What a Week!

Although S&P500 tested the 1,120 level, it ended the week well above it at 1,136.43. We note that this was a pretty bad week with the S&P500 taking a dump and finishing the week down 6.5%.

The equity market actually had a better week than the commodity markets as the Fed disappointed everyone with its announcement on Wednesday. As we touched on it before, gold did slide back down and it appears it is well on its way to fill the gap that we talked about a few weeks back. The approx. 155 support level for GLD is still there, but if we don't see at least some upward movement early next week, this falling knife could pick up speed and not ease until it hits around 150. GVZ, the gold volatility index, shot up nearly 22% today and closed at new 12-month high of 39.17. Even with such pullback, which we expected, GLD is up 15%+ YTD, compared with S&P500’s near 10% slide. At 150, GLD would still be up around 9% YTD. Of course, that is nothing compared with betting on volatility, which, based on VIX, has had a 140%+ YTD return.

S&P500 did not break below its 1,120 support level, which is good news at least for the time being. We believe the risk of going below that remains as long as S&P500 doesn't 'settle' around 1,150 - 1,160. This index has been trading erratically between 1,120 and 1,220 since early August. And it has not created a base anywhere within that range during those near two months. So, although we are slowly getting our feet wet again when S&P500 dips below 1,150 (by continuing to long non-cyclical sectors and slowly getting into a few cyclical ones), we remain cautious. If it breaks through that 1,120 support level, then we would be more aggressive in longing more cyclical sectors (ETFs) and high quality companies within those sectors.

As usual, some market moving data is due to come out next week - new home sales (Aug.), Case/Shiller home price index (Jul.), Consumer Confidence (Sept.), durable goods orders (Aug.), weekly initial claims, personal income & PCE (Aug.), Chicago PMI (Sept.) and the University of Michigan/Thomson Reuters consumer sentiment (Sept.). We expect the PCE price index to surprise on the upside. It will also help explain why the Fed chose the 'Operation Twist' and why it is divided internally when it comes to printing more money. In addition, new home sales could disappoint, especially after seeing just how foreclosures, investments and all-cash transactions drove the better than expected existing home sales. Lastly, growth in personal income during Aug. was likely negative, and if so, it would disappoint as the market expects no change. When companies are not hiring, they are also not increasing wages; and August was certainly a month that many companies, individuals and lawmakers would rather forget.

Did Bernie Disappoint?

We are amazed that it took the Fed so long to realize that the economic and financial issues we are facing are not mere temporary shocks.  And it was such realization by the Fed and its inclusion in the official statement yesterday that sent the markets down.  Based on where the futures are right now, the equity markets will likely be down today also. 

The Fed said “recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated,” and it sees "significant downside risks to the economic outlook, including strains in global financial markets."  The Fed has realized that the psychological approach to turning around the economy will no longer work.  Consumers will likely not jump up and consume as soon as they see the equity market bounce back up; and companies won't hire.  While the Fed claims that helping the state of employment and controlling inflation are its two main objectives, it has obviously ignored the first one.  And we think its announcement yesterday was an indication that it saw the risk of losing control of the second objective in the short-term increase significantly.

Simply put, the Fed's policy goal is to make long-term borrowing more attractive for businesses and consumers by buying $400bil worth of long-term US debt until June '12.  This may bring down long-term borrowing costs which the Fed believes will help drive more borrowing by businesses and consumers; hopefully based on long-term objectives such as increasing capex and adding human capital (possibly), and purchasing homes.  The impact of this type of money printing won't be felt in the economy until sometime. 

So, without a 'quickie' in store for the equity market (unlike old times), gold retreated further and it appears it might continue to do so today.  The same support levels that we touched on a while back remain for GLD.  If it gets below 170 (or around $1,760 for gold), then it can soon test low 160's (or $1,650), assuming the Fed won't make 'politically correct' statements in the near future.  In addition, the gold volatility index (GVZ) has remained at historically high levels.  The Fed's move has made the dollar the least worse, which also won't help gold; and we note that it was not expected as the market wanted to see more of an outright short-term money printing and dollar-devaluing policy.  With regards to the S&P500, if it goes below 1,150, which appears to be likely, then YTD lows of around 1,120 could be re-tested.  We've seen so much volatility, that the market appears to be 'consistently' volatile.

