Philly Fed, Initial Claims, Overall Market ... and FB

In this lengthy post, we discuss the Philly Fed business survey results, initial jobless claims, our thoughts on the overall market, and we also digress a bit and touch on Facebook (FB).

Philly Fed Business Survey

The Philly Fed business survey came in at -5.8 for May, significantly below estimates of 8.8.  It appears that the Empire State manufacturing data which came out earlier this week may have been an outlier.

Drivers for such disappointing Philly Fed survey results included the much faster delivery time which was impacted by much lower unfilled orders.  In addition, decline in number of employees and average workweek was not encouraging at all.

A couple of other things stood out in the report.  One was that the index for future capex (the next six months) in that region declined significantly to 5.3 from 21.7.  This basically indicates that businesses surveyed do not expect as much capex in the future as they did the previous month.  The other data that caught our attention was response to the question of what factors are forcing businesses not to hire aggressively.  In the current stormy political environment (which is expected given the upcoming elections) politicians usually say taxes, health care legislation, other regulations or policies, and lack of skilled workers are the biggest reasons why businesses are not hiring more.  Well, at least in the third Federal Reserve District, the biggest factor restraining hiring is the businesses' pessimism regarding topline growth in the future.  The next biggest factor was that companies wanted to keep costs low, which is expected given lack of sales growth.  Clearly, such data is not very encouraging.

Initial Jobless Claims

Seasonally adjusted initial jobless claims were again above expectations, and as we suggested before, the prior week's data was revised up.  In fact, YTD, every single week's jobless claims data has been revised up; 20 weeks in a row!

Overall Market

The equity market took another dump Thursday with the S&P 500 declining another 1.5% to 1304.86.  Since end of April, it has declined approx. 6.7%; and it is down 8.3% from its YTD high of 1422.38.  It is down 4.7% since we posted recommending transitioning to less risky equity sectors on 3/5/12.  That 1325 support level we touched on earlier this week was broken through on Wednesday.  Thursday's further decline was an indication that it could be well on its way to the 1290 level we suggested.  However, again, as mentioned earlier this week, the Facebook (FB) IPO could help create a dead-cat bounce Friday.

We haven't yet had a chance to go through FB's S-1 in much detail as we knew we wouldn't be able to get in on the action early enough.  However, we do have some hesitations regarding sustainability of FB's revenue model in the long-run.  The Company generates revenues from ads (based on number of impressions or click-throughs) and from fees that its payment platform charges businesses per transaction.  Consistent growth in ad revenues is in question.  We have already seen one major business, GM, pull its ads saying they do not pay off.  In addition, more and more FB users are on the mobile platform which creates some limitations for generating ad revenues.  Lack of screen space certainly further restrains FB to place ads on its mobile platform.  Also, we believe it is less likely for users to conduct click-throughs on ads they see on their mobile devices as compared to the ones they see on their laptops, PCs or Macs.

Although FB's user base continues to grow (for good reasons as the users love their experience on the FB platform), we could see the average revenue per user, ARPU, level off and possibly decline for the reasons mentioned above, which is not good news for the Company's topline growth.  We also note that FB's revenues from transactions, which in the March quarter made up 17.6% of total revenues, are heavily concentrated.  In other words, most of those revenues come from purchases of apps by users from one company, Zynga (ZNGA).  We are not saying that other developers won't contribute to FB's revenues, but right now the risk of client concentration is clear and present.  Also, surprisingly, we did notice seasonality in this young Company's revenues.  It appears that the March quarter is usually its lightest when it comes to topline, which could explain why they chose to go IPO after the March quarter.

Regarding FB, we are not saying that this Company will be a bust and no growth remains.  In fact, there is a lot of growth potential for FB, as many others will agree.  However, sustainability of such growth and some steps that may be necessary for this may backfire in the long-run.  Of course, the Company won't face such risk until a few more years down the road.  FB users have stayed on FB because of fewer ads and because it is free.  We just hope that with declining ARPUs in the long-run, FB won't have to consider creating a 'premium subscription' plan.  Once users get something for free or for a low price, the worst thing is to raise the price; something that NFLX has realized during the last 12 months.  We note there is significant growth potential in FB's transaction based revenues.  Then again, that space is pretty competitive with companies such as Amazon (AMZN) doing pretty well.   Unfortunately, we digressed a bit from our discussion of the overall market.  We’ll likely discuss FB in more detail once we have a chance to go through the S-1 filing and conduct some good ‘ol due diligence.

We did see some signs of a potential break of the positive correlation between gold and the equity market.  While the stocks went down further, gold spiked up a bit on Thursday.  This could be due to either that many believe commodities will still have value in bad times and/or that the macro environment is deteriorating so much that chances of further quantitative easing just may be increasing, which of course help commodities and metals such as gold.  Whether the divergence demonstrated on Thursday will last or not remains to be seen.  The gold ETF, GLD was up 2.2% on Thursday.  We must note that YTD GLD is up only .5% while S&P 500 is up 3.8%.  It’s a bit different Y/Y, with GLD up 5.6% and S&P 500 down 1.8%.

Overall, the economy is not growing as strongly as many expected and the Euro crisis continues to get worse.  For these reasons we still believe a little bounce off the lows might be short lived and 1290 for the S&P 500 is within reach.

Update on Economic Data ...

