The Overnight Report: Awaiting US Unemployment

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By Greg Peel

The Dow closed down 24 points or 0.3% while the S&P dropped 0.6% to 998 and the Nasdaq fell 1.0%.

The Dow just about spent all day in the red last night, falling to as low as down 72 at 2.30pm before yet more late buying, particularly in the banks. The S&P 500 nevertheless fell 0.56% to the Dow 30’s 0.27%, such that an equivalent fall in the Dow would have been more than 50 points. This took the S&P under the psychological 1000 level. The Nasdaq 100 is still suffering from having run harder than the other two indices in the recent rally.

Late bank buying was assisted by an announcement from American Express late yesterday that the rate on credit card losses was slowing. Credit card bad debts are considered “Phase III” in any recessionary cycle, such that big corporate name implosions are a leading Phase I, a big group of small name implosions are a coincident to lagging Phase II, and consumer implosions are a lagging Phase III. If credit card write-offs are already slowing, this is good news. American Express shares were up 3%, assisting the Dow in its lesser fall.

The broader banking sector was aided late in the day by Citigroup (a Dow evictee), which rose another 6% as the big index tracking funds continue to adjust to Citi’s upgraded weighting due to its debt/equity swap (see yesterday’s Overnight Report).

If credit card debts are falling, that would be supported by retail sales numbers. Last night saw the bulk of major retail names report their July same-store sales figures, and a calculation by Goldman Sachs analysts put the average fall at 5% year-on-year. This is a big drop compared to the sort of numbers being reported at the point where this rally began in March. However, in earlier months the figures were boosted by Wal-Mart’s result. Wal-Mart is clearly a consumer staple stock, and not a consumer discretionary, so its results did tend to slightly skew the picture.

But then around mid-year, Wal-Mart stopped reporting monthly sales numbers. Revising the same-store averages to exclude Wal-Mart shows the July fall represents eleven straight months of declines. Analysts argued over why the July figure was so weak, and one suggestion was that the extremely popular “cash for clunkers” program has sucked discretionary money away from other items. Another argument notes that inventories are now pared to the bone, and thus sales numbers can no longer be boosted by clearance sales.

Clearance sales have been a feature of 2009, and they tend to boost sales figures but reduce earnings given below-cost pricing. July also marks the start of the “back to school” season – one of the most significant sales periods in the retail calendar. Retailers have responded this year with much slimmer offerings, and shoppers have also kept Johnny’s fancy pens, exercise books, notebooks (as in computers), back-packs and Bata Scout shoes with animal prints on the sole and a compass in the heel (Do they still have those? Mum would never let me have a pair) to a minimum. And given the American public school system eschews school uniforms, fitting out little Johnny and little Jane (who are now two inches taller) for the year ahead can be a very expensive exercise. Apparel shops rely just as heavily on “back to school” as do stationers.

But Wall Street analysts have already been expecting weak sales, so last night’s numbers were not a complete shock. What analysts are now looking ahead to is inventory rebuilding. The retail sector has pared back its costs as well, which sets it up for more productive earnings on an inventory rebuild. But shops will not be rebuilding inventories until they see a pick up in sales to justify the risk.

The key to that is unemployment. Unemployment has been a very important economic indicator all through 2009 as one would expect, but as most other aspects of the US economy are now showing improvement (but not sales) then Wall Street will be hoping for signs of slowing in lagging unemployment growth as well. Unemployment hit a multi-decade high of 9.5% in June, and analysts were pencilling in 9.7% for July, although consensus seems to have pulled back to 9.6%.

Last night saw the weekly jobless claim numbers, and there was good news. New jobless claims fell by 38,000 to 550,000, but more importantly the four-week running average fell to 555,250 to continue the recent trend of reduction in this number. History shows that the end of a recession is nigh when new jobless claims peak. There was one spanner in the works, however – continuing claims had fallen in each of the previous three weeks, providing support to the peak-of-trend theory, but last week that number grew by 69,000 to 6.3m.

The July unemployment figure is released tonight, and will likely hold the key to whether this rally has peaked for now, or only just warmed up.

Last night both the Bank of England and the European Central Bank announced monetary policy decisions. The ECB decided to leave its rate at 1%, suggesting that while economic contraction was clearly slowing, expectations of only tepid growth ahead did not justify a rate increase. Similarly the BoE left its rate on hold at 0.5%, but given some improved data recently (the manufacturing index ticked over 50 last  for example meaning no more contraction) economists were anticipating the central bank would begin to rein in its quantitative easing efforts. It was not the case.

Instead, the BoE announced it would increase its bond purchases by an unexpectedly large 50bn pounds, implying that one of the world’s hardest hit major economies is still suffering under the surface. Some rather poor recent banking sector quarterly results do support this assessment.

This news sent the pound plunging against the US dollar, and the euro followed in sympathy. The dollar index thus jumped last night from 77.56 to 78.00. When the index reached into the 77s recently, it was hitting multi-month lows. This has had the effect of boosting commodity prices, providing the double-whammy along with perceived Chinese demand. The rise in commodity prices has also forced commodity funds to buy metals to reweight their portfolios, thus pushing prices higher still. But it rather came to a head last night.

Profit-taking after such a strong run was the order of the day in London, sending copper down 2% and everything else down 3-4%. Oil nevertheless held up, falling only US3c to US$71.94/bbl. The positive weekly jobs numbers helped, but in the last couple of days weather forecasters have been predicting that this year’s hurricane season – which begins about now – should be a mild one. This should have a negative impact on the oil price, but it’s hanging in there for now.

Gold was steady last night, falling only US80c to US$963.70/oz, while the Aussie is holding steady at US$0.8400 over 24 hours despite its blip yesterday on the back of Australia’s surprising jobs report.

Three factors have to be considered with regard to yesterday’s steady 5.8% unemployment number. Firstly, it was a great result. Secondly, it did not send the stock index up 50 points. It was already up 50 points at 11.30am and that’s where it closed. And thirdly, the steady figures must be taken in the context of hours worked, which continue to plunge. Over the last few months the clear trend has been that employers are reluctant to let employees go, but have compensated for a weak sales environment by reducing the number of hours those employees work (and get paid for) each week.

If Australia’s workforce were a Roman legion, you might say that instead of the legion being decimated each soldier has had one hand tied behind his back. This bodes well for future battles, when those ties can quickly be released. But in the Australian workforce, the near term outlook still suggests less money in the pocket. The good news is a lower actual unemployment rate should mean less mortgage foreclosures.

The SPI Overnight was down 17 points or 0.4%.

Earnings watch today: Minara Resources ((MRE)) and ResMed ((RMD)). It’s a Friday – profit-taking after the big run? I said that last week and was run over by a steam train.

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