Thursday, December 11, 2008 Market Update

Thursday Market Update

Despite news that was mostly negative for stocks, the indices showed resilience for most of today's session, hovering near unchanged levels until mid-afternoon. But they then lost ground and continued to fall, closing near their lows of the day. The decline spurred a shift into the safety of government-backed Treasuries and they finished with strong gains.

In late trading, the 10-Year Treasury Note was up by 24/32, lowering its yield by 8 basis points to 2.60%; the Dow was down by 196.33 points to 8,565.09; and the Nasdaq was down by 57.60 points to 1,507.88.

Today's economic news was bond-friendly; that is, either indicating economic weakness or low inflation pressures. The weekly jobless claims report showed a huge jump in initial claims last week and in continuing claims the week before.

The trade gap for October was larger than expected, reducing expectations for the current quarter GDP figure (recent predictions call for a decline in GDP in the fourth quarter of between 3.0% and 4.0%). And import prices fell sharply in November, both in the large category of petroleum products, and outside of the category.

Oil futures spiked today. The price of a barrel of light, sweet crude for next month delivery rose by $4.46 on the New York Mercantile Exchange to close at $47.98. The increase was the largest since November 24 and the closing price was the highest since December 1.

Despite waning demand for oil, the price was supported by word that Saudi Arabia had cut production of the commodity. Another factor was a decline in the value of the dollar. Apart from being seen as a trading hedge against a falling dollar, oil investments around the world are priced in dollars and traders demand higher prices when the currency value declines.

Higher oil prices are positive for the energy sector of the stock market but high energy costs are seen as a negative for the broader market since they divert funds from businesses and consumers that might have been spent in other areas of the economy.

The final straw for the stock market today was news that the bailout package for the auto industry has stalled in the Senate. A measure passed the House of Representatives late yesterday but a number of senators are pressing for more stringent conditions for the car makers.

By the end of stock trading, the Dow had lost 2.24%; the S&P 500, 2.85%, and the Nasdaq, 3.68%. The losses helped boost demand for Treasuries despite a tepid reopening auction of last month's 10-Year Note. Bids exceeded the offer amount by 2.44 to 1, not a terrible bid-to-cover ratio for a reopening, especially considering the large offer size -- but it was not exceptional.

Noncompetitive bids, a gauge of individual investor demand, totaled about $33 million, down from the $39 million in the last regular 10-Year Note reopening in September but on the high side of the average in the last couple of years.

Foreign demand was weak. Indirect competitive bids, which include those from foreign central banks, received just 12.7% of today's offering, the lowest award portion since last March. The award was 26.3% in September's auction.

Despite the soft auction results, the gains in the market pushed the yield of the benchmark 10-Year Note down to its second lowest close since perhaps the 1950s (daily records are available going back to 1960). Last Thursday's closing yield of 2.55% was the only one lower than today's in the available data.

Tomorrow brings a couple of heavyweight economic releases. One is the Producer Price Index (PPI), a gauge of inflation at the wholesale level. It fell in October by 2.8%, a third consecutive decline and the largest in the history of the data series going back to 1947.

Once again, a major contributor to the decline was energy prices. The index for this category fell by 12.8%, the biggest drop since July of 1986. Another large and volatile category is food and its index fell by 0.2% in October. But not all of the inflation news was positive. Excluding the categories of energy and food, the so-called core index rose by an above-trend 0.4%.

The year-over-year data was also mixed. The PPI was up by 5.2% from a year earlier but this was the lowest margin since September of last year. The core index was up by 4.4%, the highest margin since September of 1989.

Inflation pressures further down the pipeline were tame. At the intermediate stage of production, the price index declined by 3.9% overall and by 1.7% at the core. At the initial or crude stage of production, the overall index declined by 18.6% and the core index fell by 17.0%. On a year-over-year basis, the intermediate index was up by 10.2% but this was the best margin since last February. The crude index was down by 1.4%, the first Y/Y monthly decline since January of 2007.
With oil prices still declining last month, the overall index is expected to have fallen again by about 1.8%. The core index is expected to have risen by a tame 0.2%.

The other major release is the retail sales report for last month. With the economy shrinking and job losses mounting, consumers have been holding back on spending. In October's report, the Commerce Department said the seasonally adjusted level of sales fell that month by 2.8%. This was a fourth consecutive monthly decline and the largest in the current data series going back to 1992.

A large but volatile category is autos and light trucks. Sales fell there by 5.5%, the largest decline since August of 2005. But even excluding the category, sales were down by 2.2% in October -- also the largest drop in the sixteen year look-back period.

Another large category is sales at gasoline stations. Given the drop in gas prices, it is not too surprising that the sales number there fell sharply. The report indicated a record drop of 12.7%. Excluding both the auto and gas station figures, sales were still down by 0.5% in October following a 0.6% decline in September and a 0.8% decline in August.

Poor auto sales and falling gasoline prices are expected to have resulted in another drop in overall sales last month of between 2.0% and 3.0%. A similar decline is predicted for sales excluding autos.

