Ben Bernanke, Social Worker

The Western World has become central bank-centric.  While China seems to be furiously ginning up public works projects to support growth, Europe and the U.S. are relying on monetary policy.  Financial markets have taken notice, expecting the money spigots to begin gushing again.

That may be the problem for equity investors.  If new money creation is already baked in the cake, the time-worn axiom of buy the rumor and sell the news could well be in play.  We expect swimming in place to be the trend until decisions from the Federal Open Market Committee and a German constitutional court are announced midweek.

First to the old world.  The European Central Bank authorized unlimited bond purchases last week, making good on ECB chief Mario Draghi’s word to do whatever it took to defend the euro.  But a group of German lawmakers are seeking an injunction preventing German participation in the plan.  The court rules Wednesday.

On this side of the Atlantic, all signs point to what we have been expecting since the summer began – a third round of quantitative easing by the Fed.  It has long been our opinion that the Fed was duty-bound by both statute and conscience to act anew.  With the August jobs report showing a disappointing addition of 96,000 jobs and an unemployment rate pushed down only by an exodus from the work force of the forlorn, it seems the Fed has all the cover it needs to boost money supply growth in the hope it translates into real economic activity.

For his part, Fed Chairman Ben Bernanke made it clear at Jackson Hole the week before that policy makers could and would act if needed, remarking not only on the dry numbers describing the economic landscape but the cost to the social fabric of continued bleak employment prospects.

“As we assess the benefits and costs of alternative policy approaches, though, we must not lose sight of the daunting economic challenges that confront our nation.  The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years,” Bernanke said.

He also laid the groundwork for further action by defending the efficacy of the Fed’s prior rounds of extraordinary bond buying.

“For example, a study using the Board's FRB/US model of the economy found that, as of 2012, the first two rounds of LSAPs[large-scale asset purchases] may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred,” he said. 

The rubber meets the road Wednesday when the FOMC is slated to announce its policy decision.  At the very least, expect language in the directive extending the time horizon for keeping the Federal Funds rate target close to zero.

As for political considerations, we think they are also zero.  The Republican presidential candidate, Mitt Romney, has already said he would replace Bernanke, a Republican, if elected.  And the lags in monetary policy’s effect on the real economy prevent any palpable help for President Obama before the November election.

Meanwhile, the usual round of economic reports that follow the tone-setting employment data is slated for release.  Inflation news should be of no consequence, despite rising food and oil prices.  The biggest market mover outside central bank actions is likely to be Friday’s release of August retail sales.  Economists expect another 0.8% increase over the prior month.  A shortfall could hit markets hard if the Fed has failed to act.

Pool Dancing

You can have your Usain Bolts, Michael Phelpses and Gabby Douglases; we prefer the anonymous practitioners of synchronized swimming, an athletic art that rivals the music of the spheres for precision and elegance – kinda like the sporting life on this side of the Atlantic.  Not.  Equity prices rose and bonds fell, sending the discordant message that economic growth and rising inflation lies ahead.

Considering the fiscal cliff the U.S. is hurtling toward, financial markets are either blissfully optimistic or whistling past the graveyard.  The Dow Jones Industrial Average gained 0.32% Friday and is up 8.9% so far in the second half of the year.  Meanwhile, the yield on the 10-year U.S. Treasury note has risen 20 basis points since June 1 to 1.65%.

The action came against a skeletal backdrop.  Productivity in the second quarter was reported to have risen 1.6% after falling 0.5% in the first quarter, when hiring was more robust.  The cruelest irony of the soft jobs market is that rising output per worker has meant less pressure for firms to add workers.

Wholesale inventories declined 0.2% in July, signaling either increasing demand or business pessimism – take your pick.  And the federal budget went $70 billion further in the red last month versus a $60 billion deficit in June.

The most encouraging news was the surprising drop in initial jobless claims to 361,000 versus an expectation of 370,000.  Our colleague Rich Bieglmeier was spot on with his call on this high-frequency series.

There will be stronger hooks to hang a hat on this week.  Tuesday brings the biggest number, retail sales for July.  Recall that last month’s report of a 0.5% decline in June kindled fresh speculation that the economy was tipping over and the Federal Reserve would be forced to act.  Economists generally expect a 0.2% increase in sales and 0.3% increase excluding automobiles.

The producer price index for July, also on Tuesday, is seen rising a benign 0.2% including and excluding food and fuel prices.  The consumer price index, to be released Wednesday is seen rising a similar amount.  Also Wednesday, the Empire State Index of August business activity in New York, industrial production in July and the homebuilders index are slated for release.

