Farrell: A Thin Reed of Hope, But It's A Start

Could temporary become permanent?

Earnings this quarter are coming in better than expected. As of Monday Reuters reported that 79% of those companies that had reported beat expectations. On Tuesday a raft of companies joined the hit parade. Caterpillar reported $.64 when $.06 had been the consensus. Apple , Pfizer ,United Technologies , and DuPont also exceeded estimates. And most companies did this with revenues well off of last year's comparable quarter and, while revenues are a bit better than most analysts estimates for the current quarter, the financial performance is telling. Costs have been pared down to the extreme and it looks like employment rolls have been cut too far. Productivity is up more than you would have guessed and if there were to be any increase in final demand, I would bet the need for additional workers would be almost immediate, although it would be resisted at first.

When business starts to recover from a depressed state employers are reluctant to hire full time workers. What we need to look for would be an increase in the average work week which would imply those that have jobs are working overtime. We would also see a rise in the number of temp workers since employing them is a way of avoiding paying benefits. Temporary employment surveys are showing a hint of improvement. The recent N.Y State Empire Manufacturing Index and the Philadelphia Index showed manufacturing employment was up a touch. While manufacturing is not the engine of the economy it once was, every little bit helps. Very short term we will be looking at the weekly initial unemployment claims. They are still above 500,000 a week but have finally shown some signs of starting down (they are reported every Thursday morning). If the earnings gains stick we could see actual job gains perhaps as early as the beginning of next year. This is more a guess than anything else and is a thin reed of hope, but it's something.

The global economy, according to a recent report by JP Morgan, shrank at an annualized rate of -7.5% in this year's first quarter. It has rebounded to a growth rate a bit better than 3%. The "emerging markets" are leading the way (Singapore just reported its third quarter grew at a 14.9% rate.) Chinese officials confirmed they believe this year will show 8% or better growth and many expect low double digit. The risk is that it is fueled to too great an extent by government stimulus but, nevertheless, it is working. Chinese exports are up by a third the last six months and imports are up quite a bit more in percentage terms. China saw car sales of more than one million last month and that is by far a record. Global Industrial Production is still way below its recent peak of 117 reached in early 2008, but at Augusts' level of about 100 it is well off the recent bottom of 80.

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Business inventories in the U.S. fell -1.3% month over month in August and are off at an almost double digit pace the last few quarters. To illustrate what inventory liquidation can look like, examine the above mentioned Caterpillar's report. CAT said dealer inventories have fallen by $2.6 billion this year. They think it might bottom out with a total decline of $3 to $3.5 billion by the end of the year. If inventories shrank by $3.5 billion, levels would be half of what they were as recently as 2008. In CAT's case, a pickup in demand would be tough to satisfy.

If inventory liquidation were to just stop, GDP would receive a nice pick up. Inventory rebuild tends to happen quickly and its simulative effects are shorter term in nature, but the timing could be good as most of the government's stimulus package will be spent in the next ten months or so as well. That bodes well for a continuation of good earnings.

And interestingly, despite the dollar's weakness, the Chinese have increased their holdings of longer dated U.S Treasury paper. The Treasury International Data Capital report-TIC- showed Chinese holdings of all U.S paper fell slightly by $3.4 billion last month to $791.1 billion. Such minor movements are common. Net purchases of longer term paper increased by $15 billion after being up by the same amount the prior month. Short term Treasury bills saw a net liquidation of $19 billion. Dollar denominated assets are still the asset of (reluctant) choice since no other market has anywhere near the size and liquidity.