Posted by Joseph Y. Calhoun, III

Economic Review

I know I must sound like a broken record but the economic data week to week paints the same picture. Manufacturing related data released last week was generally quite positive, the housing market is still scraping along the bottom and jobless claims remain stubbornly elevated. I think that sentence has sufficed to describe the situation for months now but if this recovery is to be anything more than a temporary inventory rebuilding effort, that will have to change soon. The surprisingly robust consumption of the last few months would seem to have its limits if employment doesn’t start to turn around. Government transfer payments (extended unemployment benefits, tax credits, etc.) have been a significant factor in maintaining disposable income but that can’t continue indefinitely.

The weekly data got off to a good start with the Empire State Manufacturing survey from the NY Fed which showed continued strength in manufacturing. While the overall index did fall slightly from last month, the individual components were strong. New orders, shipments, inventories, delivery time and employment all rose strongly. The Philly Fed Survey released later in the week also continued to show expansion but was not quite as positive as the NY report with a draw in inventories. Both of the reports are correlated with Industrial Production which was released on Monday and was a bit disappointing. IP was up only 0.1% and that was due to an increase in utility production - which probably means it was due to cold weather.  The manufacturing component fell although that was mostly due to changes in auto production. Ex autos manufacturing rose 0.1%. And year over year IP is up 1.7%. While the IP report was a bit weak, overall it appears that manufacturing is continuing to trend upward.

Same store retail sales reported by Redbook and ICSC Goldman both showed a 3.2% year over year rise. I have been consistently surprised by consumption in this recession as the public’s attitude seems at odds with their actions. Consumer confidence surveys are consistently negative, we hear numerous anectdotes about more frugal consumers and yet every time I venture out to a mall, the places are packed. The same is true of restaurants, at least here in Miami. One explanation may be the large number of “homeowners” who have stopped making their mortgage payments and therefore have more to spend on other things. Or at least that’s part of it; I don’t think there are enough of those people to really make that much difference but time will tell.

Speaking of real estate, housing starts were down for the month by 5.9% and a 575,000 annual rate. Permits were at a 612,000 rate. Weather had some effect but housing starts have just flattened out at a lower level. That will continue until we get more of the inventory worked off. Household formation has taken a hit in this recession - as it does in every recession - and Congress may still do something stupid on immigration but the fact is that with population growth we can’t build at this low rate for very long. Home builders are already starting to acquire land again and thanks to the Congressional bailout last year, they have cash on hand to do so. Didn’t know about the homebuilder bailout? Well, don’t feel left out; most people missed it. What Congress did was allow companies to write off losses against profits from up to five years ago and collect tax refunds. Lennar used this little manuever to collect a refund of $320 million, Beazer $101 million and KB Homes $100 million. Nice payday if you own a Congressman. Anyway, starts are limping along now at a low rate but I expect them to turn higher later this year.

We got three reports on prices last week. PPI and CPI showed little inflation but the import and export prices report wasn’t as kind. While month to month changes in all three reports were fairly benign the year over year numbers are far from it. Import prices rose 11.2% while export prices were up only 3.1%. A lot of these swings in import and export prices are due to the wide swings in commodity prices (primarily oil and agricultural products) but the big rise also reflects the price of a lower value for the dollar. I’ve said this before but it bears repeating - we can’t eliminate the trade deficit by devaluing the dollar because the price of the things we import will rise and most of those things aren’t optional. We will be importing oil for the forseeable future regardless of price. Most economists and the Fed expect low inflation due to “slack” in the economy- in other words they still cling to the Phillips curve view of the world that should have been discredited in the 70s - but I will let the value of the dollar guide me. If the dollar falls, that is inflation; the general rise in consumer prices or asset prices is the result. Right now we are still seeing price rises that are a result of last year’s devaluation.

