U.S. stocks pulled back a bit on Wednesday as sovereign debt worries continued after Fitch lowered Portugal’s credit rating, and warned of another to come, and the latest housing market data showed new-home sales slipped to an all-time low, for the second month in a row.  An overall positive report on durable goods, although uneven with a number of components showing orders declined, wasn’t enough to offset the negatives.

Nine of the 10 major industry groups lost ground on the day, led by telecoms and consumer staples – strange for a traditional safe-haven like consumer staples to lead the declines on an overall down day for stocks, I don’t get that one.  Financials were the only group to close in the black, boosted by Bank of America shares after the bank announced plans to expand in Beijing.  I guess traders ignored the news that BofA will have to reduce principal values on more mortgage loans. 

Treasury securities got clocked, the yield on the two-year jumped 11 basis points to 1.09% (which is hardly attractive but that’s a large one-day increase) and the 10-year yield soared 14 basis points to 3.83%.  Tuesday’s $44 billion two-year auction was met by relatively weak demand, and that was followed by yesterday’s 5-year auction in which Treasury had to pay up in yield as demand was considerably weaker than prior auctions.  We’ll see more than $100 billion in monthly government debt issuance until the cows come home, at some point that should cause yields to break through this very low-level range. (More on this below the jump)

Market Activity for March 24, 2010

Savers Would Benefit, Economy Won’t

One shouldn’t take too much from these messy auctions as we’ve seen Treasury yields jump to current levels five times now since June, only to retreat and remain in the trading range.  But you can’t be complacent about it either; extending out on the curve in order to reach for yield in this environment is a very risky venture.

I have often wondered what will happen to yields when the Fed begins to even gently increase their benchmark fed funds rate.  One could see long-term yields declining on this event as it will signal Bernanke & Co. are at least somewhat serious about refraining from the same mistakes they made last decade.  However, one can’t forget that ZIRP has also engendered a lot of demand for Treasury securities.  All banks have to do is borrow short at basically zilch and buy Treasuries yielding something considerably higher – even 1% is much higher than near zero.  But what happens when this game runs its course, when it is no longer advantageous for banks to engage in this very easy trade?  Well, demand declines and yields go higher. 

The normalization of interest rates creates a nice opportunity for the investor who has been parking money in the short end of the curve, keeping their powder dry for more attractive yields. Conversely, it also creates additional challenges for this fragile economic state. 

Mortgage Applications

The Mortgage Bankers Association reported that their applications index fell 4.2% during the week ended March 19, which follows a 1.9% decline in the previous week.  The index was driven lower by a 7.1% drop in refinancing activity, third-straight weekly decline, but applications to purchase a home rose 2.7%.  This puts purchase applications up 6% for the month of March and should show up in existing home sales when the April and May sales figures are released – as we touched on yesterday.

The rate on the 30-year fixed mortgage rose to 5.01% last week, up from an average 4.91% during the week ended March 12.

Durable Goods Orders

The Commerce Department reported that durable goods orders rose 0.5% in February after an upwardly revised 3.9% jump in January.   But we shouldn’t focus on this headline number as it is skewed by the very volatile commercial aircraft component, which was up 32.7% last month and 135% in January – and it cuts both ways as the figure can make the headline reading look worse than overall durable goods orders actually are, such as when commercial aircraft orders dropped 28% in December and slid 40% in November. 

So, we concentrate on the ex-transportation readings to remove this volatility, which came in at a better-than-expected 0.9% increase in February (+0.6% was expected) after a -0.6% in January.  This reading is up 16% over the past three months at an annual rate – but remains 17% lower than the 2008 peak.

The most important aspect of this durables report (which is always the case, but especially right now as we need the business side to pick up the slack from consumer activity) is the non-defense capital goods ex-aircraft reading.  This is the proxy for business investment and it rose 1.1% in February after January’s disappointing 3.9% decline. 

This figure was boosted almost solely by machinery orders, which jumped 4.4% after January’s 8.8% plunge.  Business spending is about flat over the past three months, but is up about 10% annualized over the past six months – thanks to surges in November and December.  Orders for computer & electronics and electrical equipment were disappointing as both declined.

We’ve been keeping a very close watch on this non-defense capital goods ex-aircraft reading for follow through from the end of 2009 business spending increase – a situation that is typical as firms find they have unspent budgets at year end, which was particularly true last year since firms sat on their cash during the first 10 months of 2009.  Since the figure is flat over the past three months, the jury is still out.  We just cannot yet have conviction that capital expenditures are going on a consistent run that is strong enough to offset what will surely be weaker consumer activity for some time to come.  Firms will certainly manage business spending to maintenance levels, but I’m not sure that’s going to be enough to provide for a level of economic growth that’s needed to drive the jobless rate substantially lower in a reasonable timeframe. 

New Home Sales

New home sales made a new low for the second straight month, the data goes back to 1963, falling 2.2% to 308,000 at a seasonally-adjusted annual rate (SAAR) for February – sales were expected to rise, according to the median forecast.  This follows January’s 8.7% slide. 

This new homes sales data is different from the previously-owned home sales data in the sense that sales are counted when a contract is signed.  Thus, this number does reflect the most recent activity; the existing-home sales number tracks activity from a couple of months back as the sales are not counted when the contract is signed but rather when it closes – and it takes 4-6 weeks to close. 

In terms of region, sales were hardest hit in the areas that experienced the worst weather.  Sales in the Northeast slid 20%; sales fell 18% in the Midwest; the South (the largest new-home market) saw sales decline 4.5%.  The West bucked the trend with a 21% jump in sales. 

(The previously-owned home sales data from Tuesday, which declined for a third-straight month, could not really blame things on the weather as the areas hit by the snowstorms, the Northeast and Midwest, registered sales increase as the South and West regions posted declines.  Undoubtedly, something more structural is the problem – namely, foreclosures boosting supply and high joblessness depressing sales.)

The median price of a new home actually rose 6% for the month, and is up about the same from the year-ago period.  This is an unjustified move to say the least as sales are making all-time lows; it’s partially a problem that results from the home-buyers’ tax credit, that subsidy boosted sales last fall and created distortions – I’m not sure how builders thought it was appropriate to boost prices in February but prices are going to have to decline again in order to clear the market.  It’s the same old story, government can try as they will, but their attempts to change the supply/demand dynamics only delay the inevitable. 

The supply of new homes, relative to the pace of sales, rose for a fourth-straight month, up to 9.2 months worth of supply from 8.9 in January. 

Unfortunately, builders have to contend with more than just this rise in new-home supply.  Homebuilding ctivity is also affected by the rising supply of previously-owned homes.  Foreclosures will be adding to supply for an extended period of time and until job growth surges the sales are not going to be there to absorb this current and coming supply.  It will take time. 

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900