The Real Truth Behind Wall Street's Economy
Monday, November 16, 2009 | Ron IanieriRating:
With a little more than six weeks left before 2009 draws to a close, I want to give you my take on how I think this year will end for the markets. The Reasons Behind the Rose-Colored Glasses
We all are aware that the market's continued run has definitely exceeded any correlation to the real economy here in the United States. In fact, it might seem that Wall Street has its own economy -- or, at least, it sees the same numbers the rest of us are seeing, and interprets them completely differently.
Two contributing factors for that market run are the weakness of the dollar and non-existent interest rates. The fundamentals, as seen in the various economic reports, are not giving a true picture due to stimulation and manipulation.
The economic numbers, to be honest, are skewed positively anyway. For instance, take a look at the numbers that are the three biggest source of concern at this moment in time: unemployment, consumer spending and mortgages.
The Unemployment Number Isn't Doing its Job
The unemployment report currently shows the level to be at 10.2 percent. A bad number, to be sure!
Not only is this number bad, it has become this bad more quickly than expected. Further, it is not even the real number!
The real unemployment number is closer to 18 percent. The discrepancy is in how the number is calculated.
The number does not include people who want a full-time job but are forced to take part-time jobs. Seasonal jobs distort the numbers.
But the real scary problem with the calculation of this number is that those who have been unemployed for more than a year and still have not found work are not represented in that number. This is because it is determined that they must no longer be looking for jobs.
In an economic environment like the one we have, it is not unusual for people to go a year without finding work.
In reality, these people are in worse shape because they are no longer even receiving benefits (though unemployment benefits have been extended in places where unemployment is over 8.5 percent).
However, if consumer spending is over 70 percent of the economy, as we are told over and over by the media, having people with NO income at all or subsisting on unemployment for over a year can't be good!
But since these people are not counted in the unemployment number, not only do we not get a true picture of the un- and underemployed, we do not get a true read on anticipated consumer spending from the unemployment number.
What's Going to Drive Consumer Spending?
Since I have mentioned the consumer spending report, now is a good time to talk about it. When consumers spend, they spend in two ways: necessity and discretionary.
The real value of consumer spending comes from the discretionary side. This means that when necessity spending is up, it is not really good for the economy.
Usually, when consumer spending is up, it is considered good for the economy -- but not if it is driven by large increases at the gas pump or by rising food costs.
Then, it is really not so good! This is because the necessity spending is taking away from the more-important discretionary spending.
But, higher necessity spending is still included because a higher consumer spending report is a good thing. After all, as we discussed, consumer spending is 70-plus percent of the economy.
Does anyone see it as funny that the positive effect of rising gas and food prices is included in the consumer spending report?
This makes the consumer spending report look good while those same rising gas and food costs are taken out of the Producer Price Index and Consumer Price Index reports ... because it makes those reports look negative due to potential rising inflation levels.
Gets you thinking a little bit, doesn't it?
Another Figure to Ponder
The other report that is really critical right now is the housing data. One of the reports everyone eagerly awaits is the mortgage application report. This report also has a problem.
The mortgage application report is calculated by adding together all mortgage applications. This means that if you plan to buy a house and apply to more than one company for a mortgage, each of your applications is counted as a separate application.
In this environment, where mortgages are hard to come by, it is much more likely that more people are filling out multiple applications to get a mortgage.
The effect of this is that you will get a spike in applications, but no increase in housing units sold!
Instead of putting in two applications to buy one house, people are now putting in five applications for the same home. The increase in mortgage applications in itself indicates an increase in the home-buying market that is simply inaccurate and untrue.
As you can see, even under growing conditions, these numbers are skewed positively.
Where Does Reality Come in?
Can these numbers and others be fixed to be more accurate? Obviously, the answer is yes.
But why would Wall Street and Uncle Sam want to fix them? The changes would reflect more accuracy but disclose more negativity in the economy, as the real numbers will not reflect the level of misplaced optimism that the skewed numbers will.
This, in turn, will lead to consumers having a more pessimistic, though more realistic, outlook. Of course, pessimism will always decrease consumer spending ... and we all know what that will do to the economy!
The true test of the economy will come when the government pulls out of the day-to-day intervention in economic matters and we see if the real economy can stand on its own two feet!
The Head Fakes are Downright Dizzying
On the other side of the optimistic fundamentals, the technicals are throwing head fake after head fake on the downside to us.
