Wednesday, December 3rd, 2008 Market Update

Wednesday: 12/03/08 10:30 AM EST :
Market Update

Stocks opened with moderately deep losses on a bit of profit-taking following yesterday's rally and bad news on the economy's services sector. But a better than expected report on productivity and a jump in mortgage application activity last week has eased bearish sentiments and stocks have pared their earlier losses. Treasuries opened under technical pressure after huge gains but the initial decline in stocks provided some footing. However, with the improvement in stocks, Treasury notes and the long bond have fallen deeper into the red.

In today's news, the Labor Department reported that the annualized rate of nonfarm business productivity (average output per worker per hour) increased by 1.3% in the third quarter relative to the second. This was up from the preliminary estimate of 1.1% reported in early November. Productivity rose by 3.6% in the second quarter.

The revision surprised forecasters who because of the downward adjustment to the gross domestic product calculation for the quarter (-0.5% instead of the initial estimate of -0.3%) had expected a productivity gain of just 0.9%. The improvement was due to a greater decrease in hours worked (down by 3.1% instead of the originally reported 2.7%) than the downward adjustment to average output (down by 1.9% instead of the originally reported 1.7%).

The better productivity number helps stocks by suggesting greater efficiency and therefore increased projections of corporate earnings. It also helps both stocks and bonds by pointing to reduced labor cost pressure, a welcome inflation measure. This was seen in today's report, which said that unit labor costs (ULC: average cost per unit of output) rose by 2.8% last quarter instead of 3.6% as cited in the preliminary report.

Moreover, today's report revised the second quarter change in ULC to a decline of 2.6% instead of the previously reported decline of 0.1%. On a year-over-year basis, ULC rose by 1.4% in the third quarter instead of the originally reported 2.3%. Second quarter ULC rose by just 0.1% Y/Y instead of the previously reported 0.8%.

Another plus for stocks came in a minor report. The Mortgage Bankers Association of America reported that its mortgage application index surged last week by a record 112.1% as mortgage rates plunged on the announcement that the Fed would buy mortgage backed securities and debt issued directly by the mortgage agencies. It should also be noted, however, that the extent of the move may have been exaggerated by a faulty adjustment factor for the Thanksgiving Day holiday.
The report said that the bulk of the jump came on the refinance side where the index soared by 203.3%. Both the overall application index and the refinance index posted their highest readings since last March. Refinances accounted for 69.1% of application activity last week, the largest portion since last February.

But the purchase index also saw an impressive increase of 38.0% and the reading was the highest since early September. Demand for adjustable rate mortgages was feeble, representing just 1.4% of application activity, down from 3.0% the week before.

But there was also bad news for the economy released today. The Institute for Supply Management (ISM) said that its index on the non-manufacturing -- or services -- sector came in at 37.3 last month, down from 44.4 in October and below the 42.5 that forecasters were predicting. Any reading under 50.0 reflects a general contraction in activity relative to the preceding month.
The current index, the NMI or Non-Manufacturing Index is new -- first published last January. It is a composite of four seasonally adjusted indices: business activity, new orders, employment, and supplier deliveries.

The latest reading is the lowest in the current data series. Before the NMI was instituted, the business activities index was the headline indicator on the services sector, but it is derived from a single question in the survey of business purchasing managers. It came in at 33.0 last month, the lowest reading in the history of the series going back to 1997.

In addition to the weak services sector news, the employment issue was raised this morning with the release of the report from the employment services firm of Automatic Data Processing (ADP) on nonfarm private (non-government) payrolls for November. According to the company's data, the seasonally adjusted payroll figure fell by 250,000. This was a fourth consecutive monthly decline and the largest of them. October's originally reported decline of 157,000 was also revised to a larger drop of 179,000.

The news heralds the approach of Friday's report from the Labor Department. In recent months, the Labor Department's figures have been considerably worse than those from ADP. The last employment report from the Labor Department said that non-government payrolls fell by 263,000 in October. Analysts are looking for an overall decline (including government payrolls) of between 300,000 and 325,000 in Friday's report.

Still to come: this afternoon, the Federal Reserve will release its latest edition of the Beige Book, an anecdotal summary of economic conditions in the twelve Fed regions. The report is used as one of the background resources in the monetary policy committee's deliberations. The next policy meeting is slated for the 15th and 16th of the month.

The Beige Book rarely has much impact on the markets since previously released indicators have already sketched out the economic landscape. But any rhetorical variant, a particular focus or emphasis, could be perceived as a signal of Fed intentions and have some influence on traders. Currently, Fed watchers are anticipating another cut in the committee's target for the fed funds rate (overnight borrowing rate between banks) and the discount rate (rate charged for loans directly from the Fed).

Tuesday, 12/02/08 Stocks rallied yesterday morning, then fell sharply in the afternoon. But before the indices could reach unchanged levels, they rebounded once again and finished near their highs of the day. Treasuries caught a bid when stocks were sliding and remained elevated since much of the recovery in stocks occurred after the bond market closed.

In late trading, the 10-Year Treasury Note was up by 17/32, lowering its yield by 6 basis points to 2.67%; the Dow was up by 270.00 points to 8,419.09; and the Nasdaq was up by 51.73 points to 1,449.80.

Stocks got an initial boost from a technical bounce following sharp losses on Monday. But they retreated from their highs early this afternoon as auto sales figures for last month showed steep declines relative to those in November of last year. General Motors, Ford, Toyota, and Honda all reported Y/Y declines of over 30%.

But the declines in stocks triggered more bargain hunting and the indices moved sharply higher again. The market has been extremely volatile lately as economic data has been bleak but traders have been testing lows for a possible turnaround. On the 19th and 20th of last month, the Dow fell by 872.46 points or 10.36%. It then rose in each of the next five sessions for a gain of 1,276.75 points or 16.91%. This was followed by Monday's decline of 679.95 points or 7.70%. The index gained 3.31% yesterday.

The other indices have followed similar paths. Yesterday the S&P 500 gained 3.99% after declining on Monday by 8.93%. The Nasdaq gained 3.70% yesterday after a decline of 8.95%.
Despite the advance in stocks, oil futures fell again on Tuesday. The price of a barrel of light, sweet crude for next month delivery lost $2.32 on the New York Mercantile Exchange to close at $46.96. This was the lowest closing price for a front-month contract since May of 2005. Yesterday's closing price was down by $98.33 from the record high of $145.29 set on July 3.

Treasuries have been benefiting from the swings in the stock market and from the growing string of weak economic data. Word on Monday from the head of the Federal Reserve that the central bank may lower short-term rates again and make purchases of Treasuries further up the maturity spectrum provided additional support for bonds. The yield of the benchmark 10-Year Note fell by 65 basis points in the last five sessions to an historically low level (yields move inversely to price) . .