Both industrial production and capacity utilization for April came in higher than the market expected, which also means higher than our estimates.  We actually had expected a slight disappointment.  Although, we must note that the 1.1% growth in industrial production, as stated in many headlines, was misleading as growth in March was revised down from flat to -0.6%.  The actual figure of 97.4% was still above the 97.1% consensus.  Capacity utilization came in at 79.2% versus the market's 79.0% estimate and certainly above our 78.6%. We note that the March capacity utilization was also revised down.

Although the data came in above expectations, we must emphasize two things.  One is that the March figures were revised down, which could mean that Q1 GDP may actually come in below the 2.2% initial estimate.  We have stated before that based on certain indicators we believe the final Q1 GDP growth figure will be around 1.9%.  The second point of emphasis is that the higher industrial production and certainly capacity utilization go, the less likely it is for the Fed to continue its aggressive monetary easing policy, which is not necessarily good news for the equity market.

Regarding the housing numbers, as expected, permits were disappointing, but housing starts came in much higher than the estimates.  In addition, March's housing starts were revised up.

Permits for April were 715K, above the 730K expectation.  March's figure was revised to 769K from 747K.  Permits for single-unit homes grew 2% from the previous month, while permits for MDUs declined 21% m/m.  We note that the Y/Y growth rate for MDUs remained significantly above single-unit homes, 36% versus 17%, respectively.  Regionally, only the northeast did not experience negative m/m growth in total building permits (single-units and MDUs).  West had the biggest m/m decline, 14%.  However, Y/Y growth was positive for all regions with the northeast ahead of others at 33%.

Housing starts for April were at 717K, above the 680K estimates.  Starts in MDUs grew faster than single-units m/m and Y/Y.  MDUs were up 4% from March and 75% from April '11.  Single-units grew 2% m/m and 19% Y/Y.  Housing starts (for both single-units and MDUs) in the northeast region were down 21% from the prior month.  The west region was down 8%.  All regions experienced double-digit Y/Y growth in April.

While the latest figures are a bit encouraging, we note that sudden growth in permits and starts will increase inventories which could push prices further down.  In addition, due to lack of strong enough wage growth rental units remain in higher demand, even with rental rates hitting new highs in certain regions.  Lastly, the latest consumer credit figure does indicate that consumers may be abandoning deleveraging a bit too soon, which combined with only modest wage growth, may lower their chances of getting a mortgage for a new home.  It may also force them to again turn to deleveraging later this year. 

Update ...

We thought it might be time to discuss some upcoming economic indicators.

Tomorrow, Wed. 5/16/12, the US Census Bureau will release April housing starts and building permits figures.  In addition, the Fed will release industrial production and capacity utilization. 

The housing figures are a bit difficult to get a handle on, mainly due to the mixed signals brought forth by the warmer weather this winter.  For example, in March, housing starts were surprisingly disappointing as many expected construction to begin much earlier due to the warmer weather.  However, building permits and housing completions were encouraging.  Similar to many economists, we believe to see an uptick in housing starts combined with a slight decline in permits.  Housing starts and permits estimates for April are 680K and 730K, respectively.

Regarding April's industrial production, the market expects a 0.5% increase from March.  After running through some numbers, we think this might be a bit too optimistic.  We are looking for an increase, but slightly less than the consensus; approx. 0.2%.  We expect capacity utilization to also come in below the 79.0% expectation.  Given the disappointing employment figures the last two months, we believe we may see a slight decline in capacity utilization and look for that figure to come in at approx. 78.56%, .04% lower than March. 

Of course, the US economic indicators have once again taken a backseat to the crisis in Europe.  Combined with the 6%+ decline in the S&P500 that we have seen since the beginning of May, slightly disappointing economic data may not have much of an impact on the equity market tomorrow (Wed.).  In addition, the market will be waiting for the release of FOMC minutes in the afternoon.  We note that Thursday's initial claims, of which the previously reported week keeps getting revised upward, along with the Philadelphia Fed's manufacturing report, are potential market movers. 

Initial claims will likely come in slightly below the 365K consensus, but we are confident that the previous week's figure will be revised up to approx. 369K.  We think by now, given the Department of Labor's consistent upward revisions, the market has taken notice. 

Expectations for the Philadelphia Fed manufacturing figure have risen after the surprisingly high Empire State manufacturing data released this morning.  For this reason, a mere in-line Philadelphia Fed manufacturing number could be seen as disappointing.  We must also note that while the Empire State survey results were better than expected, most of it was due to the current indicators within that survey.  Significant increases in current shipments and average employee workweek, along with a slight uptick in number of employees, were encouraging.  However, the forward looking indicators were not as encouraging.  The overall forward looking index declined significantly driven by lower expectations of number of employees hired, along with declines in average employee workweek, new orders and shipments.  Again, the much better than expected headline Empire State manufacturing number could have raised expectations for the Philadelphia Fed figure just a bit too much.

Lastly, we note that since our post on 3/5/12 before the open (it was approx. 1:45AM (ET)!), the market has declined 2.9%.  It did peak at 1422.38, as we had assumed it would get above 1400, but we also suggested that it was time to rotate equity holdings into more defensive types of sectors.  In addition, our suggestion of strangle positions on VIX and USO have also worked out ok.  Unfortunately, given the weaker Euro and no further indication of Bernanke becoming more aggressive regarding QE, gold has declined.  It may go down further, but that just may be necessary in order for it to break the positive correlation it has had with the equity market since the start of the monetary easing policies.  From a technical standpoint, S&P500's next support level is 1325.  If it goes below that, then there isn't much support until around 1290.  However, the Facebook (FB) IPO (which we are still trying to figure out how it will grow its revenues consistently), along with a potential dead-cat bounce, might just help the market create a base at the 1335 - 1345 level, at least for the short term.  By the way, we note that there are reports stating GM has withdrawn its ads from FB saying those ads do not pay off. 

