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Benny Always 'Silences' Bad Economic News

2010-02-25T06:53:00Z

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

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

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

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

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

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

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

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

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

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

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

Fed's Consumer Credit report ... worrisome.

2010-02-07T04:29:00Z

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

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

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

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

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

In addition, the loan-to-value ratio of such loans stood at 92 in December, significantly above 2005's 88 and only slightly below 2007's 95. Combined with not much growth in overall consumption and continuing decline in the housing market, this ratio demonstrates 1) consumers likely did not have more cash to put towards those loans and 2) the government’s success in convincing consumers to borrow more at the great low rates.

We wonder what would happen if the Fed was forced to exit such 'stimulus' phase of the economy (or plainly - money printing) before any meaningful improvement in jobs all around the country. We must also note that although the average length maturity of these loans is 64 months (higher than 60 months in 2005), the more time for the borrower, the more likely that the borrower will hit the high-inflation phase of this great recovery (likely within the next 24 months).

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

Highlights and Lowlights of the Jan. Employment Report

2010-02-05T16:14:00Z

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

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

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

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

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

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

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

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

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

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

Another break from the 'recovery'?

2010-02-04T18:11:00Z

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

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

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

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

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

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

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

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

2010-02-02T00:30:00Z

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

GDP

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

In addition, inventories contributed approx. 67% to the growth. This is good news and bad news. It can be viewed as slowing inventory burn with replenishment on the horizon, showing that businesses are expecting some recovery in consumption. Inventory growth in calculating GDP has been positive for only two quarters (Q3 and Q4) after negatively contributing to the GDP for seven consecutive quarters. The question is - will companies actually produce more because of growth expectation or just partially replace the drastically cut inventory? We continue to believe latter to be the case.

Although imports grew for the second consecutive quarter, we noticed its smaller contribution to GDP than the prior quarter. This indicates that demand here at home remains weak, and companies remain hesitant to make growth investments or to fully replace inventories cut since Q4 ‘07.

ISM

This morning's positive news, better-than-expected Jan. ISM PMI, drove up the market nicely.

Although most of the components of the ISM were positive (except inventories), we note that prices increased more than any other component with no industries indicating that they faced lower prices in Jan. In addition, growth in imports remained weak.

We believe the excellent ISM figures represent only the upcoming inventory replenishment, which is slightly positive for the economy, but may not be sustained after Q1.

Lastly, the employment component of ISM was also positive at 53.3, but we think this may decline after Q1 as inventories may no longer require replenishment. However, in the short-term, this could be a positive indicator for the upcoming Jan. unemployment data, which will be released on Friday.

Consumer Confidence

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

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

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

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

Savings

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

Unemployment

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

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

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

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

However, the official unemployment rate may come in slightly better than expected as initial claims (although they do not represent any type of job creation) may be trending down at a higher rate than the declining labor participation force figure (basically the denominator of the unemployment rate), resulting in a lower unemployment rate figure. Today’s ISM report also provides some support for possibly a better unemployment figure on Friday.

Earnings reports this week will take a back seat to the upcoming unemployment data. Today's performance could be an indication of higher volatility going into Friday's news, which means that a long straddle strategy on SPY or S&P 500 futures might work.

President's pitch is not the solution

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

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

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

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

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

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

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

Is it time to take a break from the great 'recovery'?

2010-01-15T14:24:00Z

It appears that the economy may not be accelerating as quickly as the equity market expected or is expecting. Although we have seen improvements in different parts of the economy, the numbers remain disappointing. However, the market continues to climb higher, until today. Could reality set in at some point? Could it be that many expect the government to continue to feed everyone, including the Haitians?

Although early Q4 earnings have been mixed, we do expect overall S&P 500 earnings to come in-line or better than the current consensus. However, as we mentioned previously (a long time ago!), strong top-line growth must accompany good earnings at some point. Only top companies in the tech and defense sectors will likely be able to accomplish this as both have become necessities, literally; some through natural and habitual evolution and innovation, while others through government’s great story-telling talent.

Intel (INTC) certainly had a great quarter and provided very positive guidance. Unfortunately, JPMorgan (JPM) could not accommodate its excellent earnings with solid revenues. Other big players likely had a good Q4, but given the slightly more stable market, it makes you think whether or not companies such as Goldman Sachs (GS), very dependent on trading revenues these days, could have impressive top-line growth in 2H’10. But again, S&P 500’s 4Q’09 earnings will likely come in in-line or better than expectations.

