What Came Out of Jackson Hole This Morning

On the backs of slightly disappointing Chicago PMI but higher than expected University of Michigan's consumer sentiment survey, Bernanke appeared to have disappointed the market with his speech at Jackson Hole initially. When the speech was released, the S&P 500 dropped back down to 1400, after popping up all the way to 1410 before the speech.  Since then the market has moved back up with S&P 500 now being up by approx. 8 points.  VIX is down nearly 3%.  It appears that the market can continue to yearn for Bernanke's helping hand, which it expects will be helping the market when the FOMC meeting takes place in mid-Sept.

 

In short, Bernanke said that the Fed will not be ruling out any option.  But he also attempted to limit expectations by saying that Fed's actions "cannot fine-tune the economy".  Bernanke also said "monetary policy cannot neutralize fiscal and financial risks that the country faces".  The Fed's 'insurance coverage' of the financial market continues, inducing too much risk taking and creating a central planning strategy in this so-called capitalistic country.

 

Regarding this morning's economic indicators, the Chicago PMI print of 53.0 was lower than the 53.8 consensus.  It was also below July's 53.7.  Increase in production, new orders and employment sub-indexes, combined with lower inventories were positive.  However, order backlogs and supplier deliveries came in drastically lower than the prior month.  The Chicago PMI results support our manufacturing ISM estimate of 50.1.  That number will be released on Tuesday morning.

 

Lastly, University of Michigan consumer survey sentiment of 74.0 for August was higher than the 73.6 estimate, which was positive. 

FB Price Target Lowered at BofA

Just thought to let you know that the great BofA/Merrill lowered its valuation of Facebook (FB) to $23/sh.  This has been our valuation of the Company since the beginning.  In addition, BMO Capital Markets lowered its price target on FB to $15/sh from $25/sh.  FB is down nearly 4% while the entire market is flying high due to the upcoming Bernanke speech at 10am ET.

Our Estimate of August Mfr. ISM

As everyone is waiting for Bernanke's magic words tomorrow from Jackson Hole, and given the upcoming 3-day weekend, we thought it is a good time to provide our guesstimate for the Aug. manufacturing ISM.

 

Our model generated an ISM of 50.1, a slight improvement from July's 49.8.  We believe such a result will keep the Fed at bay as it does indicate some improvement, although it won't be something to write home about.  We note that this figure is still significantly below the YTD high of 54.8 that we saw in April.  It is also below last year's 52.5 and 2010's 57.4.  Manufacturing ISM for August will be released on Tuesday, 9/4, at 10am ET.

 

The market could be begging Bernanke to make some pro-QE comments at Jackson Hole, as it has reacted negatively to initial jobless claims and personal income & spending economic data.  Even with today's near 1% decline, and if those losses are not pared by the close, we think a QE is more than priced in.  S&P 500 is down nearly 11 points, but VIX is up only around 3.5%.

 

We will provide our estimate of August nonfarm payrolls (NFP) this weekend.

Initial Jobless Claims & July Personal Spending Disappoint

Last week's initial jobless claims and personal spending in July were both disappointing.  However, the data, we believe, was not bad enough to nudge the Fed to launch another QE.  The market also indicates this at least in early trading as the S&P 500 is down approx. 7 points.

 

Initial Jobless Claims

 

It appears that for once we were too optimistic.  Even with a higher seasonal factor applied to last week's non-adjusted initial jobless claims (as compared with prior years), the print exceeded expectations; 374K versus 370K consensus.  The upward revision of prior week's data continued with another 2K increase to 374K.  The 4-week moving average, which unfortunately has been 'trending up', came in above 370K. 

 

Personal Spending & Income

 

July personal spending inched up 0.4% over the prior month.  However, this was below the Street's 0.5% expectation.  In addition, spending growth in June was revised down 20bps to 0.3%.  Personal income and PCE price index were in-line; 0.3% and 0.0%, respectively.  Savings as a percentage of disposable income was down 10bps to 4.2%, which may be good news for spending in Aug.  We expect to see a sizable increase in the PCE price index for August given the recent spike in oil futures, and gasoline and food prices. 

Although the market is down currently, there are indications that it continues to yearn for more help from the Fed as gold remains in positive territory and VIX is up only around 2% after the bad economic news.   

 

July Pending Home Sales Up 2.4%

As we suggested yesterday, July pending home sales surprised to the upside.  The monthly change came in at 2.4%, significantly above the no change consensus.  We note that the 2.4% figure is seasonally adjusted.  In addition, while the Y/Y change was positive for all regions, the West experienced a slight m/m decline, -1.7%.  The NAR blames this on limited inventory.  The non-seasonally adjusted numbers were a different story as three of the four regions saw a m/m decline, with Northeast 'leading the way' with -20.6%.  However, similar to the seasonally adjusted figures, there was a Y/Y increase in pending home sales within every region.  XHB is up 0.6% but hasn't yet gone above its 52-week high of 23.59. 

 

Overall, the market is pretty much flat with S&P 500 up one point.  It appears that the GDP and pending home sales numbers were too good, which means it is less likely for the Fed to launch a QE this year or even give the market some hint on Friday at the Jackson Hole meeting.

Q2 GDP Growth Rate of 1.7%

The economy is estimated to have grown at an annualized rate of 1.7%, according to Bureau of Economic Analysis (BEA).  This figure is up from BEA's initial estimate of 1.5%.  It is also 10bps higher than our number. 