Disappointing Economic Data; QE3 to the Rescue?

After reading about this morning's economic indicators and how three of the four announced were very disappointing, we were surprised to see the equity market in the positive; more specifically, as we are writing this, S&P 500 is up approx. 2 points at 1387. We thought we should provide some type of perspective explaining this. So here it goes.

While the housing, manufacturing, initial jobless claims, and industrial production economic data were all disappointing this week, such disappointment has once again brought to the forefront the idea of Bernanke and the Fed coming to the rescue with another QE. Of course, the probability of another QE declined sharply, as we had suggested in March. However, hopes and dreams based on more Bernanke-type of equity market steroids remain alive, especially after seeing just how moderate the current economic growth rate is. We must note that the disappointing data may answer the question of whether or not Alcoa is the bellwether of the economy, at least for now.

Along with disappointing economic news, another factor that may give Bernanke the 'ok' for a QE is lower oil prices, which we have seen the last couple of weeks. Lower oil prices are driven by the not-very-impressive economic data, but also by what appears to be a prioritized strategy by the White House, which is to downplay a possible attack on Iran using various methods. We certainly suggested this to the White House in one of our previous posts.

Examples of some of the methods used include the so-called 'P5+1' negotiations that took place last weekend in Istanbul, Turkey. That will be followed by another meeting between Iran and the countries that have imposed economic sanctions and are threatening to bomb it, in Baghdad next month. The White House has continued to ignore negative comments made by Israel's Ben Netanyahu regarding the 'P5+1' as it knows that if it agrees, then the oil market will further price in an attack on Iran by US and Israel; and if it disagrees, then the market will further price in an attack on Iran by Israel.

The latest method used by the White House was President Obama's announcement of his plans to rein in oil speculation. This is very amusing to us. We see and hear both US political parties continue to voice support for Israel's objective to hit Iran, they continue to push for additional oil embargo and economic sanctions that basically reduce supply of oil for some period of time in Europe, Middle East and Asia; and then they blame the higher oil prices on traders and Iran.

With all of this said, it appears that the combination of bad economic news and various methods used to downplay a potential attack on Iran, have once again raised the possibility of the Fed and Bernanke proposing and executing yet another QE. In our opinion, if they do decide to take such action, it has to be done sooner than later because the Fed cannot and must not risk being viewed as a political factor in the upcoming Presidential election. By the way, we believe it certainly is one.

Lastly, we must note that one thing is positive about the market - earnings reports. Although some companies have missed expectations, most have not. However, these are Q1 earnings results, which ended at the end of March. Some early April economic data show that Q2 may not be off to a good start. Then again, corporate management teams and their investor relations departments can very easily play it safe and provide, as they say, 'conservative' guidance in order to keep the sell-side analysts' estimates low enough to beat, so the market can react positively. We remain cautious regarding the equity market.

"A Fair Market Value Update" ...

We came across this story which was published on Monday morning (4/10).  From a high-level standpoint, it basically says what we said more than a month ago.  Of course, this one provides more detail than we did, but hey, we say timing is more important.  In addition, the wide range given for S&P 500 in 2012 increases the probability of the author's projections being correct.  You could say that's a smart way to hedge projections, right?  Here's link to the article, enjoy ... A Fair Market Value Update. 



http://mogharabi.blogspot.com/

Is Mainstream Media Framing & Timing Stories for a Reason?

We were just curious about mainstream media's timing of covering certain news/events.  Of course, in our opinion, coverage of stories that impact foreign policies can be questioned most of the time as even with the social/digital media at the forefront, most information regarding those stories are provided by 'anonymous' sources from within the government which are biased most of the time.  We believe intentions can always be questioned.

This brings us to the question about coverage of foreign policy and economic related stories, such as the potential economic impact of an attack on Iran by the US and/or Israel.  We just find it interesting that the mainstream media hasn't really addressed this until now that it is seeing a pullback in the equity market (of course, thanks to Alcoa (AA), the equity futures signal somewhat of a rebound this morning).  We, of course, touched on it a while back.  But suddenly we are seeing the great CNN quoting economists regarding the possibility and negative impact of an attack on Iran, with the title of: Iran-fueled oil price spike biggest threat to economy. 

To this great timing - during a market pullback, accomodated by lower oil futures, and finally a clear Republican opponent, Romney, as the President's opponent in the upcoming election - we say thanks, to CNN.  Who knows, maybe the White House did follow our suggestion and somehow convinced its media buddies to take it easy on covering the potential disaster that may come about as a result of Israel, every White House's (whether Democrat or Republican) very important election buddy, attacking Iran, to which no White House can object. 


http://mogharabi.blogspot.com/

We ask again: Is Alcoa the Bellwether of the Economy?

Alcoa (AA), the aluminum manufacturer that many refer to as the bellwether of the U.S. economy, reported better than expected Q1 earnings. This will be taken as good news by the market, at least early on. We decided to do some back-of-the-envelope calculation to see if this 'bellwether' reputation has any merit. As usual, our analysis was not very complicated.