Going back to the economy, inventory replenishment may have given some life to the economy, but will it continue? The answer of course is based on consumption, of which we have not seen much improvement, as indicated by yesterday’s retail report and this morning’s consumer sentiment.

In addition, although initial jobless claims, viewed as a leading indicator, have declined slightly, they remain well above historical pre-recovery levels. Again, Thursday’s report (1/14) supports this view.

Of course, continuing claims has been declining a bit more rapidly, but does that really make sense given that unemployment has remained high and jobless claims have stayed above 400k? The logical explanation would be that there are many more people giving up looking for jobs than there are finding jobs. Certainly, many companies have already cut down to the bone in terms of reducing headcount. As it is well-known, the continuing claims figure does not include the number of unemployed that have basically said 'no mas'. We assume those figures would be different if everyone had the attitude that those Green Bay Packers displayed last week against the Arizona Cardinals. They fell behind big but came back to make that game 'one for the ages.' Then again, that's just a game, and the football players get paid no matter what.

Although we cited the March'09 lows as the bottom, we certainly did not expect such strong recovery in the stock market. We believe that the market is currently over-valued. In addition, given the market's recovery, the notion of 'buy anything' is no longer applicable. With volatility declining (although VIX is up nicely today), we believe fundamental analysis may be rearing its logical and realistic head. We’re using the word ‘rearing’ as fundamental analysis is the last thing traders want to hear about after a great 2009.

So, let's look at valuation for a bit. The S&P 500 is at approx. 20x 2010 GAAP earnings, which could be considered fairly valued given the expectation of a 22% Y/Y growth in earnings. With not much improvement expected in consumption (although the 2010 GDP Y/Y growth consensus is near 4%, thanks to government spending and inventory build-up assumptions), we believe earnings growth for the year could disappoint and come in less than 20%.

As mentioned earlier we’re confident that S&P 500 companies’ earnings would be in-line or better for Q4 and 1H'10. However, the second half of the year could be different. If companies are not successful at growing revenues, it appears that they may not be able to expand margins Y/Y further by cutting costs, making the overall 22% 2010 earnings growth a bit too optimistic. Based on a 17.5% earnings growth assumption, a 17.5x earnings multiple (PEG of 1.0), which represents S&P 500 at 1,000.00, would be more appropriate. Of course, government intervention, or that quick and short term high, could prove us wrong again. Trading along the lines of government's continuing intervention has and may continue to pay off for some time, but at some point even the government may be forced to say 'enough is enough'.

Time for a correction?

2009-08-17T09:38:00Z

We certainly have not participated in this great rally, and we must admit, we regret such misstep. However, we remain skeptical as although the economy has avoided the black hole, recovery is no where in sight. Unfortunately, in our opinion, the market has not yet realized such ... reality.

Unemployment

July unemployment numbers came in better than expected. Those figures included decline of 247k in non-farm payrolls (compared to the market's expectation of -325k), 33.1 average working hours, 0.2% higher average wages, and a 9.4% unemployment rate. In our opinion, these not so bad numbers were temporary and are misleading.

Decline in non-farm payrolls was impacted by more government jobs (which we hope are only temporary as the last thing we need is further expansion of the government), higher payrolls in healthcare, and the seasonally expected higher payrolls in hospitality/leisure.

However, heavy declines in other industries such as manufacturing were alarming. Manufacturing employment declined by 52k. We note that this number was helped by a 28k increase in auto workers, which we believe is temporary and driven by the famous "cash for clunkers" program. Also, as stated by the BLS, these numbers were not that bad because there may not be any more jobs (and other costs) to cut in manufacturing. Professional and business services industries lost another 38k. And financial services shed another 13k jobs in July.

What caught our attention were the temporary help and part-time employment figures. Historically, those have been leading indicators of recovery. However, we did not see any improvement in those figures. We currently have nearly 9MM part-time workers. Temporary help, which is considered a segment of professional and business services, continues to fall.

