Why is This Market Rising?

lucyb —  January 8, 2008

December was full of some of the worst economic news those of us born after The Great Depression had ever seen! Among the biggest stories of the month were the following:

The month began (12/03) with AT&T announcing it would cut 12,000 jobs, or about 4% of its work force, because of the economic downturn. Chemical maker DuPont Co. said it will cut 2,500 jobs, mostly serving the U.S. and European automotive and construction markets, due to lower demand. Then on Dec. 5 The Commerce Department reported that factory orders, which dropped 5.1% in October, (the largest decrease since an 8.5% fall in July 2000) caused big cutbacks in demand for steel, autos, computers and heavy machinery. Analysts expect the weakness will continue for some time. It was larger than the 4% drop that economists had been expecting. The drop in orders marked the third consecutive decline, with demand for both durable goods and nondurable goods falling. Demand for non-defense capital goods, considered a good proxy for business investment plans, fell by 5% in October, the biggest decline since January and the fourth straight monthly decrease. Orders for durable goods — items expected to last at least three years — fell by 6.9%, even bigger than the 6.2% initial estimate the department made last week. With the economy weakening, businesses are cutting back on their plans to expand and modernize, adding another drag to overall growth.

On the same day, we learned that employers slashed 533,000 jobs in November, the most in 34 years, raising the unemployment rate to 6.7%, a 15-year high. The new figures, released by the Labor Department, showed the employment market deteriorating at an alarmingly rapid clip. Additionally, the government said the number of people continuing to claim unemployment benefits last week reached 4.09 million, the highest level since December 1982, when the economy was emerging from a recession. The Labor Department reported that initial claims for unemployment insurance dropped to a seasonally adjusted 509,000, from an upwardly revised figure of 530,000 for the previous week. That was significantly below analysts’ estimates of 537,000, according to a survey by Thomson Reuters.

Additionally, December brought reports that a record one in 10 American homeowners with a mortgage were either at least a month behind on their payments or in foreclosure at the end of September as the source of housing market pressure shifted from risky loans to the general U.S. economy. The percentage of loans at least a month overdue or in foreclosure was up from 9.2% in the April-June quarter, and up from 7.3% a year earlier, the according to the Mortgage Bankers Association. The foreclosure crisis continued to be concentrated in states like Florida, where a stunning 7.3% of all loans were in foreclosure at the end of September, the highest in the country.

In the middle of the month Toyota announced it was putting plans to open a new plant in Mississippi on hold indefinitely, even though it is about 90% complete! The plant was set to start building the first domestically produced Prius in 2011. Toyota also said it would likely lose money for the first time in their history!

On Dec. 24, the government announced that “new claims for unemployment benefits rose, as layoffs spread throughout the economy, more evidence the labor market is weakening as the recession deepened.” The Labor Department reported that initial requests for jobless benefits rose to a seasonally adjusted 586,000 in the week ending Dec. 20, from an upwardly revised figure of 556,000 the previous week. That’s much more than the 560,000 economists had expected. A Labor Department analyst said auto-related layoffs were a factor in the increase. The four-week average of initial claims, which smoothes out fluctuations, increased to 558,000. That’s the highest since December 1982, when the economy was emerging from a steep recession. Merry Christmas!

Then January began with news that the Institute for Supply Management, a trade group of purchasing executives, said its manufacturing index fell to 32.4 in December, a greater-than-expected decline from November’s reading of 36.2. Wall Street economists had expected the reading to fall to 35.5. (A reading for the overall index above 50 signals growth, while a reading below 50 indicates contraction.) Components of the index hit historic lows. New orders fell to their lowest level on records going back to 1948. Prices fell as the number of respondents saying they had paid more in December than in November sank to its lowest monthly reading since 1949. Every sector was down. The index, based on a survey of the institute’s members, has fallen steadily for the last five months as the economy deteriorated. December’s reading was the lowest since June 1980, when the economy was near the end of a six-month recession. Happy New Year!

How Has the Market Reacted to all the Bad News?

By going up about 2% since the end of November (S&P 896), as of this writing (midday 01/07), since the beginning of December.


There are a few reasons. First, while the financial media touts the headline unemployment numbers, they generally neglect to inform their audience that while the absolute numbers are high, they are comparing to a time (1980) that had a workforce that was 50% smaller!

Also unreported was the news that productivity was up 2.2% in the 3rd quarter. This is also a long-term positive for business and consumers as rising productivity helps to keep prices down.

Also, the Fed acted aggressively in December to slash interest rates (on the money it loans to financial institutions) 75% from 1% to 0.25%. The central bank said it expects to keep rates “exceptionally low” for some time to come, as it hopes to lift the economy out of recession. It also plans to expand its lending programs and purchase securities to keep the credit markets liquid. This is important, because car companies, for example, are unable to sell their vehicles if potential buyers can’t get auto loans. It also hopes to keep homes affordable, to allow for money savings by way of refinancing and to allow banks to be profitable by providing a healthy spread between what the banks borrow for and lend for while still offering a good rate to the borrower. Indeed, a recent survey found that the national average rate fell at the end of December. Rates at year end on 30-year fixed mortgages were 5.06%, according to financial publisher HSH Associates, the lowest since the 1960s. That is good news for anyone associated with the housing market. The FED also said it would use additional tools to help stimulate the economy (more on this later).