 

Although growth in personal consumption was revised higher by 20bps (from BEA's first estimate), deceleration remained evident; 1.7% versus 2.4% in Q1.  As we mentioned on 7/27, services was the only component of personal consumption that increased Q/Q.  BEA's estimate of durable goods consumption was revised higher for Q2, from negative to no growth.

 

BEA lowered its estimate of gross private domestic investment significantly to 3.0% from 8.5%, which basically shows a slowdown from Q1's 6.1%.  Such deceleration was driven by a lower residential private investment growth rate; 8.9% from 20.5% in Q1.

 

The upward revision in government spending also contributed to the higher second estimate of Q2 GDP.  Such government portion was adjusted to a mere -0.9% from an initial estimate of -1.4%.  As we mentioned in late July, from a political perspective, it is always interesting (and not surprising) to see national defense spending improve from -7.1% to a mere -0.1% annualized rate (revised from an initial estimate of -0.4%), while nondefense spending basically plummets from +1.8% to -0.3%!

Go BLUE!!!!

By the way, no matter how good or bad the economic indicators turn out, we are confident everyone will enjoy this weekend for two reasons: 1) it is a holiday 3-day weekend (Labor Day); and 2) it is the first Saturday of the 2012 college football season.  There are some good matchups for this Saturday, of which the Michigan/Alabama game is one (at 8pm ET on ABC).  Of course, we are supporting the Wolverines although Alabama is favored to win by at least 14 points.  To that, we say: Go Blue!!!!

 

Thoughts about Upcoming Economic Indicators ...

Although this week's economic indicators are likely to take a backseat to the Jackson Hole meeting, we thought it might be helpful to provide our thoughts regarding some of the data.

 

A second estimate of the Q2 annualized real GDP growth will be provided tomorrow morning.  We continue to estimate that figure at 1.6%, as we did before the first official GDP estimate was released.  It appears that some economists are now feeling the same as the latest consensus is 1.6%, an increase of 10bps from the first estimate.  If we see something above 1.8%, expect the market to rally as it could be hinting a possible 2%+ growth in the second half, which may be viewed as good enough by the market even without a QE.  We stand by our first estimate of 1.6%.

 

July pending home sales is expected to be unchanged from the prior month.  There may be a surprise to the upside as even though the pent-up demand for a slow March - April period was evident in May and June, the summer remains a seasonally positive period for home sales.  We will likely see a slight m/m increase in pending home sales.

 

We do not foresee any big surprises in the Fed's Beige book, which is to be released tomorrow at 2pm (ET).  However, the report will be weighted heavily by the market as it may provide some color regarding if, where and when the Fed will announce the QE for which the entire market is yearning.

 

Thursday's initial jobless claims could turn out to be a slightly positive surprise, which may decrease chances of a QE and lower the market.  The seasonal factor to be applied is slightly higher than last year, which basically pushes the seasonally adjusted figure further down.  In addition, given the continuing uncertainty regarding the US and global economies, some late hiring (mostly temporary positions) may have also helped lower initial claims.  However, we do not expect initial claims to come in significantly below the 370K consensus.  In short, we expect something within the 350K - 360K range.  By the way, as usual, the prior week's initial jobless claims will likely be revised higher.

 

We will also see the personal income, spending and PCE data for the month of July.  We don't expect much of a surprise.  If we see a combination of lower savings and higher spending, expect a slowdown in consumption even during the seasonally better September month.  August was not a bad month.  However, we believe consumption has been negatively impacted by higher gasoline prices, which will likely result in a cut back in spending by consumers in September until the Christmas shopping season begins.  July PCE will likely show that inflation is under control, which is positive for a QE.   However, as a reminder, this data is for July.  We believe higher food and energy costs have had an impact in August and will impact the September headline PCE and CPI significantly.

 

This week will end with the release of the Chicago PMI survey and the University of Michigan's consumer sentiment survey.  We do not expect much of a surprise in any of these two indicators; and if there are any surprises, the market reaction will be subdued as the wait for Jackson Hole and FOMC continues.  

Mixed Economic News ...

The Case/Shiller home price index for June surprised to the upside.  Unfortunately, even though the market is up slightly, the positive reaction was not as significant as some may have expected as such news was too good for the market.  As a reminder, this data was for June.  Consumer confidence for Aug. was also released this morning indicating declining confidence in nearly everything.  The bad news offset the good news, which is why the market is up.  Anticipation of what will come out of Bernanke's mouth this weekend and after the Sept. FOMC is pushing the market higher.

 

Case/Shiller home price index

• 10-city index up 0.1% and 2.2%, Y/Y and m/m, respectively.
• 20-city index up 0.5% and 2.3%. Y/Y and m/m, respectively.
• Y/Y decline in prices were evident in Atlanta (-12.1%), Chicago (-1.7%), Las Vegas (-1.8%), Los Angeles (-0.6%), New York (-2.1%), and San Diego (-0.2%).  In terms of a Y/Y price increase, Phoenix led the way with a 13.9% Y/Y change in home prices.
• The biggest monthly price increase was in Detroit, followed by Minneapolis and Chicago.

 

The Conference Board Consumer Confidence

• The Aug. consumer confidence index declined to 60.6 from a downwardly revised 65.4 in July.  The Aug. figure is the lowest since last Nov.
• What is alarming is that the expectations sub-index represented nearly this entire decline as it dipped to 70.5 from 78.4; while the present situation sub-index declined to 45.8 from 45.9 in July.
• Consumer sentiment regarding the labor market deteriorated within the expectations and present situation indexes.  Only 15.7% said they expected an increase in their incomes.  While this figure is very low, it represented a slight improvement from the prior month.