I have never, ever seen so many sell signals get ignored and reversed on a regular basis, and I probably won't ever again!
Hopefully, I will be able to convince either Teeka Tiwari or Chris Rowe to write about it in more detail in their reports this week, as I am quickly running out of room here. (Of course, there's always next week!)
With the technicals and fundamentals misguiding us on a regular basis, what can we use to get reliable indications of future market movements?
Year-End 'Bonus' Round
Well, one is market psychology. This is always predictable. The market always wants to go up! You want it to go up, Wall Street wants it to go up and so does the government.
But now, Wall Street wants it to go up even more! No bonus last year and two major questions next year could make it a no-bonus scenario again next year.
The reality of the economy, continued unemployment, soaring inflation, and rising interest rates will all be problems. But added to this is the potential legislation limiting the big Wall Street bonuses.
With a bonus on the table this year, I expect Wall Street to keep this market up until mid-December when bonuses are paid. This year's bonus is important with Wall Street missing last year’s and, in all likelihood, next year’s.
This year has a big bonus all but written in with the market up at these levels. So, we are in a situation where we have to combine the fact that this year may be Wall Street's last chance to go home with BIG checks due to potential upcoming legislation, along with the fact that this might be the one bonus year sandwiched between two non-bonus years.
What's an Investor to Do?
Add it all together, and I see the market unchanged and more likely up into mid-December (bonus time for Wall Street), barring a catastrophic event.
After that, it's anybody's guess, but I will not be heading home for Christmas being long the market!
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Ron Ianieri
Contributing Editor
The Tycoon Report
Economic Calendar for the Week of Nov. 16-20
MONDAY, NOV. 16
8:30 a.m. Retail Sales
* Importance (A-F): This release merits an A-.
* Source: The Census Bureau of the Department of Commerce.
* Release Time: 8:30 ET around the 13th of the month (data for one month prior).
* Raw Data Available At: http://www.census.gov/svsd/www/advtable.html
The retail sales report is a measure of the total receipts of retail stores. The changes in retail sales are widely followed as the most timely indicator of broad consumer spending patterns. Retail sales are often viewed ex-autos, as auto sales can move sharply from month-to-month. It is also important to keep an eye on the gas and food components, where changes in sales are often a result of price changes rather than shifting consumer demand.
Retail sales can be quite volatile and the advance reports are subject to rather large revisions. Retail sales do not include spending on services, which makes up over half of total consumption. Total personal consumption is not available until the personal income and consumption reports are released, typically two weeks after retail sales.
Highlights
* Retail sales in September exceeded expectations as sales only fell 1.5% month-over-month. The consensus expected sales to have declined 2.1%.
* Core retail sales, total sales excluding auto dealers, building materials, garden equipment and supply stores, and gasoline stations, posted its second consecutive positive month-over-month growth numbers in September. Core sales rose 0.5% in September after rising 0.7% in August.
* When just autos are excluded from the data, retail sales grew a robust 0.5%, well above the consensus expectation of only 0.3% growth.
* Just about all sectors of retail sales posted positive growth with only motor vehicle and parts (-10.4%), dealers building materials, garden equipment and supply stores (-0.2%) and miscellaneous store retailers (-1.9%) showing monthly declines.
* Furniture and home furnishing stores jumped 1.4%; food and beverages stores increased 0.7%; health and personal care stores increased 0.8%; gasoline station spending increased 1.1%; clothing and clothing accessories stores rose 0.5%; sporting goods and hobby stores rose 0.1%; and general merchandise stores increased 0.9%.
Key Factors
* The drop in sales was due to the end of the Cash for Clunkers stimulus program. The stimulus boosted auto sales in August an order of magnitude above typical demand levels. The heightened demand level could not be sustained in September and sales at auto dealers plummeted 11.8%.
* Core sales are showing the strength of the consumer. Autos, building materials, and gasoline station expenditures are highly volatile and these components tend to push the data away from its "true" path. With core sales improving, the economic recovery seems to be on more stable ground.
* What is even better is that core sales rose in August due to a back-to-school tax holiday. These tax breaks were removed in September and demand continued to grow in spite of a lack of government assistance.
