Market Commentary

It is all about sustainability.
November 02, 2009

It is all about sustainability.  It appears consensus believes third quarter growth was nothing other than a sugar rush.  I argue the opposite believing growth is sustainable partially the result of inventory building.  During the third quarter inventories declined at a $130 billion annual pace.  This decline was smaller than the record decrease of $160 billion that occurred in the second quarter and contributed 0.94% to growth as per the Commerce Department.

In my view inventories are extremely lean; manufacturers will boost production as demand stabilizes which makes it more likely companies will start hiring again.  Wishful thinking?

Friday October’s unemployment data is released. Consensus is estimating a 9.9% headline rate and a decline of 175,000 in farm payrolls, the smallest drop since August 2008.  What I find encouraging is the improvement in the 4 week average of initial jobless claims, an improvement that only began during the last week of this reporting period.  If this trend continues job creation could potentially occur as early as January/February.

Today the ISM Manufacturing Index is released.  It went above 50—the line between an expanding and contracting manufacturing sector—for the second consecutive month in September.   This data point can either support or nullify my view job creation could occur in the intermediate future.  Incidentally consensus is estimating a 53.0 reading vs. September’s 52.6 reading, the highest level since August 2006.  It would also be the strongest three month consecutive gain since 2Q06.

The FOMC also meets this week.  Wednesday the Committee is expected to leave monetary policy unchanged but some are expecting a tweaking of its statement.  I believe some of last week’s equity weakness could be attributed to these concerns fearing the nascent recovery would roll over once some of this high powered money exits the financial system.

Speaking of high powered money, it appears LBO financing is returning.  As per Bloomberg lenders arranging buyout lending in October is eight times greater than the amount raised in all of the first quarter.

Even though amount is a pittance as total bank lending to speculative grade US companies plummeted 65% to $90.3 billion in 2009 from $254 billion in the same period last year and one ninth of the record $790.5 billion issued in 2007 [Bloomberg] at least there is some recovery.

In fact Credit Suisse stated there is a possibility because of the lack of deal flow and the massive amounts of bank reserves—over $1 trillion—spreads might contract to dramatically creating an unbalanced market.

Wow!  What a statement.  I am not aware of any other time where there was a dearth of deals not satisfying cash demands.

If the above scenario remotely occurs, I ask how much longer banks will avoid more conventional lending as LBO financing is regarded as the most aggressive type of borrowing.

Turning to equity action on Friday, stocks were crushed Friday on this sustainability argument.  As mentioned many times I believe the averages are prone to profit taking and I think a reason for the light volume sell off was the result of year end mutual and hedge fund selling.  As noted last week their fiscal year ends October 31 and is perhaps attempting to post capital gains.  It were the market leaders—financials, energy, commodities and basic manufacturers—that were crushed.

I do think it is noteworthy to write that the Dow did trade to its 50 day moving average bounced off this level and ended higher.

What will occur this week?

Last night the foreign markets were mixed. London was up 0.60%, Paris up 0.57% and Frankfurt up 0.10%.  Japan was down 2.31% and Hang Sang down 0.61%.

The Dow should open   moderately higher rebounding from the worst week since May.  Ford crushed estimates making (operative word) vs. the consensus view of a large loss.  The 10-year is off 6/32 to yield 3.41%.