 

 

The market remains in the black with the S&P 500 up nearly 2 points.  XHB is not displaying much reaction to the good news regarding the Case/Shiller index.  The ETF is up only 0.13%.  The consumer discretionary ETF, XLY, is leading the way, up 0.3%, followed by financials (XLF) and consumer staples (XLP) both up 0.25%.  This alone indicates the anticipation of some magic words from Bernanke this weekend or during the third week of Sept. 

Sector Performance Update for Week Ending 8/24/2012

 

New Home Sales Up; Prices Down

Seasonally adjusted new home sales for July came in better than expected, but prices declined.  Given the market's initial reaction, it is assuming that the better numbers lower chances of a QE, as we have mentioned before.  We will see if losses will be pared yet again by the close with hope that something will come out of the Jackson Hole conference and if not, out of the Sept. FOMC meeting.

• Annualized rate of 372K new home sales for July were slightly higher than the 368K consensus.  This figure showed a Y/Y 25.3% increase.  In addition, the June sales figure was revised up.
• The months' supply dipped to 4.6 from 4.8 in June.  Although it appears that inventory has declined or remained flat, we note that both mean and median prices declined sequentially and Y/Y.
• Monthly increase in sales was driven by a 76.5% spike within the Northeast region.  Sales in the West and Midwest declined slightly from June. 
• On a Y/Y basis, sales increased in every region, led by a 68.3% increase in the West. 
• Most of the homes sold were in the $200K - $299K price range, similar to June and last year. 

Not Very Encouraging Economic News ...

Initial jobless claims for last week came in higher than economists expected.  The Eurozone (EZ) PMI for August showed contraction yet again, but was up slightly from July.  The HSBC PMI for China was down from the prior month, yet again.  We believe given that the EZ PMI was better than the prior month, and even with such disappointing jobless claims, chances of a QE3 by the Fed have not increased.

 

Initial Jobless Claims

• Seasonally adjusted initial claims print was 372K versus a 365K consensus, and up 4K from the prior week which was upwardly revised by 2K.
• Seasonally adjusted 4-week moving average increased to 368K, up 3,750 from the prior week. 

Flash EZ PMI (August)

 

Overall output index (includes manufacturing and services) increased slightly to 46.6 from 46.5 in July.  This was driven mainly by an increase seen in France, while output PMI in Germany came in lower than the prior month.  Similar to the US ISM index, anything below 50.0 shows contraction.  Within EZ, PMI has contracted for seven consecutive months. 

The services index dipped to 47.5 from 47.9, while manufacturing increased to 45.3 from 44.0.

• New orders sub-index inched up a bit, but remained below 50.0 for the 13th consecutive. 
• Order backlog sub-index was also below 50.0, but came in slightly better than the July figure.
• The employment sub-index continued to paint a grim picture as it remained well below 50.0. 
• However, again, it was slightly better than the prior month, driven mainly by increase in manufacturing employment.
• Unfortunately, output prices index remained above 50.0.  We believe continuing increase in output costs will show up in output prices (which also increased but remained below 50.0, showing lack of demand) sooner or later, possibly resulting in stagflation.

 

 

S&P 500 futures is down 3.75 points as it appears the market will open in red.  Of course, this figure could be much worse given such bad economic news, but as usual, the market has faith in that Fed 'insurance'.  Many believe additional color regarding a QE, or as we term it, a psychological QE, could be provided at the Fed conference in Jackson Hole, WY next week.  The next so-called catalyst that may delay or limit a decline in the market is the next FOMC meeting scheduled for Sept. 12 - 13.  Some are also hoping for a better than expected new home sales number, which will be released in approx. 30 minutes. 

FOMC Minutes Released ...

The FOMC minutes were released earlier, and in our opinion, there was no surprise.  The Committee recognized slowing economic growth, slow recovery in employment, slight improvement in housing, and basically everything else that we have been talking about.

 

It also thinks it will have inflation under control with a 2% ceiling.  We disagree, especially as the Israel and Iran war gibberish continues.

 

Most members favor monetary easing, if necessary.  This does not guarantee a QE, especially in September.  However, the release was worded nicely to keep the hopes of a QE alive.

 

Basically, we need to continue to wait until at least the September meeting.  We still do not expect a QE, especially given the slightly better economic numbers (not necessarily good) released in recent weeks.  We also note that the market has gone up more than 2% since the FOMC meeting in late July and early August.  Many say that the Fed does not weigh the equity market's performance heavily when making a decision; we disagree.  Again, a QE is already priced in and chances of an actual one (not a verbal or psychological one) before end of 2012 are declining.  Of course, the S&P 500 turned positive after the release of FOMC minutes. 

Update on July Existing Home Sales

We finally accessed NAR's website (realtor.org) and got our hands on July existing home sales data.  As we expected and mentioned earlier, the 4.47MM annual run rate was below expectations of 4.51MM, but up from last year's 4.05MM rate.  Inventory increased 1.3% in July, but that represented a 6.4 months' supply, down slightly from June's 6.5.  We expected increase in inventory along with a higher months' supply figure.

 

Overall median price increased 9.4% Y/Y, driven by the 24.5% jump in the Western region. In terms of price ranges, Y/Y sales declined only in the lowest price range.  Most of the Y/Y increase was within the $250K - $500K and $500K - $750K ranges.  Regionally, the areas that showed decline in lowest price range ($100K and below) increased the most within the highest price range ($1MM+). Distressed homes as a percentage of total sales dipped to 24% from June's 25%.

 

Sales were up m/m in every region except for the West where it was unchanged.  Y/Y sales increased in every region.