Big Picture
* Retail sales fell off dramatically starting in September 2008. That was when the financial markets fell apart and the news became apocalyptic. Auto sales rebounded due to the Cash for Clunkers stimulus plan, but is expected to remain depressed over the next several months. Retail sales are likely to remain weak for quite a while given the current trends in employment, and the negative wealth impact for depressed prices for homes and stocks.
TUESDAY, NOV. 17
8:30 a.m. PPI: Producer Price Index
* Importance (A-F): This release merits a B-.
* Source: Bureau of Labor statistics, U.S. Department of Labor.
* Release Time: Around the 11th of each month at 8:30 ET for the prior month.
* Raw Data Available At: http://stats.bls.gov/news.release/ppi.toc.htm
The Producer Price Index measures prices of goods at the wholesale level. There are three broad subcategories within PPI: crude, intermediate, and finished. The market tracks the finished goods index most closely, as it represents prices for goods that are ready for sale to the end user.
Goods prices at the crude and intermediate stages of production often provide an indication of coming (dis)inflationary pressures, but the closer you get to crude goods, the more that these prices track commodity prices which are already available in traded indexes such as the CRB (Commodity Research Bureau).
At all stages of production, the market places more emphasis on the index excluding food and energy, referred to as the core rate. Food and energy prices tend to be quite volatile and obscure trends in the underlying inflation rate. Though the market reaction is determined by the month/month changes, year/year changes are also noted by analysts. The index is not revised on a monthly basis, but annual revisions to seasonal adjustment factors can produce small adjustments to past releases.
Highlights
* Headline PPI turned negative for the seventh time over the last year as prices dropped 0.6% in September. The consensus expected headline producer prices to post no growth.
* As with the previous drop in July, the volatility in the energy market played a major role. Energy prices declined 2.4% in September after increasing 8.0% in August. In July, energy prices had dropped 2.4% after increasing 5.6% in the previous month.
* Food prices also declined for the seventh time over the last 12 months, but the drop was a very modest 0.1%.
* Somewhat surprisingly, core prices also tumbled 0.1% in September.
* Intermediate goods prices rose 0.2% after increasing 1.8%. The increase in prices was due to a large jump in core prices (0.9%) as food costs declined 0.5% and energy prices dropped 2.1%.
* Crude goods prices declined 2.1%, but prices for core crude goods rose for the fifth consecutive month (3.6%).
Key Factors
* The drop in core prices is a little unnerving for inflation hawks as it means that declines in energy and food costs have begun to pass through to other goods. The pass-through of energy price drops could be seen in the motor vehicle sector where all producer prices for all modes of transportation with the exception of heavy motor trucks declined in August.
* As production picks up and producers demand a higher quantity of inputs, we expect producer prices to increase over the next several months.
* A pickup in producer prices does not necessarily mean an increase in consumer prices. The PPI has not done a great job at predicting CPI numbers over the last several years. With consumer demand still weak, producers will probably try to nurture demand by selling goods at low prices and take less of a profit.
Big Picture
* PPI trends were highly volatile in 2008, mirroring the trends in global oil prices. Falling global commodity prices and weak economic demand will keep inflation in check at the producer level. If global economies remain weak in 2009, as is widely expected, inflation at the producer level will be insignificant. There may even be concerns about global deflation.
9:15 a.m. Industrial Production
* Importance (A-F): This release merits a B-.
* Source: Federal Reserve.
* Release Time: 9:15 ET around the 15th of the month (data for month prior).
* Raw Data Available At: http://www.federalreserve.gov/releases/G17/Current/g17.txt
The index of Industrial Production is a fixed-weight measure of the physical output of the nation's factories, mines, and utilities. Manufacturing production, the largest component of the total, can be accurately predicted using total manufacturing hours worked from the employment report.
One of the bigger wildcards in this report is utility production, which can be quite volatile due to swings in the weather. Severe hot or cold spells can boost production as increased heating/cooling needs drive utility production up.
In addition to production, this monthly report also provides a measure of capacity utilization. Though the rate of capacity utilization is seen as a critical gauge of the slack available in the economy, the market does not completely trust this measure.
Highlights
* Industrial production rallied for the third consecutive month as production increased 0.7% in September. The consensus expected a much more moderate increase of only 0.2%.
* The jump in production was expected to be driven by the auto industry, and the sector didn't disappoint as motor vehicle production rose 8.1% as assemblies of autos and light trucks increased 13.0% to 7.15 million vehicles.