Increase in weekly average hours of work was somewhat of good news. But then again, given the lack of stability in most positions within the workforce combined with continuing decline in employment, many are working harder just to keep their jobs. In addition, although total average weekly earnings increased slightly, we believe such movement was driven not only by more hours worked, but also partially by the increase in minimum wages which went into effect in late July. Of course higher minimum wages could impact weekly earnings more positively, but we believe it will also drive many companies to layoff more workers.

The July 9.4% unemployment rate was very welcomed by the market. Unfortunately, many overlooked the fact that such figure was due to many unemployed no longer looking for jobs. The BLS stated that the labor force participation rate declined by 20bps in July. The BLS excludes those when calculating the 'official' unemployment rate. Luckily, it also provides a rate which includes the discouraged workers. Unfortunately that rate increased to 10.2% in July from 10.1% in June.

Overall, the employment situation in the U.S. has not improved. Of course, the figures that we discussed are lagging indicators. However, the employment figures that we consider as leading indicators, such as jobless claims, remain very weak. Last week's initial jobless claims came in at 558k, approx. 14k higher than market’s expectation. Initial jobless claims have remained above 500k for approx. nine months.

Lastly regarding employment, some are comparing the current situation to previous recessions. As displayed by the graph below (provided by FAO-Economics), some believe that the similarities seen in the chart indicate that we are well on our way to a recovery. We must note several differences between this recession and the ones included in the graph. First, we believe this recovery will be another jobless recovery, similar to the last two recessions. As displayed in the chart, employment did not recover to pre-recession levels. However, we note that consumer debt levels were also lower in those recessions, which leads us to believe that employment may not be a lagging indicator during this downturn. In order for consumption to recover, consumers can no longer borrow more (although the government can!). For this reason consumption, which represents 70%+ of the economy, will not aid in recovery until there is some improvement in the employment picture.

Figure 1 (provided by FAO-Economics)

Consumption

Consumption remains weak as shown by last week's retail report which indicated a 0.1% decline, worse than the market's expectation of a 0.8% increase. That figure was more disappointing when we exclude auto sales, which of course have been pumped up by the "cash for clunkers" government program.

In order for consumption to rebound, we need some stabilization in the declining consumer revolving credit, combined with increase in consumer confidence. However, both continue to decline (Figure 2). We note that week's preliminary University of Michigan consumer confidence of 63.2 was significantly below the 69.0 consensus estimate.

Figure 2

What we are looking for is a combination of deleveraging, higher savings rates followed by stabilization in unemployment, all of which represent a slow recovery. Unfortunately, this is not yet taking place.

Although we are seeing some deleveraging in consumer balance sheets, as the revolving credit continues to decline, we have not yet seen a correction in revolving credit as a percentage of disposable income (Figure 3). We believe this is mainly due to continuing rise in unemployment (Figure 4), which may not be a lagging indicator in this recession.

Figure 3

Figure 4

We note that we may see some sequential improvement in consumption in August, which would be due to seasonality (back-to-school spending) and not necessarily consumers wanting to spend more.

Lastly regarding consumption, the bulls are now widely using the phrase "pent-up demand" (we no longer hear or read the "green shoots" phrase too often) and believe it will drive the economy to full recovery in 2H09. In order for consumers to meet their pent-up demand, they must have income, credit and/or other assets. Unfortunately, currently that is not the case. Many also state that consumers have profited from the latest rally in equities. Unless consumers are the institutional funds, we must disagree. Unfortunately, it is more likely that the average investor jumps in at the peak of this rally, which of course is bad news. We note that approx. 25% of the population is in the 45 - 64 year age bracket; and this figure continues to increase every year. We believe that with so many risks and uncertainties associated with the economy, the job market and the equity market, which all significantly impact retirement savings, it is unlikely that most individuals in this age group jumped in (after getting out in late '08 and early '09) and benefited from this rally.

Housing Market

We have seen some improvement in the housing market as June sales of existing and new homes increased 3.6% and 11.0% sequentially. However, we believe this has been driven by the great 'gift' that the government provides for first-time buyers. We wonder how the housing market will behave after such 'gift' expires by the end of November.

Inventory remains high as the months-to-sales figures for both existing and new homes remain significantly above historical average and prior recessions. June's month-to-sales ratio came in at 8.8, which was a significant improvement from May's 10.7. However, we believe such improvement is temporary and, again, based on government's gift to first-time-buyers. Increase in new home construction, which many believe is positive, will add to the market's inventory dilemma.