 

Lastly, we note that 34% of sales were to first time buyers.  This is up from 32% in June, but remains significantly below what NAR refers to as the normal conditions' 40%+.  

Existing Home Sales Miss Expectations; Prices Rise

July annualized existing home sales came in below expectations; 4.47MM versus the 4.51MM consensus.  However, XHB is up nearly 2% in reaction to the 9%+ Y/Y increase in prices.  XHB is still below the 52-week high of 23.44 that it hit last week.  We cannot provide additional detail as the realtor.org website appears to be down.  This could be due to the fact that the existing home sales data was leaked approx. 30 minutes before its scheduled release.  We may provide more information regarding existing home sales once we can access realtor.org.  The overall market remains slightly in red with S&P 500 down around one point.

 

Sector Performance Update for Week Ending 8/17/2012

The upward momentum (if it is actually a momentum with very light trading volume) of the equity market continued last week as the S&P 500 moved up nearly another 1%.  The sectors that we had suggested in March trailed the market.

It appears that although the latest economic news has been disappointing but not to the extreme, the market continues to be pricing in a Fed action, while the probability of an action has been declining.  Of course, as we have mentioned a few times during the last 24 months, a mere smile on Bernanke's face or just an insinuation that the QE option is on the table, is also considered a QE, a psychological one.  Although for the time being the market has proven us wrong (during the last 3 - 4 weeks) we remain convinced that it is overvalued.  We will see if the FOMC minutes which are due out on Tuesday will have any psychological impact(s) on the market.

In addition, even though the home builder index, XHB, took one step back after we mentioned on Jul. 15th that it has gone up too far too fast, it more than made up for it and took a few steps forward.  XHB dipped nearly 5% by Aug. 1st, but has increased more than 12% since; it has gained more than 8% since we touched on it.  We continue to have our doubts.

Upcoming economic indicators include FOMC minutes, new and existing home sales, FHFA housing price index, and the always important initial jobless claims.  We think many continued to refinance their homes at more affordable rates in July, which could have resulted in a slowdown in existing home sales.  Regarding new home sales, the annualized 368K consensus, which is represents by an 18K increase from June, we think, is rather optimistic.  Any slight miss on the new home sales figure may bring XHB just a bit closer to reality.  We look for an increase in months' supply for both existing and new home sales in July.  Our view regarding initial jobless claims hasn't changed - will likely remain above 350K and it is even more likely that the prior week's data will be revised up. 

Sector performance update for the week ending on 8/17/2012 is provided below.  We note that the sectors we mentioned in early March have continued to outperform the overall market, although that gap is narrowing. 

Improvement in Consumer Confidence

Similar to what we saw in PPI and CPI earlier this week, higher oil and gasoline prices have yet to impact not only producers but also the consumers.  The University of Michigan consumer sentiment survey print of 73.6 was higher than the 72.2 consensus.

Although we basically batted above .500 on economic indicators this week, the market has not yet moved in the direction which we expected.  However, we continue to feel that QE is priced in and market is overbought.

Technically, S&P 500 is slightly above its linear regression resistance level, which is around 1416.  It is also approaching Fibonacci retracement's 0%, which is at 1422.  We believe these are resistance levels.  The support level we are looking at right now is 1360.  MACD of 15.6 is not too far from the 17.6 we saw at the YTD S&P 500 high of 1422.  This may be indicating that the huge upwards momentum we have been seeing the last 3-4 weeks is on its way to slowing down.  In addition, the McClellanOscillator is showing that the market is nearing the overbought level.

Of course, the drug or insurance that the Fed is expected to provide for this market partially explains increase in optimism, not necessarily in the economy but just the market.  Whether the economy will follow the market with its own upward movement remains in doubt, in our opinion; and a 'convergence' of state of the economy and the market will take place.  We think it is more likely that the equity market will slowdown rather than the economy will speed up.  Let's see what Bernanke has up his sleeves at the meeting in Jackson Hole, WY.

By the way, it appears that we won't see much of a dead-cat bounce in FB or GRPN as they are down 2.2% and 8.0%, respectively.  The wait for that GRPN support level to be created continues.  It will be a long wait.  XHB remains in the black today after yesterday's big 3%+ move to the upside.  S&P 500 is up nearly 1.0, while VIX is pretty much flat.    

Mostly Disappointing Economic News ...

Housing starts, initial jobless claims, and the Philadelphia Fed survey figures were disappointing while building permits came in above expectations.  The S&P 500 remains hopeful as it is pretty much unchanged even after bad economic news.

Initial Jobless Claims

Latest seasonally adjusted initial jobless claims of 366K were slightly above the 365K consensus.  Not surprisingly, an upward revision was yet again applied to the previous week's number; 364K from 361K.  YTD, there have been maybe only one or two weeks where jobless claims were not revised higher. 

Housing Starts & Building Permits

Housing starts annualized rate of 746K was significantly below the 763K expectation; down 1.1% sequentially, but up 21.5% Y/Y. 

• Housing starts for single-unit homes were down 6.5% from June; up 17% from last year.
• MDUs (multi-dwelling units) did well as usual, up 9.6% and 30.1% m/m and Y/Y, respectively.
• Total starts were up Y/Y in most regions with the West leading the way, up 48.1% Y/Y.  The Northeast disappointed with housing starts down 10.5% from last year.  Sequentially, the Midwest was the only region with an increase; up 17.0%.  The West also led the way, this time down 5.3% m/m, more than the other regions.

