Thursday, February 25, 2010

Benny Always 'Silences' Bad Economic News

The equity market reacted to the housing market data as if we were back in late 2005. Disappointing new home sales of 309K (annualized), significantly below the 354K consensus, was disappointing enough to send the S&P 500 up nearly one percent! Of course, we cannot forget the fact that Mr. Bernanke testified today and said exactly what he knows his ex-colleagues at Goldman Sachs and the equity markets love, "low for an extended period." Add to all of this, last week's very disappointing jobless claims and the very high new homes inventory of 9.1 months (highest since last May) and one would not expect the market to shoot up 1%.

We concede that this type of movement would be understandable if it was believed that we were at the 'bottom' with no where to go but up. However, we ask - weren't we at the bottom in March '09? And given the 63%+ increase in S&P 500 since, combined with the not so greatly improved economy, is a continuing rise in the equity market really justifiable?

Well, it may be, as it is clear that the government, which can justify virtually anything, has been the driver behind such movement. Here is another example - the passing of today's jobs bill in the Senate. This is something that can cost over $13 billion during the next ten years. Tax exemptions are for social security payroll taxes. Given the indirect, but potentially very significant, impact of this on social security benefits, we are just amazed. Add to that a $1,000 income tax credit to businesses for every new employee that they retain for more than a year, and you have nothing but the government influencing the participating businesses' strategies.

The tax exemption will be in effect only until the end of Congress' 2010 calendar year, which is Sept. With no indication of strong improvement in consumer or business demands within this economy, why would businesses, any businesses, risk increasing their headcounts for no return? We actually forgot, that return is provided by the government, which means that as soon as it is shut off, so are the working hours of the newly hired employees of participating businesses. Even with low rates, businesses are not willing to borrow to expand. Will incentives such the ones mentioned above help this situation significantly enough to start a long-term job and economic recovery? No.

Of course, the government's actions and policies all come with good intentions, as it hopes that one day the real economy, the consumers and small businesses will jump on the 'bandwagon' (in addition to all lawmakers getting re-elected). When such phrase is used in sports regarding specific teams, we know we should not be placing much money on those teams when in Las Vegas.

Regarding some other economic data released today, the Case-Schiller Housing price index came in very slightly (1bp) better than expected. But let's be realistic, those figures were for the month of December, nearly three months ago. With indications of higher inventories and foreclosures, we envision continuous lower housing prices.

Given our consistent 'whining' and complaining about the current state of the economy and about certain steps taken by the government, what do we propose? Nothing. We propose that the Fed and the government do nothing. We propose that the Fed allow the market to determine the interest rate. We propose that with higher rates, individuals increase their savings. We propose for the government and the Fed to allow banks to patiently wait until higher savings increase their capital. After which, not only would consumers have some money to spend (creating demand), but banks would also be loaning money, their clients' money (not the government freebies, the supply of which appears endless, which in the long-term will make them useless).

Regarding tomorrow's jobless claims figures, we expect something slightly lower than the current 460K consensus, which the government and the market will likely take as good news. We expect lower numbers as we think staying home during the bad weather motivated more people to file for initial claims 1.5 weeks ago, rather than last week. However, we believe tomorrow's figure will remain above 430K and close to 450K, which is not positive no matter how one may look at it. We do expect continuing claims to be up for the 2nd week in a row.

January durable goods orders will also likely be better than expected, due to some New Year optimism demonstrated by some businesses in early January. With these in mind, it wouldn't surprise us if the market hit another "high" tomorrow. Such movements are mere but yet very important, short-term highs. If S&P 500 does not hover around 1100 long enough, the risk of another and more significant pullback increases, each day as it moves further above 1100, in our opinion.

For Friday, we expect a slightly lower second estimate of last year's Q4 GDP growth, which we do not believe will impact the market too much. In addition, existing home sales for January may not be disappointing as both some sellers and some buyers may have too quickly hit the market fearing that buying homes this cheap is a chance of a lifetime. However, Friday's likely disappointing Chicago PMI and University of Michigan's consumer sentiment, combined with the market moving up on Wednesday (and possibly on Thursday), will likely push the market down a bit, giving us a taste of what may happen next week with possibly three very important indicators (ISM, ISM Services and unemployment) being disappointing .

