Market Analysis

The bond market improved last week and the momentum has continued this morning on investor fears about the Euro zone. Essentially, the concern is three-fold.

First, the concern is that the near-$1 Trillion band-aid approved by the EU to alleviate the threat of short-term default in Portugal, Ireland, Greece and Spain (known now as the “PIGS”) is not a fundamental fix to the real problem which is the current level of deficit spending in those countries.  There is a very interesting chart at http://en.wikipedia.org/wiki/File:Income_Taxes_By_Country.svg that provides a graphic representation of just how high the taxes are in France, Germany and Belgium in relation to the “PIGS”. It will be easy to see how the citizens of these high tax countries will not want to see their taxes go towards the bailout of countries whose citizens are paying significantly lower tax rates.

Second, the concern is that higher taxes and smaller government payouts that will be required by the “PIGS” will cause their economies to reverse and will cause the entire European Union to fall back into recession.

Third, the concern is that the entire European Union structure and its common currency could collapse.

To put the countries of concern and the European Union in perspective, let’s first look at the European Union. The EU’s 2008 GDP of $18.388 Trillion was 30% larger than the US’s 2008 GDP of $14.204 Trillion. If you take the first 3 “PIGS”, Portugal, Ireland and Greece, their combined GDP in 2008 was $928 Billion. That is slightly less than the combined 2008 GDP of New Jersey and Ohio, and represented only 5% of the European Union’s 2008 GDP of $18.388 Trillion. Spain is a bigger issue with 2008 GDP of $1.6 Trillion (slightly less than California’s 2008 GDP of $1.85 trillion), however, Spain’s public debt as a percentage of it’s GDP at 50% (according to the CIA’s 2009 World Fact Book) is fairly low compared to other European countries and, in fact, is lower than the US’s ratio of 52%. Italy’s ratio of Public Debt to GDP is 102, France’s is 79.7 and Germany’s is 77.2.

The above conversation is not to suggest that the debt problems in Europe are not real. However, I think most American’s would find it odd if world markets were to “flee” our currency and if there were dire projections of our breaking apart if New Jersey and Ohio or even New Jersey, Ohio and California were to have financial difficulties (and many would suggest these states do have financial difficulties).

Moving on to the economic calendar, below is a recap of the headlines for this week:

Monday, May 17, 2010

May Empire State (NY) Manufacturing Index – came in at 19.11, far below expectations for a 30.0 value.

Tuesday, May 18, 2010

April Housing Starts and Building Permits – Starts expected to increase by 30,000 to an annual rate of 656,000. Permits expected to stay flat at an annual rate of 680,000.

April Producer Price Index - expected up .1% vs up .7% in March. The Core PPI (excluding food and energy) expected to be up .1% vs up .1% in March.

Wednesday, May 19, 2010

April Consumer Price Index – expected up .1% vs up .1% in March. Core CPI expected to be unchanged compared to unchanged in March.

Thursday, May 20, 2010

Initial Jobless Claims for Week Ended 5/15/10 – expected down by 4,000.

Continuing Jobless Claims for Week Ended 5/8/10 – expected down by 27,000.

Conference Board’s April Leading Indicators – expected up .2% vs March up 1.4%.

May Philadelphia Fed Survey – expected 21.3 reading vs 20.2 reading in April

The sell off in stocks continues this morning, with the Dow currently down over 200 points.  This is despite the Conference Board's Consumer Confidence Index for May coming in stronger than expected.

One has to wonder why European leaders are not doing more to get in front of this crisis.  Perhaps there is an ulterior motive such as devaluing the Euro in an attempt to revive exports and give a boost to tourism?  It continues to be hard to imagine that the end game will be default but as long as mum is the word, markets will most likely continue to fret about the worst case scenario.

Both bonds and stocks are flat this morning.  There appears to be some apprehension in the mortgage market that the run up on bond prices which has brought rates down may have run out of steam.

The economic calendar for this week is recapped below:

Monday, May 24, 2010

• April Existing Home Sales - expected up to 5.65 million annualized pace, the actual # came in at 5.77 million, slightly higher than expectations.

Tuesday, May 25, 2010

• May Conference Board Consumer Confidence Index  - expected value of 58.3 vs 57.9 in April

Wednesday, May 26, 2010

• April Durable Goods Orders - expected up 1.4% vs April down .3%.  Not including the transportation component, expected up .7% vs April up 3.5%.
• April New Home Sales - expected up to annualized pace of 425,000 vs 411,000 in April.

Thursday, May 27, 2010

• Initial Jobless Claims week ended 5/22/10 - expected down to 455,000 from 471,000 the prior week.
• Continuing Jobless Claims week ended 5/15/10 - expected down to 4.6 million from 4.625 million the prior week.

Friday, May 28, 2010

• April Personal Income, Spending and PCE Index - Income expected up .4% from up.3% in March, Spending expected up .3% from up .6% in March and PCE index expected up .1% from .1% increase in March.
• May Chicago PMI (purchasing manager's index) - expected 60.0 reading vs 63.8 in April
• Final May Univ of Michigan Conumer Sentiment Index - expected 73.2 vs 73.3 preliminary estimate.