• Annualized building permits of 812K were above the 770K expectation; up 6.8% and 29.5% m/m and Y/Y, respectively.
• Permits for single-unit homes were up 4.5% from the previous month and up 23.0% from last year.
• MDU permits for 5+ unit homes were up 10.5% m/m and 47.3% Y/Y.  For the 2 - 4 unit homes, building permits were up only 4.2%.  It appears that the trend of building large MDUs will continue during the next six months, which we believe is not good news for the housing market.  Continuing increase in MDUs may not allow inventories to get low enough to push rental rates even higher in order to convince renters to buy.  This is not good for the overall housing market. 
• Regionally, permits declined from the previous month only in the Midwest; down 4.2%.  Hand outs of permits continued to increase in the West; up 14% from June.  Compared to last year, building permits were up in every region, with the West, again, leading the way, up 53.8%.

Philadelphia Fed Business Outlook Survey

Philly Fed's survey for August came in at -7.1, below the -5.0 consensus.  Although this is slightly better than July's -12.9, it shows continuing deceleration of growth and possibly contraction within manufacturing.

• New orders remained in negative territory, -5.5, a slight improvement from July's -6.9.
• Shipments and unfilled orders sub-indexes continued to be disappointing.
• Unlike what we saw in the Empire survey yesterday, the 0.6 improvement in inventories (-6.9 from -7.5) do not necessarily indicate significant inventory replenishment coming up the next couple of months.
• The employment sub-index declined further, down 0.2 to -8.6.  There was slight improvement in average workweek, up 2.7 but remaining significantly below zero at -14.6.
• The forward looking index was down 6.8 from July at 12.5.  Most important sub-indexes were also lower from July, indicating that businesses are not as optimistic as they were earlier this year. 

We have had more bad news than good news, but yet not terrible news.  However, the market continues to wait for the Fed to announce something, maybe another 'psychological' QE, at its meeting in Jackson Hole, WY.  The market is pretty much flat.  Many continue to have faith in home builders as the XHB ETF is up 0.2%.  FB is down nearly 7% and trading below $20/sh.  GRPN is down approx. 6% and trading below $5/sh.  We are still waiting for that stock to create a support level.  It appears it is not happening anytime soon, and certainly not within the $5 - $6 range. 

Home Builders Continue to ... Build

August NAHB housing market index of 37.0 was above the 35.0 consensus and is at a 5-year high.  Results of regional indexes were mixed.  The Midwest and the South indexes increased while those of the Northeast and West decreased.  The XHB ETF is up $0.12 or 0.53% in early reaction to the data.  While we do not have much confidence in this data, we note that it could further lower the chances of a QE3 announcement. 

Mixed Economic Data ...

From a QE3 probability standpoint, economic data released yesterday and this morning can be viewed as mixed.  From a fundamental standpoint, they are all negative.

Tuesday's PPI & Retail Sales Release

Yesterday, both headline and core PPI came in above expectations, as we suggested.  What was surprising was that higher energy costs had not driven the increase in headline PPI.  Given that, then we can expect the August PPI and CPI to increase much more; not good news for pro-QE experts.

Retail sales were significantly better than expected, which may not have been good news for the QE pushers.  In addition, today's CPI news (which we will discuss shortly) indicate that much of the increase in sales were likely result of good discounts offered by retailers.

CPI

This morning, both headline and core CPI came in below expectations, which is good news for QE pushers, and was not what we expected.  However, we note that given that higher energy costs were not yet evident in PPI, today's CPI 'miss' is an indication of a hefty move up coming in the August CPI. There was no change in July's headline CPI versus the market's expectation of a 0.2% increase.  Core CPI increased 0.1%, 10bps lower than the consensus.

Empire Manufacturing Survey

The Empire manufacturing survey came in significantly below expectations, indicating further contraction in manufacturing during August.  As we mentioned before, result of this survey is an outlier more often than not when compared with other Federal Reserve Banks' surveys.  However, the data is still considered as very disappointing.

• Overall index came in at -5.85 significantly below the +5.0 consensus.
• New orders declined further and remained in negative territory; -5.50 in Aug., from -2.69 in July.
• Further decline in shipments added to the bad news.
• Inventories dipped significantly from zero to -8.24.  This might be good news for the short-term as inventory replenishment may be due the next couple of months.
• Employee sub-index continued to decline; down to 16.47 from 18.52, but still above the YTD low in June.
• Average workweek also increased, which may explain why the employee sub-index did not decline further.

As we mentioned before, the Philly survey which is due out later this week will give us a better idea about whether or not we should take the Empire survey results seriously.

July's Industrial Production & Capacity Utilization

The lagging indicators industrial production and capacity utilization both were in-line with expectations.  Industrial production of 98.0 was 0.1 above our estimate, while capacity utilization of 79.3 was in-line with what we expected.  Again, these are data points from the prior month, but capacity utilization did confirm the better than expected payroll numbers that we saw in July.  However, some early employment related data for August has not been very positive.

In summary, the only data that helps keep hopes of a QE3 alive is the CPI miss.  Other indicators were not too hot, nor too cold, indicating that this recovery remains a modest one at best, but not bad enough for the Fed to take action, in our opinion.  The equity market opened pretty much flat.  We note that the not-so-objective NAHB housing market index is due out in 15 minutes.

Reduced Chances of a QE3 in September

We have been saying this for a while, and now it appears that some big names, such as Goldman Sachs, are also saying it: probability of a QE3 in September has declined.  This could make the upcoming Fed meeting (or conference) at Jackson Hole, WY pretty much an eventless one. 

