed’s actions would prove to be inflationary.
However, since the exhaustive moves of November 4th in virtually every asset class, in reality, the markets have been re-pricing what the Fed and Congress actually have precious little to offer in terms of providing any freshly-minted stimulus.
In turn, this begs the question, how well will the economy do without continued life-support from the government? There is still scant evidence of a vibrant organic recovery 17 months into the statistical GDP bounce from the lows.
At least initially, the reversal of all these risk-on trends that dominated the landscape for the past two months suggests that the pullback that became apparent after the peak in April is likely to be sustained over the intermediate term. The U.S. economy is fragile, with real GDP growth likely to slow to a 1.5% annual rate, below the consensus view of 2.6%. The negative fiscal shock we are likely to see early in 2011 could well trigger something closer to zero growth in the first quarter.
In other words, we will very likely again be debating a double-dip scenario in coming months. In the meantime, the core PPI (which removes the effects of food and energy) just came in at -0.6% in October, so evidence of any sustained inflation at the final stage of production is hard to find. The labour market picture remains confusing with a plethora of conflicting data points of late, but nothing on this file looks very promising. The housing market cannot get out of its own way. Gasoline prices are pennies away from hitting $3 a gallon. Heavy cutbacks are coming from state and local governments in the U.S. Extended/emergency jobless benefits are about to lapse at a $70 billion cost to personal income over the next five months. What can we really expect from the consumer going forward is a legitimate question — holiday shopping surveys show a marked falloff in spending plans among low-end households.
The fiscal disarray at the state and local government is a major headwind for the U.S. economy. We will all probably look back a year from now at what Cisco had to say last week about how its sales were pinched by the cuts from the state and local government sector — this is the second largest contributor to economic activity with a 13% share of total spending on goods and services. Remember how Cisco proved to be a critical inflection point for the stock market in both 2000 and 2007. History doesn’t rhyme, but...
Now to the technical backdrop. Based on momentum and sentiment extremes achieved at the nearby highs, it seems likely that the stock market will be on a declining path, at least through year-end. In turn, further meaningful increases in market interest rates are unlikely.
In retrospect, we are coming off a period where it was extraordinarily difficult to go against the consensus on both the direction of the markets and the direction of the economy. The recent Barron’s Big Money poll showed that over 60% of fund managers favoured equities versus just 3% for bonds. But, the extremes now seem clear at this point. The divergences at the recent “failed high” are so reminiscent of what we saw in September 2000 and again in October 2007 that it sends chills up my spine.
The number of new lows on the NYSE rose dramatically over the last two days — hitting 137 yesterday. This pattern is eerily similar to what we saw coming off the April highs as well.
The S&P 500 has been locked in a rough 1,000-1,200 range now for 14 months. Most pundits still believe we are in a cyclical bull market but that is not the case — it has been a sideways market now for over a year. Moreover, after testing support in July, the market hit resistance levels in November, so it would seem logical to expect the index to make a run at the low end of the range. The only question is whether support will hold up once again.
U.S. PRODUCE PRICES: AUTO DEFLATION
We had to do a quick double-take when we saw our Bloomberg screens yesterday morning as it’s not often we see such a downside miss. Producer prices in the U.S. were much weaker than expected, coming in at +0.4% MoM in October versus 0.8% expected, but the real eye-popping number was the core measure. Excluding food and energy, producer prices fell 0.6% on the month compared to the +0.1% collectively expected by economists (in fact, the closest forecast was -0.2%).
A steep decline in auto and truck prices drove the decline, falling 3.0% and 4.3% respectively. October is a notoriously tricky month for auto prices as new-model-year cars and light trucks are introduced, so the seasonal-adjustment process is especially difficult. While we certainly don’t think we’ll see a repeat of such a decline in the November data, it is worth noting that price trends even before this large decline were negative, on a year-over-year basis.
While weak auto prices accounted for a large chunk of the weakness, even outside of autos, core prices were still down on the month, with weakness in computers, home furnishings, and machinery and equipment suggesting that disinflation/deflation pressures are still very much present. In fact, St. Louis Fed President Bullard (a voting member of the FOMC) was on the tapes yesterday saying that he remains concerned about disinflation trends and that “U.S. policy should strive to avoid the possibility of a Japanese-style deflation.”
U.S. INDUSTRIAL PRODUCTION: A MIXED REPORT
Industrial production was flat in October, a below-expected result. This follows a -0.1% MoM print in September. To be sure, a large decline in utilities (down 3.4%) was partly to blame. Manufacturing was up a healthy 0.6% with strong gain in autos (+1.6%).
The September industrial production diffusion index came in at 47.6, the first time it has been below 50 since June 2009 (when the economy was still in recession). Below 50 means that industries are contracting rather than expanding. This metric is lagged a month, but it pays to note that the beloved and ballyhooed ISM index came in at 54.4 in September.
This reminds us that in October, we saw the manufacturing payroll diffusion index slip to 42.1 from 54.3. Again, being a diffusion index, this signifies that more manufacturing firms were cutting their staff levels than those in expansion mode. And, the venerable and respected ISM index came in at 56.9. Makes you wonder what it is that the ISM is supposed to be measuring, and whether it gets the attention it deserves.
As an aside, despite all the excitement over the October ISM data, the reality is that both industrial production and capacity utilization rates have not budged since July. And here we are, nearly a year-and-a-half out of recession (supposedly), and the level of industrial output is still roughly 7½% below the level prevailing before the downturn began in late 2007. For all the talk of how this cycle looks at least as good as what we saw in the 1991-92 or the 2002-03 recoveries, let’s just say for the record that never before has production been this far below the prior peak this far into a statistical bounce back.
NATIONAL ASSOCIATION OF HOMEBUILDERS (NAHB) HOUSING MARKET INDEX: NO REAL IMPROVEMENT
The best way to show an increase in an economic data point is to have it come off a downwardly revised number the month before. This was the story with the NAHB housing market index — it came in at 16 in November, which was actually a tad worse than the consensus estimate of 17. But, you would not have known that reading because the press reports focussed on the one point increase from 15 in October — never mind that October used to be 16 before the revision!
The details of this report were a mixed bag as well, with present sales unchanged, while future sales ticked up to 25 from 23 and buyers traffic moved up a point to 12.
We liked to put these numbers in perspective, especially in relation to past recessions. While it is encouraging that the headline moved up a point to 16, consider that the average level in an expansion is 53. Not only that, but the current reading is still below the average recession level of 28 and the average reading at the end of a recession, which is 42. We still have a long ways to go in terms of a housing recovery.
CANADIAN GDP COULD DISAPPOINT
Canadian manufacturing shipments fell 0.6% in September, but this was better than what most economists were expecting. The key to this number is the inflation-adjusted figure and it was not good, coming in at -1.4%.
This means that our early take on September GDP is for a small 0.1% MoM increase, if wholesale and retail sales sectors post modest growth. This would be disappointing for third-quarter real GDP, which could come in at 1.3%, a few tenths below the Bank of Canada’s estimates.
David A. Rosenberg
Chief Economist & Strategist Economic Commentary
drosenberg@gluskinsheff.com
+ 1 416 681 8919
Source: Market Musings & Data Deciphering
http://www.fmxconnect.com/
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