Focus Shifts from Earnings to Economy
The Fortigent Invesetment Research Team
May 11, 2009
Economic & Market Update: May 11, 2009
“Focus Shifts From Earnings to Economy”
The Fortigent Investment Research Team
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.
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.
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.
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.
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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