There are many questions regarding the housing market, such as - what will happen once the government no longer induces many to buy? Have employment, credit and savings improved enough to maintain the slight upward movement that we have seen during the last two months? Has the average investor profited from this latest rally in equities in order to put his/her gains towards a new home, a transaction which now will likely be based on higher mortgage rates? We believe answers to these questions clearly point to continuing weakness in the housing market. Although, again, we note that the government's assistance could artificially create additional upside during the next couple of months.

Of course, this government could continue to run the economy (and not the country), and may not only extend its housing 'gift' policy, but also provide more so-called incentives for people to spend while they are in debt and/or unemployed. Mortgage rates are higher but home sales are also increasing, while income is declining and job losses continue. What does this mean? It means again that the only factor behind the recent higher home sales is the 'gift' policy, which again could be 'wrapped up' by the end of November. Adverse impact of such policy, besides not allowing the housing market to correct itself, is that it could lure many sellers to take their homes off the market. Some sellers could begin thinking that 'hey, maybe I should wait. Prices are slowly going up, so I'll wait to get a higher bid.' If this occurs, we can expect additional increase in inventory.

July housing starts and existing home sales figures will be released this week, which we believe will likely be in-line or better than expected. But again, we believe this is temporary.

Q2 earnings season has ended

Pessimism which lowered expectations and drove many analysts to post very low Q2 estimates, was certainly helpful for many public companies during the Q2 earnings season.

However, we note that as of last week S&P 500 Q2 operating earnings actually came in lower than expected. According to the latest S&P numbers, Q2 earnings were $13.94/share, lower than the $14.31/share estimate that we saw in late June. We note that the latest S&P figure is based on approx. 91% of S&P 500 companies’ earnings.

Although the market has spiked up approx. 50% since the Match lows, we expect continuing pessimism as estimates across the board have been adjusted lower. Q3 and Q4 estimates are now 4% lower than they were in late June. For 2010, Q1 and Q2 projections have been adjusted lower by 2%, Q3 by 3% and Q4 by approx. 0.5%. In our opinion, these numbers indicate that the market just may be ahead of itself.

Summary

We believe that the state of the economy has not improved as much as the equity market currently indicates. Given where the S&P 500 closed at last Friday, it appears that the market expects a rapid or 'V' shaped recovery, although the S&P 500 operating earnings estimates indicate otherwise. Given continuing weakness in employment, consumption and the housing market, we believe the economy has a long way to go before recovering. For this reason, the market is overvalued and we expect a correction within the next couple of months, more specifically, before the start of the Q3 earnings season.

Is Alcoa a bellwether for the US economy?

2009-07-09T01:03:00Z

It is becoming pretty tough to answer yes to this question, especially after Alcoa's Q2 earnings release.

We won't go through the earnings results as everyone is aware that they came in better-than-expected, driven by cost reduction and strong demand in China. Another pleasant surprise was the Company's revenue figure, which was nearly $300MM higher than what the analysts were looking for.

With that said, from a macro standpoint, nearly everything else mentioned on the call was negative. It appears that the Company's well-being is in China's hands. We do not view the better results as a signal for an economic turnaround in the U.S. anytime soon.

According to CEO Klaus Kleinfeld, global aluminum demand projection for 2009 has not changed. It remains at -7.0%. However, without China, that figure slides down to -10.0%. The Company's projection for various end markets is provided below:

Source: Alcoa analysis

Obviously, when it comes to North America, we're not seeing any good news in the table above. And who knows how significantly this could change in 2010, given the lack of consumption, unemployment, and higher savings; all of which are indications of no demand, resulting in less manufacturing and construction.

China is the only region in which Alcoa expects to see some growth. According to Kleinfeld, the fact that China's stimulus plan has strong infrastructure components, or is "shovel ready", is helping Alcoa. In addition, given China's average domestic savings rate of 40%, the government is pushing the Chinese to lower that rate, open credit card accounts and consume. Unfortunately, that is not the case with us, nor can we afford to do that.