If one is talking about AA's quarterly performance being an economic indicator, then sales growth is what one must look at. The Company's 70% Y/Y decline in earnings, although it beat the very credible Street's estimates, certainly should not be considered a good economic growth indicator. For this reason, we focused on the Company's sales growth.

We first looked at the correlation of AA's top-line growth and U.S. GDP growth. Not surprisingly, the two are positively correlated. The figure, based on 13 years of quarterly data, was approx. 0.60.

We then regressed annualized GDP growth per quarter against AA's sales growth. It turns out that a 1% AA quarterly sales growth represents an increase in US GDP growth of only 20bps. We must say that the AA sales coefficient turned out to be statistically significant, explaining 33% of the variation in GDP growth. However, based on this very complicated & simple linear regression (!), AA Q1 sales growth indicates only a 1.9% Q1 GDP growth, significantly below 2.4% which is the midpoint of economists' estimates ranging between 2.2% and 2.6%.

For this reason, if AA's performance is a bellwether of the economy, then maybe we should not be overly optimistic about Q1 economic growth.  In addition, maybe the higher Feb. wholesale inventories reported on Monday were due to lack of sales rather than higher projected sales.  Or as we have been before, we can remain a bit hesitant in viewing AA quarterly results as a bellwether for the U.S. economy. Of course, after the market's (S&P 500) 4.3% decline over the last five trading days, we do expect AA's better than expected earnings to have a positive impact, but we doubt such impact will last long.

Regarding the Company’s quarterly earnings presentation, its 2012 end-market guidance calls for strong growth in North American automotive and heavy trucks markets, partially offset by weakness in the beverage can industry, and commercial building and construction. The only bright spot that AA sees in Europe is the beverage can packaging end-market, in which AA expects a 5% - 7% growth this year. For China, the Company lowered its growth projections of the automotive and trucking industries, while it slightly upped growth forecast for commercial building and construction.

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After hitting levels to which we referred as fair value, S&P 500 has already broken below the two support levels that we mentioned before, 1390 and 1375; and it is not too far away from 1350. It will likely remain between 1350 and 1365 until the important PPI and CPI figures are released on Thursday and Friday, respectively (in addition to the initial jobless claims). We note that the 1350 level can be considered very important as the S&P 500 hit that level and went slightly above it multiple times in 2011 before beginning its near 19% correction phase in Aug. '11. The 1300 level, or another 4% decline, could become more probable if that 1350 support level is broken through.

Lastly, we must note that Bernanke did not mention further quantitative easing on Monday night. The market is beginning to discount any probability of further easing after June, which also explains the latest pullback.

http://mogharabi.blogspot.com

Disappointing March Employment Report

The March employment report was basically a whiff or a strikeout.  Given the start of baseball season, we thought we might as well include some baseball lingo.  BLS threw the market a mean yakker.

The market is closed for today, but the S&P 500 futures were down 1.1%. With such a disappointing report, Bernanke may begin talking about further monetary easing again. His next public appearance will be at the Federal Reserve Bank of Atlanta's Financial markets Conference on Monday night.  We wouldn't be surprised if many politicians and/or Wall Streeters were leaving messages for Bernanke, begging him to be kind to the equity market when making his Monday night speech.  Who knows, but maybe President Obama is thanking the Lord for the Easter Holiday (Good Friday) for which the markets are closed.  He and many others are probably hoping the negative impact of such a bad report will die down a bit by the time the market opens on Monday morning.

Regarding the report, NFP went up by 120K, but significantly below the Street's 200K expectation.  In addition, it was lower than the 246K in March '11.  The private sector added 121K versus the 215K that the Street expected.  This was also lower than the 261K jobs added in March '11.

Manufacturing did well by adding 37K jobs.  This was slightly higher than the 26K manufacturing jobs added in March '11.  On the other end, 33.8K retail jobs were lost in March.  Last year, this sector had added 7.7K jobs.  The surge in temporary help services to which we pointed in the Feb. report, dipped down a bit in March, losing 7.5K jobs.

Average weekly hours declined to 34.5 hours in March from Feb.'s upwardly revised 34.6 hours.  This was in-line with expectations.  Hourly earnings change was also in-line at 0.2%.  We must note that hourly earnings change for Feb. was also revised up, to 0.3% from 0.1%.

Of the unemployed, 42.5% have been without jobs for more than 27 weeks (or approx. 6 months).  This is only slightly lower than Feb.'s 42.6% and remains a concern.  As we have said before, these figures are not impressive given that we are in the third year of recovery.

Unemployment rate dipped 10bps to 8.2% mainly because the labor force participation rate also declined. Participation rate went down to 63.8% from 63.9% in Feb.  This figure was also lower than the 64.0% in March '11.  As usual, we think U-6 unemployment rate is a better measure to look at.  It dipped by 40bps to 14.5%.  Although the decline is positive, this level is still very high.

Again, the futures indicate a negative reaction to the disappointing report.  When the market opens on Monday, this will likely be very true.  However, some of the losses will likely be pared by the time the market closes on Monday, mainly due to Bernanke’s upcoming speech on Monday night.  Many may decide to wait to hear what Bernanke says before making a move.  We’ll see.  Happy Easter to everyone!

http://mogharabi.blogspot.com/

Equity Market to Fed & Bernanke: "I Wanna Get High, So High!"

