U.S. stocks gained ground for a second-straight session, pushing to a new 17-month high.  The broad market hasn’t endured a significant sell-off (which I’ll define as more than a 1% move) in 20 sessions.  The market appears to be strangely complacent as just one of the five down days during this 20-session stretch has been to the degree of 0.5% and three have been only fractional losses. 

The National Association of Realtors reported that existing home sales came in a bit better-than-expected during February, showing activity fell 0.6% for the month.  This followed record declines during the previous two months.  Even though the headline figure beat expectations, the inventory data within the report suggested trouble lies ahead for home prices.  As a result, stocks moved into negative territory following the report.  However, comments from two Fed officials suggested that the central bank was likely to remain extremely accommodative for longer than the market had previously expected and that gave fuel to a rally that began around lunch and accelerated in the final 30 minutes of trading. 

Specifically, it was the later of the two speeches, delivered by San Francisco Fed Banks President Janet Yellen, that was likely behind the rally late in the session.  She stated: “The economy will be operating well below its potential for several years.”  The market hears that and gets juiced that the Fed will keep monetary policy floored for well beyond a six month time frame. 

Not surprisingly, commodity-related basic material stocks led the rally – the commodity trade rolls on dovish Fed comments.  Industrials and tech were the other leaders.  All 10 major sectors gained ground on the session.

Market Activity for March 23, 2010

Can the Dollar Rally Continue?

On many occasions we’ve talked about how the dollar rallies only on fear, that run for safety that ensues when investors sense something bad is about to occur.  And in fact, the greenback has bounced roughly 9% since early December when it appeared the U.S. currency was going to test its all-time low.  I get this feeling when talking to people that they are largely unaware of this move.   Don’t get me wrong, the dollar remains beaten down, the current quote of 81 on the Dollar Index (DXY) means it’s out of the danger zone for now (my view of the danger zone being the mid-70s on the DXY) but the low 80s hardly suggests the dollar is strong.

But a substantial rally could be on the horizon even as Washington runs up insane deficits and the Fed remains massively accommodative – a very loose monetary policy does not normally lend to a rising domestic currency value.  However, as most readers understand, I do not believe the economy has emerged from the woods just yet.  Debt-driven recessions just don’t fizzle out, they linger and the political response to these harsh economic contractions cause even more harm that prolongs and exacerbates the downturn.  As a result, the safety trade is likely to roll again, and that means dollar strength. 

There is also something else that must be considered.  The sovereign debt woes in Europe are not going away and if those countries are to get a handle on their deficits (if not voluntarily, then eventually by the force of the market) and the entitlement programs that have created the problem then this will intensify the economic weakness within the Eurozone.  What’s needed is complete budgetary restructurings. This will engender more economic damage in the short term, but it’s necessary to make things right from a longer-term perspective. 

So what does this mean for ECB monetary policy?  It likely means that they will be forced to remain extremely accommodative for a very long time in an attempt to ease the economic damage.  I would suggest they need to ease the damage via tax policy, but they’ll choose the easier way of attempting to do so through monetary policy.  That means they may hold this extreme level of accommodation longer than even Bernanke & Co will choose to do.  If so, interest rate differentials will move in our favor and provide the impetus for additional dollar gains against the euro.

There is still much talk among retail investors of bailing the dollar here, and I can understand the logic as policy is not conducive to a sound currency, but one should be careful in thinking myopically in this regard.  Many things are occurring that may just incite a big dollar rally – at least over the next year or so.

Existing Home Sales

The National Association of Realtors (NAR) reported that previously-owned home sales fell 0.6% to 5.02 million at a seasonally-adjusted annual rate (SAAR) in February.  This was slightly better than expected; the consensus estimate was for sales to decline to 5.00 million.  This data for February essentially measures contract signings from December and January as existing home sales are not counted until the contract closes. 

The drop in sales marks the third month of decline, and the previous two months were record-setting slides of 7.2% in January and 16.2% in December – if not for December’s plunge, the decline in January would have been a record, going back to 1968.  Roughly 42% of buyers were first timers (up from 40% in the prior month), so without the refundable tax credit subsidy activity would have been worse.  This shows the duress the market is under, 40% of sales is driven by the subsidy.  Distressed sales made up 35%, which is in line with the previous few months. 

A rise of 4.8% in condo/co-op sales buoyed the overall sales data as single-family units fell 1.4% to 4.37 million units SAAR.  The 13-year low of 4.04 million units appears to be put in, meaning we won’t make a new one, but it’s getting close.  We should see some bounce in April and May (contracts signed in March and April) on warmer weather and the NAR is running commercials alerting potential buyers that the tax credit is set to expire in a few weeks.

As a result of the slip in sales and foreclosures hitting the market, the inventory-to-sales ratio rose to 8.2 months worth from 7.6 in January.

The median price of a previously-owned homes ticked up slightly in February to $164,300, but is down 2.1% from the year-ago level.

Again, we should expect some bounce in sales for April, May and into June due to the combination of warmer weather and buyers scurrying to get in on the tax credit before it expires (contract has to be signed by April 30).  However, a real recovery in housing will not occur before durable and substantial job growth is in place. 

The NAR’s chief economist said he was “crossing his fingers,” hoping the tax credit encourages a second surge in sales -- wishful thinking abounds.

Richmond Fed

The Richmond Federal Reserve Bank’s gauge of factory activity within the fifth Fed district accelerated to a reading of 6 in March (a print of 5 was expected) from 2 in February.  Activity has cooled in the region after printing readings of 14 for three months in a row June-August, but has returned to expansion mode after two months in negative territory (December and January) so we’ll take it. 

In terms of the sub-indices, they largely pointed higher but were mixed.  New orders rose to 10 from 9; capacity utilization increased to 3 from -3; vendor lead times up to 8 from 2 (nice move in these two readings and suggests job growth to come).  However, order backlogs fell to -7 from 0 (which does take away from the thought that workers are becoming stretched); and wages fell back to contraction, down to -3 from 3.

This higher reading from Richmond marks the third regional factory index for March now and all point to increased activity for the month.  The manufacturing sector is clearly leading things. 

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900