Kleinfeld did mention that the automotive industry in the U.S. may be stabilizing in 2H09, but then again, we do know that such stabilization is nothing but inventory replenishment, demand for which is not yet clear. And we must say this may also be partially driven by the 'cash for clunkers' government policy, which will not positively impact auto demand in the long-run. As a reminder, June auto sales (announced last week) came in below expectations, below 10.0MM and below sales in May.

Overall, even though Alcoa's Q2 results beat expectations, we do not view it as an indication of a turnaround in or stabilization of the U.S. economy. Cost reduction and strong demand from China were behind those results. We do not yet see significant increase in consumption, stabilization of the unemployment rate, decline in savings rate nor an end to the deleveraging that nearly every household continues to execute.

The fantasy-to-reality consumer transition will take time

2009-07-06T10:56:00Z

It appears that it will take some time for consumption to rebound in the U.S., which could lengthen the recovery of this latest recession.

In order for consumption to rebound, we need some stabilization in the declining consumer revolving credit, combined with increase in consumer confidence. However, both continue to decline. We note that the increase in consumer confidence since April '09 is likely due to what we believe to be a non-warranted 33% increase in the equity market since the March lows.

What we are looking for is a combination of deleveraging, higher savings rates followed by stabilization in unemployment, all of which represent a slow recovery.

Although we are seeing some deleveraging in consumer balance sheets, as the revolving credit continues to decline (Figure 1), we have not yet seen a correction in revolving credit as a percentage of disposable income (Figure 2). We believe this is mainly due to continuing rise in unemployment (Figure 3), which we do not view as a lagging indicator in this recession. We also believe that more and more of the currently employed consumers are becoming cautious as they may be next. This also explains the continuing increase in savings rate.

Figure 1

Figure 2

Figure 3

Higher credit card default rates, decline in home equity loans (as the housing market has yet to hit a bottom) also provide support for our view that consumption recovery will not begin in Q3, nor in Q4.

We would like to see savings rate climb to 8% (from 6.9% in May), the level at which it stabilized in the late 80's. In addition, although it may sound extreme, we would also like to see revolving credit as a percentage of disposable income to decline to 4% - 6% (from 8.5%), where it was in the late 80's. During the mid-to-late 80's, we believe consumers were 'wowed' more by credit cards. Unfortunately, over time, the increased awareness of credit cards, changed American consumer behavior and started the enormous leveraging for which we are now paying. Of course, although we are hoping for consumers to once again become realists, the federal government's policies and unfounded optimism may lengthen the fantasy-to-reality transition.

Lastly, the Fed will provide an update on change in consumer credit on Wednesday at 3pm (ET). The current consensus stands at -$7.5 billion, which we hope will be met. We note that although this data is somewhat lagging, again, the trends we see will provide us a clearer picture of a maybe-recovery.

Savings rate highest in 15 years

2009-06-26T14:24:00Z

We believe the American consumer is taking the right steps to survive the current crisis - deleverage and increase savings. Of course, these steps do not help stimulate the consumer spending dependent economy in the short-term; and that's fine with us. As mentioned in our June 17 article, "The Savings Rate Must Increase", savings rate must increase in order to reduce consumer debt, restore long-term consumer confidence, and provide capital for overall economic growth.

May's Personal Income and Outlays report, which was published earlier this morning, indicated consumers may be thinking along the same lines. While personal income increased 1.4%, much higher than expected mainly due to government payouts, personal consumption expenditures (PCE) were only in-line with expectations, at 0.3%, which resulted in a 6.9% savings rate, the highest in 15 years. We must note that such a high rate is driven by the higher 'government sponsored' income, which we believe (and hope) will not continue. In fact, wages and salaries (excl. govt. payouts) decreased 10bps for the month. That decline could have been higher if it were not for a 20bps increase in wages and salaries of government jobs. Without government assistance, we may have seen a decline in consumption.

While we view this morning's report as positive, we believe in order for the economy to benefit from higher savings rate, consumers will have to maintain savings rates above 6% for another 3 - 9 months.

On a positive note, higher savings may also drive a potential recovery of the housing market as they can keep inflation and interest rates, therefore mortgage rates, low. However, we believe this will be more than offset by unemployment in the short to medium term.

We continue to expect more savings, minimal growth in consumer spending, therefore a slower turnaround in the GDP, from which the economy and the country will benefit in the long-run.