S&P 500 is down 15.03, or 1.10% today.  Simply put, the stay of that Fed 'insurance', the QE3 or 4 or infinity, is now less certain, based on the FOMC minutes released yesterday.  We touched on this in early March and in our last post , even after Bernanke juiced up the market.  In addition, it appears that Spain is now slowly taking Greece's role in this entire Eurozone fiasco that's been going on for a long time.  And no matter how low (comparatively speaking) Italy's 10-year yield is, don't count out Italy; its time may come due shortly.  The ECB President, Draghi, also hinted this morning of the increasing risk of inflation in the EZ.

All of this, basically hides the not-bad ADP employment report for March, which was pretty much in-line with estimates.  ISM Services was a slight miss, but not too bad.  So, what does all of this tell us?  For one thing, it demonstrates just how much the market has become dependent on the Fed's helping hand.  The addiction to QE policies will be tough to let go, as we're seeing today.  Such addiction has also brought about the non-rational market, where bad news is actually good news.  The more bad news, the more likely it is that the Fed will continue to supply the Street with the 'product' to which institutional and retail investors are addicted.  If the last couple of months' economic data had been worse, the Fed would've likely stated that more than "a couple" of its members are in favor of implementing more monetary easing policies.  As a reminder, Operation Twist ends this June, so we will see if the Fed begins to hint to expect more QE after June.  As many have stated, it will be tough to implement a QE post-June, mainly due to the upcoming Presidential election.  The Fed does not want to do anything that favors either side.   So the ones that did not begin to transition towards the risk-off strategy, better hope that this Friday's employment figures come in way worse than expected so that the Fed can start distributing more gibberish about the increasing likelihood of another QE. 

Let's not forget about oil.  As talks about invading Iran have died down, WTI front month has dipped to below $103.  However, this does not necessarily mean that gasoline prices will follow.  On the downside, gasoline prices do not adjust as quickly as they do on the upside, and we believe it will be even slower this year given the increasing volatility in oil futures.  The volatility is of course driven by lack of certainty regarding a strong-enough economic recovery, another QE by the Fed, and an invasion of Iran by Israel, the US, or both. 

Regarding the potential war with Iran, it appears that things are getting pretty heated between Israel and the US.  The White House may have listened to our suggestion that we included in our last post (of course we're only dreaming about that possibility!).  But it may have taken it a bit too far as there are reports (by Israel of course) that the US has leaked some strategic information regarding Israel to the media with the intention to either delay or change Israel's plan to attack Iran.  As an example, Israel's objective of using Azerbaijan as a base on which to station and fuel its aircrafts, and from which to attack Iran, was leaked to the Foreign Policy publication; at least that's what the pro-Israelis say.  No matter what though, for the time being, the tension between the US and Israel has increased; but we all know that the so-called 'tension' will die down as soon as some pro-Israel lobby groups dangle the re-election carrot in front of the Obama team. The risk of a war with Iran still remains, no matter if Obama wants it or not. 

From a technical standpoint, if S&P 500 closes below 1,400, and assuming that Friday's employment report won't be too good or too bad, then we could see S&P 500 dip down to around 1,390.  The next two support levels below that are 1,375 and 1,350.  The reason we chose to assume a no surprise in the March employment report is that we haven't yet had a chance to come up with our own estimate, mainly due to time constraints.  If we do, and if our estimates change anything we mentioned in this post, we will make sure to post an update before Friday morning.  

Bernanke Juiced Up the Market Once Again

Since our March 5th post, S&P 500 has risen slightly above 1,400 to which we referred at that time as the fair value. Nothing much has changed with regards to the recovery; it remains modest at best. We believe increasing chances of implementation of QE3 by the Fed, has driven the market higher. Two things, in our opinion, have increased those chances: less talk regarding a military attack on Iran, which has put the higher gas prices and fear of inflation on the back burner (although gas prices continue to rise); and a not so strong recovery as indicated by the latest economic data. These have helped keep the QE3 option on the table. This was verified today by Bernanke's speech at the NABE (National Association for Business Economics) conference.

We remain convinced that the threat of another war waged by US/Israel, higher gasoline prices even before the summer driving season, lack of enough growth in wages or full time jobs, and the S&P 500 being fairly valued will create a market pullback.

Military attack on Iran by Israel/US?

It is interesting that we're seeing and hearing less gibberish regarding the potential attack on Iran by Israel or the United States. Although less talk about this possible military conflict was expected especially after the almighty AIPAC conference, we certainly didn't expect near-complete silence from the White House. Then again, it is understandable. We can just imagine that the 'Executive Summary' section of a White House memo would look like this:

Open discussions with the press regarding aggressive military options against Iran will impact the economy and the upcoming election negatively.

• More Iran war talk has increased speculation regarding oil and gasoline prices.
• Higher gasoline prices will likely dampen consumer sentiment, consumption and therefore economic growth.
• Voters' focus will also be shifted back to the economy from a negative standpoint, allowing the opposing party to create storylines of the Administration’s economic ‘failure’ which can be pitched to voters effectively.

 The amount of war talk is recommended to be minimized. This will allow opposition to make the 'bomb, bomb, bomb Iran' pitch, which the current Administration can then label as the culprit behind higher gas prices, and pressures on the economy and Main Street's pocketbooks.

Again, the above is just our imagination and in no way does it represent any official document from the White House or any other part of the government. If we were part of the staff, that's the advice we would give.

Economic data - not so bad, but also not so great.