Lastly, to make things worse, initial weekly claims came in above expectations, 423K vs 418K.  In addition, the previous week's figures were upped by 4K.  Continuing claims declined, but we note that many other factors may have driven this, including many unemployed running out of their unemployment benefits (regular, extended and emergency).

Existing Home Sales Up Nicely

Existing home sales came in at a seasonally-adjusted 5.03MM rate, easily beating the Street's 4.70MM estimates; up 7.7% from July and 18.6% Y/Y.  Lower prices, which were 5.1% below last year were likely the driver of such growth.  However, we remain pessimistic regarding the real-estate market (as we have for a few years) as majority of the growth were for homes priced between $100K and $250K.  In addition, a sizable chunk of the sales, 22%, were investors; all-cash buyers were 29%, up from last year's 28%.  First-time buyers represented 32% of the purchases in August, unchanged sequentially and up from last year's 31%.  Inventory remained at high levels historically, although it did dip to an 8.5 months supply from 9.5 in July.  Maybe those builders with surprising number of building permits are beginning to see some indications of demand pickup.  However, we note that it is still a bad market (or shall we say buyer's market ... for the buyers with the income, savings and cash) with prices being pressured, combined with unemployment at high levels, continuing deleveraging per household, no growth in wages and lack of savings, it is tough to think of the August data as a trend and assume it will continue.  If we do see another blip, then a lot of properties may be dumped onto the market as investors made up more than one-fifth of purchases made in August and they may just want to get them off their hands.  And let's not forget continuing foreclosures.  We always hope for the best but take the worst into account. 

  

Refinancing Drives Up MBA Mortgage Index Slightly

The MBA Mortgage index went up 0.6% last week. Refi's edged up 2.2% while demand of loans for home buying went down 4.7%. We'll see how the existing homes sales figures turn out later this morning.

Gold above $1,800 and Builders Building without Much Demand

Looks like today, the Fed's index finger of its market-helping hand was seen; and that gesture brought the Fed back to the front pages. The equity market gave back nearly all of its morning gains and decided to wait for the Fed's rate decision which is expected tomorrow. But as we anticipated, with the Fed in the headlines on the front pages, gold reacted pretty well and got back over $1,800 again. We think it will still remain volatile and might retreat back again (for reasons mentioned before), unless the Fed bluntly states that further monetary easing is coming along. We note that the Fed is the best political org that this country has to offer. In addition, for this latest upturn to gain some momentum, gold will likely have to cross $1,820 - $1,825 first. With regards to GLD, that comparable level would be around 179 - 180.

Regarding economic news, housing starts data were disappointing. 571K for August represented 5% and 5.8% sequential and Y/Y declines, respectively. Building permits were slightly better than expected and up 3.2% and 7.8% sequentially and Y/Y, respectively. We've been asking this for a couple of years - do we really need more homes built? Shouldn't we get rid of all the inventory (incl. foreclosures or shadow inventory) first? Will aggressive buidling put the builders in the same situation it did after 2007? Besides a few areas where the higher income people live, real estate markets have remained very weak. We have not yet seen strong indications of growth in demand. And for this reason, we wonder why the government and the market want to see more construction, from which some jobs may be created but will not last long.

Tomorrow (Wed.), in addition to the Fed's rate decision, we'll get the latest on the MBA Mortgage index and August's exisiting home sales, which might provide some initial color regarding whether or not the increase in building permits was good news or not. The Street expects August home sales to come in at a 4.7MM seasonally-adjusted annual rate.

More Manufacturing Data and Consumer Sentiment

First, we thought we must provide a summary of the Philadelphia's Fed business outlook survey, which we did not include in yesterday's lone post.

The survey was disappointing, similar to Empire State's. It came in at -17.5 versus a -10.0 consensus. More businesses upped their employee count which was positive, but was offset by pretty much no change in average employee workweek. In addition, surprisingly, more businesses said their inventory levels were higher.

As was with the Empire State's, the forward looking survey was more positive. More businesses expect more new orders and shipments. However, at the same time, they expect a dip in inventories, which tells us uncertainty remains going past the next six months for these manufacturers; and the increase in number of employees and average employee workweek (as indicated in the forward survey) will likely be temporary.