Michigan Consumer Sentiment - good & bad

2009-06-26T14:12:00Z

There were no surprises in the Michigan Consumer Survey published this morning. The overall index increased to 70.8 in June, from May's 68.2. This figure was the highest since September of last year. However, the increase was mainly driven by the Present Conditions index, which includes the rally that we have seen in the equity market. In fact, the Expectations index actually declined slightly to 69.2, from 69.4, indicating that consumers remain doubtful. The decline in June reversed a three month increase which had begun in March.

The lower expectations index, combined with higher savings rate that we saw in the personal income report, indicate a slower recovery in consumption.

Initial claims disappoint, as we expected; last week's revised upwards

2009-06-25T13:03:00Z

Claims for the week of June 20 jumped to 627k from upwardly revised 612k. The 4-week average of initial claims also went up. It increased to 617,250 from 616,750.

In addition, as we expected, continuing claims increased, reversing what many "green shooters" were referring to as the start of a downward trend. The only slightly positive news was that the 4-week average of continuing claims declined by 3,250. However, again we have cited many reasons as to why this may be occurring, none of which is a bottoming-out signal of U.S. unemployment. We look for another all-time record of the exhaustion rate in Dept. of Labor's next monthly report.

Lastly, federal program extended benefits, continued to increase week-to-week. It shot up 29,150 from the prior week. We expect this figure to continue to increase. We note that this number lags continuing benefits by one week and initial claims by two.

Economic indicators for June 25, 2009

2009-06-25T06:49:00Z

Q1 GDP will likely be revised and many think the new figure will be slightly better than the 5.7% contraction that was previously released. What we will be looking at is the price index. Given Fed's statements yesterday, the market could react negatively if the price index was revised upwards.

Consensus -
GDP: -5.7%

Initial jobless claims will likely come in slightly higher than the 600k consensus. Of course, there is a chance of an upward revision of last week's numbers. We expect an increase in continuing claims after last week's surprising decline, which we believe was possibly driven by no filings 1-2 weeks before/after the Memorial Day weekend, higher exhaustion rate, and not all auto industry 'victims' yet being accounted for. As a reminder, continuing claims lag initial claims by one week.

Consensus -
Initial jobless claims: 600k

Technical observation of S&P 500

2009-06-24T22:15:00Z

It appears that after today's minimum gain, the S&P 500 is on the brink of hitting the Golden Cross (bullish; when the 50-day and 200-day MA's cross while both are going up). However, this has not yet occurred as although the slope of the 200-day MA has flattened and is nearing zero, it has not yet turned positive. But the 50-day MA (900.5) did cross the 200-day MA (897.2).

If S&P 500 stays positive for the next few days, the 50-day MA would remain above a positively sloped 200-day MA, which could be viewed as a bullish signal. However, even a small decline in the index can turn slope of the 200-day MA negative again.

The 50-day moving average is almost at a turning point too. The slight increases that we saw these last two days in the S&P 500 prevented it from going down.

With all of that in mind, we could see a bullish signal for the S&P 500 the next few days, if the market continues to go up. However, if not, and if the 50-day MA becomes negatively sloped, we could see S&P 500 at 850 again.

For this reason we think a simple straddle strategy might be appropriate for SPY. Buy SPY Jul 91 calls and SPY Jul 91 puts. Although we're entering the Summer season, which has not been volatile historically, we're thinking that important economic news (initial claims, personal spending, consumer confidence, and unemployment rate) which will be released the next 2 to 10 days, combined with the current state of the economy, will help increase volatility.

We also looked at the Bollinger Bands and it appears that we're at a very narrow range right now, which could mean that a breakout is due. Lastly, the ADX (avg. directional index) is sloping upwards but only at 18.7 right now. A slight push above 20 could indicate a positive trend in the making, which will likely bring many others on board to long SPY for the short-term. Of course, if such trend is reversed and ADX remains below 20, many may jump the ship and push SPY back down to $85 (or S&P 500 to 850).

No surprises in Fed's statements; does not expect inflation for "some time"

2009-06-24T18:40:00Z

The Fed did not change its rates. It said the economy is still contracting but at a slower pace. Unfortunately, the Fed sounds like it does not expect inflation, with which we disagree. Another way to look at this is that the Fed does not expect economic recovery anytime soon (likely not even by Q4 as all "green shooters" expect), therefore it does not see a threat of inflation. We believe that without any "exit" strategies, the Fed will have a tough time addressing inflation which can pop up without any warnings. We think that just re-stocking inventories, which many companies may do in anticipation of a recovery, could ignite inflation, or would put a pressure on earnings as producers will not be able to pass the higher costs to consumers and would absorb those costs. The Fed disappointed, in our opinion.