Lastly, we thought to mention something regarding the US’ ever expanding debt, to which any new jobs bill will add. There may come a time when, unfortunately, the government will no longer be able to help everyone due to high debt. At that point, many may begin protesting and demanding support from the cashless and/or dollar-valueless government, similar to what the Greeks are doing these days. We hope that at that time, we, along with many others, will be vacationing on one of those beautiful Greek islands.

Sunday, February 7, 2010

Fed's Consumer Credit report ... worrisome.

We thought we should provide some initial comments on the Fed's consumer credit report released on Friday, as we believe it may have contributed to the equity market's turnaround from triple-digit losses mid-day to a slight gain at the close.

Decline of $1.7billion in credit was much less than the $10.0billion decline expected by analysts. We believe this was driven by Christmas shopping and various government 'incentives.'

It is safe to assume that many consumers, now a bit more confident than last year, decided to treat themselves or loved ones to more or better gifts during Christmas season. In addition, the very slow improvement in the employment situation (although may not be maintained) and the government's lovely gifts for additional consumption (such as cars), may have convinced many to tap into their unbalanced balance sheets and, temporarily, slow down the deleveraging process.

To make it simple, we compared the Dec. '09 results to 2005, which was when the housing market peaked. Dec. consumer credit balance remained above the 2005 level. More specifically, the $2,456.8 billion was 7%+ more than the 2005 balance. The revolving credit balance remained 4%+ above 2005. In addition, the non-revolving balance is above that of 2007! This is alarming and demonstrates just how much further consumers levered themselves in only 24 months, 2005 – 2007, before attempting to correct their actions. We believe many are determined to reduce their debt further, but cannot do so while unemployed.

Thanks to the government and the lower rates, the average amount financed for a car continued to rise in Dec. to $30,598, from $30,506 in Nov. and only $24,133 in 2005. Of course part of this is explained by the fact that consumers were borrowing more for their homes in 2005, and that today's rates are more than 40% lower than rates in 2005. However, with lower unemployment and overall income per household, such increase in auto loans, in our opinion, is unsettling.

In addition, the loan-to-value ratio of such loans stood at 92 in December, significantly above 2005's 88 and only slightly below 2007's 95. Combined with not much growth in overall consumption and continuing decline in the housing market, this ratio demonstrates 1) consumers likely did not have more cash to put towards those loans and 2) the government’s success in convincing consumers to borrow more at the great low rates. We wonder what would happen if the Fed was forced to exit such 'stimulus' phase of the economy (or plainly - money printing) before any meaningful improvement in jobs all around the country. We must also note that although the average length maturity of these loans is 64 months (higher than 60 months in 2005), the more time for the borrower, the more likely that the borrower will hit the high-inflation phase of this great recovery (likely within the next 24 months).

Simply put, we believe that the lower decline in consumer credit in Dec. was only for the short term. We hope we are correct, because if not, then, with the help of the government's stimulus programs, we are only delaying the significantly negative impact of high debt. Actually, so is the government.

Friday, February 5, 2010

Highlights and Lowlights of the Jan. Employment Report

As we expected, the 'official' unemployment rate was better than the consensus, and BLS reported a loss of 20k in non-farm jobs, compared with analysts' expectations of a gain of 5k. Of course, BLS refers to such state of non-farm employment as "essentially unchanged". It appears that BLS never fails to disappoint. In order to support a positive or negative reaction to this morning's report, one must look at the details.

Long-term unemployed continued to increase. There has not been yet any sign of reversal in this upward trend. Let's put it this way, the number of long-term unemployed in Jan. was 6.3MM, up from 6.1MM in December. Approx. 200k additional people became long-term unemployed in the month of January. This figure was 2.7MM and 5.9MM in Jan. and Nov. (respectively) of last year.

2.5MM people not included in the 'labor force'. As we had expected, the number of people in the labor force, as viewed by BLS, declined further. More specifically, total not in the labor force was 2.54MM, up from 2.49MM in Dec. Discouraged workers made up 42% (1.1MM) of the non-labor force figure, up from 38% (929k) last month. What a combination - more workers quit looking for jobs, and overall, additional workers continued to lose their jobs. When including the non-labor force figure results in an unemployment rate of 11.1%.

