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Mid-Week Analysis

Mortgage Applications
Total Manufacturing Industry  Shipments
Construction Spending

This week certainly marks a continuation of unsettled conditions in the U.S. equity market. So far this week, the Dow has gained 1%, while the S&P500 is largely unchanged. Economically sensitive issues are significantly outperforming, with the Transports gaining 2% and the Morgan Stanley Cyclical index jumping 3%. The Morgan Stanley Consumer index is unchanged. The small cap Russell 2000 and the S&P400 Mid-Cap indices have declined about 3%, while the high-flying Utilities have dropped 4%. After today's rally, the performance within the technology sector has been somewhat mixed, although certainly more stocks have been declining than advancing. The NASDAQ100 has declined 3% and the Morgan Stanley Technology index 1%, while the Semiconductors have actually gained 1% so far this week. Heavy selling has left the Street.com Internet index and the AMEX Biotech index 8% lower. The NASDAQ Telecommunications index has declined almost 3%. The financial stocks are mixed, with the S&P Bank index sporting a gain of 1%, while the AMEX Broker/Dealer index has dropped 2%. The financial stocks performed quite poorly today. It will be interesting to see if this marks an inflection point for this sector that has experienced very strong performance for the past quarter.

Credit markets are trading poorly this week as yield rise all along the yield curve. Two-year Treasury yields have added 3 basis points, 5-year yields 6 basis points, and the long-bond 5 basis points. The key 10-year Treasury has underperformed, with a jump of 8 basis points. After outperforming for some time, mortgage-backs performed poorly today with yields increasing 6 basis points. For the week, both mortgage-backs and agency yields have jumped about 8 basis points. The 10-year dollar swap spread has fluctuated wildly, narrowing four basis points yesterday and then widening four basis points today. We would assume such volatility is indicative of derivative-related trading programs. The dollar has generally advanced about 1%.

And while the marketplace and media focus has been on a faltering technology sector and increasing credit-quality concerns, there is anther issue developing that is also market unfriendly. It is becoming increasingly clear that the economy remains extraordinarily strong, with many indicators actually pointing towards acceleration over the past two months. Such a development is anything but conducive to the wished for "soft landing." With September auto data now in, it is clear that the great auto boom lives on. Sales were reported near a record annualized rate of 18 million units, about 1 million vehicles above Wall Street estimates.

A quote from Toyota's Jim Press sums up the situation: "There is no debating the strength of the economy, nor the importance of sustained consumer confidence on record-breaking industry sales."

Bloomberg quoted Paul Ballew, director of sales analysis for General Motors: "The industry is up 4.5% versus year ago. Key pluses are the overall health of the U.S. economy, and improvements in vehicle affordability. Sales in the third quarter were above our expectations, primarily because of vehicle affordability…we are on a record pace. We are going to test the 18 million threshold. We see some moderation in 2001, but it'll be minor. The calendar year as a whole has been running about 18.1 million units… We're not anticipating a fundamental adjustment in our production schedule. Our fourth-quarter production schedule is down slightly from year ago, but last year was a record year."

For the month, Toyota experienced its best September on record with sales 15% above last year, as well as its best third-quarter on record. Lexus sales were 24% above September 1999. It was also a record month for Honda, with sales almost 13% above last year. Honda's luxury Acura line saw sales jump 20% from a year ago. Nissan sales were 17% above last year, with its luxury Infinity line having its best September ever. It was also the best September ever for Mitsubishi, with sales 18% ahead of last year. Sales surged 37% at Hyundai. It was not, however, just the Asian manufacturers that posted huge months. BMW sales ran 30% above a year ago, and at Porsche sales surged 41%. Mercedes-Benz and Audi had their best Septembers in the US ever, while Volkswagen had its best September in 27 years.

It was also a record September for DaimlerChrysler, with sales 5% above a very strong year ago period. Total truck sales were 20% above year ago levels, with record SUV and minivan sales. Sales were strong at Ford and GM, although slightly ahead of last year at Ford and somewhat below a very strong last September at GM. Overall, the "Big Three" saw their share drop to 64.7% from last year's 67.6. The Japanese share has increased two points to 26.4%.

