Sunday, May 04, 2008

Weekly Wrap

Here is a copy of Briefing.com's Weekly Recap:

There were five trading sessions this week, but for the most part it ended up being a three-day work week. That's because things didn't get really interesting for market participants until Wednesday.

Sure, there was the news Monday that Mars is going to buy Wrigley (WWY) for approximately $23 billion and the news Tuesday that Mastercard (MA) had a blowout quarterly earnings report, but that, and other items like the FDA shooting down a new cholesterol drug from Merck (MRK), led to a James Bond-like trade in that the indices were shaken, but not stirred.

The stirring action was reserved for the latter part of the week, which brought the Q1 GDP report, the FOMC meeting and the April employment data. In addition, it also brought some noteworthy movement in the dollar and some volatile activity in the commodity arena.

If there was a theme to be identified beneath the action, it was one of reassurance. Specifically, there was reassurance that the economy isn't nearly as bad off as has been advertised. That said it's important not to confuse the message here. The economy isn't very good right now, but clearly, the recession so many alarmists have been talking about remains quiescent.

To begin, first quarter GDP was up 0.6%, driven by a 1% increase in personal consumption expenditures. Contrary to popular belief, the consumer continues to spend in the face of rising gas prices, falling home prices and declines in payrolls.

Importantly, the trends in personal spending, business investment and net exports suggest real GDP growth for the second quarter should be close to flat, but that is without the fiscal stimulus. The latter will provide a meaningful boost to consumer spending that should lead to real GDP growth in the range of 1% to 2%. In brief, things are shaping up in such a way that there won't be a decline in real GDP for any quarter this cycle.

The Fed appears to be feeling better about the economy's prospects, too. After cutting the fed funds rate Wednesday another 25 basis points to 2.00%, it issued a directive that was different in tone from prior directives. In particular, the directive omitted a prior reference to the idea that "downside risks to growth remain."

The Fed's statement acknowledged some indicators of inflation expectations have picked up, yet it stuck with its view that it expects inflation to moderate in coming quarters.

Overall, the Fed's directive implied it would now be in a wait-and-see mode and that the rate-setting committee would act in appropriate fashion to incoming data. However, in removing the downside risk phrase, the Fed left the impression that it would like to believe it is at the end of its rate-cutting cycle.

The stock market was in rally-mode ahead of the Fed decision and got an added boost shortly after the headlines hit the wires. In striking fashion, though, it sold off sharply late in the day and ended Wednesday in negative territory. The knee-jerk explanation was that there was disappointment in the directive and the idea that the Fed didn't sound more hawkish on inflation.

That explanation didn't fly with us seeing that the inflation-sensitive back end of the Treasury curve rallied after the decision.

Other probable causes for the sudden turn of events included the inability of the S&P 500 to hold above a key technical resistance point at 1400 and month-end selling activity. Whatever the case may have been, Thursday's trading action quickly confirmed that we were right to be skeptical of the mainstream excuse for the selling.

On Thursday the S&P 500 jumped 1.7% while the Nasdaq Composite soared 2.8%. Huge gains in the financial and technology sectors powered the advance, as did a noticeable drop in commodity prices that were impacted by a strengthening dollar.

For the week the dollar index advanced 1.0% while the CRB Commodity Index, which tracks 19 different commodities, slipped 2.3%. The CRB Index had been down as much as 5.0% for the week at its low on Thursday. Oil prices, which nearly hit $120 per barrel last Friday, dipped to $110.30 on Friday before rallying back sharply to close the week at $116.32. Gold prices, meanwhile, fell 3.6% to $862.10 per ounce.

The dollar's strength was rooted in the assumption that the Fed is likely done with cutting interest rates. The Fed showed Friday, though, that it isn't done with its efforts to improve liquidity to ease the pressures in some term funding markets. It raised the amounts available for depository institutions at its biweekly Term Auction Facility from $50 billion to $75 billion and said it will now accept AAA/Aaa rated asset-backed securities at its Term Securities Lending Facility Auctions.

Market participants seemed pleased with the Fed's announcement, but their focus Friday was primarily on the April employment report, which was better than expected on most fronts.
Nonfarm payrolls declined 20K (consensus -75K), the unemployment rate fell to 5.0% from 5.1% (consensus 5.2%), hourly earnings rose just 0.1% (consensus 0.3%) and the average workweek dipped a tenth of a point to an expected 33.7 hours.

The nonfarm payroll decline is statistically insignificant on a base of 137.8 million workers, but it was quite significant in that it indicated there hasn't been a deterioration in payroll trends, which is what is typically seen in recessions. There has been a 260K decline in nonfarm payrolls the last four months or an average of 65K. In the 2001 recession nonfarm payrolls declined 281K in the month of April alone.

Like the message we conveyed earlier, this employment report is not indicative of a strong economy. Still, in the context of eradicating the worst economic fears, it was very supportive.
The stock market made a nice move in the wake of the jobs report, but succumbed to some week-end selling interest that pared its gains considerably. Nonetheless, the market ended Friday's session higher to close out what technicians will see as a breakout week with the S&P 500 ending above 1400 and at its highest level since January.

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