Below is a glimpse of economic data released since March 5th, with respect to market expectations ('Estimate'). You will see that while not all numbers were disappointing, they were also not so great. Overall, the economy is growing, but at a moderate pace. And as indicated today by the market's reaction to Bernanke's speech, the market believes the economy must remain on the life-support system provided by the Fed, or else! Well, that life support system may not remain operational for long if oil and therefore gasoline prices continue to move higher and higher.

Lastly, given the drastic movements in VIX since our March 5th post (in which we made a few suggestions) - VIX jumped approx. 20.5% by March 7th and has taken a dump since, down nearly 32% - a strangle position on VIX options would've been a good move. The same cannot be said about USO, but then again silence regarding Iran, along with Saudi Arabia’s numerous promises has slowed the upward movement in oil prices.  We note that additional potential market-moving data will be released this week.  They include Case/Shiller real estate price index, consumer confidence, final durable goods orders for Feb., PCE, Chicago PMI and the final UMich consumer sentinment for Mar. 

Feb. CPI increased 2.9% Y/Y, below our 3.02% estimate and inline with the consensus. CPI, excluding food & energy, also came in lower than our estimate; 2.2% vs 2.3%. This was also pretty much inline with the consensus. While these figures may bring a bit of relief, we note that no matter how much the US tries to tap into its oil reserves, the threat of an attack on Iran will keep oil prices and gasoline prices at high levels. In addition, yesterday's PPI results did indicate that producers are facing higher costs, which will ultimately be passed down to the consumers via higher prices. Lastly, we believe at aroun 1400, the S&P 500 is fairly valued. The further it goes above that level, the more extreme a pull-back will likely be. Of course, the futures indicate that the market will be reacting positively to the CPI numbers.

Upcoming CPI data ...

Friday's CPI data will be analyzed in great detail as it may force the Fed to delay QE3 even if QE3 will be the "sterilized" version.

We estimate the CPI data to come in slightly above expectations, driven by increase in the labor force as indicated in last week’s employment report. We expect overall CPI M/M change of 0.53% versus the consensus of 0.4%. This also represents a 3.02% increase over the last 12 months. Core CPI, which excludes food & energy prices, will likely show a 0.26% M/M change versus a consensus of 0.20%. Core CPI Y/Y change, we estimate, will be approx. 2.30%, ahead of the Fed's 2.00% target.

If our estimates turn out to be correct and/or if the annual change comes in above 2.00%, then we could see the market react negatively as it may hint that potential risk of too much inflation could force the Fed to re-think its overall QE policy.

Regarding the market's performance today, S&P 500's near 1% move up is driven by slightly better than expected retail sales data. We note that those figures were positively impacted by higher gasoline prices. We are getting closer and closer to the CY '12 1.0 PEG that we discussed last week, which basically indicates where S&P 500 would be at fair value plus a QE premium.

http://mogharabi.blogspot.com/

High Gas Prices Threaten Stock Market Gains: Report (Morgan Stanley/CNBC)

Appears that Morgan Stanley is thinking basically the same thing we mentioned early last week  - a more cautious/conservative view of the stock market for the time being.  Below is the link to the story provided by CNBC.  We must note that there are also many others that disagree.

Link: High Gas Prices Threaten Stock Market Gains: Report

Thoughts on the Employment Report ...

The Feb. NFP and private payrolls print was more in-line with our estimates than the consensus. NFP came in at 227K versus our 217K and the 210K consensus. Private sector added 233K jobs versus our 235K estimate and the 225K consensus.

A few things stood out in the report. Within the private sector, while professional and business services added 82K jobs in Feb., more than half of those, or 45K, were temporary positions. We touched on this in our March 5th post. What makes this figure even more interesting is that in Feb. '11 only 28% jobs added in this sector were temporary. Historically, increase in temps has been a leading indicator of recoveries or downturns. Whether or not they are indicating an upcoming downturn during the next 6-12 months remains to be seen. They certainly do indicate employers' hesitancy in making that 'commitment' and adding more full-time employees.

The less Y/Y decline in government jobs wasn't surprising, given what we had noticed in the Challenger report, however, we had expected more than a 6K decline. Then again, it is an election year.

Hiring in construction actually declined by 13K, which was surprising to us given the warm winter that we've had this year. The same thing can be said of the 7.4K jobs lost in the retail trade sector.

With these good jobs numbers, the unemployment rate remained at 8.3%, in-line with the consensus. We don't pay much attention to this figure as it depends on the labor force and participation rate, which do change. Basically the base used to come up with the official unemployment rate is questionable. This rate remained unchanged because the participation rate increased by 20bps from Jan., after having decreased steadily from 64.2% in Feb. '11 to 63.7% in Jan., which of course helped make the decline in unemployment rate look so attractive. The U-6 unemployment rate, in our opinion, is a better measure to look at. It declined by 20bps to 14.9%. This level is still very high.

In addition, the average time that people have been unemployed remained very high, 40 weeks. Although this figure has declined from 40.9 weeks in Nov. of last year, it is still well above the Feb. '11 36.7 weeks. Here's another figure that remains alarming: 42.6% of the unemployed have been without jobs for more than 27 weeks, or approx. 6 months. These numbers aren't very impressive given that we are in the third year of recovery from the 'Great Recession'.

Lastly, average weekly hours remained at 34.5 hours, unchanged from Jan. And the hourly earnings change of a mere 0.1% was only half of the 0.2% that the market expected. Average weekly earnings went up by only 0.13%. With lack of much wage growth and latest surge in energy prices, next week's CPI and PPI numbers become even more important, as we mentioned in our last post.

