Kevin Spires, CFA, FRM

Obama's reelection odds at www.intrade.com took a slight hit with the announcement of Paul Ryan as the vice-presidential choice for Mitt Romney, but held steady through the Republican convention.  The odds stand at 56.7% heading into the Labor Day holiday and the Democratic Convention next week.  The election season will take off in earnest next week and the next 60 days should be interesting to say the least.

I believe that this election will have profound effects on financial markets over the next 5-10 years.  An Obama reelection will lead to a consolidation of the massive advances that Central Planning has made over the past 10-12 years (Yes, the Bush Administration saw a number of advances for Socialism, including the Medicare Prescription Drug Program, No Child Left Behind, TARP, the creation of Homeland Security and the TSA, and the appointment and reappointment of Ben Bernanke - the most interventionist Fed Chairman in the history of the Federal Reserve). 

In the medium term, more government equals less growth.  Over the course of a
decade, this will pass through to less corporate profits and lower returns to equities.  I would lower my average 10 year real GDP growth rate expections from 2.75% to 2.00% based on a consolidation and continuation of the past decade's growth in the Federal Government.

Kevin Spires, CFA, FRM

The US Housing Market has put on an impressive run in the past 12 months.  Housing Starts are up 21.5% Y/Y, with completions up 5.4%, and homes under construction up 17.0%.  New Home sales have risen 26%+ over the past 12 months driving inventories down by 14.5%.

Despite all that wonderful data, the US Housing recovery is still in its infancy.  Housing Starts are still 50% below normal levels - implying an additional 100% growth in starts over the new few years.

Continued strong growth in the near term is expect as the NAHB/Wells Fargo Housing Market Indicator (HMI) has accelerated higher over the past 3 months.  Housing Starts, which lag the HMI by 2-4 months, should further accelerate in the next 1-2 months as well.

With the increased activity levels, Home Prices look to have bottomed as well.  Further sentiment increases as measured by the HMI could lead to some modest increases in Home Prices after a brutal 6 year decline.

All this impressive data has led to strong performance by Housing Sector stocks.  XHB, a Housing Sector ETF is up 30%+ relative to the S&P 500 and up an impressive 65% over the past twelve months.

Click on our Monthly Housing Sector Chart Package for more data...

Kevin Spires, CFA, FRM

Included in the 2nd Quarter GDP update this morning was the first look at economy wide corporate profits.  In my mind, the first shot across the bow presaging the next recession has been fired.

Domestic Corporate Profits, as reported by the Bureau of Economic Analysis, are highly correlated to the S&P 500's Earning Per Share (EPS). 

Q2 Corporate Profits, after tax, were down slightly from the first quarter, and are down 10.9% from their peak in the 4th quarter of 2011.  Much of the swing is due to the expiration of accelerated depreciation allowances - which were lowering profits and taxes, but even accounting for those adjustments, overall profits look like they have peaked.

If Corporate profits have peaked, look for them to mean revert over time and fall back to their long term average - which would imply a fall of 25% from current levels.  Peaks in Corporate Profits have a good record of leading peaks in GDP growth over the past 40 years - usually by at least 6-8 quarters.

I have been dismissive of calls for a double dip recession based in part on the strength in Corporate Profits.  A sustained drop in profits would be the first real shot across the bow of this recovery.  All the noise of Europe, flash crashes, Debt Ceiling Debacles, and the Japan Earthquake/Meltdown supply shocks were meaningless in the face of low interest rates and growing corporate profits.   With the peak in Corporate Profits, one of the preconditions of a recession is now in place -

While the www.intrade.com election odds of President Obama are below their recent highs, they are still holding above 50% at 57.6%.  I fully expect this election to be tight up to the end.

 Kevin Spires, CFA, FRM

The Federal Reserve just released the results of its quarterly Senior Loan Office Survey(SLOS).  The results show continued easing of credit conditions across the vast majority of Real Estate, Commercial and Industrial Loans (C&I), and Consumer Loans.  Demand continues to be strong across most categories as well. 

The SLOS is a great predictor of C&I loans.  The SLOS conditions for medium and small business loans leads C&I loan growth by 4-6 quarters.  Loan conditions have been easy enough to support 10-15% loan growth since the summer of 2010.  Conditions will continue to support credit creation over the next 4-6 quarters.

There is no evidence of a credit crunch in the SLOS data.  One interesting tid bit is that the FOMC had the SLOS data in hand for their last Open Market Committee meeting last week. 

It is very difficult to argue for QE3 when credit conditions are this supportive of credit creation.  The recent acceleration in Money Supply and Bank Credit should continue based on the Senior Loan Officer Survey.  This data alone should have been enough to stop the Fed from embarking on further Quantitative Easing.  It may be a bit premature to call Mission Accomplished, but the way I read the data, the Fed should be moving towards a normalized policy stance, not trying to ease further.  Talk of a recession is fanciful and I think by year end, the chatter will move back towards the timing of the next Fed tightening and QE3 will have a stake put

With the S&P 500 (represented in the chart by the SPY ETF) approaching cycle highs, President Obama's reelection odds are back up to 58%.  Since the start of 2011, Obama's reelection odds have a 73%+ correlation to the SPY.

A strong stock market is a plus for Obama at this stage of the election.  If the S&P 500 is the best indicator of the economy's performance, then President Obama is a decent favorite to win reelection over Mitt Romney.

Kevin Spires, CFA, FRM

The ISM Manufacturing Survey results were reported this morning and the composite was 49.8 for July versus 49.7 in June. 

New Orders also dipped below 50 for the first time during the recovery at 48.0.  This is a bit ominous as it implies a contraction in Industrial Production growth could take hold in the next quarter or two.  The European Crisis and the looming fiscal cliff in the U.S. are causing weakness to seep into the Manufacturing Surveys.

I am a bit doubtful that this weakness will translate into a broader slump (based on employment, housing, and liquidity indicators), but the sharp contraction in new orders, if extended, would be a strong piece of evidence that a deeper slump was imminent.

Kevin Spires, CFA, FRM

The ADP Employment report was released earlier this morning and according to ADP, 163k private sector jobs were added in July versus 172k jobs added in June.

The ADP report is the single best predictor of the number of jobs to be reported by the government on Friday with a 92.5% correlation over the past 10 years.  The main difference between the Jobs Report released by the government and the report released by ADP is the additional count of government jobs by the government.
I strongly believe that the ADP report is a better report.  Their number is based on a count of actual payroll jobs that are processed through their system.  The government report is based initially on a survey that requires thousands of employers to self report their payroll numbers.  (Disclosure:  My wife's small business is a payroll survey respondent).  The government slowly revises the payroll count as it receives actual payroll tax data and it's count becomes better, but only with long lags.

Based on the ADP report, I would expect 150-175k total additions to payrolls to be reported by the Jobs Report on Friday, but anything 100k either side of that range shouldn't be a surprise.  The seasonals seem to be favoring greater job growth, with fewer auto manufacturing layoffs, but you can never discount the effect that the European Crisis and the looming fiscal cliff might have had on