A Cosmetic Rally

The catalyst for yesterday's broad-based rally was the better-than-expected Q3 GDP report. The report itself looked good at first glance, but if you take away some of the cosmetics--namely government stimulus---the seemingly beautiful GDP report looked a little less appealing.

The stock market correction talk was muffled yesterday after the S&P 500 surged 2.25%, led by a monstrous 4.3% gain the financial sector.

The catalyst for the broad-based rally was the better-than-expected Q3 GDP report. The report itself looked good at first glance, yet it had some cosmetics applied to it to make it look as good as it did. Take the cosmetics off, and, well, the seemingly beautiful GDP report looked a little less appealing.

For instance, the government certainly played the role of make-up artist in the third quarter. Motor vehicles and parts accounted for 1.01 percentage points of the 2.36 percentage point contribution to real GDP from personal consumption expenditures, residential investment added 0.53 percentage points, and government spending contributed 0.48 percentage points.

Government stimulus efforts then accounted for nearly 2/3 of the increase in real GDP. The change in private inventories, meanwhile, accounted for about 1/4 of the increase.

The takeaway is that stimulus efforts helped turn the economy around in the third quarter. Once the cosmetics are taken away, though, will things look as pretty? Probably not.

From our vantage point, the Q3 GDP report was more homely than stunning after the cosmetics were removed.

The move in the stock market was disproportionate to the news that drove it. After all, the data itself is dated and it wasn't that far from consensus estimates.

Still, the eager buying activity in its wake spoke to the pent-up interest in buying on dips from underperforming money managers that we have discussed in past postings. The timing of the rally was certainly coincidental, too.

The month end activity often skews to the prevailing trend (upward in this case) in what has been euphemistically referred to as window dressing by fund managers. That was perhaps especially true yesterday considering October is the fiscal year-end for many funds.

The early bias this morning is slightly negative. The S&P futures are indicating a downward start of about 0.6%.

There is a good bit of economic data out today. The Personal Income and Spending, and Employment Cost Index, reports, which were released at the bottom of the hour, didn't cause much of a stir since they were very much in line with expectations.

Personal income was flat in September and personal spending declined -0.5%. The income and spending components were embedded in yesterday's GDP report so, as the police might say, "keep moving, there is nothing to see here."

Similarly, the Q3 Employment Cost Index was up 0.4% as economists expected. Wages and salaries (70% of compensation) and benefits (the other 30%) were both up 0.4%.

According to the report, compensation costs, wages and salaries, and benefit costs for private industry workers decelerated for the 12-month period ending September 2009, registering the smallest increases since each series began. Compensation costs were up just 1.2%.

Employment costs are an inflation marker for the Fed, so there isn't likely to be much inflation concern on these numbers.

The Chicago PMI report is due at 09:45 ET (consensus 49.0; prior 46.1)), with the University of Michigan Consumer Sentiment report (consensus 70.0; prior 69.4) to follow at 10:00 ET.

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