The September Chicago PMI report came in at a dissapointing 46.1 compared to
consensus expectations of 52 and August's reading of 50. While today's report
gives "double dippers" some ammunition to play with it is important to realize
that this is a volatile data series on a month-to-month basis, even during
powerful "V" shaped recoveries (see attached long term chart). Therefore while
we do not expect this number to be well received in the short term (the SPX
fell more than 1% in the aftermath of its publication) it does not represent a
clear stumble on the road to recovery. Tomorrow's national ISM data will now
become an even more sensitive piece of data than it was already with consensus
looking for a moderate improvement at 54.0.


In terms of the Chicago PMI sub-indexes perhaps the worst news was that new
orders fell back from 52.5 to 46.3, indicating a moderate drop from the month
before. The inventory reading rose strongly from 27.5 to 38.9 which indicates
that inventories are still falling, but by a significantly slower pace than
before. The real outlier came from the capital equipment purchase index which
showed a very strong rise to 109.40 (100 = neutral). However, as with the
"headline" number these sub-indexes tend to be very volatile and so we would
avoid reading to much into any single month's report. -
chicagonewordersep09.gif - chigagopmisep2009.gif

The tepid NAHB sentiment data that came out earlier this month proved to be
an accurate indicator of the August Home Sale data (this should be
remembered for the September release which is scheduled for October 19th).
New home sales (one family) came in at 429K, essentially unchanged from the
July reading of 426K. Although this missed consensus by 10K this only
reflects approximately 800 houses sold over the course of the month
nationwide (since we are dealing with annualized data) and therefore is not
a significant miss. This data does keep the "V" recovery off the 2008/
collapse intact but does not yet show an extension higher towards a more
normal or functional new home market. On balance we would call the data on
the disappointing side of acceptable but as we argued throughout the
collapse of the new home market it is the trend and not the individual
readings that really matter. We would therefore be happy to accumulate housing
related equities on any post-data weakness.

Inventory data, however, is more encouraging with the total number falling
10K to 262K and the monthly inventory falling to 7.3 months. Of this number
completed homes for sale (which peaked at 199K in January 2008) represent
114K, the lowest number since December 2005, and close to the 30 year
average of 103K.

(See attached file: W-NHSLNFS.gif) - W-NHSLNFS.gif

The FRB balance sheet continues to develop in the manner we outlined
several weeks ago. The "emergency" provisions introduced in late 2008 are
being allowed to run off with both the Commercial Paper facility (CPFF) and
the Foreign CB facility now only $42 bln. and $59 Bln respectively. At the
same time the "permanent" MBS facility continues to grow rapidly increasing
this week by $49 bln (5.92%) to $689 Bln. As a result the overall FRB
balance sheet grew by $44 bln (2.11%) to 2,132 Bln over the last week and
Reserve Bank Balances by $22 bln (2.51%) to $889 Bln.

As we have argued before, although the FRB has not significantly changed
its activity in recent weeks the EFFECT of this activity has arguably
become more powerful, particularly in regards to the domestic US economy, since
the offset available from the run-off of the "emergency" facilities is now
insufficient to cancel out the monetization of the MBS market. This week's
anouncemnt that MBS purchases will taper off towards the end of the year will
reduce the pace of monetary expansion when measured in weeks, but not the
eventual size of the balance sheet when it is expected to reach its full
position of MBS next March. We are becoming more convinced that the long term
risks (12-18 months) of the current situation are firmly on the side of
overheating rather than the "double dip" that so many others seem to favor.



(See attached file: W-FARBCRED_Index.gif) - W-FARBCRED_Index.gif

August Existing home sales disappointed consensus estimates this morning
(total sales being 530K versus consensus 550K) but it should be recognized
that we are dealing with volatile annualized data and this month's report
in no way suggests that the dreaded "double dip" has actually commenced.
Attached is a chart of existing single family home sales which establishes
the point that the strong recovery since the springtime very much remains
intact and also reminds us that even the most powerful cycles are
punctuated by significant "data blips" in both directions. We do not expect
this recovery to be any different and for this reason we would use a
reasonably long term ma to establish a trend over the coming months (the
current chart shows the 24 month ma).