20k non-farm jobs cut. Unlike what most analyst's were expecting, what was a growth of nearly 5k jobs in Jan., net 20k additional people lost their jobs.

Most of the losses came from construction (-75k) and transportation and warehousing (23k courier and messenger jobs were cut). Approx. 42k positions were added in retail. Net manufacturing was negative, 11k job cuts, however it included some bright spots such as 23k more jobs in car manufacturing. A temporary boost brought forth by the government.

The number of temp positions increased by 52k, which can be viewed as positive, for now. During most recoveries, temporary jobs grow before permanent ones, as employers remain uncertain regarding the stability of the recovery. However, in this case, with lack of consumer demand, lack of an upturn in the housing market, continuing deleveraging process of consumer balance sheets, and increased productivity per worker, we believe many employers may realize that they do not need to replace the temp workers with full-time employees.

And of course, one cannot discuss employment without mentioning the federal government, as it added 33k jobs in Jan. Nearly 9k were for the upcoming 2010 Census. Let's hope those employees can weather the emotional storm when conducting the census.

Net result of BLS' revisions is negative. This might not appear as significant. We just wanted to point out the 1k job-loss net result of BLS' data revision for Nov. and Dec. Nov. revision of job growth, +64k from +4k, was more than offset by the Dec. revision of job-loss, -150k from -85k. Here is the most alarming figure - net results of BLS' revisions over all 12 months in 2009 was additional job cuts of 579k. In other words, during 2009, BLS initially (monthly) under-reported job cuts by more than half a million.

9.7% unemployment rate. This is self-explanatory, but we'd like to again point out that including the people 'marginally attached to the labor force' (as referred to by BLS), the unemployment rate would be 11.2%. It is a slight improvement from Dec.'s 11.4%.

Overall, we believe a full recovery in the state of employment will continue to take some time, which will delay the overall economic recovery. We do not consider unemployment as a lagging indicator in this recession. As we expected, the Jan. figures were not necessarily disappointing; however, we believe they were also impacted by the Christmas Season. We look for continuing job cuts in manufacturing in Feb., driven mainly by construction and automobile. In addition, we believe that a sizable number of temporary workers will begin to respond to surveys by saying they no longer expect to find a full-time job, which depending on how BLS' views it, they will be excluded from labor force calculation or will be part of net temp job count. We look for similar results in the retail sector in Feb. All of this may result in net job cuts (again) for Feb.

Thursday, February 4, 2010

Another break from the 'recovery'?

It appears unemployment is not improving as much as the market's upswing (prior to today) had indicated, providing support for our view that the market is (and soon to be 'was') over-valued. Initial jobless claims of 480k for the last week of Jan. came in higher than expected and highest since the Nov. 14, 2009 reading of 501k. In addition, continuing claims for the week of Jan. 23 increased slightly. As we have noted before, declines that we had seen in continuing claims had been suspect as it is likely that many of the 27+ weeks unemployed are no longer, or cannot any longer, claim unemployment benefits. However, if initial claims continue to rise (if so, at a minimum rate and certainly not as much as they did in the prior year), and if many of the unemployed decide to receive extended benefits, then we will likely see an increase in continued claims, as we did this morning.

Although initial claims is viewed by many as a leading indicator, we still expect the Jan. unemployment rate to be in-line or better than the 10% consensus. However, we also view the expected gain in non-farm jobs as unlikely. We believe this was indicated by the ADP employment report yesterday. Unless the unemployment rate and the non-farm jobs figure come in significantly better than expected, we do not foresee a significant one-day bounce (after the market's current dive; S&P 500 is down 2%+).

The volatility for which we had hoped going into Friday's numbers (benefiting the SPY or S&P 500 futures straddle trading suggestion) has certainly been there.

The productivity figure also released today is another sign that it will take a bit longer for the employment situation to improve. With such high unemployment and a rather flat consumer demand (compared to normal economic conditions), it appears that companies still have room to cut and/or implement additional policies to make their operations even more efficient than what they have done during the last 12-18 months. This basically implies that the state of the economy must change drastically before companies feel more at ease to hire additional workers. Higher productivity is likely due to the large amount of fear that the currently employed have about possibly losing their jobs. Such incentive has driven them to work hard and produce much more than they or their employers expected.

