Reality Settles In

Daily State of the Markets 
Wednesday Morning – February 3, 2010  

Good morning. As I have mentioned a time or twenty over the years, the goal of our morning missive is to attempt to identify the driving forces behind the market’s movements. While there were lots of stories during yesterday’s market, it is my humble opinion that reality is settling in over the corner of Broad and Wall. In short, it is the reality that the administration can’t just ram through legislation (on any front) that helped stocks to a second triple-digit gain on Tuesday. And it is the reality that both the economy and the earnings picture are improving that just might help the bulls out in the future.

We’re of the mind that the recent 6.6% pullback was triggered by the fear of what politicians might do to the banks and/or any other sector that could fall out of favor. Sure, stocks were overbought and due for some corrective action. But an overbought condition by itself is never enough to actually start a decline. No, there needs to be a trigger. And from where we sit, it was the political backlash that stemmed from the Republican win in Massachusetts that was what the bears needed to get something started.

The administration effectively declared war on Wall Street by announcing new taxes on the banks and then announcing that banks would be forced to change the way they do business. Thus, it wasn’t surprising that the fear of what the politicians might do next wound up being the reason the selling in the stock market started a few weeks back.

However, when Barney Frank said he wasn’t so sure he supported the administration’s plans to change the banking system right here, right now, reality began to sink in. And then when Senator Dodd said that Obama’s grand plan for the banks might make it tough for him to get any financial regulatory reform accomplished on a bipartisan basis, once again, the reality of life in Washington began to sink in on trading desks.

So, while we find the Volcker Rule to be a sound idea, the reality is it probably isn’t going to get done in its present form – if at all. And in light of the fact that the stock market is fairly fond of gridlock in Washington, this new reality is music to the bulls’ ears.

The other big reality that traders are being reminded of at the moment is that the economy is indeed improving. Comments from the CEO’s of UPS and Cummins certainly support the newly rediscovered economic reality. On the UPS (UPS) conference call, the company said that it looks like the recession is finally over. And then Cummins (CMI) mentioned that is can see consistent profit growth returning after 2010.

But to play devil’s advocate, we should probably point out that stocks are continuing to mirror the movements in the dollar. And as you might have guessed, the dollar has been in decline over the last two sessions. So, this remains something to watch going forward.

Turning to this morning, we got mixed results on the jobs front. First, ADP reported that the private sector lost 22,000 jobs in January, which was better than the consensus expectations for a decline of 30,000. The December ADP Employment report was revised higher to show a total decline in jobs of 61,000, which is an improvement from the original report of 84,000.

However, Challenger, Gray & Christmas reported that employers announced plans to cut 71,482 jobs last month, which was above the 45,094 seen in December.

Running through the rest of the pre-game indicators, the markets were higher in Asia and are hovering around breakeven in Europe. Crude futures are down $0.29 to $76.94. On the interest rate front, we’ve got the yield on the 10-yr trading higher at 3.68%. Next, gold is moving down by $5.60 and the dollar is lower against the Yen and Euro but higher against the Pound. Finally, with about 45 minutes before the bell, stock futures in the U.S. are pointing to a modestly lower open. The Dow futures are currently off by about 40 points; the S&P’s are down about 6 points, while the NASDAQ looks to be about 9 points below fair value at the moment.

* Report includes items that make comparisons to the consensus estimate questionable

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