Tuesday, March 02, 2010

We're Entering the Market's Quarterly ''Dead Zone''

With earnings season now winding down, we're entering a ''Dead Zone,'' which runs from late February until mid-April, when first-quarter earnings season begins. February brought us mostly-positive earnings surprises and a 2.85% gain in the S&P 500, but in March, I expect economic and political news to overly influence Wall Street. Last week, for instance, Wall Street stressed over the euro-crisis and plunging consumer confidence, but celebrated rising durable goods orders and a positive fourth-quarter GDP. You can expect more of the same roller-coaster ride in March, starting with the jobs report coming this Friday.

Stat of the Week: +5.9% GDP Growth - Or is it 1.6%

On Friday, we witnessed a surprisingly-strong U.S. GDP revision to +5.9% (annual rate) for the fourth quarter of 2009. However, nearly two-thirds of that growth came from changes in inventories, not sales. Turning to actual demand, the U.S. economy grew by only 1.9% (annual pace) in the fourth quarter, revised down from an initial 2.2% estimate. Excluding exports, sales to U.S. purchasers rose at a 1.6% annual rate (consumer spending rose 1.7%), which is a more accurate reflection of real domestic growth. A revival in consumer spending is the key to sustained growth in 2010.

More Trouble Brewing For the Consumer

Maybe the ''real'' Stat-of-the-Week should be Consumer Confidence, which fell by a whopping 11.5 points last month, falling from 56.5 to 46. Economists were expecting only a small (one-point) drop to 55.5, but apparently growing job worries (new jobless claims being higher-than-expected for six of the past eight weeks) caused a new loss of confidence, sending the stock market down sharply last Tuesday.

In a normally healthy economy, the consumer confidence index averages about 95 points - double last month's reading. Unfortunately, the Conference Board's confidence index has ranged from 46 to 57 since last May, after having bottomed out at a record-low 25.3 in February 2009, so clearly economic anxieties remain very high among consumers, reflecting a low propensity to spend their cash right now.

Meanwhile, the Conference Board's ''present situation index'' plunged to its lowest level in 27 years to 19.4 in February, down from 25.2 in January. Clearly, consumers are having a hard time seeing a jobs recovery. On Thursday, the Labor Department announced that the number of people filing first-time claims for unemployment rose by 22,000 to 496,000 in the week ending February 20. This figure has now risen in six of the first eight weeks of 2010 - a reversal from the sharp drop in the last months of 2009.

Durable Goods Up….Housing Market Down

Some of the best economic news last week came from the Commerce Department, which announced on Thursday that orders for U.S. durable goods rose 3% in January, due largely to a 126% jump in civilian aircraft orders. Economists were only expecting a 1.5% rise, so the surge in aircraft orders, mostly from Boeing, came as a pleasant surprise. But excluding transportation orders, durable goods orders declined 0.6% to $131 billion, after rising 2% in both November and December. Total durable goods orders were at the highest level in 14 months, so Wall Street celebrated the headline gains, ignoring the sordid details.

Alas, there was lots of bad news on the housing front last week. On Tuesday, the Case-Shiller home price index reported that home prices in 20 major cities fell a scant 0.2% in December. But the next day, the Commerce Department announced that sales of new U.S. homes plunged 11.2% in January to an annual rate of 309,000, the lowest sales rate on record - dating back to 1963 when such records commenced. This was the third straight drop in new home sales and it was totally unexpected by most economists.

Finally on Friday, the National Association of Realtors reported that existing home sales declined 7.2% in January to a seasonally adjusted rate of 5.05 million, the lowest in seven months, raising concerns about the durability of any housing recovery. Sales of existing homes have now fallen two consecutive months. In December, existing home sales fell 16.2%, the largest decline on record. The silver lining is that inventories of unsold homes fell 0.5% to 3.265 million - a 7.8-month supply at the current sales pace. (There are also an unknown number of homes kept off the market by banks, making inventory harder to measure.) Distressed sales, such as foreclosures and short sales, accounted for 38% of sales in January, up from 32% in December, so it appears that foreclosure activity is rising as banks unload unsold homes.