High unemployment combined with increased efficiency is not positive for the economy, unless we finally realize that this economy is in a transitional state, and government policies intended to artificially boost consumption will likely backfire in the future.

Lastly, factory orders came in better than expected, but combined with the initial claims and productivity data, it could result in too much inventory going into 2H'10 ... again.

Let's wait and see just how well the BLS will craft and present the Jan. unemployment data tomorrow. One never knows, the BLS, the government and the main media can pitch anything to create some confidence. It has not worked yet.

Monday, February 1, 2010

Thoughts on the latest and Upcoming Economic Indicators and the President's Latest Strategy

The market (S&P 500) declined 3% since we posted our Is it Time to Take a Break from that Great ‘Recovery’? blog. Q4 earnings reports have not been disappointing, but we believe a sense of fundamental-based valuation of the market and companies is beginning to creep back in. Most companies' impressive EPS have not been accompanied with at least the hope of top-line growth, which we believe is necessary for this economic recovery to continue.


Friday's preliminary Q4 GDP report of 5.7% was certainly better than the 4.7% consensus. However, PCE growth was responsible for only 25% of the reported growth. In addition, it accelerated at a slower rate in Q4 than it did in Q3; an indication of the continuing absence of meaningful growth in consumption, which is a necessity for this economy to recover.

In addition, inventories contributed approx. 67% to the growth. This is good news and bad news. It can be viewed as slowing inventory burn with replenishment on the horizon, showing that businesses are expecting some recovery in consumption. Inventory growth in calculating GDP has been positive for only two quarters (Q3 and Q4) after negatively contributing to the GDP for seven consecutive quarters. The question is - will companies actually produce more because of growth expectation or just partially replace the drastically cut inventory? We continue to believe latter to be the case.
Although imports grew for the second consecutive quarter, we noticed its smaller contribution to GDP than the prior quarter. This indicates that demand here at home remains weak, and companies remain hesitant to make growth investments or to fully replace inventories cut since Q4 ‘07.


This morning's positive news, better-than-expected Jan. ISM PMI, drove up the market nicely. Although most of the components of the ISM were positive (except inventories), we note that prices increased more than any other component with no industries indicating that they faced lower prices in Jan. In addition, growth in imports remained weak. We believe the excellent ISM figures represent only the upcoming inventory replenishment, which is slightly positive for the economy, but may not be sustained after Q1. Lastly, the employment component of ISM was also positive at 53.3, but we think this may decline after Q1 as inventories may no longer require replenishment. However, in the short-term, this could be a positive indicator for the upcoming Jan. unemployment data, which will be released on Friday.

Consumer Confidence

What drives confidence is comfort brought forth by the ability of a consumer to have money in his/her pocket for consumption of goods other than mostly necessities. The government can print more money and/or place the cash in the consumers' hands for only a short period. The results have been such that not many have found a job, and many could be taking additional risks regarding investments of their minimal and nearly extinguished savings.

Last week’s consumer confidence survey showed slight improvement and came in higher than the consensus. However, overall, it appeared that consumers remained pessimistic.

While more consumers responded that business conditions were good (9.0% from 7.5%), even more viewed those conditions as bad (46.1% from 45.7%). Consumers expecting improvement in the short-term declined (20.9% from 21.2%) and more believed the conditions will worsen in the future (12.7% from 11.8%).

Regarding the employment situation, less consumers believed jobs are “hard to get” (47.4% from 48.1%). We believe this is driven merely by short-term ‘enthusiasm’ which is expected as the New Year has begun. We note that only 11.8% said that jobs are “plentiful”, down from 12.7%. In fact, less expect more jobs to be available in the future (15.5% from 16.4%).


savings increased slightly in December to 4.8% (from 4.5% in Nov.), it remains significantly below the 6.8% historical level. Uncertainty and fear due to lack of jobs, are driving consumers to save more. We believe higher savings and further deleveraging of balance sheets will in time bring back consumer confidence. Of course, the government and the Fed (not much difference between the two these days) are creating barriers by keeping rates low and attempting to convince consumers to again take more risk.


