U.S. major stock indexes ended essentially flat on Wednesday as the EU sovereign debt story weighed just enough to erase early-session gains.  The Dow closed up slightly and the S&P 500 down a smidge.  The tech-laden NASDAQ performed the best of the three majors; tech earnings are the most solid of all industries – financials profits are up the most on paper but it’s artificial. 

Yesterday’s earnings reports were good for the most part, which offered support to the market.  Again though, I can’t help but mention for a second day that multinational companies are reporting weak domestic growth; most of the profit growth is coming from overseas, currency translation and payroll cost-cutting.  The financial company reports of the past couple of days showed that their profits are coming from big trading profits, thanks to Dr. Zero.  I continue to believe that the banks are going to have a reality problem a couple of quarter out as the home sales reports will show distressed properties are making up a larger percentage of total sales – that percentage has been averaging about 35% and data from various states suggests it’s going over 40%; price declines will follow and that means banks will have to set aside more cash, which cuts into earnings.  With 30% of home borrowers either underwater or with less than 5% equity, there is zero room for additional price declines.

On the EU sovereign debt problem, the relevance regarding the Greek financing issue is not that the country defaults on some payments per se, but that other EU countries have similar budget problems.  Since the Eurozone is heavily dependent on government spending, the required and austere budget cuts will certainly be seen in their already very weak GDP readings.  Further, I suspect that European banks hold large amounts of government debt and as those securities get whacked, so does the capital of those banks – as goes the capital so goes the lending.

The major industry groups were split with five up and five down.  Industrials led the gainers and health-care the losers – the shares got hammered relative to the market, down 1.74%.

Market Activity for April 21, 2010

Supplies and Greece Halt Recent Crude Bounce

Yesterday’s energy report showed crude oil inventories rose 1.89 million barrels last week compared to an expected decline of 750,000 barrels.  An early-session rally in crude was also halted by a little boost in the U.S. dollar as the euro weakened on the rising chance that Greece will default, or the strongest EU members will pay a high price to make sure Greece and the other basket cases don’t miss a debt payment. I should be careful, maybe even refrain from such name calling as our own public finances are far from sound as we blindly follow Europe down their treacherous fiscal path. 

Crude was pushing to $85/barrel prior to the Energy Department report; it closed at $83.68 and is down into the $82 handle this morning. 

Mortgage Applications

The Mortgage Bankers Association reported that their applications index rose 13.6% for the week ended April 16, following declines of 9.6% and 11.0% in the prior two weeks. 

Applications to purchase rose 10.1% after a 10.5% slide in the prior week – so you put these two weeks together and it is a bit surprising there’s been no pick up just ahead of the tax credit’s expiration.  (That credit has two expiration dates: April 30 for the contract to be signed or June 30 for the contract to close. I hadn’t thought borrowers would wait to take the chance a May signing would close in time, but if so we’ll see it via a pop in sales over the next couple of weeks.)

Refinancing activity bounced 15.8% after a 9.0% decline in the prior week.  The average rate on the 30-year fixed mortgage fell to 5.04% from 5.18%.

Incentivizing Strategic Default

So Fannie Mae announces it will reduce the wait time for some borrowers, with regard to the time between their foreclosure transaction and obtaining a new mortgage, to two from four years.  Now, this only applies to borrowers who have 20% down on the new mortgage two years hence – except for some extenuating circumstances in which a borrower with just 10% down will too be able to acquire a new mortgage just two years after reneging on their commitment.  Fannie Mae increased the wait period for high-risk borrowers to seven years. 

While the increase for those with poor credit scores or low down payments is a needed step (although one can see political outrage arising over this decision), the reduced time for the more financially stable borrower is not only wrong, it may just create more housing-market damage than would otherwise have occurred.  What borrower defaulting on a mortgage today will have the 20% down for a home in two years?  Those who would strategically default -- borrowers who now understand they paid too much for their house and sees the chances of returning to an equity position (loan is less than the house is worth) anytime in the near future as remote.  They can continue to make payment on their mortgage, and maybe even quite easily, but because of the aforementioned factor simply decide to escape responsibility from their commitment.  These people should be punished, instead of making it easier for them to acquire a mortgage again.   Just another stupid policy decision that will come back to bite.  Thank you very much.

This Week’s Data

This week has been really light on the data front thus far but this morning we’ll get into more material releases with producer prices (March), weekly initial jobless claims, existing and new-home sales (March) and durable goods orders (March).  The home sales data and durable goods orders reports will certainly get a lot of attention.  We should see home sales rebound a bit after three months of decline for existing homes and four months of weakness for new homes – we’ll watch for the distressed sales figures and the resultant decline in prices.  (For existing homes any sales bounce from the tax credit expiration won’t show up until May-June as sales are not counted until the contract is closed; for new homes any tax credit boost will show up in March and April.)  The durable goods report will be important too as we’ll need to see a solid reading from the business spending segment; it has gotten off to a poor start in the first quarter, unable thus far to extend upon the strength seen in the fourth-quarter – we’ll need something meaningful to offer evidence that the spending in Q4 wasn’t just the typical year-end event.

But while these reports are substantial to the direction of the market, the jobless claims figure is this week’s sine qua non release.  Initial claims need to show a move to the 400K level and continuing claims need to show the long-term unemployment situation, which currently resides at the highest level in the postwar era – and by a long shot, has begun to improve

Everything hinges on jobs.  Corporate profits will not be sustained without robust job growth – simply put, the final demand that is necessary to keep the profit rebound going cannot occur without significant labor-market repair.  And housing, you can forget about a consistent improvement in the housing market without the jobs to support it.  

Have a great Earth Day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900

www.acrinv.com