* Beyond manufacturing, which rose 0.9% in September, mining production increased 0.7% while utility production declined 0.7%.
* Capacity utilization increased 0.6 percentage points to 70.5%.
* Manufacturing capacity utilization increased to 67.5% from 66.8%, mining utilization rose to 83.6% from 82.9%, and utility utilization fell to 78.1% from 78.7%.
* All stage-of-process groups posted nice gains as crude stage utilization increased to 82.5% from 81.4%, primary and semifinished increased to 67.3% from 67.0%, and finished goods group increased to 69.3% from 68.6%.
Key Factors
* The numbers were even better than the headline suggested as total manufacturing excluding motor vehicle production rose a healthy 0.5%. This includes strong growth in consumer goods excluding motor vehicles, which jumped 0.3%.
* There is a drawback to the strong production numbers. We have not seen orders for manufactured goods pick up. If orders stay low we could end up with a big increase in manufacturer inventories. This would cause manufacturers to pull back on their production. If this scenario occurs, manufacturing production will see a "double-dip" as production rises today and quickly falls back in a few months.
* While the double-dip scenario is plausible, we believe production will more likely follow a kinked path where growth is strong right out the gate and then moderates but still increases for several months in 2010.
Big Picture
* Production held up surprisingly well through most of 2008 due in part to strong exports. Exports grew at a 7.0% annual rate in 2005, 9.1% in 2006, 8.4% in 2007, and at an annual average rate of 7.8% through the first three quarters of 2008. Then, the bottom fell out in the fourth quarter as the financial crisis spilled over to the real economy at home and abroad, severly impacting global trade and end demand that led to declining levels of industrial production and capacity utilization. The near-term trend is expected to improve as financial markets, and global economies, have stabilized.
WEDNESDAY, NOV. 18
8:30 a.m. Housing Starts and Building Permits
* Importance (A-F): This release merits a B-.
* Source: The Census Bureau of the Department of Commerce
* Release Time: 8:30 ET around the 16th of the month (data for one month prior).
* Raw Data Available At: http://www.census.gov/const/www/newresconstindex.html
Housing Starts are a measure of the number of residential units on which construction is begun each month. A start in construction is defined as the beginning of excavation of the foundation for the building and is comprised primarily of residential housing.
Building permits are permits taken out in order to allow excavation. An increase in building permits and starts usually occurs a few months after a reduction in mortgage rates. Permits lead starts, but permits are not required in all regions of the country, and the level of permits therefore tends to be less than the level of starts over time.
Highlights
* Housing starts rose 0.5% in September to 590,000 units. The consensus expected starts to jump to 610,000.
* Multi-family starts declined 15.2% to 89,000 units.
* Single-family starts rebounded in September and grew by 3.9% to 501,000 units and is now back to July's levels.
* Building permits fell 1.2% to 573,000. Single family permits declined 3.0% to 450,000 units while multi-family permits rose 6% to 123,000.
* The total number of homes currently under construction has fallen to a new historical low at 582,000. The declines have been steady for the past year.
* Completions also continued to fall and are now at 693,000.
Key Factors
* The consensus expectations may have been a little unrealistic. Housing starts posted strong gains in the initial report for August based upon a large increase in multi-family housing units. Multi-family construction is incredibly volatile and typically a strong monthly increase is quickly followed by a severe drop.
* While housing starts may have reached the bottom earlier in the year, the strong bounce back that the market was expecting has not occurred. Starts have been bounded within a fairly narrow range of 585,000 to 595,000 units for the past four months. Builders understand that the market remains oversaturated with unneeded supply. We expect starts to remain at this level for quite a while.
* The biggest concern last month was the drop in single-family construction. Single-family units tend to follow a fairly straight path and the drop could have led to a several month downturn.
* Our estimates of future housing starts is based upon single-family construction holding steady.
* The drop in permits does not necessarily project a decline in future starts. Permits are often issued months in advance and if demand picks up builders could rush out to obtain their permits and begin construction immediately.
Big Picture
* Housing starts are at extremely low levels and the outlook is not likely to improve any time soon due to high levels of inventories of unsold new homes. An uptrend in construction will require an improvement in employment and income, and then take some time as inventories need to be reduced. Government action to boost mortgage seems to have helped, and starts have begun to stabilize.
8:30 a.m. CPI: Consumer Price Index
* Importance (A-F): This release merits a B-plus.