With nothing being said or done by politicians in Europe to quell investor fears, there is not much for investors to do but be fearful.  Thus bonds continue to improve and stocks deteriorate. 

In economic news, Initial Jobless Claims for the week ended 5/15/10 were expected to be down by 5,000 to 439,000.  Instead they increased to 471,000.  Continuing Jobless Claims for the week ended 5/8/10 were expected to be down to 4.6 million from the prior week's 4.625 million.  Instead they came in at 4.625 million but the prior week was revised up to 4.665 million, so technically Continuing Claims declined.  The Conference Board's April Leading Indicators were expected to be up .2% and instead were down .1%.  The May Philadelphia Fed index expected to be up slightly to 20.7 came in stronger than expected at 21.4. 

Bonds opened flat but are improving slightly in morning trading.  Stocks opened higher but have since turned negative.

In economic news today, the Producer Price Index (PPI) was down .1% vs expectations that it would be up by .1%.  Taking out food and energy though, the core PPI was up .2% which was higher than the .1% expected.  April Housing Starts increased to a 672,000 annualized pace vs expectations for a 655,000 number.  April Building Permits, however, dropped to an annualized pace of 606,000 vs expecations for a 680,000 level.

At this juncture no news is not good news in the eyes of those watching the EU crisis.  What is probably necessary to quell investor panice are a combination of  public statements by the leadership in Greece (and possibly the other PIGS) to the effect that regardless of the austerity measures required, they will take advantage of the lifeline thrown to them by the EU and will not default on their debt and also statements by the stronger EU members that they plan to stand behind the Euro.  While the press reports that some in Greece are suggesting they should abandon the EU and default (like Argentina) or restructure (like Uruguay), I would imagine that cooler heads in leadership in Greece are looking at the pain experienced by Argentina after they defaulted on their debt, with over 50% of the population falling below the poverty line, and will determine that the austerity measures are not so bad.  If you follow this link and scroll about 1/2 way down the article, you will see that at the height of the Argentine crisis their poverty rate exceeded 57%   http://en.wikipedia.org/wiki/Argentine_economic_crisis_%281999%E2%80%932002%29

Despite economic reports that generally met or exceeded expectations, bonds continue to improve as investors continue to pull money out of Europe and park money in US Treasuries and mortgage-backed securities.  The Dow is currently down 120 points on continued fears that the austerity measures in Europe which will be required to bring debt levels down in Portugal, Ireland, Greece and Spain could put a halt to what was already a weak economic recovery in Europe. 

In economic news, April retail sales were up 0.4% vs a +0.2% estimate.  Excluding the auto component, sales were up 0.4% which was slighty lower than the +.5% estimate.  March sales were revised higher, to +2.1% from the originally reporting +1.9%, with March ex-autos revised to +1.2% from the +0.9% originally reported.

April industrial production was up 0.8% which was exactly as projected.  The U. of Michigan mid-month May consumer sentiment index come in at 73.3 which was slightly lower than the 73.5 the market was expected but which was still higher than the 72.2 from last month. 

Bonds are up slightly this morning and stocks are down slightly.  In economic news Initial Jobless Claims for the week ended 5/8 were down 4,000 as expected bu the prior week's claims were revised higher by 4,000 so the net effect is that the Jobless Claims number is the same as last week.  Continuing Claims for the week ended 5/1 were up to 4.627 million from an upwardly revised 4.615 million from the week prior.  While the jobs situation and weakness in the housing sector clearly remain drags on the economy, corporate profits continue to exceed expectations.  Yesterday after the market closed, Cisco reported a 27% quarterly sales jump and profits of $2.2 Billion for the quarter ended May 1.  Their CEO called the quarter the best ever.

It is important to note that while there is a possibility that there is room for more improvement in interest rates which would most likely be driven by spin about doom in Europe, there is also a clear possibility that the European debt crisis at least for the short term is over and that we are moving into the next stage of the crisis which will be laying the groundwork for all this debt world wide to be paid off.  What is not clear in that overall equation is how governments in the US and Europe will "pull back" all the money they have printed in their "quantitative easing" measures.  It is also possible, that while no one is talking about it right now, the ugly inflation word will "rear" its head again.  If, due to economic weakness, governments do not rein in their money supply for fear of triggering an economic downturn, then we could see a scenario where all currencies devalue compared to commodities.  This type of scenario is not interest rate friendly.  I am not suggesting that this would happen right away. However, at some point the topic will most likely arise again and the question then becomes whether it brings with it a media frenzy.  It is important to note that much of the improvement in rates has come from short term holders of bonds who are just trying to play it safe while they wait to see if the European Union falters or the stock market plunges.  The long term money that buys US bonds is concerned about medium term inflation.  Also, while the US is currently probably the most secure of the "weak", we are probably not far from the day when the press turns its spotlight back on just how bad our deficit situation is.  

