The Dow tops a psychological milestone

The bulls have been gunning for the Dow’s all-time high for several weeks, and on Tuesday, positive sentiment finally helped the oldest and best known of the major market averages close above a threshold that hadn’t been seen since Oct 2007.

Yes, it may be just a psychological barrier, but it’s one that gets plenty of attention. And today, in a rocky session, the Dow added another 42 points.

General themes that have been driving equities higher include:

· Slow but steady economic growth

· Profits are topping a low hurdle

· Quieter credit markets in Europe (more of a removal a roadblock)

· The search for yield

· A very accommodative Fed policy

· The renewed interest in LBOs and mergers

· A sense that China’s economy won’t stall

· Europe is expected to exit its recession later in the year

· The fiscal cliff was avoided at the beginning of the year.

Are there risks? You bet. Some include the possibility that European credit markets could flare-up again, China could experience a hard landing, or the U.S. recovery could stall.

Cliff diving

Bad news continues to dribble out of Europe, and there is always the ever-present worry about corporate profits and how the global economic slowdown will hit the bottom line.

But the major players in the upcoming fiscal negotiations appeared to be digging in their heels on Wednesday, suggesting a protracted battle is brewing over the fiscal cliff.

That’s not what the Street wants to hear. Still, it shouldn’t come as a surprise as an emboldened president and a tax-averse House Speaker unveil their opening positions.

On Friday, a meeting of top Democrats and Republicans ended on a more conciliatory note in what are sure to be difficult talks.

Looking skeptically at September’s unemployment rate

The unemployment rate unexpectedly fell in September by three ticks to 7.8%. Most economist had anticipated an unchanged reading or a small rise to 8.2%.

In the meantime, nonfarm payrolls rose by a muted 114,000 last month. That was generally in line with expectations given the weak economic recovery. Further, the private sector managed to generate just 104,000 jobs.

So what gives? Why the outsized drop in the politically sensitive indicator?

The unemployment rate did not decline due to discouraged job seekers leaving the job market, which has occurred in some of the prior reports.

In fact the rolls of the employed rose by an astounding 873,000 (including 582,000 part-time workers), according the the household survey!



Quirks in seasonal adjustments?
The last three years have recorded outsized gains in part-time employment September, which then washes out in October.




The BLS might want to review their statistical models.

The Fed–shoot now, ask questions later

The markets had anticipated the Fed would act, but the magnitude of the FOMC’s open-ended commitment to increase its balance sheet was met with a bullish stampede today.

And it wasn’t just stocks. Oil, gold and a host of other commodities gained ground.

The Fed is trying to reflate, and it won’t stop until it sees substantial progress in the labor market. In fact, the Fed’s statement was clear:

“If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.”

So it's not just looking for improvement. The Fed will continue its bond purchases until it sees "substantial improvement."

At least publicly, it does not believe it will materially add to inflation, but the key question is whether its latest path will aid the economy and move the needle on the unemployment rate.

QE1 and QE2 - or $2.3 trillion in bond buys - have failed to significantly lift the economy. Bernanke even acknowledged in his press conference that "I don't think our tools are that strong."

The Fed chief has said before that monetary policy is not a panacea, but that was an interesting remark as the central bank embarks on a new chapter.

The 3 E’s–Earnings, Economy and Europe

While investors brace for the upcoming earnings season, Europe, and Spain in particular, are still on the radar, while the economy remains front and center.

Sluggish growth has liquidity-addicted traders hoping for a lifeline from the Fed, but the latest minutes the last meeting offered few concrete signs that a new burst of liquidity is on the way.

A few Fed members thought “further policy stimulus likely would be necessary,” but  several others felt new actions “could be warranted if the economic recovery were to lose momentum.”

The Fed will never send a definitive signal of future action, but traders were hoping for something a bit stronger.

With interest rates at a record low, however, many doubt a flood of new cash into the financial system would have much impact on the real economy.

Spain’s bailout–the thrill is gone

A hastily announced bailout of Spanish banks last weekend – to the tune of up to €100 billion ($125 billion) – managed to spark a rally in the Dow that lasted barely an hour on Monday morning.

As we’ve seen in the past, the devil is in the details, and surging Spanish, and to a lesser extent Italian bond yields, are reflecting a market that was not convinced Europe is turning the corner.

Stocks, however, have posted decent gains thanks to growing expectations that the Fed will offer up new measures at its meeting next week.

Further, a report yesterday by Reuters that global central banks may act in a coordinated fashion if credit markets significantly tighten following next Sunday’s election in Greece also supported sentiment.

Attention is now turning to the parliamentary elections in the Hellenic Republic this Sunday. A victory by pro-austerity parties would likely soothe concerns, especially if a coalition can be formed.

However, if the radical left comes out on top, fears of a Greek exit from the 17-nation currency could further jar markets, barring any central bank intervention.

A discouraging nonfarm payrolls report

Nonfarm payrolls rose a disappointing 69k in May, less than half what was expected; June revised downward from 115k to 77k

The unemployment rate rose from 8.1% to 8.2%.

The internals of the nonfarm payrolls number were poor.

I’m hearing some chatter that this is still weather-related payback from a mild winter?  So let’s look at some of the numbers.

· The service sector produced 218k in Feb, including 89k in professional and business services in Feb.

But in May those categories fell to 97k and -1k, respectively.

It’s hard to argue that a hiring manager in a high-rise looks out the window and checks the Weather Channel before making his/her hiring decision.

If there is a silver lining, the household survey that measures the unemployment rate showed a 422k rise in employment, but a 642k increase in the labor force produced the 0.1% increase in the unemployment rate. Pick up in June activity?

This is a volatile measure of employment and markets ignored it. DJIA futures went from -100 to -200 in the blink of an eye, and the 10-year Treasury fell from 1.53 to 1.48%.

The Fed –

This raises chatter of QE3, but the 10-yr is already near 1.5%!

If the Fed wants to get rates down, Europe and economic worries are accomplishing this. However, the action in the bond market, coupled with weakness in employment and commodities is troubling. And low rates just aren’t jump-starting growth.

That a monetary policy that focuses on asset appreciation. Still, there’s only a tenuous link between higher stock prices and consumer action. And the blunt action of Fed bond buys could reignite commodity inflation.

But if the Fed moves ahead, purchases of mortgage-backed securities may be considered, as the 30-year fixed mortgage has badly lagged the drop in the 10-year Treasury.

One last point, action in commodities and the recent “collapse” in 10-year yields is worrisome. The bond market, which does a better job than the stock market in terms of future activity, is screaming the “R” word.

Bernanke’s testimony next Thursday now becomes an even bigger market event.