We emphasize that those big firms continue to believe a QE3 will be announced and/or implemented before the end of 2012, likely in Dec.  We believe this won't happen unless Israel attacks Iran which will of course drag the US into another war.  If so, then political reasoning will override an economic one and will force the Fed to launch a QE3.  Yes, even if the attack pushes oil prices significantly higher, the Fed and the government will agree to ignore threats of inflation, as a war would likely contribute to the economy initially, potentially lowering impact of too much inflation.  In addition, the government would love to tie that patriotic emotion that many Americans feel during a war (whether the war is justified or not) with the pitch of 'help your country and consume more, especially the American goods' to not only make the QE more effective (not likely) but also more justifiable.    

GRPN, FB, Economic Indicators, & Europe

We will first comment quickly on Groupon (GRPN) and FB, and then we will touch on some upcoming economic indicators.  We remain convinced that the equity market is overbought and a QE3 is more than priced in.

Groupon (GRPN)

It appears that another social media stock plummeted in AH.  Groupon (GRPN), basically a company that offers group discounts for various goods and services online and sends 'targeted' spam emails providing the same discounts, was down nearly 20% after reporting mixed Q2 results.  We are not yet very familiar with this company and do not have any money in the stock.  What got our attention was the beating it was taking after Q2 results.  We looked into the numbers and did a quick back-of-the-envelope valuation (using a DCF model with conservative assumptions) and came up with a $9/sh valuation.  Although this represents an attractive upside, we will likely first learn more about the Company and wait for the stock to create a base or support level (maybe around $5 - $6) before even considering getting in.  We note that at $6.06/sh in AH, the stock clearly represents another IPO failure in the social media space as GRPN's IPO price in early Nov. '11 was $20/sh.

Facebook (FB)

At $21.60, FB is only slightly below the $23 valuation we gave it before the much-hyped IPO.  By the way, the IPO price was $38, as we are sure everyone knows by now.  As if the 19%+ decline after the Q2 earnings wasn't bad enough, 270MM+ more FB shares will hit the market this week as FB's lock-up expiration is this Wednesday.  These shares could push FB even lower.

Economic Indicators

From a macro standpoint, some July retail sales numbers, along with PPI are due out on Tuesday, 8/14.  We do not have specific projections for retail sales and PPI, but expect to see monthly increase in both of them.  Given that front-month oil futures have increased over 20% since end of June, we expect more of an increase in headline PPI than the core figure.

However, as we have stated before, the higher cost of oil is passed on to consumers via increase in gasoline prices very quickly.  For this reason, Wednesday's headline CPI, one of the inflation measuring sticks, may disappoint.  We think it will come in above the 0.2% increase that the market is expecting.  And it is not just gasoline that will be pushing CPI higher, higher food prices are at fault also.  Expect many to downplay the headline CPI figures and focus on core CPI, which exclude food and energy costs, in order to maintain their faith in a QE3.  Bernanke is expected to provide more color regarding a QE3 at the end of this month.  Unfortunately, the market's recent upsurge is making a QE3 less likely.

On Wednesday, in addition to CPI, the Empire State manufacturing survey results for August will be released.  We have seen before that this survey creates some outliers when compared with the Philly, KC, Dallas or Richmond Feds'.  We do expect decline in sub-indexes such as employment.

July's industrial production and capacity utilization are also due out on Wednesday.  We are looking for a 0.5% increase in industrial production which is equivalent to an index value of 97.9; slightly below the Street's 0.6% or 98.0 estimates.  Our capacity utilization estimate of 79.3 is pretty much the same as the overall consensus.

Weekly initial jobless claims will be released on Thursday.  We look for a slight increase from the prior week (seasonally adjusted).  However, as long as the number of claims remain below 370K (the Street's new 'good news' breaking point), we will likely not see much of a reaction.

The housing market has become the hot topic lately, on the positive side.  Thursday's housing starts and building permits will be market movers.  We continue to believe that the home builders space is overbought.  Any slight miss in these two housing indicators could put a dent into the home builders ETF, XHB.  We note that, unfortunately, XHB has moved up nicely, 3.5% to be exact, since we last discussed it on 8/3.

The Philly Fed's manufacturing survey results will be released on Thursday.  We believe this one provides a better idea about August's manufacturing ISM.  In addition, it can be used to see if the Empire manufacturing survey results should be taken seriously or not.

Lastly, University of Michigan's consumer sentiment will come out on Friday.  We do not have a specific projection, but think it will be pretty much in-line with the Street's 72.2 estimate, which is lower than the previous 72.3.  Higher food and energy costs may have more than offset the increase in the equity markets.

By the way, we just learned that Germany's and France's Q2 GDP both came in 0.1% better than expected.  Germany's economy grew at a 0.3% rate versus the 0.2% expectation.  France remained unchanged while many thought it would decline by 0.1%.  In our opinion, this news certainly does not indicate a recovery or a lesser likelihood of seeing contraction in Europe.  However, along with some other not-too-bad data, this puts a QE3 announcement at the end of August at risk.

Sector Performance Update & more ...

After the nearly 2% spike in the S&P 500 today, we are certain many are saying to themselves "thank Goodness it is Friday".  Obviously, today's upward movement, which brought the S&P 500 1.7% in the black for the week, was driven by the better than expected July employment report.  We did point out earlier this morning that the report was not as good as it first appeared.  However, given the trend of disappointing economic data the last few months, the market was waiting to embrace any good news.