Also on tap are jobless claims, housing starts and the Philadelphia Fed’s survey on Thursday.

On the earnings front, big retailers are in the spotlight.  On tap to report quarterly results are Home Depot, Wal-Mart, Target and Sears.  The results could be key to setting the tone for the week.

This week, we inaugurate our Houdini Award with a nod to Goldman Sachs for escaping criminal prosecution for touting securities it was betting against, proving once again it’s better to be right and lucky.

And our Laurel Wreath goes to Shakespeare’s “scepter’d isle,” for hosting all the Bolts, Phelpses, Douglases and synchronized swimmers while delighting our teenage daughter with a closing ceremony performance of English boy band One Direction.

Meanwhile, U.S. investors prepare for the post-Olympics fiscal cliff-diving competition in 2013.  Good luck.

Real Tough Guys

Spare us the oohing and aahing over the “severity” of the sanctions against Pennsylvania State University football in the wake of an investigation that found the sainted Joe Paterno guilty of covering up for a child rapist.  If we were Southern Methodist University, we would secede from the National Collegiate Athletic Association, hire a lawyer and sue for the revenue it lost when its football program was kicked to the curb.

All SMU got from the NCAA was the death penalty in the early 1980s for the good old-fashioned all-American way of gaining an edge  –  paying its scholars to block and tackle.  But Penn State?  It still gets to play, pack its stadium with 100,000-plus fans for each home game this season, and still be on television.  Great.  If you’re so inclined you’ll be able to watch and listen to the blow-dried bloviators speak of the indomitable Penn State community and the “healing” virtues of intercollegiate competition.

This is what passes for disapproval.  Oh well.  We’ll get over it, though we won’t be as big a college football fan as we used to be.  We’re free of that now.  Of course, Western Civilization will fall if Oklahoma falls to Texas this October, but we can take it.

What we can’t take is the sense that the NCAA is somehow trampling out the vintage where the grapes of wrath are stored.  Self-righteous to a fault, the NCAA proved to be as gutless as the Penn State administration and its hypocritical head coach.  We don’t have the numbers, but $60 million is probably what parking tickets are to Federal Express   –   just the cost of doing business

No, the NCAA flubbed it.  To sleep at night it chose to tell itself a story, the one about what a tough guy it was for making the Lions cut back on the number of linebacking studs it could stuff into Theory of Volleyball 101.

In our ideal world, every male freshman would receive a flyer (or a text message nowadays) informing him of football tryouts the Saturday before Labor Day, leather helmets would be optional, the coach would be a professor wanting to make some extra dough.

But, alas, it isn’t so and never was.  The men who ran Penn State and its football “program” thought it more important than little boys and sought to protect it rather than them.  By not pulling the plug, so did the NCAA.

Rescue Me

Lumberjacks yelled TIMBERRR!  Golfers bellowed FORE! Markets wailed LEMMEE OUTA HERE!  Yep, last week’s reports from the Institute for Supply Management and the Bureau of Labor Statistics provided scary bookends for the mounting body of evidence the U.S. economy is rolling over.  But are equity prices anticipating rescue?

Though the major stock indices went south Friday, they remain higher than the close on June 1, when the May payrolls report ushered in the specter of recession.  The S&P 500 closed Friday at 1,354.68, down 124 points on the day and off 0.8% for the week, but up 6.0% since June 1. Similarly, the Dow Jones Industrial Average, also down 0.8% on the week, is up 5.4% since June 1.  And the NASDAQ Composite, which managed a gain of 0.1% for the week, is up 6.9% since June 1.  The market’s performance leads us to believe sentiment still clings to the expectation that policy levers will be used to keep the motor running. 

Pessimists sing along with Diana Ross and the Supremes that  “… there ain’t nothin’ I can do about it.”  Fiscal policy is all but sidelined by Washington gridlock in this election year, and some central bankers are dogged by the uneasy sense that more action is futile in an economy caught in a liquidity trap.

But Federal Reserve Chairman Ben Bernanke has rejected the notion the Fed has no arrows left in its quiver and has pledged the Fed is ready to act if necessary.  The upshot, we believe, is that QE 3 is inevitable.  We think another round of quantitative easing, that is, printing money by purchasing financial assets from commercial banks, will be launched at the Federal Open Market Committee’s next meeting in August.  The minutes from the June FOMC meeting will be parsed when they are released on Wednesday.  The policy makers extended “Operation Twist” at that meeting.

The argument for further Fed action got support last week from news that the ISM’s diffusion index of manufacturing activity in the U.S. slumped into contraction territory for the first time in three years, falling to 49.7% in June from 53.5% in May.  The production and employment sub-indexes were up, but a steep drop in new orders was the canary in the coal mine.