* Source: Bureau of Labor statistics, U.S. Department of Labor.
* Release Time: 8:30 ET, about the 13th of each month for the prior month.
* Raw Data Available At: http://stats.bls.gov/news.release/cpi.toc.htm
The Consumer Price Index is a measure of the price level of a fixed market basket of goods and services purchased by consumers. CPI is the most widely cited inflation indicator, and it is used to calculate cost of living adjustments for government programs and it is the basis of COLAs for many private labor agreements as well.
It has been criticized for overstating inflation, because it does not adjust for substitution effects and because the fixed basket does not reflect price changes in new technology goods which are often declining in price. Despite these criticisms, it remains the benchmark inflation index.
Highlights
* Headline CPI prices came in as expected with growth of 0.2% in September after increasing 0.4% in August.
* Core CPI prices also grew by 0.2% as energy prices were mostly flat in September. After growing by 9.1% in August, gasoline prices increased by only 1.0%.
* Food prices fell 0.1% in September after increasing 0.1% in August, housing prices fell 0.3%, apparel prices rose 0.1%, medical care prices increased 0.4%, recreation prices declined 0.1%, education and communication prices rose 0.7% and other goods and services prices increased 0.4%.
* Owner occupied rent fell 0.1% and is expected to continue to decline over the next several months.
Key Factors
* The increase in core prices was almost completely due to the end of the Cash for Clunkers stimulus plan. The drop in new car prices due to the government rebate pushed prices down 1.3% in August. As the rebate was lifted, new car prices were not able to stay at that artificially low level and increased 0.4%.
* One of the consequences of the Cash for Clunkers program was a large drop in used car inventories. Demand for used cars continues to be high and the lack of supply helped push prices up 1.6%.
* Ownership prices have remained stubbornly high given the severe drop in housing prices. As prices continue to moderate, rents should eventually fall in line.
Big Picture
* Inflation trends have weakened. The decline in energy prices after the last summer's spike has taken CPI down to -2.1% on a year-over-year basis as of July 2009 data. Energy prices have again increased, yet the core rate should ease due to weak demand. Low inflation rates are likely to continue through 2009 although continued month-over-month deflation is not likely.
THURSDAY, NOV. 19
10 a.m. Philadelphia Fed Index
* Importance (A-F): The Philadelphia Fed Index merits a B.
* Source: The Philadelphia Federal Reserve bank.
* Release Time: Third Thursday of the month at 12 ET for the current month.
* Raw Data Available At: http://www.phil.frb.org
There are many regional manufacturing surveys, and they tend to be ranked in order of timeliness and the importance of the region. The Philadelphia Fed's survey is first each month, actually coming out during the third week of the month for which it is reporting. Several smaller surveys are then released before the Chicago purchasing managers' report on the last day of each month. A few, such as the Atlanta and Richmond Fed surveys, are released after the National Association of Purchasing Managers' report and are of little value.
Highlights
* The Philadelphia Fed Business Outlook came in at 11.5 for October, below the consensus forecast of 12.0. The reading in September was slightly higher at 14.1.
* Manufacturing in the Philly region continued to expand, albeit at a lower rate than last month.
* New orders increased slightly from last month as the index grew to 6.2 from 3.3. Shipments continued to expand but at a slower rate than last month 3.3 vs. 8.2.
* Inventories continue to be a problem as inventory levels contracted at a much faster rate in October (-31.8) compared to September (-18.1).
* The prices situation is a little disheartening. Prices for supplies expanded in October while prices received contracted.
* The employment situation remains weak as the number of employees index and the average employee workweek both continue to contract.
Key Factors
* The lack of usefulness for the Fed's Business Outlook surveys can be seen with a quick comparison between the Philly report and the Empire State Manufacturing Survey from the New York Fed. The New York Fed is showing an extremely strong pickup in the manufacturing sector as the index improved a whopping 83% to 34.57 in October while the Philly report showed business conditions declined 18%.
* It is impossible to discern which survey is telling the truth about the state of the manufacturing sector. The surveys can only give us an idea on how the manufacturing sector is doing in each Fed region.
* If the price gap between inputs and outputs continues to widen, firms will have a very difficult time remaining profitable.
Big Picture
* The Business Outlook does not accurately predict nationwide manufacturing and its usefulness is limited to what is going on in the Philadelphia region.
Source: Briefing.com