Despite the moderate sales number, inventory showed a surprisingly large
drop of over the course of the last month. Total inventory fell by 440K
(over 10%) to 3,622K. Single Family home inventory (see second chart) fell
by 300K (9.09%) to 3,000K. This is still some distance above the long term
average of 2200K (pink line on chart) but it should be noted that inventory
levels have fallen by a rapid 16.67% over the last 12 months. We would
therefore describe August's data as being broadly acceptable and see any
short term weakness in housing related stocks as a buying opportunity.



(See attached file: M-EHSLSL_Index.gif)
(See attached file: M-EHSLHAFS_Index.gif) - M-EHSLSL_Index.gif -
M-EHSLHAFS_Index.gif

Norges Bank (Norwegian Central Bank) kept their "key policy rate" unchanged at
1.25% today but as the accompanying statement shows this is unlikely to remain
the case much longer. As we commented yesterday on Canadian home-sales data
there are increasing signs of pressure in commodity-producing developed markets
to start tightening monetary policy.

-----------------------------------------------------------------------------


Key policy rate unchanged at 1.25 per cent

Norges Bank's Executive Board decided today to keep the key policy rate
unchanged at 1.25 per cent.

Some very strong home sale data out of Canada this month. There are increasing
signs of economic acceleration in the developed markets that are also heavy
commodity producers. This was one of our main thematics earlier this year and
seems to be playing out in the manner we expected.

2009 has seen record compression of credit spreads in general and it comes
as little surprise that as we approach the end of the quarter significant
inflows into the high yield space have forced yields sharply lower once
more. The Credit Suisse HY II Index (DLJHYTW, red line bottom chart) fell
63 bp to close at 9.98%, the first time it has been in single digits since
June 12th 2008 and less than half its peak yield of 21.02%. The spread to 5
year T-note (black line top chart) fell to 7.57%, its lowest reading since
July 25th 2008. While this is a drop of almost 1200 bp from the December
2008 record (19.50%) there are reasons to believe that further compression
may take place in the coming months.

Looking at the long term performance of this index we find that the average
spread since it was created in 1986 is 5.80%, while the average nominal
yield is 11.46% (base Treasury yields were far higher during the late
1980's and late 1990's). Both prior recessionary credit cycles saw yield
spreads soar above average and then rapidly repair, even as delinquency
levels continued to rise. Given a backdrop of a recovering economy, ample
liquidity and an FRB seemingly on hold for the foreseeable future it is
reasonable to assume that HY spreads can fall to at least their long term
average. Since we do not expect medium term Treasury note yields to move
significantly higher in the next few months the vast majority of this
spread compression would presumably be transmitted to the actual nominal
yield of the credit instrument. Remarkably this would take the index down
to around 8%, close to the record lows experienced between 2004-2007. We
are aware of course that extremely poor underwriting last cycle and
ultra-low Treasury yields make historical comparisons more difficult, but
it should also be realized that the recoveries of the early 1990's and
2000's saw HY spreads fall well below their 5.80% average so we would
maintain that our target is attainable.


(See attached file: W-.JUNK_Index.gif) - W-.JUNK_Index.gif

The August Building Permit data confirms yesterday's NAHB data and suggests
that Homebuilders are yet to embrace the notion that their industry may be
in the early stage of recovery. Given the scale of destruction this is
perhaps understandable and it will probably take several months of
improving sales before we really see a dramatic response in terms of the
number of new starts and permits. Everything therefore points to new single
home inventory getting very scarce by the end of 2009. The other major
factor behind starts and permits is the availability of capital. In this
regard we note that a number of homebuilders have succeeded in completing
significant debt offerings in recent weeks and it may be that with balance
sheets now starting to repair a more positive level of activity will start
to become apparent in the coming months.