And the notion of an incipient downturn grew stronger with Friday’s news that nonfarm payrolls grew a paltry 80,000 in June, below expectations that were raised when ADP said Thursday that its survey of private sector employment showed a gain of 176,000.  The unemployment rate was unchanged at 8.2%.

Abroad, the misery continued as Eurostat reported the unemployment rate in the 17-nation euro zone rose to a record 11.1% in May from 11% the previous month.  Spain's unemployment rate was the highest in the euro zone at 24.6%, while Austria had the lowest jobless rate at 4.1%.

Next week, the producer price index and the University of Michigan consumer sentiment survey will be released Friday.  For now, though, it’s up to earnings season to set the tone.

The Week That Was and the One to Come

Oh what a week it was for relationship building.  Chief Justice Roberts and enough Supremes stopped in the name of love from jilting Obamacare, the European Union got less unperfect and Miss Data wasn’t all that into us but friendly enough.  Mr. Market responded to it all with outsized gains on the last trading day of the quarter.

Ahead, of course, is the June jobs report to be released at the end of a four-day work week.  The May report showed a disappointing 69,000 additions to nonfarm payrolls, so the June statistics will be looked at for trend confirmation or reversal and the impact on monetary policy makers.    

But let’s look at what last week told us.

SCOTUS STOCKS

Shares of hospital companies predictably shot higher because the Supreme Court’s 5-4 decision to preserve the Affordable Care Act largely intact means care providers will have more paying customers.  Insurers sagged because the Act imposes restrictions that could hurt profits. 
Despite the predictable Tea Party exasperation, we suspect corporate America was relieved that one cloud of uncertainty was gone.

A MORE PERFECT (EUROPEAN) UNION

The stock market took great pleasure in the outcome of the EU summit in Brussels.  What that outcome will lead to, however, is harder to figure out.  No matter.  Mr. Market has a story and he’s sticking to it – for now. 

As best we can tell, the EU decided to decide about recapitalizing banks and creating a pan Eurozone banking regulator, taking the first step toward a real fiscal union that would issue Eurobonds backed by everybody, including that old killjoy Germany and the prodigal sons of the south.

THE WEEKLY DATA DATE

We think the most worrisome indicators were two releases from Chicago, the city that works, the poet said.

The little noticed Chicago Fed’s national activity index reached the lowest level in a year, dropping to a three-month average of -0.34 in May from -0.13 in April. The one-month index dropped to -0.45 in May from +0.08 in April. The Chicago Fed asserts that below -0.7 on the three-month average indicates a recession has likely begun.

The much more noticed Chicago Purchasing Managers Index stayed in expansion territory at 52.9% in May vs. 52.7% in April.  But here’s what caught our attention:  New orders and order backlogs were a negative and inventories rose.  That’s not a recipe for growth.

Meanwhile, from Washington we learned that personal income increased 0.2% in May, largely on investment gains.  Personal consumption expenditures, however, were flat vs. the prior month.
Paradoxically, the brightest star in the sky continues to be housing, the keystone of sustained expansion.  The Case-Shiller price index rose 1.3% in May.

THE WEEK TO COME

As noted, the big dog will be the June employment report on Friday.  Economists are looking for about a 100,000 gain in payrolls and unchanged unemployment rate of 8.2%.  ADP will preview the Labor Department’s number with the release of its private sector payroll tally on Thursday.

If the jobs numbers come in as weak as May’s, expect talk of another round of quantitative easing by the Fed.  Ben Bernanke said the Fed was ready to act if the economy required it.
Also on tap are the ISM Purchasing Managers’ Index for manufacturing for June and construction spending for May on Monday.  Factory orders for May is out Tuesday.

The U.S. shuts down Wednesday to celebrate its independence.   Happy Fourth.

The Rock Market Decoded

Imperfection being the constant of the human condition, equity valuations are always undershooting or overshooting, kind of like our putting stroke.  This condemns investors to watching our old pal Sisyphus push the rock uphill only to see it roll down again.  This is what economists, lyrical souls that they are, call “reversion to the mean.”

So, whether pondering the futility of our golf game or the arc of stock prices, one asks: “Where is that damn rock headed?”

To answer this, we are faced with another conundrum.  It can be said that equity valuations are predictors of corporate profitability, which, in the aggregate, depends on economic growth.  Those valuations should adjust as evidence accrues one way or the other.  This is what finance professors, ever the blithe spirits, call the “discounted cash flow or dividend discount model.”

