Settling For Less in the New Normal

Good Evening: Just as they have during 9 of the past 10 sessions, U.S. stocks suffered a setback in the morning, only to rally late in the day. Unlike so many recent sessions, however, all the major averages remained in the red as the closing bell rang on Wednesday. A sell off in China, some weakish economic data, falling commodity prices, and a poor 5 year note auction gave Mr. Market a list of reasons to retreat today. That he cedes ground only grudgingly is a testament to the old gentleman’s resilience, but it may also mean a larger move (up or down) is coming. The VIX, for example, is proving just as resistant to decline as are the main indexes. PIMCO’s Bill Gross would argue that the old man would be well advised to keep his pulse in check until nominal GDP growth shows some resilience of its own.

The big news overnight was not earnings related, but China related. Whispers are flowing from Beijing that the central government either is, or soon will be, attempting to rein in the breakneck pace of lending by that nation’s banks. I have no idea whether these rumors will prove to be true, but they were given currency by a 5% fall in Chinese stock prices today, as well as by the large thumping delivered to the types of commodities China loves to consume. Then again, these moves could simply be a corrective head fake after long upside runs, so market participants will be watching China’s next PMI number (Thursday night) for clues. Since Chinese demand has been the fertilizer to the green shoots spotted here and in Europe, any threats to that demand will likely have a cooling effect on global risk appetites.

U.S. stock index futures were thus on the defensive this morning when word hit the tape that Yahoo! and Microsoft had finally struck a deal. In an interesting display of how things have changed over the 20 month courtship between the two companies, Yahoo went from being the subject of a $40 billion takeover to simply sharing some search assets with MSFT. No cash will be changing hands, so Microsoft will be getting most of what it wanted from Yahoo, while YHOO’s shareholders are left to wonder why its former CEO didn’t simply hit a bid and get a check back in 2007. Above $34/share back when the takeover talk was thick, YHOO today finished just north of $15. Settling for less than one had hoped (just ask anyone trying to sell a home) has become a theme since the great tumult arrived, and what happened to Yahoo! is emblematic of our times.

Stocks opened 1% lower this morning before recouping most of those losses. Durable goods orders sent a mixed message, with the headline figure a disappointment and the ex-transportation figure an upside surprise (see below). The Fed’s Beige Book was similarly filled with positives and negatives for analysts to argue over, but after the morning lows more or less held this afternoon, the major averages rallied into the bell. As they did yesterday, energy and materials names weighed on the averages. For once, though, the indexes were all moving together, and the final losses ranged from the Dow’s 0.3% to the Russell 2000’s 0.65%.

Treasurys were up when stocks were down this morning, but they, too, finished mixed after a poor 5 year note auction. Both the bid to cover and indirect bidder ratios were much weaker than in other recent auctions. I guess that’s what happens when a government offers record amounts of new paper. The dollar built upon yesterday’s rally and finished 0.7% higher, a fact which only encouraged further liquidation in the commodity pits. The rumors from China and the firm greenback were already conspiring against commodities when a report showing a huge build in crude oil inventories knocked that market for a loop. Falling energy prices were the biggest factor in today’s 2.7% drubbing suffered by the CRB index.

Tonight I’d like to discuss two different articles that came out today, and while the authors (Barry Ritholtz and Bill Gross) may not have much in common, they both would like to remind investors not to get too carried away with the recent batches of less poor economic data. Barry’s gripe has to do with the latest housing data, and it’s posted on his fine website, The Big Picture (see Permalink below). I’ll let Barry tell the tale in his own words, but the key point to take away is that the reported rise in the June new home sales figures was less than meets the eye. New home sales for June of 2009 were in fact the worst totals for any June since 1982. Barry offers multiple charts to buttress his main point — that a return to “a healthy market cleared out of excess inventory with genuine price increases is likely years away . . .”

PIMCO’s Bill Gross would also like to waggle a finger at those who think global warning better describes the current investment climate. Though many investors may think they’ve found a “love potion” in the frisky stock market action since March, Mr. Gross warns folks not to be led astray by hope. He contends that our leveraged economy was structured to live in a world of 5% nominal GDP growth, a rate he sees as unattainable in the “New Normal”. Returns on risk assets will suffer in this environment, Gross says, and those who hope all the government’s efforts at stimulus will return the U.S. economy to status quo ante are bound to be disappointed.

There are what he calls “quality constraints” (i.e. collateral haircuts and actual down payments!) on most of these federal lending programs, and he sees nominal GDP settling in around a sub par 3%. He wraps up by saying that “a 3% nominal GDP ‘new normal’ means lower profit growth, permanently higher unemployment, capped consumer spending growth rates, and an increasing involvement of the government sector, which substantially changes the character of the American Capitalistic model”. Rather than a love potion, it would seem Doctor Gross is prescribing a dose of the Cod Liver Oil remedy of past generations. Well, just as Yahoo’s shareholders realized today, I guess we’ll all have to settle for less in the “new normal”.

— Jack McHugh

U.S. Markets Wrap: Stocks, Treasuries, Oil Drop, Dollar Rises
U.S. Durable Goods Orders Rise Excluding Cars, Planes
Worst June New Home Sales Since 1982, by Barry Ritholtz
Investment Outlook: Investment Potions, by Bill Gross, PIMCO

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