(See attached file: M-NHSPATOT_Index.gif) - M-NHSPATOT_Index.gif

While this week's headline Initial and Continuing claims appear to be in
line and slightly worse than expectations it looks as if some very hefty
(and therefore probably inaccurate) seasonal adjustments are being used.
Initial Claims (red line) which cover the period through September 11th
plummeted in Non-Seasonal adjusted data - no doubt in part due to the Labor
Day holiday although we doubt that this would account for the entire 60K
drop (there does not seem to be a similar level of decline in prior Labor
day weeks). Continuing claims (which cut off on September 4th) also still
show a steady and rapid decline rather than the very jerky moves between
6,100K and 6,250K that is shown in the headline data over the last 3 weeks.

By late September the seasonal adjustments start to become positive but our
sense is that since this is anything but a normal year in terms of
employment, the non-seasonally adjusted data, although harder as to interpret,
may be a better guide as to what is actually developing. As with our
cooking we like our statistics with as few artificial additives as
possible.



(See attached file: D-INJCJCNS_Index.gif)
(See attached file: D-INJCSPNS_Index.gif) - D-INJCJCNS_Index.gif -
D-INJCSPNS_Index.gif

The September NAHB Housing Data came in at 19, in line with expectations today.
We would have liked to have seen a slightly stronger number but anticipating
the point at which data starts to run strongly ahead of consensus is always a
tricky business. As it is the September data shows broad improvement with
Present Sales improving by a couple of points to 18 and Traffic by 1 point to
17. Future Sales however ticked down to 29 from 30 - which is hard to reconcile
with the other data. In summary the data is consistent with the early stages of
a cyclical recovery but we would expect to see significantly stronger data in
the last 3 months of the year. - sg2009091650588.gif

This month's CPI data confirms the pattern shown by yesterday's PPI
release. Once more while the 12 month "headline" inflation rate remains in
negative territory the shorter term 3 month indicator is now strongly
positive and is moving at an annualized rate of 3.6%. As with PPI we would
expect to see the 12 month data turn positive sometime during the Q4 2009,
but do not expect to see a really problematic reading until late 2010.

We are also keeping a close eye on the PPI/CPI ratio, which is one of our
favorite indicators of longer term inflationary pressures. We note that
after collapsing in late 2009 this ratio has bounced off its rising 7 year
trend and has made a series of higher highs in recent months. This
certainly suggests that we are at the early stages of at least a strongly
"reflationary" cycle, and perhaps a more problematic (in the longer term)
inflationary one.


(See attached file: D-.PPI_CPI_Index.gif)
(See attached file: M-CPI_INDX_Index.gif) - D-.PPI_CPI_Index.gif -
M-CPI_INDX_Index.gif

The August PPI data really should be the final nail in the coffin of the
deflationary thesis and offers the first hints that inflationary forces are
starting to build in the US economy. As the attached chart shows the
overall index appears to have made its cycle low and is starting to track
higher and while the YoY index is still a remarkably low -4.3% this really
reflects the collapse of commodity input prices that took place between
August and October 2008. Indeed even without further rises in PPI the YoY
index would push above zero by November. The quarterly ROC (red line) is
perhaps a better guide as to what lies ahead and has recovered from a
reading of -6.91 (an annualized fall of 27.64%) to the current reading of
2.64% (an annualized rise of 10.56%). It would therefore not be surprising
to see the YoY index recover to mid single digits by the early part of 2010
with perhaps more problematic readings being visible by the summer. Since
PPI rises lead CPI by several months we continue to see the end of 2010 as the
likeliest time frame for significant inflationary pressures at the level of CPI
becoming visible but we are prepared to adjust this expectation in the months
ahead.

In the meantime it should be recognized that recovering PPI is indicative
of recovering demand and gross margins in the industrial sector. Our advice
continues to be to take advantage of this by maintaining a broad exposure
to economically sensitive issues since the more problematic phase of this
recovery still seem to be several quarters away.