Jobless claims fell slightly last week but this report continues to disappoint. We’re still stuck over 450,000 when we need numbers at least in the 300s to get any significant job growth. I don’t expect this to be a jobless recovery as most do. The recoveries from the last two recessions were marked by slow employment recoveries but the recessions were also marked by relatively mild drops in employment to begin with. The very rapid deterioration of jobs in this recession and the depth of the cuts argues for a more robust recovery. Rising productivity can only go so far and if the recovery continues companies will have to hire. But so far….it isn’t happening and my thesis may be just wrong. This is - by far - the most worrying economic statistic I follow.

Leading economic indicators continued to point to expansion but the details weren’t that impressive. Yield spread is still the largest positive contributor while consumer expectations, jobless claims and building permits are the big laggards. As I’ve said in the past consumer confidence isn’t something that concerns me but jobless claims are a big worry. The LEI spiked higher as the recovery started and has now stalled at the higher level. For a renewed uptrend we’ll need to see more positive components.

Markets Review 

The large cap indices joined their smaller brethren in breaking out last week. The mid cap and small cap indices broke out first and it seemed only a matter of time before the large cap S&P 500 and Dow followed suit. That happened last week and despite a small sell off on Friday, it was a positive week. Breadth continues to be very strong but volume is still weak. There is broad participation in the rally with new highs swamping new lows. In other words, this is a healthy and pretty normal rally. The question - as always - is whether it can continue and for now I remain in the bullish camp. That doesn’t mean we can’t or won’t have corrections along the way, but until I see evidence that the economic recovery is stalling, I see no reason to alter my bullish stance on stocks.

The market is not especially expensive at these levels if earnings estimates are to be believed. And for the last few quarters analysts have been too pessimistic in their outlook and have had to play catch up in their estimates. Most estimate changes have been higher over that time but now the changes are more even handed with as many estimate cuts as rises. While some might take that as evidence that the analysts have caught up to reality I see it differently. I think once again that analysts are underestimating the earning power of US corporations. Productivity is rising rapidly and sales comparisons to last year are still fairly easy. Rising sales and rising productivity mean rapidly rising earnings. I expect the vast majority of companies to beat estimates again in the first quarter.

After the first quarter, well that’s a tougher call and depends on how the recovery proceeds. As the second quarter progresses we’ll have a better idea if the recovery is accelerating and can adjust our expectations concerning earnings. If employment starts to ramp up confidence in the recovery will climb and so will expectations. If employment doesn’t start to improve soon, I don’t see how positive economic momentum can be maintained. And we simply can’t get much higher stock prices without higher earnings because interest rates are already at rock bottom so multiple expansion seems unlikely. In fact, interest rates may be the more important factor in coming months as the Fed tries to work its way out of the quantitative easing business. If they screw it up and interest rates spike higher, all bets are off in the stock market. I don’t want to pre-judge the outcome but I have to say I am skeptical that Bernanke and Co. can pull this off without a major disruption somewhere.

Foreign markets continue to lag the US as they have since October. I still believe that foreign economies, particularly the emerging markets, offer better growth prospects over the long term than the US but it isn’t exactly a contrarian move to be bullish on those markets right now. In fact the two most contrarian plays right now are to be long US and Japanese stocks. The Japanese market in particular is a wallflower and cheap as hell. Stocks trade for about 1.4 times book value and includes some of the world’s best known brands. Yes, they look expensive on an earnings basis but that is based on earnings in a deep recession. From a macro viewpoint there are problems, most notably a large debt to GDP ratio, but I think they may finally be ready to address some long standing issues. Deflation has dogged the economy for years but the BOJ may finally be ready to push the yen lower and there seems little appetite for more Keynesian stimulus that has accomplished little over the last two decades. I have been out of the Japanese market for a while but the sun may be rising again.

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Posted by Joseph Y. Calhoun, III

Very interesting graph provided by Barry Ritholz at The Big Picture:

I’ve been bullish on this market since last March (Bottom?) and stayed that way through the sideways corrections along the way and I’d love to say that this chart means that it has even more to run…..but I don’t think this means all that much. Every market is different and the duration of the rally is dependent on policy which can’t be predicted. Could the bull market move higher and last longer? Um, yeah. Could it peak right here and return to bear mode? Yep. It depends on policy, monetary and other and until we know how those things come out it makes no sense to try and predict the future. Still, at least this tells us we aren’t in some kind of uncharted territory.