We have mentioned this a few times before, and it is very basic - in order for the economy to recover, the issue of unemployment must be addressed; not by the government, but by the market itself. Unemployment is no longer a lagging indicator as households no longer have multiple credit cards to tap into and continue to spend. With jobless claims remaining over 400k, solid improvement in unemployment, therefore meaningful growth in consumption, remains a few quarters out.

Unemployment numbers are due out this Friday, and they represent a significant catalyst for the equity market to either bounce back (as it may have begun today) or decline a bit further. Although the market had already declined 3% the last 1.5 weeks and prior to today, given certain bearish technical indicators, a miss on the unemployment rate figure can still have a significant negative impact on the market. Of course, all of this depends on how the BLS (Bureau of Labor Statistics) decides to present the data.

We looked at the relationship between initial claims, continuing claims and the official unemployment rate. As expected, all three are highly positively correlated. Initial claims and continuing claims are no longer accelerating. In fact, from a monthly standpoint, it appears that initial claims are now trending down. Under 'normal' conditions, we would easily identify this as a sign of a recovery in employment. However, we believe that it only indicates a deceleration in unemployment, not necessarily a recovery or job creation.

We note that the long-term unemployment figure (jobless for more than 27 weeks as reported by BLS) has been trending up and increasing for a long time, indicating no jobs found by the current unemployed, and no 'job creation' (as the politicians love to say) by the market or the government. We would look for the long-term unemployment figure to continue to trend upwards.

However, the official unemployment rate may come in slightly better than expected as initial claims (although they do not represent any type of job creation) may be trending down at a higher rate than the declining labor participation force figure (basically the denominator of the unemployment rate), resulting in a lower unemployment rate figure. Today’s ISM report also provides some support for possibly a better unemployment figure on Friday. Earnings reports this week will take a back seat to the upcoming unemployment data. Today's performance could be an indication of higher volatility going into Friday's news, which means that a long straddle strategy on SPY or S&P 500 futures might work.

President's pitch is not the solution

The President is attempting to address the unemployment issue by making the government's very 'visible hand' more visible (possibly by putting on one of those Michael Jackson gloves) and even bigger. The tax incentives for businesses based on additional hiring proposed by Obama do not resolve the economic issue at hand. Such strategy is only a short-term solution which carries the risk of creating inefficiencies within companies.

The hiring that such an incentive might create is not long-term. In addition, we believe that companies will concentrate on hiring lower-wage and easily dispensable employees while benefiting from this great government incentive.

Such proposals also carry the risk of possibly veering companies off of the 'efficiency' track, on which they have been forced to stay by current market conditions. These risks, we believe, illustrate the President's political motivation behind such a solution. While we are not affiliated with any political party, we have to state the obvious - after losing the MA election, the Democrats are throwing everything at the wall, hoping the one that sticks will help them maintain their majority seats in both the House and the Senate.

Payroll tax cuts make sense; however, we believe that many businesses will view it only as a short-term policy. Given the continuing increase in the deficit (unbelievable figures released today by the White House), the Obama Administration will have to increase taxes at some point (more likely than cutting spending), increasing the likelihood that this policy is only temporary. With this in mind, many businesses may not want to take the risk of increasing their headcount at a lower cost, only for that cost to increase again in the future.

As we have mentioned before, the government (both Democrats and Republicans) appears to be doing everything now - spending to keep the GDP growing, giving money to people hoping to increase consumption, giving money to banks so they can easily take risks with it, and telling the unqualified homeowners that what they and their banks did was ok. These incentives, these tax credits, are good only for the short-term. They continue to delay the deleveraging of US households and that of the government, which we think must take place before we can have a more stable and long-term growing economy. Unfortunately, politics make everyone basically blind.

We believe the long-term solution is to increase interest rates a bit in order to 1) lower the risk of future inflation (due to all of this great money printing); and 2) provide incentives for consumers to save and deleverage their balance sheets. More savings means more capital for banks to lend out, which means possibly more businesses borrowing, which means those businesses may hire more based on higher demand as consumers actually have some money to spend. This very slow process (very slow especially given the politicians' 2 or 4-year-only time horizon) could bring back consumption and job creation.

Overall, in our opinion, whether this Friday’s unemployment report will provide a boost for the market or not, one thing remains clear - the market remains over-valued and traders and investors may start giving a second look to the long-lost fundamental analysis and valuation of the equity market.