(See attached file: M-PPI_INDX_Index.gif) - M-PPI_INDX_Index.gif

The September University of Michigan Sentiment Index came in at 70.2 versus an
expected 67.5 and August's reading of 65.7%. This takes the index back up to
the level we were at in June and means that we also at exactly the same level
that we were at on the eve of the Lehman crisis once year ago and we would
describe this data as consistent with an economy at the early stage of a strong
recovery that is not widely recognized to be taking place. While we are happy
to see a stronger reading than expected it is important to understand that at
this point in the cycle Consumer Sentiment is merely a reflection of the
consensus view and has little predictive capability even within the narrow
confines of consumer behavior.


We would only expect to see really strong readings reported (above 85) once the
idea of a robust economy is more widely held, but this does not in itself
preclude the average consumer shopping at a more "normal" level in the
meantime. - sg2009091135948.gif

For all the speculation about Chinese monetary conditions the August data
which was released last night shows that remarkably little actually
changed. The "moderately loose" policy clearly remains intact despite the
grumbling about potential asset bubbles by the Chinese Central Bank. This
is hardly surprising since the Chinese authorities primary concern is to
stimulate domestic demand and therefore overcome the effect of the collapse
in exports that occurred last year. In this regard it is worth noting that
the August trade data announced last night showed exports are still down
-23.4% on a YoY basis.

In terms of specifics New Loan growth rose to 410 Bln RMB (320 bln last
month) keeping the 12 month moving average at 828 bln (approximately $120
bln per month). This allowed M2 to grow by 370 bln RMB, for an annual rate
of change of 28.4%. Chinese M2 is now larger than US M2 by $148 bln (in an
economy whose nominal GDP is 25% the size). Those looking to China as the
source of imminent monetary tightening appear to be somewhat wide of the
mark and while we view this monetary growth as a potentially serious long
term inflationary influence it is also a shorter term positive for global
asset markets.


(See attached file: D-CNMSM2_Index.gif) - D-CNMSM2_Index.gif

As the SPX index forces its way to new recovery highs we are finally seeing
some signs of capitulation in the VXO index. Earlier this month we had
commented on the very high spread between the level of Implied Volatility
and Historical Volatility with participants arguably overpaying as much as
a 40% premium over "fair value" for short term protection. We felt that
this was likely to be resolved by a rise in the equity market and a
collapse in implied volatility and so far this is the way things have
played out.

As a result the VXO has finally entered the very low 20's (blue box on
chart), an area that has so far been avoided over the course of the
recovery rally. This does not mean that sentiment is yet unhealthfully
bullish, in fact it would take several weeks of sub-20 readings to create
such a scenario and other measures such as the AAII poll remain in negative
territory this week. Indeed even at 21.83 the VXO still trades at a very
hefty premium to 21 day (16.72) or 30 day (15.57) Historic Volatility.
Nevertheless, by moving into a new lower trading range the VXO index does
signal that we are arguably moving into a later phase of the rally in which
a lower emphasis on the dangers of an imminent and severe correction starts
to be priced in by the marketplace.


(See attached file: D-VXO_INDEX.gif) - D-VXO_INDEX.gif

These quotes (and the conclusions of the paper they are drawn off) are in
keeping with our assumption that Central Banks will in prove to be far too
loose for far too long by the end of this cycle.

This is an interesting little story that helps explain how in the end all
cycles are self-correcting. While the focus in commercial real estate is now
almost solely on the negative forces coming to bear (these really should have
been considered 18 months ago when they were equally obvious and not priced
into property or mortgage credit markets) there is also the potential for some
organic growth in demand at lower rental levels. While this will not prevent a
significant amount of commercial real estate delinquency occurring,
particularly amongst over-leveraged borrowers who paid peak 2005-7 prices, it
will mitigate its ultimate severity for those who approached this asset class
more prudently.