Fed funds rate target range remained at 0.00% - 0.25% because it "continues to anticipate that economic conditions are likely to warrant" those levels for "an extended period."
It was positive regarding the financial markets.
However, it remained negative on consumption, citing unemployment, declining wealth and tight credit as reasons why.
The Fed "expects that inflation will remain subdued for some time."
The Fed also did not change its plans to buy $1.25 trillion of mortgage backed securities. It appears that the Fed anticipates further devaluation of those so-called assets later this year, making them more attractive to purchase.

5-year Note Auction Was Successful

2009-06-24T17:16:00Z

Surprisingly, it appears bidders were not worried too much about potential inflation, therefore did not demand higher yields. The yield on today's offering was 2.7%, slightly lower than a 2.72% which many had expected. Bid/cover ratio of 2.58 was very strong. This is good news as many view it widening the spread of the notes yield and the equity market yield, which makes the stocks more attractive.

Again, this is very surprising. We remain cautious because suddenly it appears that everyone (at least market players) is ignoring the realistic threat of inflation. All markets are displaying too much confidence in the Fed and the entire government, which is literally scary. We'll see what the Fed says later this afternoon. Given all of the political BS surrounding the entire market, we think the Fed will not say anything negative. But we hope that the Fed will be more realistic.

New Home Sales Disappoint

2009-06-24T14:39:00Z

New home sales for May came in at 342k, significantly below the 360k consensus. In addition, the April figures were revised down. Annual sales rate in April was lowered from 352k to 344k. May's sales were still below April's downwardly revised figures. Today's results, combined with yesterday's existing home sales, indicate that the housing market may not have hit the bottom yet.

Besides the overall miss, another figure that caught our attention was month's for sale. This number increased to 11.5, from 10.8 in the prior month. We view this as another indication of weak demand in the housing market.

The only positive number that we saw was a slight decrease in the month's supply, going to 10.2, from 10.4 in April (then again, April's month's supply was revised up to 10.4 from 10.1). However, as mentioned before, this figure remains significantly above what we have seen on average during other recessions. Month's supply was around 8.1 in prior recessions. The overall historical average figure is 6.1.

The housing market remains weak. With inflation possibly around the corner, this market could take another hit. We will see what the Fed will have to say about inflation later today.

Technically, S&P 500's downward trend could be reversed today

2009-06-24T13:22:00Z

The better than expected durable goods and MBA Applications survey have pushed S&P 500 futures up more than 1%. If S&P 500 closes above 900 today, it will not only be crossing the 200-day MA, but will also prevent the slope of the 50-day MA from turning negative; all of which are very positive.

We note that new-home sales, comments from the FOMC meeting and the 5-year note auction could impact what we are seeing now. We had a negative sentiment for all of these, but then again, we're dealing with politics and today's durable goods numbers will probably give the Fed something to brag about, which would be positive for the market.

Durable goods better than expected

2009-06-24T13:20:00Z

Surprisingly, May durable goods were not only positive, but they matched April's increase. It appears that inventories of manufactured goods remain at low levels.

Durable goods orders increased 1.8% in May from the prior month. We expected a decline of at least -0.7%.
We note that shipments were down 2.1%; however, shipments of cores capital goods were up 0.3%. This was the first increase since Dec.

Again, we may have been too pessimistic about this economy. However, we remain cautious.

MBA Mortgage Application Survey better than expected

2009-06-24T13:19:00Z

For the week ending June 19, both the purchase and refi indexes showed week to week growth as mortgage rates began to fall slightly.

Total index came in at 548.2, up 6.6% from the prior week
Purchase index was at 280.3, up 7.3% from last week
REFI index was at 2116.3, up 5.9% from the prior week

We certainly did not anticipate such positive news. However, we must note that this data also displays the sensitivity level of purchases and ref's to mortgage rates, which is very high. If inflation shows its ugle head (which many fear it will), purchases and refi's could plummet very quickly.