MarketView for September 11

Summary   

Stock prices were a bit lower on Friday after posting five straight days of gains as the rally started to show signs of fatigue along with a drop in crude oil prices. A modest pullback was expected despite strong data on consumer spending and a positive outlook from FedEx. October crude oil futures slipped more than $3.00 to $68.83 due to a rise in refined fuel inventory. Chevron rose fell 1.2 percent to $70.58 and was the top drag on the Dow. Exxon Mobil (XOM.N) also shed 1.2 percent to $69.83.

The Reuters/University of Michigan Surveys of Consumers, indicated that consumer sentiment rose more than expected in early September, moving to its strongest level in three months. The Reuters/University of Michigan Surveys of Consumers said the preliminary reading of its consumer confidence index for September rose to 70.2, the highest since June, from 65.7 in August.

FedEx Corp added to the growing sense of economic recovery when it said profits would be higher than it had earlier expected, citing an improving economy and fuel prices.

Shares of Morgan Stanley rose 1.7 percent to $29.13 after Citigroup raised its price target on the stock, and a day after it said its chief executive would be stepping down. Medtronic fell 2.1 percent to $38.21 after the company said it was warning doctors about problems with 6,300 implantable heart devices because the batteries in the devices drain sooner than normal.

Wholesale Inventories Fall

Businesses reduced inventories at the wholesale level for a record 11th consecutive month in July, although sales rose by the largest amount in more than a year, according to government data released Friday.

Rising sales should help convince businesses to stop slashing inventories and increase their orders for more goods, a shift that would boost production at America's beleaguered factories and aid a broader economic recovery.

The Commerce Department said wholesale inventories declined 1.4 percent in July, more than the 1 percent drop economists expected. But that decline followed a 2.1 percent fall in June, down from the 1.7 percent drop originally reported.

Sales at the wholesale level rose 0.5 percent in July, making it the fourth consecutive increase and the largest gain we have seen since the’ 2 percent jump in June 2008.

Wholesale inventories are goods held by distributors who generally buy from manufacturers and sell to retailers. They make up about 25 percent of all business stockpiles. Factories hold another third of inventories and retailers hold the rest.

The July inventory drop left the inventory to sales ratio at 1.23, meaning it would take 1.23 months to exhaust stockpiles. That was slightly lower than the 1.25 ratio in June, but still above the 1.13 inventory to sales ratio of a year ago.

The rise wholesale sales come amid continued weakness at many retail establishments, which reported lackluster back-to-school sales in August. However, automakers saw a spurt in activity from the government's popular Cash for Clunkers program.

August Budget Deficit Lower Than Expected

The government on Friday posted a smaller-than-expected $111.40 billion budget deficit for August, marking a record-matching 11 straight months of deficits. The August budget gap was well below expectations and was slightly smaller than the year-earlier budget gap of $111.91 billion. A Treasury official said some $25 billion in August 2009 federal benefit payments were shifted to July,

With one month to go in the 2009 fiscal year, which ends September 30, the deficit stood at a record $1.378 trillion, versus a same year-ago deficit of $500.53 billion. The White House budget office on August 25 forecast a $1.58 trillion deficit for the full 2009 fiscal year, implying that September, in normal times a surplus month, would produce a deficit of more than $200 billion.

A September deficit would mark a record 12 consecutive months of deficits. Only three other times has the United States racked up 11 consecutive monthly deficits, July 1982 to May 1983, May 1986 to March 1987 and May 1991 to March 1992.

The Treasury said receipts for August fell to $145.54 billion from $157.02 billion a year earlier, marking a 7.3 percent decline. For the first 11 months of the fiscal year, receipts are down 16.2 percent to $1.885 trillion from $2.251 trillion, as the economy struggled through the worst recession since the 1930s Great Depression.

Outlays for August fell to $256.94 billion from $268.93 billion a year earlier. For the fiscal year to date, outlays, driven largely by spending on economic stimulus and financial rescue programs, are up 18.6 percent to $3.264 trillion.

When and How Will It End

There is little argument against the theory that diversification, defined as buying different asset classes on the expectation that profits in some will help to offset losses in others for any given set of economic circumstances. The difficulty for some is that with gold at 18-month highs, equity prices rising rapidly off recessionary lows and a rally in the bond market sending yields on some debt to their lowest point since July, the investment climate is anything but typical.

The worst global economic contraction in decades prompted low interest rates around the world and central banks, including the Federal Reserve, to take the extraordinary precaution of buying the debt of their own government in a bid to keep liquidity in the system. However, the question then becomes one of where and when does much of that liquidity disappear.

As economies recover, that liquidity has to find a home of some shape or type. The big question is how long this atypical investment climate will continue. The answer depends to a great extent on when central banks end those extraordinary actions, known as quantitative easing (QE), and why they end it.

Spot gold is up 14 percent year to date, the benchmark Standard & Poor's 500 index .SPX is up 15.5 percent while the dollar index .DXY, the dollar against a basket of six currencies, is down 5.5 percent. The dramatic run-up in bond prices has occurred despite the dollar deteriorating, data showing further economic stabilization and Wall Street hovering at a one-year high.

Bond bulls say the economy remains vulnerable with consumers restraining their spending as they try to heal household balance sheets battered by fallen home values and shrunken stock portfolios. Gold, meanwhile, has benefited from a decline in the U.S. dollar with recovery hopes fueling interest in currencies seen as higher risk.

Those same hopes are helping to send stock markets higher on expectations that economic recovery will boost corporate profits.

Ending QE because of a return to worldwide economic growth would be an acknowledgment that the crisis is past. Markets should begin to function normally with investors buying one asset class at the expense of another while the Fed begins to mop up liquidity. Improved economic demand would likely benefit stocks, to the detriment of the bond market.

Alternatively, if QE is left too long and the global investment climate becomes inflationary, financial markets could be in for another period of turmoil, one that could negatively impact bonds and stocks.