Friday's Employment Report ...

Regarding Friday's employment numbers, we think the warm winter likely had a positive impact, which will be diminished during the next few months. In addition, the impact of higher energy costs hasn't yet been realized by many companies and therefore is likely not yet visible in the Feb. figures. All of this, combined with a slight uptick in hiring within the public sector, we believe will result in NFP in-line or better than the 210K estimate. We think the number will be around 217K.

As usual, the private figure will be higher. Wednesday's ADP provided some color regarding that. Historically of course, ADP and BLS private payroll numbers have been very highly correlated. Although they both move in the same direction more than 95% of the time, the m/m changes can vary significantly. For example, during the last 12 months, m/m change in BLS private NFP has ranged from being 168K less to 96K more than m/m change in ADP. The BLS m/m change has come in less than the change in ADP in 5 of the last 6 months. But again, given what we discussed earlier, we think growth in BLS private payrolls will be in-line with or slightly better than the ADP growth released Wednesday. We estimate private job growth of around 235K.

If the employment numbers do beat the consensus, of course the market will react positively, but such reaction will be short lived. Even with what appears to be another successful round of kicking the Greek default-can down the road, we could see some profit taking at the end of Friday, limiting the upside for the day. While after the not-so impressive manufacturing data, the Fed and the press may have been hinting that QE3 will be launched soon, we believe the better than expected employment figures could put QE3 back on the shelf again, which would be another reason why many would do some profit taking.

In addition, given the latest rise in energy prices, next week's CPI and PPI reports will be very important, and until they are released, uncertainty in the market will likely increase. Lastly, capacity utilization, which is also scheduled to be released next week, will provide more color on how to interpret Friday's employment numbers.

Thoughts on Challenger & Initial Claims Reports ...

Challenger Job Cuts Report

While the Challenger Feb. job cuts report appeared to be slightly better than the previous month's, a couple of things stood out which supported what we mentioned earlier this week.

First, the YTD pace of job cuts is running at 18% more than last year’s. 105,214 jobs have been cut this year compared to 89,221 same time last year. Another 25.6K job cuts in March, which is only 62% of job cuts announced in March '11, and this year's Q1 job cuts will be higher than last year's, keeping this recovery a modest one at best.

Second, unlike last year, most of this year's cuts have been in the consumer products and transportation sectors, indicating the negative impact of higher oil prices which also drive gasoline prices higher. According to the report, "Both sectors are undoubtedly feeling the impact of rising fuel prices as heavy users of fuel, but also from their dependency on consumers, who are being forced to spend more on gasoline and less on the products and services provided by these firms.” And believe it or not, Feb. figures would have looked worse were it not for the 'recovery' in government jobs (most states and local). Again, this recovery is a modest one at best.


Initial Jobless Claims (3/3/12)

Seasonally adjusted figure came in above expectations, 362K vs. 351K, which is not good news. It was also higher than the previous week's figure, which itself was revised higher by 3K to 354K. Although seasonally adjusted initial claims have been below 400K in 8 out of the last 9 weeks, they have not gone below 350K in 4 years!  In addition, we note that the seasonal factor applied to the raw figure was the highest for the first week of March since 1995!

For this reason, we believe it is also important to look at the raw, or non-seasonally adjusted number, which was approx. 365.8K, up 31K+ from the previous week.


The, what we believe to be bad news, is partially offset by yesterday's inline ADP private payroll number of 216K. Then again, those ADP figures get revised more than even the government employment-related numbers.

We will provide more thoughts on tomorrow's expected BLS employment figures later today.

Market Update ...

The Dow, NASDAQ and S&P 500 are all more than 1.0% lower today.  At least for the time being, it appears that our more risk-off strategy was the right call. Then again, let’s see if it lasts longer than two days. VIX is up 21% this week.

With Greece’s sovereign debt issues driving the market lower, oil and gold are following along. With oil lower, GDP may not be that negatively impacted and gas prices could spike up only close to $5 this summer. But we note that this appears to be a no-win situation, at least for this year. Oil below $105 may be good for the economy, but the lower it goes the more likely it will increase chances of a military conflict with Iran. Morality of wars isn’t usually questioned among the ‘decision makers’. However, potential economic impacts of wars are always taken seriously. Lower oil prices may reduce short-term economic impact of such a conflict, allowing war hawks to roll out the ground and/or air attacks on Iran. But of course the significant long-term costs associated with such an attack, which mostly the US servicemen and taxpayers will be bearing, are basically swept under the rug, possibly one of those expensive and classic Persian rugs.

Regarding stocks, from a technical standpoint, we note that if the S&P 500 closes below 1342, another 1.0% - 1.5% downside, or 1325, could come within the next few weeks. Of course, any positive jobs data later this week could change all of that.

Lastly, if the market does go through a lengthy correction phase, the Fed could activate its ‘insurance’ policy, QE3, sooner than later, but unfortunately at a higher premium – higher inflation in the long-run.

Equity Market, War, Oil, and the Economy

Well, given the equity market's excellent performance during the last five months, we thought we should provide some thoughts regarding our past and future strategies. We'll first review performance of our recommendations and then we'll provide some thoughts regarding oil and the state of the economy. We will also touch on why we think it may be time to move towards a slightly less risky strategy.

S&P 500 went below the 1,120 level which allowed us to implement our more risk-on and aggressive strategy, as we mentioned in late Sept. '11. It actually closed at its year low of 1,099.23 on 10/3/11. The index has increased approx. 22% from the 1,120 level. XLY, consumer cyclical ETF, increased by nearly 29%.

