Friday, October 8, 2010

Sitting on a Signal

The Fed last met to discuss the condition of the economy on Sept 21. The U.S. central bankers said they were “prepared to provide additional accommodation if needed to support the economic recovery.” They also left the benchmark lending rate in a range of zero to 0.25 percent while noting that inflation measures were at levels “somewhat below” the central bank’s mandate to achieve stable prices and full employment. The Fed statement boosted speculation that the central bank will buy more Treasuries sometime later this year.

Fed observers/speculators are guessing that the FOMC will be announcing a new program of quantitative easing (QE) when they meet next on November 2-3. Some members of the FOMC are speaking about their need for evidence of trends that would threaten the Fed's mission of price stability (keep a lid on inflation) and full employment. Today they get the release from the BLS of the last employment data before the FOMC meets in early November. There is the suggestion is that a report indicating no, or little, improvement would support a new QE program announcement in November. Here is a brief look at the highlights. Payroll employment in September declined 95,000, following a revised 57,000 dip in August and a 66,000 decrease in July. The September fall was significantly more negative than the median forecast for an 8,000 decrease. But on the positive side, private nonfarm employment continued to rise, advancing 64,000 in September, following a revised increase of 93,000 the prior month. The median market forecast was for an 85,000 boost for private payrolls.

Fundamentally, toxic assets are still on the balance sheets of the TBTF banks in the US, UK and Europe. (See the second graph). The threat of a renewed crisis caused by the collapse of the global credit system is still a possibility. Banks are the lynch pin in our credit based world and they hold all the political cards too. Fundamentally, the continuing concern is that consumer and commercial lending do not recover with enough volume to contribute to a real economic recovery. That leaves the economy to look to the government for stimulus of some shape.
With that backdrop, what are some signals to look for? A rally up to S&P 1170 might inspire some profit taking, with bargain hunters looking to test the water around 1130. Breaking through and closing below 1130 should alert investors to look for signs of a shifting mood and be ready to take the opportunity.

Here is a look at the condition of large US banks, looking at the non-performing loans in a couple of different ways through June 30. The blue line illustrates the percent of banks whose allowance for loan loss reserves
exceeds their non-performing loans, looking only at banks with assets greater than $20 billion. The red line shows the total of non-performing loans as a percent of assets at all banks. The message in this graph is that banks in general have not been in a worse condition to lend since this data collection series was started in 1988.

Here is a look at the bond market from several types of bond indexes. The primary view is of the Barclay's aggregate bond index. This index is about 60% treasury bonds, 20% agencies and 20% corporate credits. Clipped in below is the ETF that tracks the Barclay's 1-3 Yr Treasury Bond. Below it is the ETF that tracks the Barclay's 1-3 Yr Credit Bond. This ETF also includes 25% exposure to foreign quasi-sovereign credit. Are bond prices turning lower in a sustainable move?

There are some stock market sectors that can be early indicators of the mood in the market. The horizontal gray and red bars show volume by price. Semi-conductors are one sector. Are they making a breakout? Emerging markets continue to be taking the lead. And in its own world is gold, represented further below by stocks of the miner's.

After considering the condition of the major lenders, trends in the bond markets, several unique stock market sectors now look at currency from the US dollar perspective. The next graphs illustrate how much foreign currency the US$ will purchase. For a brief and helpful description of how currency rates are determined, read the article by John Hussman dated August 23, 2010.

Lastly, consider the number of stocks in the S&P 500 making a price that exceeds their 150 day moving average. Obviously, a sign of strength in those company prices. The clip on the bottom of this graph illustrates the S&P 500 price for a simple comparison.

Conclusions made from this analysis lead me to think there is still money moving into the risk that is in the emerging market equities and the gold miners. The bond market graph no longer supports the idea of money leaving bonds. For one idea of where this cash is coming from, consider the concept described here of the Fed's Plunge Protection Team. The recent strength in semi conductors had a lot of resistance to bull through and it appears to have done that. A little more time, moving above the new support level will prove it is a breakout. These are interesting times. We might look back and see that the sectors that have 'always' owned the definition of volatile, emerging markets and precious metals miner's, have become the new blue chips. Keep an eye on them.