We are not great fans of the Monthly Non-Farm payroll data (we far prefer
the weekly Continuing Claims data) since it is far too volatile and subject
to seasonal adjustment and revision to be a truly useful "real time"
indicator of where the US economy is at any given time. Nevertheless we
cannot ignore its influence and we would certainly agree that this data
needs to improve over time in order for our assumption of a strong V shaped
recovery to prove correct. This month's data of -216K is acceptable in that
regard since it shows a reasonable sequential improvement from both last
month's Initial (-247K) and Revised (-276K) readings. We are less bothered
by the unemployment rate since this simply reflects changes in the
assumptions regarding the size of the total labor force rather than any
real change in the underlying economic situation.

From our perspective the best way to make sense of the data is to look at a
long term chart that covers several cycles. Attached is a 40 year chart of
the total Non-Farm Labor Force (as opposed to the Monthly Change which is
the headline data). As can be seen on a 3 month basis a clear "V" shaped
recovery has been put in place (although the rate of change is still in
negative territory) and we would expect this indicator to makes its way
above zero sometime in Q1 2010. The 12 month ROC is yet to register an
improvement, which really reflects the fact that the employment shock
started in August of last year, but this indicator should register a clear
turn for the better by the time next month's data is issued.



(See attached file: D-NFP_T_Index.gif) - D-NFP_T_Index.gif

Silver has fully participated in gold's breakout and is currently
challenging its recovery high in terms of price and relative to gold (green
line on bottom chart). As we suggested yesterday this breakout has the
potential to develop into a significant run-up for precious metals.


(See attached file: D-SILV_Comdty.gif) - D-SILV_Comdty.gif

After months of frustrating inactivity there are finally some signs that
gold may be about to breakout of its gridlock to the upside. The USD price
has just poked its head above its declining trendline and is therefore now
targetting the June high at $990. Of perhaps more importance is the fact
that gold measured in a variety of non-USD prices is also breaking out. We have
noted for weeks the highly unusual lack of volatiltiy in non-USD prices (see
second chart which shows gold in EUR, GBP and AUD) and have always felt that
whichever direction prices eventually moved would be the start of a potentially
significant development.


(See attached file: D-GOLDS_COMDTY.gif)
(See attached file: D-GOLDS_Comdty1.gif) - D-GOLDS_COMDTY.gif -
D-GOLDS_Comdty1.gif

August ISM data offered further support to the idea that the US has
commenced what will turn out to be a strong recovery. The overall index
came in at 52.9, slightly better at consensus of 50.5 and a sizeable
improvement on last month's reading of 48.9. Of course this number still
only represents a moderate improvement (50 being neutral) from last month
and so those who hold on to the consensus view that a recovery has started
but that this will prove to be weak and short-lived (the "square root"
being the recently favored metaphor) can still incorporate the overall
index into their economic view. However, when one looks at the sub indexes
of this survey such a viewpoint becomes far more problematic.

Most clearly this can be seen in the New Order data (red dashed line on
both charts). This rose very strongly to 64.9, the strongest reading since
December 2004. Historically readings above 65 have only been seen in strong
Manufacturing recoveries and as can be seen on the second chart the overall
ISM index typically follows the New Order index quite closely (although at
the ends of positive cycles New Orders tend to overshoot). Further support
for the notion that New Orders will lead the overall index can be found
from the Inventory data, which only moderately improved to 34.4 in August,
which still represents a rapid reduction in Inventory levels. As a result
the difference between New Orders and Inventories is now 30.5, a level that
has only previously been reached during the powerful 1974/5 recovery. It
therefore appears that the Overall Index has managed to enter positive
territory even though the process of Inventory replenishment has not yet
begun, which implies that some significantly stronger readings can be
expected later on in the cycle.


(See attached file: D-NAPMNEWO_Index.gif)
(See attached file: D-NAPMPMI_Index.gif) - D-NAPMNEWO_Index.gif -
D-NAPMPMI_Index.gif