The Euro-Crisis Deepens: Can Germany Save Greece?

Internationally, Greece's debt crisis is dominating the news. Last week, Otmar Issing, one of the fathers of the euro, wrote in The Financial Times that the euro was meant to be a monetary union, not a political one. Monetary control is centralized, but each nation reserves the right to tax and spend on its own. This principle was enshrined in the Maastricht treaty in the early 1990s, prior to the euro's launch in 1999.

Now, the euro's viability as a multi-national currency is being tested by Greece's debt crisis. Greek Prime Minister George Papandreou told Greece's Parliament on Friday that ''brutal steps'' were needed to repair the country's finances, and those steps are necessary immediately. Specifically, Papandreou said ''We must do whatever we can now to address the immediate dangers today [since] tomorrow will be too late.''

Complicating Greece's woes, Fitch Rating's downgraded Greece's four largest banks. S&P also warned that it could downgrade Greece by one or two categories, which could push the country's long-term rating into junk bond territory. Greece announced tax increases on fuel, tobacco and liquor and a 10% cut in salary budgets as it battles to reduce the budget deficit to 8.7% of GDP from an estimated 12.7% in 2009.

The other problem is that Greek civil servants and pensioners are fighting any austerity proposals. Several thousand protesters marched through central Athens with posters proclaiming ''People above markets'' and ''Capitalists should pay for the crisis.'' As a result of a Greek national strike, airplane flights were grounded, schools were shut down, and train, bus and ferry services were canceled throughout Greece. No newspapers were published Wednesday, since the journalists' union was a part of the national strike.

This is essentially a showdown between Greece and the rest of the European Union (EU). Other troubled nations (like Portugal, Ireland and Spain) are watching closely, since they may need to be rescued next. Spain's 19% unemployment rate, housing crisis and rising electricity rates (due to an ambitious expansion into expensive solar projects) have combined to keep Spain in recession. On Tuesday, demonstrations in Madrid and Barcelona reflected the anger in Spain over proposed delayed retirements to age 67 (from 65).

Even France is looking a bit more like Greece, as refinery workers at Total went on strike, triggering a run on filling stations, since Total supplies half of France's petroleum products. French air traffic controllers also walked off the job, just as Germany's Lufthansa pilots ended their strike and British Airways cabin crews voted to go on strike. In other words, Greece may be just the tipping point. If they pass austerity measures, similar cuts may spread to Spain, Portugal, Ireland and other euro-zone nations.

The market response to the euro-crisis is clear: Global hedge fund managers have piled into massive bets against the euro. Some are even targeting parity (with the euro sinking to $1 from its peak near $1.60).

Asia is Now Driving Global Growth

The good news is that economies in China, India, Japan and elsewhere are functioning well (unlike Greece). Click here to view an interesting graphic display of how the various economies are recovering (or not) in L-shaped (Western Europe), U-shaped (North America), V-shaped (China, India and other emerging economies) and W-shaped (Great Britain) curves:

Last week, Japan posted its biggest export increase in almost 30 years. According to the Ministry of Finance, the value of exports in January rose 40.9% vs. the same month a year ago, the fastest annual increase since February, 1980. Japan's shipments to Asia, which accounted for more than half of total exports, were up 68.1% vs. the same month a year ago, while exports to China, its biggest trading partner, rose by a whopping 79.9%. All Asian economies have benefited from the robust recovery of China.

Despite Toyota's U.S. woes, shipments of Japan's motor vehicles were up 342.8% in January, thanks to China. Also the value of exported car-part sales rose 156.6%. China's expanding manufacturing sectors led to strong demand for chemicals from Japan, which rose 107.5%, while machinery rose 68.8%. Japan's overall industrial output rose by a seasonally adjusted 2.5% in January, the 11th straight monthly increase. Taiwan and Thailand also reported strong export growth last week, due to booming exports to China.