Now ... how are the consumers feeling? Well, that's what University of Michigan (with that great win against Notre Dame last week) and Thomson/Reuters tell us with their survey of consumers. The preliminary results for the month of Sept. (released this morning) were better than expected; 57.8 versus a 56.3 consensus. This was also up from August's 55.7. Although this represents some improvement, we must note that it is significantly below last year's 66.6 preliminary reading.  Consumers may be thinking that the glass is half full, but is it?

Economic Indicators Update and Some Thoughts to Think About ...

Given that some what we consider as important economic indicators came out, we thought to post our thoughts on them.

No indication of much improvement in the state of employment as initial unemployment claims (seasonally adjusted) for last week were 428K, significantly higher than the Street's 410K estimate and up from the previous week's 411K and . We note that the previous week's figure was adjusted higher by 3K.

On the pricing front, it appears higher prices continue to be passed on to the consumers. CPI came in up 0.4%, higher than the 0.2% expectation. Core CPI was in-line with expectations. However, we note that oil has remained around the $85 - $90 levels. As mentioned before, expectations of further monetary easing policies will likely push commodities higher or limit their downside even on weak economic data. This won't help contain inflation during a pretty much flat economic growth period.

Empire State manufacturing survey results were also disappointing. Overall, it declined to -8.82 from -7.72, not only indicating contraction at a higher rate but also much lower than the Street's -4.0 expectation. New orders dipped slightly as compared to last month. Shipments plummeted. Inventories declined, which could indicate at least some improvement in the coming months. Prices increased, both paid and received. As expected, the index for number of employees dipped to contraction levels (below zero) and to make things worse, the average employee workweek was unchanged and remained negative. The forward looking part of the survey was a bit more positive, although still nothing to write home about. We think we're likely to see some inventory replenishment, but the upside for that will be short-lived. Although most components of the forward looking survey showed some improvement, both the number of employees and average employee workweek indexes declined, which we believe may offset the positive side of the forward looking survey.

According to our great Fed, industrial production increased 0.2%, 20bps higher than the estimates on the Street. Of course, the great Fed did reduce its previously released figures for April, May and June. Capacity utilization was in-line with expectations at 77.4%, which as we've said before remains below growth period average of 80% - 85%.

Based on most of this data, it appears that the state of employment will not improve much.

In terms of the equity market, well, the higher chances of the great Fed (and other central banks) coming to the rescue, as mentioned before, more than offset negative economic news. Last week's volatility pretty much met our expectations. The S&P 500 dipped below its 1,175 - 1,180 support levels; again, the possibility of a QE3 kept it from testing its YTD lows. We must say it did hit the 1,136 level intra-day on 9/13, but then the Chinese came to the rescue as rumors that China would help out Italy brought smiles to everyone's faces.

Gold has been taking a breather (mentioned in Aug) as the dollar, even given further upcoming monetary easing, has become the best of the worst. This is especially true given the troubles that Euro faces and doubts regarding continuing high growth rates in emerging markets. And as the Euro story remains on the front pages, gold might retreat further. In addition, gold, or the GLD ETF, hasn't necessarily filled the gap created when it shot up to $1,900 (or around 186 for GLD) pretty much straight from $1,600 (or around 157 for GLD) in a very short period of time. Once the Fed's QE3 comes back to the front pages, we'll likely see gold gain some strength.

Lastly, we’d like to offer some things to think about. Can Greece really recover and avoid defaulting? If not, does this continuing support from ECB increase the risk of the contagion effect? Can the developed economies and markets continue to ‘kick the can down the road’? Will there be a QE4 after what appears to be a more likely QE3? And will the bickering between the White House and Congress (and within Congress) over another increase in debt limit be as exciting as the most recent one? This is based on the assumption that the new jobs plan will pass, which will likely force the lawmakers to raise the debt limit again. We’re thinking about these, as we’d always like to think that we are thinking.

Wikileaks Discloses The Reason(s) Behind China's Shadow Gold Buying Spree

A pretty interesting perspective provided on zerohedge.com based on info from Wikileaks ...

