Economic & Market Update: October 5, 2009

“Green Shoots Withering in the Fall Season”

Chris Maxey, Analyst

http://www.Fortigent.com

Last Week’s Highlights:

Economics This Week:

Data Leaves Investors Disappointed

The positive momentum imbedded in the markets failed to carry over into the new quarter as traders and investors began to question whether the liquidity fueled rally of the past six months has gone too far, too fast.  The third quarter turned out to be one for the record books as the Dow Jones Industrial Average closed up 15%, the best quarterly performance since 1998, and the best third quarter performance since 1939.  However, markets rolled over very quickly as we entered the fourth quarter in anticipation of a poor report on unemployment. 

Source: Wall Street Journal

Traders’ negative sentiment on the September jobs report turned out to be correct as the economy posted a job loss of 263K, well in excess of the consensus 175K.  Since the recession began the economy has lost a net 7.2 million jobs.  The underemployment rate stands at 17.0% due to a growing number of people that are being forced to accept part-time work due to a lack of full-time positions.  Overall, September’s report offered little reason to cheer and even Ben Bernanke postulated that it will be a ‘very weak recovery for some time as many people will still find that their job security and their employment status is not what they wish it was.’

Source: Center on Budget and Policy Priorities

Although equity investors have been generally optimistic over the past six months, the Treasury markets are sending a different signal altogether.  Yields on the 10-year Treasury fell all the way to 3.1% before retreating to 3.2% in the face of this week’s excessive supply.  Regaled fund manager Bill Gross announced that he has been purchasing Treasury securities in anticipation of a deflationary environment in the coming months.  His fund, the Pimco Total Return fund, moved from 25% of the funds assets in government securities as of July to 44% as of the most recent month end. 

Even the International Monetary Fund (IMF) suggested that future economic growth will be limited.  The IMF’s World Economic Outlook is anticipating that last year’s crisis will permanently reduce future economic growth by as much as 10%.  Developed economies face a wider gap than the emerging economies but it looks as though no economy was safe from the destruction that occurred. 

Source: International Monetary Fund

Those Pesky Mortgages

This past week the Office of the Comptroller of the Currency and the Office of Thrift Supervision jointly released the second quarter 2009 Mortgage Metrics Report.  The report covers trends on about 64% of the outstanding mortgages in the US and provides a comprehensive snapshot of the state of the market.  Mortgage modifications have been the topic du jour lately as the government continues to struggle to find a way to prop up the flailing housing market, but unfortunately, it looks like current tactics are only serving to delay the day of reckoning. 

Loan modifications include everything from term extensions to rate reductions with rate reductions showing up as the most convenient and popular option for mortgage servicers.   Principal reductions represent a small sliver of the modification market.  Within three months of modification, slightly more than 25% of the modified loans were already 60 days delinquent.  Extend the data and the problem is even worse – 56% of mortgages that were modified in the second quarter of 2008 were delinquent within one year.  

Source: Wall Street Journal

Part of the problem is that banks are unwilling to add further losses to their balance sheets by reduce principal amounts, so instead, banks are offering small consolations to borrowers that are doing little to solve the problem.  Principal reductions only represent 10% of all loan modifications in the second quarter (although that is up from 3.1% in the first quarter).  If modification programs are unable to plug the hole in the proverbial dam then we may be faced with problem mortgages for years to come. 

The Week Ahead

With little economic news to focus on, investors will turn to earnings and Treasury auctions for direction.  Dow component Alcoa unofficially kicks off third quarter earnings season on Wednesday.  Analysts are looking for S&P 500 earnings to be down 22% on a year over year basis.  Positive earnings momentum will add a spark to the equity markets heading into year end.  51% of companies beat revenue estimates in the second quarter, following only 43% that were able to do so in the first quarter of this year. 

The Treasury is set to auction $78 billion in debt this week.  Included in the auctions are $7bln (Monday) in 10-yr TIPS, $39bln (Tuesday) of 3-yr notes, $20bln (Wednesday) of 10-yr notes and finally, $12bln (Thursday) of 30-yr bonds.  Friday’s weak employment report may actually help contain yields throughout this week’s auctions. 

Ben Bernanke will speak on the development of the Fed’s balance sheet on Thursday.  Overseas, the European Central Bank and the UK’s Monetary Policy Committee are meeting to discuss monetary policy in their respective regions.  No rate hikes are expected, but statements from both groups will be closely dissected. 

On Tuesday, the World Business Forum meets in New York.  Featured speakers include President Clinton, economist Paul Krugman, T. Boone Pickens, Jack Welch and a wide-ranging group of other business leaders.  

Quotable:         “For well over a century, business cycles have run an unceasing round.  They have persisted through vast economic and social changes; they have withstood countless experiments in industry, agriculture, banking, industrial relations, and public policy; they have confounded forecasters without number, belied repeatedly prophecies of a ‘new era of prosperity’ and outlived repeated forebodings of ‘chronic depression’.”  Arthur F Burns (1904-87), former Chairman of the Federal Reserve.

Lighter Side:

Source: Dilbert

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