GLD has increased by only 4% since our last post, but then again we all know that it has outperformed the equity market over the long-term.

Looking ahead, S&P 500 is at 13.7x and 12.6x CY '12 and CY '13 EPS estimates, respectively. It may be surprising, but we think the '12 multiple is more attractive as it assumes a 15% EPS growth, which translates to a mere 0.9 one-year PEG. A PEG of 1.0 would mean that there is another 10% upside to the S&P 500 for this year. The 2013 estimates represent a PEG of 1.5. Excluding the 'Great Recession', S&P 500 has been trading at average one-year PEG of only 0.9 during the last 23 years. In addition, recent increase in oil prices could impact not only economic growth but also company margins which may result in lower than expected EPS.

The economy appears to have stabilized a bit, given the latest employment, consumer confidence and manufacturing data.

However, we note that the recovery remains very moderate at its best. Companies have basically cut to the bone and can no longer reduce HR. In addition, a big chunk of the hiring has been of temps.

In terms of economic growth, consensus for '12 GDP growth is a mere 2% followed by 2.2% in '13. We note that these estimates may be negatively impacted by recent rise in oil prices.

The housing market remains at the bottom, although existing and new home sales have been improving. Such improvement in sales and decline in inventories have been driven by short sales, foreclosures and bulk buying by institutions. Given lack of enough wage growth and continuing deleveraging by consumers, it may be tough to see a strong rebound this year.

We must point out that even though the latest economic data has been positive, it could have a negative impact on the market as it may reduce the chances of implementation of the Fed's QE3. Without such 'insurance' provided by the Fed, overall risk associated with the equity market could increase.

In addition, the sovereign debt crisis in EU remains. Greece may have kicked the can down the road, but there will come a time when it will have to clean up its mess. The same can be said of the other PIIGS. And debt crisis is not the only thing EU has to worry about these days. Given the current economic downturn in that region, the US lawmakers have actually begun to put mainly Greece, Italy, Spain and Belgium in literally a choke hold. None of these countries can say no to the US oil embargo on Iran which will begin in July. Such embargo will not only increase oil prices (as we have already seen), but it will also negatively impact those countries' potential economic growth as they will have to spend millions on their refineries to handle oil coming from other providers, which by the way have not yet been determined.

And this takes us to our so-called oil analysis. Since the end of Q3 '11, WTI oil spot price has increased 35%. Front month futures crossed $110 last week. And as a result, gasoline prices are expected to hit record highs even before the big driving summer season begins.

Oil has risen due to some economic stability in the US, some very modest growth, possibility of a QE3 by the Fed, and of course the war gibberish spewed out by Israel and the US, to which Iran has reacted with more gibberish. The last factor, the geopolitical one, we believe, is the biggest driver of higher oil prices.

How will higher oil prices impact economic growth? Given what we believe to be a quadratic relationship between oil prices (inflation adjusted) and real GDP, our analysis of historical data showed that oil prices likely impact GDP negatively if they reach levels above $105, which they have. Given the non-linear relationship between the two, we cannot say how much each $5 increase in oil price will impact GDP. We can say that at $110, GDP growth is likely impacted by approx. -12bps; at $115 by -30bps; and at $120 by nearly -50bps or -0.5%. Some believe WTI could go as high as $130 this year, potentially knocking off 1.0% from GDP growth, based on our analysis.

While President Obama, when speaking to AIPAC today, sounded as though he may not want to hit Iran, we must admit that history has proven over and over that it is not the President of the US that makes decisions regarding policies in the Middle East! And the President understands that the more talk there is, the higher oil prices will go which may hurt his chances of remaining in office. In addition, if Israel does strike Iran, given US' commitment to the state of Israel, it is very likely that the US will get involved one way or another. We will likely get more color on this, at least for the short term, tomorrow during Bibi's and Obama's press conference.

In our opinion, July is the key month. We don't think any military action will be taken between now and July. We think this is due to the US at least giving some EU countries (mainly Greece, Italy and Belgium) some time to adapt to the embargo which they are forced to ... force upon Iran. As we mentioned earlier, the oil embargo could be costly for those countries to abide by.

Chances of an attack on Iran, assuming nothing else changes, will likely increase after July. Some so-called "market indicators" indicate that there is nearly a 40% chance that either the US or Israel or both will execute an overt air strike on Iran before the end of this year. Although this figure is below 50%, it is considerably higher than the 23% and 30% representing possible strike before end of June and Sept., respectively.

Given possible chances of attacks on Iran and its negative impact on the economy and the equity market, a couple of simple strategies might help reduce such potential impact. If there is an attack, oil prices will jump further. It’s not only Iranian oil but also oil from Saudi Arabia and Kuwait that may be at risk given the possibility that Iran can create havoc at its Strait of Hormuz. If there is no attack, then the premium currently in oil prices will likely be reduced. Given all of this, a less costly strangle position on USO could help. We recommend the out-of-the-money positions for calls and puts that expire after July, or in Oct. The same reasoning could be applied to holding a strangle position on VIX.

In terms of equity positions, the market is getting closer and closer to being fairly valued, assuming no unusual events take place. Given this, we would probably begin moving some of our positions into safer sectors such as staples and utilities, both of which may benefit from possible upturn in oil prices and/or an economic slowdown.

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.