Today, the Mortgage Bankers Association reported its weekly application index. The overall index added 4%, and was 11% above last year. Both the Purchase index and the Refinancing index increased 4%, with the Purchase index 11% above year ago levels. Yesterday, the Commerce Department reported August new home sales slightly below both July and last August. The average (mean) price was $203,000,with an inventory of 4.1 months. Thirty-four percent of new homes sold were priced above $200,000, compared to 30% last August. New home sales remain on track for the second strongest year on record. The S&P Homebuilding index has surged 55% since its trading low on July 24th.

Monday, it was a stronger than expected report on August construction spending, with total spending 5% above August of 1999, and 10% greater than August of 1998. Increased construction outlays were led by continued strong advances in government and commercial projects. Also Monday, the National Association of Purchasing Managers reported its Manufacturing Index at 49.9. Since the index was below 50, the media was quick to point out that this report pointed to another month of "economic slowdown." Well, digging into the data, we see that Production jumped from 48.7 to 52.1, Employment increased from 48.2 to 50.9, and Prices Paid added almost 2 points to 58.1. We do not see this NAPM as a "weak" report. And then today, there was a stronger than expected report for August Factory orders. This report was boosted by surging aircraft and defense orders, as well as an up tick in electronics and electrical equipment after July's notable drop. Orders for non-durables also posted a solid recovery after July's weakness.

Also today, the National Association of Purchasing Management's non-manufacturing index was reported at a stronger than expected 62. This index has bounced back two straight months from 55.5 reported in July. New orders rose to 61 from 59.5, and backlogs jumped more than 4 points to a record 56.5. Prices paid increased more than one point to a strong 60.5. MarketNews International quoted Ralph Kauffman, chairman of the NAPM's non-manufacturing survey: "I don't think there are signs of an appreciable slowdown in non-manufacturing. If manufacturing stays down long enough it's probably inevitable that the rest of the economy will slow down sooner or later, and perhaps even contract. But we're nowhere close to this situation."

Kauffman also stated that rising backlogs was related to bottlenecks in the supply chain. "Respondents said backlogs rose not because they couldn't get the work done, but instead due to difficulties getting materials from their suppliers."

We appreciate the cogent research comments from Scotiabank on the non-manufacturing survey: "The Trend: Healthy income growth continues to underpin demand for non-durable goods and services, adding further zeal to the non-manufacturing sector…comments from respondents indicate that business is picking up faster than expected, factories are near full capacity and that inventories are rising on fears of future price increase. All this suggests that activity outside of the industrial sector is very upbeat and should remain so for the balance of the year."

Recent data certainly supports our view of a continued hot economy, with problematic overheated demand. But, then again, why wouldn't the boom run with unrelenting historic money and credit excess? The slight moderation from a couple months back now appears little more than the "pause that refreshes." Accordingly, today's "Reality Check" column from MarketNews International caught our attention: "US Recruiters Say September Job Orders Rebounded." Quoting John Bowmer, CEO of "Adeco SA, the world largest staffing firm," "there is no slowdown - things are good out there - there's no significant change in the temper of our business…the job market is not significantly different from where it has been overall - it may be up or down .1%, but I've seen no major change. The shortage is still with people, not jobs. There's still a bigger demand than supply."

"A Chicago-based recruiter said he saw an acceleration in demand in September prompted by an over-reliance on summer internship programs that left employers holding the bag once the fall semester began. ‘Corporations are struggling to find help - orders are far exceeding the number applicants available - we're back to where we were in May. Those internship programs gave employers a break for the summer. But that loosening was transitory - and with ‘no signs' of economic slowing, employers are now losing ground when it comes to recruiting. We're back to business as usual."

A Dallas-based recruiter stated, "There's no letup in job orders. I can tell you September was a whole lot stronger than it was a year ago…I keep expecting to see a slowdown based on what I read in the financial pages. I'm on the lookout for any major negative trend. I saw a little negativity back in July, but August and September bounced back with such a vengeance that my gut concern dissipated." The CEO of Outsource International noted "a strong recovery in demand for manufacturing jobs in the last 45 or 60 days. Most of that is coming from our construction business and distribution business (which includes retail distribution). We're seeing strong demand." MarketNews also noted an executive of Manpower, "after being concerned about the overall direction of the economy earlier this summer…is now feeling more optimistic." The executive stated: "We are living in a rate-tightened environment with energy costs at significantly higher levels from where they've been for the last couple of years. I did see some slowing in July and August but any nervousness I had about the month of September was unfounded."

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