But, as Mitt Romney was laughed at for averring, corporations are people.  If they depend on economic growth for wealth creation, they must – like each butcher, baker and candlestick maker who makes up the economy – be doing the growing themselves.

Or, in the words of another presidential candidate, the sage possum Pogo of yesteryear’s funny papers, “We have met the enemy and he is us.”

Which leads us to yet another riddle (Bear with us; fearless predictions will be forthcoming).  If we assume the market never gets it right, our task is to divine in which direction the rock is undershooting or overshooting.  This is what Wall Street wags mean when they say, “Nobody rings a bell at the top.”

We find it our task, then, to stand athwart the midpoint of 2012 and judge the direction of economic growth and its doppelganger, the rock on the hillside.  As always, the evidence is inconclusive, but try we must and, again like Sisyphus and our erratic putting, take pleasure in the effort if not its result.

First, let’s put the concerns of this vale of tears into four buckets in order of significance:

The Old World: Europe is falling into recession.  Greece is a mess.  Spanish unemployment is 24%. The break-up of the Eurozone appears imminent.

The New World: U.S. real GDP growth slowed to a 1.9% annual rate in the first quarter.  Jobs growth has plummeted from 200,000-plus per month in the winter to just 69,000 in May.  The “fiscal cliff” of 2013 looms.

The Orient: China’s gallop has slowed to what for it is a trot, with GDP growth at “just” 8% or so.

The Golf Course: Can we build a repeatable swing?

Next, let’s parse these concerns and spy which way the rock will rotate.

The Old World: Germany, already caving to the growth advocates, will accommodate them further.  The European Central Bank will cooperate.  Italy’s technocratic compromise, though far from the best of all worlds, will be copied.

The New World:  Romney could very well be president and inherit a recovering economy (the very one he is running against, reminiscent of Bill Clinton’s good fortune in 1992).  If Europe can muddle through (see above) expect the rock to signal economic growth.  Whoever is elected, we can’t believe politicians will be so thickheaded as to let sequestration and tax hikes to kick in January 1.

The Orient:  China may be the model for the rest of the policy makers in the civilized world.  With inflation slowing, the authorities have plenty of room to address slumping growth.  The central bank recently cut interest rates for the first time since 2008, and the government is looking to ramp up public investment projects.

The Golf Course:  Head down, eye on the ball, turn in a barrel, all without thinking about it.

Our conclusion:  Buy the dips and take one more club than your ego tells you.  Sisyphus would do no less.

Jobs Market Goes to the Movies

Payrolls grew in April, so what’s to grouse about?  Edward G. Robinson’s reply in Key Largo to Humphrey Bogart’s observation comes to mind.  “Yeah, that’s it! More! That’s right. I want more.”

The Bureau of Labor Statistics reported that 115,000 jobs were created last month, below the 160,000 or so economists were expecting.  Prior months were revised upward, though.  February job growth was pegged at 259,000, up from the previous 240,000 estimate, and March payrolls are now seen as having risen 154,000 vs. the 120,000 gain previously reported.

The average work week was unchanged at 34.5 hours in April. The manufacturing workweek edged up by 0.1 hour to 40.8 hours, and factory overtime rose by 0.1 hour to 3.4 hours. The average workweek for production and nonsupervisory employees was unchanged at 33.8 hours.

In April, average hourly earnings for all employees on private nonfarm payrolls rose by 1 cent to $23.38. Over the past 12 months, average hourly earnings have increased by 1.8 percent.  In April, average hourly earnings of private-sector production and nonsupervisory employees rose by 3 cents to $19.72.

The unemployment rate dipped slightly to 8.1% from 8.2%, largely because participation in the labor market shrank.

BLS data in all their glory can be found at http://www.bls.gov/news.release/empsit.nr0.htm.

This tepid growth in jobs and stagnation in wages suggests the economy remained aloft in the first month of the second quarter, though its air speed drifted to levels that should cause concern in the cockpit.

Perhaps the warm winter skewed earlier figures abnormally higher and economic growth is settling back to a more realistic level.  Perhaps the specter of the unraveling of that great fossil museum known as Europe weighs on international corporations’ animal spirits.  And perhaps the sleeping housing construction sector is a cork still lodged in the champagne bottle.

Whatever the cause, expect sideways action in the stock and bond markets for the foreseeable future.  With most of the impetus from positive first-quarter earnings surprises now spent, international events (particularly elections in France and Greece) could take center stage in the investment melodrama.

For the faint of heart (and our ticker is none too aroused right now), we nominate dividend payers such as AT&T (T) and Philip Morris (MO).  Americans may not be working as much as they would like, but they’re not going to give up cell phones or smoking.