As most probably know by now, yesterday was a highly unusual trading day, with an erroneus trade triggering automatic computer generated selling which triggered human panic.  At one point the Dow lost nearly 1,000 points. It finished down 348 points.  Today selling pressure continues for stocks with the Dow down another 160 points in morning trading.  While mortgages have benefitted somewhat, the real beneficiary of the "fear" trade has been US Treasuries.  The spread between the 10 Yr Treasury and mortgage rates has widened as those fleeing the market are "parking" their money in what is viewed as the safest asset class which are the Treasury notes.

In economic news, April's Non Farm Payroll report showed an increase of 290,000 vs expectations for an increase of 187,000.  In addition, whereas analysts had been projecting the bulk of the increase to be from temporary Census workers, only approx 66,000 of the increase was  from Census.  Additionally, Feb and March revisions to the report increased job growth by 121,000 in those 2 months.  In a separate report which utilizes a different suvey though the nation's jobless rate inched up to 9.9% from 9.7%. 

Bonds are up this morning on continued weakness in stocks over continued fears regarding the debt crisis in Europe.  Underlying the concern about the European debt crisis is fear that required public sector austerity measures will cause Europe to slip further into recession which will drag down other economies. European countries have a higher percentage of GDP tied to public sector spending.  

In economic news, the April ADP Employment Change report showed that the private sector added 32,000 jobs which was slightly better than the 30,000 expected.  The April Institute of Supply Management (ISM) Service Sector index came in at 55.4 which was slightly lower than the 56.1 the market had been expecting but which matched the index figure for March. 

Yesterday the stock market surged on news of the Greek bailout. Today, stocks are slumping on fears that some European Union member countries might not get on board with the bailout. In the backdrop, corporate earnings continue to be strong. This morning Merck, Phizer, ADM and CVS all reported earnings. Only ADM's was below analyst's expectations and it was still much better than last year, with a quarterly profit of $421 million vs $3 million for the same quarter last year.

In economic news today, March Factory Orders which were expected to be down .2% were up 1.3%. Pending Home sales for March, expected to be up 5% were up a seasonally adjusted 5.3%.

Below is a recap of the economic calendar for this week:

Monday, May 3, 2010

• March Personal Income, Spending and Personal Consumption Expenditure (PCE) Index - Incomes were up .3% as expected compared to a .1% increase in February, Spending was up .6% as expected compared to a .5% increase in February and the PCE Index, a measure of inflation at the consumer level was up .1% as expected compared to a 0% change in February.
• March Construction Spending - Up .2% vs market expectations of a .3% decline and a 2.1% decline in February.
• April Institute of Supply Management Manufacturing Sector Index - 60.4 reading vs expectations of a 60.0 reading and a 59.6 reading in March.

Tuesday, May 4, 2010

• March Factory Orders - Up 1.3% vs expectations for a .2% decline. February's Factor Orders were revised up 1.3% vs initial reports of a .6% increase.
• March Pending Home Sales - Up 5.3% vs expectations of a 5% increase and compared to a 8.3% increase in February.

Wednesday May, 5, 2010

• April ADP Employment Change Report - expected to show a 30,000 increase in private sector payrolls vs a 23,000 decrease in March.
• April Institute of Supply Management (ISM) Service Sector Index - expected to be 56.1 compared to 55.4 in March.
  

Thursday, May 6, 2010

• Initial Jobless Claims for the week ended 5/1/2010 - expected to show an 8,000 decrease.
• Continuing Jobless Claims for the week ended 4/24 / 2010 - expected down by 45,000.
• 1st Qtr 2010 Initial Productivity Estimates - expected up 2.4% vs up 6.9% for the 4th Qtr 2009.
  

Friday, May 7, 2010

• April Nonfarm Payrolls Report - expected increase in payrolls of 187,000 compared to a 162,000 in March. The nation's unemployment rate is expected to stay steady at 9.7%.
  

We will update our economic calendar for this week tomorrow on our Market Update which can always be accessed at www.IronHarbor.com/MarketAnalysis .

Today, bond markets are down slightly on an improved situation with the debt crisis in Greece.  Over the weekend a $146 Billion (US Dollars) bailout was negotiated, whereby the International Monetary Fund (IMF) and European Union (EU) are lending Greece funds to enable it to not default on its debt in exchange for Greece pledging to push through $40 Billion (US Dollars) of budget cuts which is equivalent to approx 13% of their gross domestic product.  While there are still concerns about the debts of other European countries like Spain, Portugal and Ireland, the underpinnings of the recent "flight to safety" trade from the European debt crisis appear to be dissipating.  The stock market rallied today on the Greek bailout news.  The Dow was up over 140 points.

In other economic news today, March Personal Spending, Income and the Personal Consumption Expenditure Index (PCE - a measure of inflation at the consumer level) all came in exactly where the market had been projecting.  Income was up .3%, Spending was up .6% and the PCE was up .1%.  In separate news, Construction Spending for March was up .2% vs expectations of a .3% decline in spending and the Institute of Supply Management's Manufacturing Sector index was up to a 60.4 reading vs expecations of a 60.0 reading.