U.S. stock indices ended mixed on Friday as the Dow and S&P 500 ended slightly higher, while the NASDAQ, mid and small cap indices failed to close above the cut line. 

It was another session in which early gains were rejected as we headed into the afternoon session.  Comments from former Fed Chairman Greenspan, calling the recent rise in Treasury yields the “canary in the mine” (regarding the government’s fiscal situation), may have been a factor weighing on investor sentiment.  Stocks also had to deal with the downed South Korean naval ship along a disputed border with the North -- and naturally the rumors that follow. 

Even though the S&P 500’s gain was only fractional, eight of the 10 major industry groups closed higher on the session.  Basic material, consumer discretionary and industrials led the way.  Health care and technology shares were day’s only losers.

For the week, the Dow Industrial gained 1.0%; the NASDAQ Composite rose 0.80%; and the S&P 500 added 0.50%.  The gains marked the fourth-straight week of increase for all three indices. 

Market Activity for March 26, 2010

A New New Plan to Prevent Foreclosures

Washington has announced an expansion of its foreclosure prevention efforts since the previous program, known as HAMP (Home Affordability Modification Program), has been about 96% ineffective relative to its goals of stemming 4-5 million foreclosures.  Even though the subsidies provided lower the interest rate to as low as 2% and extend maturity to 40 years, to date it has successfully modified only 168,000 mortgages.

Under this new plan the FHA will take a much bigger role – man, this agency is so done – by allowing unemployed underwater borrowers (roughly 25% of all mortgages are higher than the home is worth, or about 10 million borrowers) to refinance into government-backed loans.  The plan will sharply reduce payments, or even place a 3-6 month moratorium on payments.

The FHA is already in deep trouble as roughly 14% of the loans they back are delinquent.  Since mortgage modifications have about a 51.5% recidivism rate, meaning they are back in default nine months later, one can expect the FHA’s woes to increase.  To qualify, the borrower must be current on payments and the loan balance would have to be reduced in order to qualify for even the FHA’s low loan-to-value requirement. 

Try as the government will, the efforts to stem this problem in a quick manner will have the opposite effect – supply/demand fundamentals and the price mechanism that allows for market equilibrium cannot be repealed by government policymakers.  The best thing we can do is allow these foreclosures to occur, besides many of these situations are due to people making very poor decisions – little-to-no money down, buying too much home on top of that, and of course all while they were financing cars and plenty of consumer goods items.  The market must be allowed to come into equilibrium by finding a market-clearing price.  Until that happens, this only delays the inevitable.  For now, just add on another transfer of risk from the private sector onto the government.  Although, I guess this risk hasn’t been transferred at all, as it is the private sector that funds the government. 

Final Revision to Q4 GDP

The Commerce Department released its final interim revision to fourth-quarter GDP (these figures get revised several more times over the following years but it’s the final in the near term) showing the economy grew at a slightly lower rate than previously expected.  The figure came in at 5.6% at a real annual rate last quarter; it was previously estimated to have increased 5.9%. 

The components that led to the lower revision were household consumption, non-residential structures and inventories.  That is, household consumption and commercial building increased less than previously expected and inventories declined more than previously calculated.  Remember, we have yet to see an actual inventory rebuilding; stockpiles have just been reduced at a lower rate than was the case in the previous quarter, which is all it takes to add to GDP.  Again, that reduction was a bit more than previously estimated.

Real final sales were up 1.7% for the quarter vs. the 1.9% estimated in the previous calculation.  This figure measures the increase in GDP, excluding the boost from inventories.  As we talked about last month, this is a weak reading as it has averaged 4%-plus coming out of the prior four recessions.

University of Michigan Confidence Survey

The U. of M. consumer sentiment gauge held at 73.6 in March, the same reading as February.  Higher stock prices and an easing in the level of job losses has lifted the measure from the 30-year lows hit last year.  The record low of 51.7 was hit in May 1980 but last year the measure remained at deep depths for a longer period of time.  The survey began in 1978 and the average over this period is 86.5.

The economic conditions index (which is designed to track consumers’ perceptions of their own finances) rose to 82.4 from 81.8 – that’s the highest in two years; the long-term average is 98.1. 

The economic outlook index (designed to project the direction of consumer spending) slipped to 67.9 from 68.4 in February – the historic average is 79.0.

Futures

Investor sentiment is upbeat in pre-market trading.  It looks like the market wants to make yet another run for Dow 11000 and S&P 500 1180 – the Dow came within 45 points of 11K last week and the S&P 500 hit 1180 before those rallies were rejected.  A push to that 1180 mark on the S&P may offer the boost to tackle the pre-Lehman collapse level of 1250. 

I really wish the market would pause for an extended period here, additional moves higher only increase the disconnect between stock prices and economic realities.  If we were to pause and allow many of the economic challenges to begin to run their course and eventually improve, I think we could escape a substantial pullback.  The further we run though, the harder the fall.  I’m concerned a 20% pullback, which is a matter of time after the 72% jaunt over the past year, may turn into something worse as investors have to have the collapse of 2008-2009 in their heads – even if it currently appears that they’ve erased that event from memory.

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900