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Posted by Joseph Y. Calhoun, III

Via Reuters:

The U.S. Second Circuit Court of Appeals on Friday ordered the Fed to release details of emergency lending programs it adopted starting in late 2007 to shore up the financial system and forestall a complete meltdown of global financial markets.

Bloomberg LP, the parent of Bloomberg News, and News Corp’s Fox News Network sought details of the central bank’s actions under the federal Freedom of Information Act, or FOIA, which requires government agencies to make documents public.

The Fed argued against disclosure, citing an exemption that it said allows federal agencies to refuse to disclose trade secrets and commercial or financial information.

It also contended that allowing disclosure of participants in the programs and the collateral they posted could cause “competitive and reputational harm,” perhaps triggering bank runs, and impede the central bank’s ability “to effectively manage the current, and any future, financial crisis.”

But giving the Fed power to deny disclosure because it thinks it best to do so “would undermine the basic policy that disclosure, not secrecy, is the dominant objective of,” Chief Judge Dennis Jacobs wrote for a three-judge panel.

“If the Board believes such an exemption would better serve the national interest,” he added, “it should ask Congress to amend the statute.”

Bloomberg had won its case at the district court level, while Fox News had lost its case. The Second Circuit ruling threw out the ruling against Fox and ordered a lower court judge to decide what materials must be disclosed.

I believe that one of the reasons interbank lending came to a halt in the fall of 2008 was that banks had no way to know which banks were solvent and which ones weren’t. That was a direct result of the Fed’s emergency lending programs so in my mind, the Fed was part of the problem not the solution. This ruling chips away a little of the immense power of the Fed and is a welcome development.

Steve Liesman just interviewed some schmuck from the Independent Community Bankers Association who claimed this was an awful ruling and that it could cause banks to fail if discount window borrowers identities were routinely disclosed. Sorry pal, but if a bank is borrowing from the discount window it has done something very, very wrong to its balance sheet and probably deserves to fail. It isn’t the disclosure of discount window borrowing that causes failure; its whatever you did that put the bank in a situation where borrowing from the discount window was necessary. I’ve got no sympathy for bankers who have screwed up their balance sheet and want to hide behind the Fed. Too bad, so sad. Let’em fail and move on.

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Posted by Joseph Y. Calhoun, III

Full text of the FOMC post meeting statement:

Information received since the Federal Open Market Committee met in January suggests that economic activity has continued to strengthen and that the labor market is stabilizing. Household spending is expanding at a moderate rate but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly. However, investment in nonresidential structures is declining, housing starts have been flat at a depressed level, and employers remain reluctant to add to payrolls. While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability.

With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve has been purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt; those purchases are nearing completion, and the remaining transactions will be executed by the end of this month. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

In light of improved functioning of financial markets, the Federal Reserve has been closing the special liquidity facilities that it created to support markets during the crisis. The only remaining such program, the Term Asset-Backed Securities Loan Facility, is scheduled to close on June 30 for loans backed by new-issue commercial mortgage-backed securities and on March 31 for loans backed by all other types of collateral.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy action was Thomas M. Hoenig, who believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to the buildup of financial imbalances and increase risks to longer-run macroeconomic and financial stability.

Essentially no change in the assessment of the state of the economy. The language changed slightly - the labor market is stabilizing versus the deterioration..is abating - but basically they see the economy as slowly improving. The statement about investment is slightly changed as well. In January it said that business investment in equipment and software appears to be picking up whereas this month they say that investment has risen significantly. The inflation language is exactly the same and still based on faulty Phillips curve thinking.

Hoenig dissented again and they added an explanation this time: “Hoenig…believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to the buildup of financial imbalances and increase risks to longer-run macroeconomic and financial stability.” Isn’t it the actual maintenance of the fed funds rate at exceptionally low levels that causes the imbalances and not just the language? Just wonderin’…..

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