Economic & Market Update: July 6, 2009

“Out with a Whimper, in with a Bang”

The Fortigent Investment Research Team

http://www.Fortigent.com

Last Week’s Highlights:

Consumer Confidence:               49.3 – confidence dips on higher unemployment

Home Price Index:        -18.1% YoY – index back to mid-2003 levels

ISM Index:                                 44.8 – falling inventories depress index level

Nonfarm Payrolls:             -467K – healthcare and education again provide only gains

Unemployment Rate:              9.5% – broad based job losses continue

Stocks:                                896 – poor jobs report roils the market

10-year T Bonds:         3.50% – flight to quality after higher than expected job losses

Oil:                                      $65 – concern about global economy weakens crude

Dollar/Euro:                   $1.40 – flight to safety as investors question recovery

Economics This Week:

Date      Item                                          Est.                     Comment

7/8        Consumer Credit:            -$7.5B      Consumers continue to pay off debt

7/9        Wholesale Inventories:  -1.0%      Inventories still in decline

7/10      Trade Balance:               -$30.0B     Moderation expected in trade balance

7/10      Michigan Sentiment:           71.0     Surge in confidence slowing

Investors Happy For Once

Last week was a subdued one as investors fled to the beaches, but the transition from June to July brought closure to one of the best quarters for investors in a very long time. 

To be exact, the Dow Jones Industrial Index finished up 11%, while the S&P 500 index was up slightly more than 15%.  Surprisingly, the DJIA spent just one solitary day in positive year-to-date territory during the quarter.  More encouraging for the S&P was the fact that this was the first positive quarter since mid-2007, as evidenced by the chart below. 

Source: NY Times

Commodities emerged as the biggest winner year-to-date as investors sought ways to capitalize on reflationary trades.  The biggest driver of performance in the commodity complex was a $34 billion surge in assets under management, the second highest appreciation on record. 

Source: Barclays Capital

Credit markets provided a much starker dichotomy during the quarter.  The big loser, as expected, were Treasuries as the broad Treasury market fell by 3.1% and is now down 4.5% for the first half of the year.  On the contrary, the investment-grade corporate bond universe returned nearly 11% in the quarter due to an increased risk appetite among investors.  High-yield bonds did even better, with a 23% return during the quarter. 

As the numbers show, it was generally a strong quarter for risky assets as the notion of ‘green shots’ became firmly entrenched.  A continuation of this performance is largely predicated on whether those green shoots will blossom into a full-fledged recovery or whether they will merely whither on the vine. 

Third Quarter Starts on a Foul Note

Unfortunately, the June unemployment report released last Thursday brought a stark reminder that we are not entirely in the clear.  The unemployment rate crept up by 0.1% (primarily due to a shrinking work force), but the number of jobs lost came in worse than expected at 467,000.  As the chart below shows, the number of jobs lost in this recession is now the second worst on record, in terms of the percentage of jobs lost.  Since December 2007, the number of unemployed individuals has increased by 7.2 million.

Source: Calculated Risk Blog

Underlying trends in the report provide no strong signs of optimism either.  Total private sector hours worked touched an all time low in June, while the average weekly earnings are also stagnating. 

The employment report led Vice President Joe Biden to acknowledge that the Obama administration ‘misread the economy’ by projecting a peak unemployment rate of 8% during the creation of the $787 billion stimulus package.  Critics of the administration have already gone as far as calling for a second round of stimulus but that may be a premature decision since a mere $120 billion of the package has been paid out thus far. 

Without some semblance of normality or recovery in the jobs market it’s hard to imagine how the economy can truly be expected to flourish.

Epic Tug-of-War in the Works

A recent report from Fitch clued us into an issue that has quietly been lurking in the shadows – credit card defaults are surging to previously unseen levels.   

Moody’s and Fitch Ratings both issued reports in recent weeks acknowledging that credit card charge offs at the major banks crossed the important 10% threshold, settling at 10.44% in June, according to Fitch.  The charge off rate is a measure of credit cards that banks do not expect repayment on. 

In an effort to combat those losses, which are expected to top $70 billion industry-wide, Citigroup, JP Morgan and other major banks are raising interest rates and minimum required payments.  This was done much to the dismay of those on Capital Hill who recently passed legislation designed to prevent such abusive (depending on your view) practices. 

At the same time that Citigroup was raising interest rates by as much as 3%, the Obama administration proposed a new Consumer Financial Protection Agency designed to oversee the consumer lending industry – everything from credit cards to mortgages.  The bill gives the proposed agency extremely broad powers, including the ability to limit loan officer compensation and assess whether banks are acting in a discriminatory fashion in how loans are structured, based on race, gender and age.

This is obviously going to set up a long and tenuous battle between politicians who favor increased regulation and banking industry executives who believe that more regulation harms industry-wide creativity.    

The Week Ahead

Economic data is on the light side this week, but lingering concerns about the weak unemployment report last Thursday will likely place greater emphasis on the initial and continuing claims reports this week. 

The key geopolitical event of the week is the Group of Eight meeting in Italy from Wednesday to Friday.  No major policy announcements are expected but discussions about the dollar’s reserve status seem almost inevitable, as leaders from several emerging economies, notably China, will be in attendance.    

Lastly, Alcoa will begin second quarter earnings season in earnest on Wednesday.  Analysts’ expectations are for a 33.5% year-over-year decline in earnings for the second quarter. 

Quotable:         “We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.” Declaration of Independence, July 4, 1776.

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