Given that the entertainment/business channel, CNBC, is watched by professional and retail investors, we should point out something interesting from CNBC's website - one of its experts, Larry Kudlow, posted an article saying basically the same things we have been saying about this week's economic reports (link: The Job Report's Bad News).  Mr. Kudlow's views may be driven more by his political beliefs, but his economic reasoning makes sense, in our opinion.  We note that we do not support any of the Presidential candidates as we think 'they are all the same'.

Below is a review of some important economic indicators released this week.

• Dallas Fed July business survey results were very disappointing; -13.2 versus 2.0 estimate.  The survey's forward index also went into negative territory.
• June m/m change in total personal income was above expectations, but wages & salaries were down.  Personal income for the last three years was revised down.
• June m/m change in personal spending was a big zero, below the 0.1% increase that the Street expected.
• Case/Shiller home price index declined Y/Y less than expected; -0.7% versus the -1.8% consensus.
• Chicago PMI of 53.7 for July was above the 52.5 estimate.  Increases in new orders and order backlog were good news, but employment and capital equipment sub-indexes were disappointing as they showed a sizable decline.
• Conference Board's consumer confidence index of 65.9 was much higher than the 61.0 consensus.  The June figure was revised up.  Decline in the 'Present Situation' index was more than offset by optimism shown in the 'Expectations' index.
• July manufacturing ISM was disappointing and remained below 50.0.  New orders went up by only 0.2 points, more than offset by decline in order backlog, employment.
• ADP print was 163K, significantly above the 127K consensus.  The June number was revised down.
• July ISM services of 52.6 beat expectations by 0.5 points. New orders, inventories, and export orders went up, while employment, backlog of orders, imports and inventory sentiment were down.
• The July state of employment report beat expectations with 163K net-additions to the NFP, much higher than the 100K consensus.  Hours worked remained unchanged.  Hourly wages increased by only 2c and were below expectations.  The seasonality factors applied to the data by BLS remain in question.  For example, the 25K net additions in manufacturing certainly did not go along with the data provided by most of the Federal Reserve Banks' surveys and the ISM.  While the 'official' unemployment rate barely changed, the seasonally adjusted U-6 unemployment rate went up 10bps to 15%.  Labor force and its participation rate continued to shrink.  And the household data showed a decline of 195K in number of people employed.

The weekly sector performance update is below.  We note that although the market has shot up during the last couple of weeks, the sectors that we recommended in early March have outperformed the rest nicely, as shown in the third column ('Since 3/2/12') of the table below.

S&P 500 Continues to be Overbought ...

With such great news regarding employment, we feel it is now logical to no longer assume a divine intervention by the Fed and Bernanke this year.  For this reason, we thought to give you an idea about just how overvalued the market has become.

Let's look at some simple numbers.  At 1393, S&P 500 is trading at 15x and 13.5x CY '12 and CY '13 EPS ("as reported" EPS), respectively.  Given that we are already half-way through CY '12, let's focus on CY '13.  The forward 13.5 P/E ratio for 2013 represents a PEG of 1.23, which is based on the 11% 5-year forward CAGR (the current consensus).  We think the market should be trading pretty much at a PEG of 1.0, which would make the forward P/E around 11.0 and S&P 500 around 1135, significantly lower than where it is today.  Another way to look at it is to say that the S&P 500 is assuming at least a 13.5% growth in EPS for the next five years, for which the probability is not very high.  We have also seen weakness in top-line guidance of many companies reporting their Q2 results.  With revenue growth barely moving, S&P 500 is trading at approx. 1.3x and 1.2x CY '12 and CY '13 sales; again a bit too high, in our opinion.  And we are assuming some pick up in revenue growth in 2013.

These are some of the reasons why we're thinking that additional monetary easing is more than priced in.  Lastly, based on what we said in March, which given the way the market has moved the last 4-6 weeks can be considered as insignificant, we were not extremely bearish regarding the equity market.  We recommended rotating holdings into more conservative sectors such as utilities and consumer staples.  We still stand by that. 

July NFP & ISM Beat Expectations ...

July state of employment and services ISM reports were better than expected and the market is certainly reacting positively.  In our opinion, a one month's report does not change the underlying slowing economic and job growth trend that we have been seeing.  In addition, the better numbers actually reduce probability of another QE3, which we believe the market is more than pricing in. 

• Net change in total NFP was 163K, above our 100.5K estimate and the Street's 100K.  Government jobs dipped 9K, making the private NFP total change 172K.
• Hourly earnings went up by only 2c, or 0.1%, less than the Street's 0.2% estimate.
• Weekly hours worked remained unchanged at 34.5 hours.
• The questionable headline unemployment rate was pretty much unchanged.  Although the BLS cites it at 8.3%, it went up by only 3.7bps to barely above 8.25%. 
• However, the more important U-6 unemployment rate which pretty much takes every unemployment type into account, increased by 10bps to 15.0%.  The non-seasonally adjusted U-6 figure also went up by 10bps, ending at 15.2% in July.  U-6 has increased by 0.5% since March '12.
• Labor force participation rate declined another 10bps from previous month to 63.7; that's down from last year's 64.0. 
• Number of people employed declined 195K from June, but up 2.77MM from last year.  This household generated data certainly does not go hand in hand with the establishment data. 
• We also note that an additional 348K people left the labor force compared to June; and 2.03MM compared to last year!
• The long-term unemployed (27+ weeks) figure declined by 185K from June.
• Interestingly, the manufacturing sector added 25K jobs.  It is interesting because three out of the five manufacturing business surveys conducted by Federal Reserve Banks showed declines in their employment sub-indexes in July.  The July manufacturing ISM employment sub-index also declined.  We wonder how much the seasonality adjustments applied by the BLS have impacted manufacturing and total NFP numbers. 
• In the BLS selected industry list, only construction showed a monthly decline in jobs. 
• Temporary help in professional and business services continued to grow with 14.1K jobs added.
• The leisure and hospitality space also looked good with 27K positions added.