On Dec. 16 the Labor Department reported that consumer prices, an inflation barometer, fell in November by the largest amount on records going back 61 years as energy costs posted nearly double the decline of the previous month. Prices fell 1.7%, surpassing the previous record decline of 1% set in October. It was the largest one-month decline dating to February 1947. Core inflation, excluding food and energy, showed no increase at all in November after a 0.1% drop in October. The overall slide in prices reflects the big drop in energy costs in recent months. After hitting a record at $147 per barrel in mid-July, crude oil has fallen by $100 per barrel since then, pushing down the price of gasoline from a record $4.11 per gallon in July to $1.34 in the most recent Energy Department survey.

Then there are reasons that are stock market-related. Insider buying continues with positive activity in almost all sectors of the market. Since the early October sell-off, insiders have taken a long-term view and purchased their shares at an impressive pace; that action continues. The latest insider data shows a modest slowing of that action after four weeks of buying at a better than 2-to-1 pace. The latest insider data shows them buying at a better than 2-to-1 pace for the fifth week. For the 11th consecutive week, their buys exceeded their total sells. The insiders must remain optimistic for their company’s potential or they wouldn’t be buying at a rate not seen for 10 years. Insiders are normally predisposed to sell but throughout 2008 insiders have used any market retreat to accumulate their shares. That is long-term bullish, signaling that trading is at the area of a major bottom. Insiders are buying because valuations are low. In 2000, investors were paying $6 for every dollar of book value in the S&P index. Now that number is down to $1.80 for each dollar of capital. That is certainly a better deal. Also, the S&P 500 now has a dividend yield of 2.9% — more that the 2.5% you can get on a 10-year T-Bill! If the market has a net return of less than 2.5% per year with a beginning yield of 2.9%, we are all in some trouble! The S&P yield has not been above the yield on the 10-year T-Bill since the mid-1950s!

Who’d a Thunk it?

When last summer crude oil peaked at $147 a barrel, nobody thought we would ever see crude oil under $50 a barrel ever again! The top of the crude oil prices was marked by congressional hearings on why the price was so high and a prediction from the Goldman Sachs commodity analysts that oil would hit $200 a barrel by the end of 2008. Well, what no one thought possible has happened. Crude oil has tumbled below $50 a barrel and the average gallon of gasoline is now less than $1.80 nationally, both four-year lows. The decline in energy prices is unprecedented. It provides some relief to consumers and businesses, and has occurred as the nation dips into recession. No one believed crude would lose $100 in value in such a short period. Economists’ estimates are that gas prices at this level are the equivalent of sending $1 trillion in tax rebate checks to taxpayers.

Anyone Got a Match?

So what does the FED mean when it says it will use additional tools? One thing it means is that it will create money. Over the past year the FED has created almost $1 trillion as measured by money supply figures commonly known as M2. Roughly speaking, M2 is the measure of currency in circulation, demand deposits, money market funds, savings accounts and time deposits. Add this to the additional stimulus created by the decline in gasoline prices (also about $1 trillion). Then add in the government loan and bailouts — $750 billion appropriated by congress. The current Treasury Secretary, Hank Paulson, has doled out about half of this money and the balance awaits the Obama team. Another $100+ billion for AIG plus the rebate checks that were sent to taxpayers earlier in the year totals about $1 trillion. Obama and the congress have promised an additional stimulus package of about $775 billion. By the time it is passed into law, it will likely be either at or more than $1 trillion. That adds up to about $4 trillion in stimulus sloshing around the economy (much of it by the middle of ’09). It is like spreading gasoline on the floor at a smoking lounge — sooner or later something will catch fire.

Markets tend to give you the unexpected, just as everyone becomes convinced that something fluid becomes something permanent. The markets and public were convinced that ever-rising oil prices were permanent and they were wrong. Likewise, almost all are convinced that gloom and doom are surely to be with us for awhile. Ask anyone and they will tell you. However, there are things that no one is thinking now. Things like the economy will stabilize and that the recession will end sooner than is commonly thought, etc.

Which brings us back to the beginning: Why are the markets up in the face of all the bad news? The answer, in our opinion, is three-fold.

First, the worst outcomes have been factored in by investors who are starting to think that we might not get a worst outcome.

Second, all the news is not bad in spite of the headlines.

Third, with all the gasoline lying around, something will ignite the fires of the economy and inflation sooner or later.

We hope the market will still be up (compared to the end of November) by the time you read these words. Markets will fluctuate and we are sure to see more down days, maybe even a retest of the October lows. In any event, we stand by our prior missive “No Time to Sell” and look forward to writing another “Who’d a Thunk it” about the market.