Though the PPI and retail sales report are tomorrow's major releases, there are a couple of others scheduled as well. The Commerce Department will release its report on business inventories for October. This is more comprehensive than the wholesale inventories report since it also includes the manufacturing and retail sectors.

In September, the inventory level declined by 0.2%, the first contraction since March of last year and the largest since July of 2005. Sales also contracted, falling by 2.0% after a 2.2% decline in August. The comparatively larger rise in outflows pushed the inventory-to-sales (I/S) ratio up from August's 1.27 to 1.29, the highest since February of last year.

The overall inventory level for October is expected to have fallen by 0.1%. A larger decline in sales is expected to have pushed the I/S ratio up again.

Lastly, the preliminary consumer sentiment index for the month from the University of Michigan will be released on Friday. Given the state of the economy, it is not surprising that consumers are pessimistic. The final index for November came in at 55.3, down from October's 57.6 and the lowest reading in twenty-eight years. Forecasters are predicting a bounce to about 58.0 in this month's preliminary reading. Though lower gas prices may be a positive influence, the bleak employment situation may result in a lower than forecast index number.

10:30 AM EST : The economic releases of the day were more bearish than expected but they have not had a major impact on the markets as traders have become accustomed to bad news. The stock indices began with sizeable losses but they have worked their way higher and are currently narrowly mixed. Treasuries are moderately higher.

In today's news, the Labor Department reported that the seasonally adjusted level of initial claims for state unemployment benefits rose last week by 58,000 to 573,000. Though the seasonal manipulation of the data to account for Thanksgiving may have contributed to the spike, the jump was still the largest since September of 2001 and the claims level was the highest in twenty-six years.

The four-week moving average, which smoothes out some short-term volatility, rose by 14,250 to 540,500 -- also a twenty-six year high. For the forty-nine weeks of the year to date, the average initial claims figure has been 412,000. For the same period last year, the average was 319,878.
The report said that continuing claims rose by 338,000 to 4.429 million in the week ending November 29 (continuing claims must be at least a week old). The increase was the largest in thirty-four years. The four-week average rose by 130,750 to 4,133,500. For the first forty-eight weeks of the year, the average continuing claims figure has been 3,248,188. For the same period last year, the average was 2,539,729.

Last week's employment report for November prepared traders for today's news. It said that nonfarm payrolls fell by 533,000, the largest drop since December of 1974. The employment report also said that the percentage of the active workforce without jobs rose from October's 6.5% to 6.7%, the highest unemployment rate since October of 1993.

There were a couple of trade-related releases this morning. The Commerce Department said that the seasonally adjusted value of imports exceeded that of exports in October by $57.2 billion. This was wider than September's gap of $56.6 billion and was larger than the $54.0 billion deficit figure that analysts had forecast.

Their expectation was based on the declining price of oil, a major import. The report indicated, however, that the volume of imported oil increased in October. Overall imports still declined by 1.3% from September to October, but exports dropped by 2.2%.

Net exports are a component of gross domestic product and the larger deficit figure means a larger subtraction from the fourth quarter calculation than previously thought.

Another report released this morning showed that inflation pressures associated with the trade situation are contracting and this is a plus for both stocks and bonds. The Labor Department said that its index of import prices fell by a record 6.7% in November (the data series goes back to December of 1988). October's originally reported decline of 4.7% was revised to a drop of 5.4% and contractions have now occurred in each of the last four months.

Not surprisingly, the major reason for the decline was the drop in prices for petroleum products. The category saw a dive of 25.8% last month. However, even excluding the category, prices were down by 1.8%.

The report said that overall import prices were down by 4.4% from a year earlier with petroleum prices down by 29.0%. Excluding petroleum, prices were up by 2.4%.

Prices also fell on the export side of trade. The overall decline was a record 3.2% in November following a 2.0% decline in October. The large but volatile category of agricultural products saw prices fall by 7.0% following an 8.4% decline in October. But even excluding agriculture, export prices declined by 2.9% last month.

Low inflation preserves the value of stock and bond investments. In addition it diminishes the argument against further interest rate cuts by the Federal Reserve. But the import / export news is also a reminder of declining demand as the global economy slows and this is a negative factor for stocks.

Still to come: the Treasury will be auctioning an additional amount of last month's 10-Year Note issue. The initial issue had an exceptionally large face value of $20 billion and tomorrow's reopening will have an exceptionally large face value of $16 billion.

The last regular reopening auction was in September (there were four atypical reopenings of old issues in October). Despite the fact that it had an offer amount of $12 billion, the highest for a 10-year reopening since December of 2003, it was well-received. Bids exceeded the offer amount by 2.51 to 1 -- in line with the average bid-to-cover ratio of 2.53 for the twelve reopenings preceding September's.

Noncompetitive bids totaled about $39 million, up from the twelve-auction average of $23 million. And foreign demand was also firm with indirect competitive bids receiving 26.3% of the offering, up from the twelve-auction average award portion of 13.7%.

Today's deadline for competitive bids is 1:00 PM Eastern time. The deadline for noncompetitive bids is noon . . . .