While the July NFP beat estimates, many of the details we provided above show that things are not improving as significantly as they should.  Although the market is applauding the report, we remain pessimistic.  S&P 500 is up 1.8%, closing in on the 1390 level!  CSTR is up more than 1%, while FB and NFLX are pretty much flat.  XHB is up 2.2%, but remains lower than where it closed at last week. 

The market is also being helped by the slightly better than expected ISM services report. 

• ISM services for July came in at 52.6, up from June's 52.1 and higher than the 52.3 consensus. 
• New orders, inventories, and export orders went up. 
• However, employment, backlog of orders, imports and inventory sentiment were down. 
• The employment sub-index dipped three points to 49.3; below 50.0 is not necessarily encouraging. 
• Lastly, this better than expected ISM services number is barely above the LTM low of 52.1, and certainly below that period's 53.9 average.  Again, it is not necessarily encouraging. 

Update ...

Today, although headline economic indicators appeared mixed, we believe they were disappointing.  However, no sign of love came from the Fed's Bernanke or ECB's Draghi as they both basically said all options remain on the table but did not provide specifics as to when new monetary easing policies may be launched.  Many remain hopeful that tomorrow's NFP will disappoint enough to force Bernanke to provide clearer indication of a QE3 later this month.

The market is showing disappointment in the Fed and the ECB as it remains in the red for the day.  S&P 500 is down 1.3%.  Again, surprisingly, VIX is up only 1%.  Lack of indication of volatility in the future could mean that the market is assuming that no action on the part of Bernanke could be an indication of a better than expected NFP tomorrow.

Last week's initial jobless claims of 365K were 5K below consensus.  However, the prior week's numbers were revised up again, by 7K.  We believe this slight 'miss' which is positive for the jobs market is mainly due to some early hiring of temps, which we believe will likely be let go by end of summer.  Companies continue to hesitate in hiring full time employees.  For this reason, temp hiring may move up again for a couple of weeks in Sept., but will ease back until later into Christmas season.  The 4-week moving average dipped slightly by 2,750.

June factory orders went down 0.5% from May, much worse than the +0.5% consensus.  Although the June numbers are basically considered old news, a few things in today's published report stood out.  Without orders for transportation equipment, factory orders fell 1.8% in June! Without the ever necessary defense equipment, orders fell by 1.5%.  Orders for computers and electronics products (excl. semiconductor equipment) fell by 4.4%.  Orders for household appliances fell by 3.5%.  Some small bright spots in the report included a 1.3% increase in orders within durable goods industries (excl. the semiconductor space).  We note this increase was lower than the April to May change of +1.5%.  Orders for construction machinery also went up a bit.

July NFP Est. Revised Up to 100.5K

As much as we hate to update our numbers too often and/or have our estimates be smack down in-line with the professional estimates, that is the case with our updated July NFP estimate.  Given the significantly higher ADP number that was released this morning, after an update, our model generated an NFP of 100.5K, higher than our initial 80K, and pretty much at the same level as the 100K consensus.  We note that even if Friday's NFP figure meets expectations, it will not be very positive for the market.  The market will give us an idea about what NFP will make it move nicely higher (either because of the strength of the figure or its extreme weakness which could push the Fed into monetary easing) or not-so-nicely lower (based on a not too hot nor too cold NFP print) after the FOMC television event in about 30 minutes.  With 100K net jobs added per month and declining real wages (excl. government wages as shown in yesterday's June personal income & spending report), the current and potential state of the economy, we believe, does not warrant where the equity markets are currently.  Of course, the premium given to the markets is mostly based on another QE, in our opinion.

ISM Remains Below 50; ADP Surprises to the Upside

ISM disappointed and remained below 50.0, while ADP was the bright spot.  In addition, construction came in-line with expectations.  The S&P 500 is up less than a point, while VIX is down slightly.  We assume this combinatin is due to the market's anticipation of hearing some magic words from Bernanke this afternoon.  We will apply the ADP results to our NFP model and may provide an update on the NFP estimate later today, if necessary.

ISM Manufacturing (July)

• July manufacturing ISM of 49.8 was below the 50.2 consensus; above our 48.0 estimate. 
• New orders increased slightly to 48.0 from June's 47.8.  However, backlog of orders declined, down 1.5. 
• Unfortunately, given the decline in backlog orders and only a slight increase in new orders, the +5.0 increase in inventories isn't necessarily good news.
• ISM's employment sub-index dipped 4.6 to 52.0 in July.  We note that the report mis-stated the direction of the employment sub-index in its table as "growing", which it obviously is not.
• By the way, prices index increased a bit in July, thanks to the ever-continuing hope of another QE, which drove up oil during the month.
• The ISM figure was not as bad as we expected, but it was bad as it remained below 50.0 (which indicates contraction) and, more importantly, it was lower than economists had estimated.

ADP (July)

• ADP print was 163K, significantly above the 127K consensus. 
• June's change was revised down by 4K to 172K.  We note that in June, while ADP reported 172K, private NFP came in at a mere 88K. 
• Service providing sectors made up most of the net 163K addition of jobs, as usual, with 148K.  Goods producing added 15K.  Goods producing has been volatile while job additions in service-providing sector has been steady. 
• Seeing a more consistent increase in the productions sector, we believe, will be a better sign for the overall economy.
• But again, the headline ADP change was much better than expected.