Economic & Market Update: May 11, 2009

“Focus Shifts From Earnings to Economy”

The Fortigent Investment Research Team

http://www.Fortigent.com

Last Week’s Highlights:

Construction Spending:     0.3% – nonresidential construction provided a positive boost

Consumer Credit:             -11.1B – massive decline as consumers cut back on credit

Nonfarm Payrolls:            -539K – better than expected but remains elevated

Unemployment Rate:         8.9% – mostly inline with projections on government hiring

Wholesale Inventories:    -1.6% – continued contraction in inventories

Stocks:                              929 – S&P 500 index officially in positive territory on the year

Bonds:                                  3.3% – Fed likely to step up purchases at these levels

Oil:                                          $58 – economic strength benefits crude oil

Dollar/Euro:                        $1.36 – higher risk tolerance pushes investors overseas

Economics This Week:

Date      Item                                     Est.                     Comment

5/12      Trade Balance:           -29.2B           Global trade retrenchment moderating

5/13      Retail Sales:                   -0.1%           Easter in April likely provided boost

5/14      PPI:                                      0.1%           Volatile energy prices likely helped

5/15      CPI:                                     0.0%            No significant price pressures

5/15      Consumer Sentiment:  65.0             Pessimism about economy in decline

Stress Tests Prove To Be Not All That Stressful

Following the near 6% surge in the S&P 500 index last week, we have officially entered positive territory year-to-date.  We’re not sure about everyone else out there, but this is easily the most exhausting “flat” year we have ever experienced.

All the focus last week was clearly on the results of the bank stress tests.  The administration carefully leaked the results leading up to official release on Thursday, presumably to temper investors’ expectations.  Ultimately, 10 of the 19 banks were instructed to collectively raise $74.6 billion.  The administration obviously did an effective job managing expectations, as the financial sector was up 23% for the week.

This week brings the end of first quarter earnings season here in the US, when Wal-Mart reports on Thursday.  The trend is decidedly positive as 62% of companies beat analyst expectations, representing the first quarter on quarter increase since 2006.  Earnings provided an early warning sign for investors in 2007 as the number of companies surpassing expectations fell rapidly. 

Source: Bespoke

Initial Claims

Updating a topic we discussed in mid-April, the number of individuals applying for first time unemployment benefits waned in recent weeks.  Conversely, the number of people filing for continued unemployment benefits remains at record levels.

It looks increasingly likely that we witnessed a peak in layoffs at the end of March and gradually stabilized since that time.  The good news is that fewer people are being laid off, but fewer people are also having luck finding a new job. 

Source: Econoday

This is a positive development for the broader economy as previous peaks in filings for unemployment benefits occurred just weeks prior to the end of recessionary cycles.  What the data does not tell us is how quickly or slowly the recovery will happen, but consensus surrounding this data anticipates the recession ending in June of this year, much earlier than many prognosticators are forecasting. 

Source: Bloomberg

Credit Easing Continues

With the commonly held notion that credit led us into this crisis and may also lead the way out, credit related indices had a tremendous run in the first several months of this year. 

The TED spread recently fell below 1%, from record levels in November, after the bankruptcy of Lehman Brothers.  The TED spread is a broad indicator of perceived credit risk in the general economy. 

Source: Bloomberg

Spread-related securities, such as high yield bonds and investment grade corporate bonds retracted noticeably in the first few months of this year, from abnormally wide levels.  The Barclays Capital High Yield Index fell to 1,100 bps over Treasuries, from near 2,000 bps at the end of last year while the Merrill Lynch US Corporate Master Index contracted from approximately 650ps to under 500bps.

Source: Calculated Risk Blog

Lastly, rates on short-term commercial paper fell rapidly following the direct intervention of the Federal Reserve in this market.  The Fed is actively purchasing commercial paper to depress rates and provide financing for many companies.  As shown below, the spread on lower-rated commercial paper dropped from 600bps to less than 100bps, a sign that investors are willing to take added risk in this market. 

Source: Federal Reserve

The credit picture is not representative of a full-fledged recovery but points to signs that the economy is in recovery mode and provides another glimmer of hope for the future trajectory of this recession. 

The Week Ahead

With earnings in the rearview mirror, investors will turn their focus back towards the economy, both here and abroad.  Key releases include Chinese CPI and PPI data on Monday, the Chinese and US trade balance on Tuesday, Wal-Mart earnings on Thursday and finally, US CPI and PPI data at the end of the week. 

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