"Wondering why gold at $1850 is cheap, or why gold at double that price will also be cheap, or frankly at any price? Because, as the following leaked cable explains, gold is, to China at least, nothing but the opportunity cost of destroying the dollar's reserve status." ... http://www.zerohedge.com/news/wikileaks-discloses-reasons-behind-chinas-shadow-gold-buying-spree

Help Wanted!

We thought the employment numbers may come in below expectations, but a big fat zero for non-farm payroll (NFP) employment was a surprise. Given Bernanke's promise, we didn't think the market would react this negatively if the NFP figure was non-negative, but then again, a zero is nothing to write home about. We note that the bad news was made worse as the NFP numbers for June and July were revised down significantly. June's figure went down to 20K net jobs added from 46K, and July was revised down to 85K from 117K. This may help further explain the market's early reaction to the job numbers.

Most private NFP figures were either unchanged or increased in August, resulting in a net 17K for the month. Manufacturing declined slightly by 3K, while information technology dropped by 48K, of which 45K was due to the VZ strike. However, even if we add the VZ number to private NFP, the resulting 62K would still be well below the 100K Street consensus.

Government NFP declined 17K, slightly less than the 25K estimate.

We also noticed somewhat of a bad combination - lower average workweek for private NFP employees and only a 1.9% increase in average hourly earnings during the last 12 months. Lower workweek indicates lower demand for production and/or services. In addition, the hourly earnings growth trails the 12-month inflation which is above 2% currently. These two basically are not very good news for the job market and overall consumption.

In terms of the market, after crossing 1,200 and reaching around 1,220 earlier this week, given what seems to be a pull-back today, 1,250 for S&P 500 doesn't appear realistic.  The next support level is around 1,175 - 1,180.  If the market goes below that level, with Bernanke's promise, we're not sure if it will really test the YTD lows of 1,115 - 1,120 from now until end of Sept.  Then again, as mentioned before, because QE2 did not stimulate the economy, doubts regarding effectiveness of QE3 may override a possible short-term boost it may give to the equity market. 

Lastly, we thought to comment on a recent report that President Obama "pulled back proposed new national smog standards".  He basically told the EPA ... you-know-what.  This is surprising given Obama's image as a liberal.  Then again, he is a politician and the elections are ONLY about 14 months away.  We don't have an opinion on the right or left, or on the smog standards and/or their impacts on the economy, government spending, etc.  However, we must say that politicians of all kinds (with maybe one or two exceptions) will do or say anything to get elected.  Of course, everyone already knows this.

Still have Faith in the Fed?

Today, initial claims were slightly higher than expectations, 409.00K versus 407.00K estimate. The smoothed out 4-week moving average increased by 1,750 to 410.25K. Although continuing claims fell, as we had expected, they did not fall below expectations. Continuing claims for week of Aug. 20 stood at 3.735MM, down 18K from the previous week.

ISM came in above expectations as we had assumed yesterday. 50.6 was slightly higher than our estimate and above the 48.5 consensus. There was no revision to the July figure. Also, as we expected, we saw contraction (below 50.0) in production, new orders and backlog. Although employment was below the previous month, it remained above 50.0. 

Other economic indicators released included July construction spending and Q2 productivity levels and unit labor costs. All of those figures came in worse than expected. Although the construction data was for July, most stocks in the industrial goods sector and construction industry reacted very negatively to the news. We note that there may be a bounce, a temporary bounce, in construction, mainly due to the Irene hurricane.  Also, although this was for Q2, we note that lower productivity and rising labor costs are not good news for the jobs market.

The Fed-driven rally did not continue today, even though the ISM headline figure was better than expected. This could be a sign that anticipation of further monetary easing was mostly priced in. And it could pave the way for a volatile market tomorrow (Fri. 9/2), which is the big labor data day, going into the official Labor Day weekend.  We note that some of that volatility could be discounted due to the upcoming job market speech by President Obama next week.

In terms of tomorrow's payroll numbers, we do not have an estimate. We must note that although the employment indexes for most manufacturing data were not at contraction levels, initial claims and ADP data did indicate that the official employment numbers may come in below expectations. As mentioned earlier in the week, as long as the payroll numbers are not significantly worse than expectations, stocks will likely remain flat or could go up in anticipation of a Fed move. An upward move became a bit more likely after today's decline. But again, overall, we are not really sure where those employment numbers will fall.