U.S. stocks gained some ground yesterday, marking the third increase this week and the ninth out of the past 11 sessions.  The market was able to shake off some disappointing earnings announcement from the telecom and health-care industries, due to health-care related charges, as the first rise in home sales in four months helped ease other concerns.  Investors also looked past the EU sovereign debt situation, which is getting rather ugly.

Consumer discretionary shares were the best-performing sector, killing the field as they rose 1.66%.  Basic material and industrials were next in line.  Health-care shares, the worst-performing sector, got hit again yesterday..

Financial shares were among the six major industry groups that gained ground for the session, but credit default swaps (insurance against default or downgrade) on U.S. banks rose as investors speculate that financial-regulation legislation will reduce the industry’s profitability. 

Market Activity for April 22, 2010

The Origin Escapes Criticism

In his speech yesterday on increasing financial regulations, President Obama stated: “Some on Wall Street forgot that behind every dollar traded or leveraged, there’s a family looking to buy a house, or pay for an education, open a business, save for retirement.”  

I’m not going to defend the behavior on Wall Street, which sometimes has a casino-type mentality than something that resembles investing, but let’s point the finger where it matters.  If not for the Fed holding rates insanely low for three full years during the previous decade then the leverage ratios would have never gotten so high; and if home-borrowers wouldn’t have attempted to purchase more home than they could afford, fomented by a very low cost of borrowing, then this would have never occurred to begin with.  It is the Fed’s mistaken monetary policy that’s the origin of this mess, not to let social engineering from Congress off the hook. 

Wall Street doesn’t think about individual families when they’re making trades (it’s a ridiculous statement to suggest that they should) and certainly not when the Fed is tangling ultra-cheap money in their faces—oh, and just in case anyone has forgotten, not when investors are desperately searching for products that get them more yield, without regard for risk, as the Fed makes yields on safer investments unattractive.  Sound familiar?  Well, it should because it’s happening again.  The comments we hear these days from all kinds of politicians make great sound bites, but they don’t do diddly to confront what caused this mess.  To play on James Carville’s phrase meant to  deride Bush I: It’s the Fed, stupid.

No, Eight Wasn’t Enough

Shifting gears, the other day we mentioned that Greece wanted to know: Is eight enough?  (Is 8% high enough for investors to say we’re being compensated for the risk of default?)  Apparently not, as the yield on their 10-year note hit 8.84% yesterday, and the two year hit 10.20% -- that’s quite the inverted curve.  As a result, Greece has now asked the EU/IMF to activate its bailout deal (although there isn’t one specifically in place as it’s all been about talking markets down instead of applying something concrete to this point). 

The EU is between a very big rock and a very hard place.   They have to bail Greece out as they can’t afford the capital erosion within their banking system (European banks, just like U.S. banks with U.S. Treasury securities, own government bonds and they count as capital).  But when they do, even Germany and France will end up feeling the heat.  It won’t happen right away as the markets are likely to calm following a rescue, but rescuing Greece, Portugal, Italy and Spain all at the same time is going to be quite the feat.  You know, rescues work for a while but the bill eventually comes due. 

Jobless Claims

The Labor Department reported that initial jobless claims fell 24,000 to 456,000 in the week ended April 17, following two weeks of increase that brought the reading up to 480K for the third time in three months.  The four-week average rose 2,750 to 460,250.

The continuing claims data plunged as the standard issue of claims (those that last for the traditional 26 weeks) fell 40,000 to 4.646 million and extended benefits, those EUC claims that last up to 99 weeks, slid 508,187 to 5.347 million.  

So, let’s hope that this big move down in continuing claims is signaling that the long-term unemployment situation (44 out of 100 of those unemployed have been jobless for 27 weeks or longer, by far a postwar record) has improved.  However (here goes this guy again with his “howevers”) we must remember that benefit extensions lapsed again over the past few weeks and Congress just passed another extension of these…well, extensions.  Since the standard issue of continuing claims have a one week lag to them (the data is for the week of April 10) and EUC claims have a lag of two weeks (latest data is for week of April 3) the slide may be due to the expiration of benefits. 

If continuing claims fall over the subsequent couple of weeks, then we’re looking good.  But if they rise again, then we’ll know it was only due to the temporary expiration of the extensions, not some improvement in long-term unemployment.  I believe the latter will prove to be the case.  In fact, the ridiculous length of benefits is actually the main cause of the surge in long-term unemployment.  You think the above illustration in the chart above is a coincidence?  Sure, there are a lot of people put out of a job for a long time simply because of the construction boom and bust – all of the 1.9 million construction jobs created in the 10 years ended 2007 were eliminated over the past two years.  But when you are going to offer unemployment benefits for a period of two years, then you are going to also have a lot of people who wait to take a less-than-desirable positon at least until those benefits run out. 

Inflation Watch

The Producer Price Index (PPI) rose a greater-than-expected 0.7% in March (0.5% was expected) as the year-over-year (y/o/y) results have bounced back to 6% -- the two-decade high of 10% was hit during the commodity-price spike in the summer of 2008. 

The reading was driven by the food and energy components (precisely the items the Fed likes to exclude, how convenient) as gasoline rose 2.1% for the month and is up 66% y/o/y and the food component rose 2.4% in March and is up 6.8% y/o/y. 

While PPI is definitely a price gauge to keep an eye on, it doesn’t all flow to the consumer level of prices – productivity allows firms to absorb these costs and in the current environment businesses are less likely to pass these costs onto the consumer, for now.  That said, the gasoline situation is going to become an issue for the consumer if the increase in pump prices continues. 

From an overall inflation watch, we’ve spent a lot of time talking about its likely trend over the next couple of years due to the Fed’s unprecedented monetary easing.  We’ve also discussed, that for now the consumer-level inflation gauges are likely to remain tame – that is, until credit begins to expand again; this means the Fed’s money pumping activity over the past couple of years, which has been fallow due to slide in lending activity, will rush into the system and outpace the rate of production.  (Too much money chasing too few goods equals inflation.)

However, with the adoption of FASB 166, which states that all loans are brought back onto to the balance sheet, it makes gauging credit activity more tricky.  This accouting rule change has caused the bank credit figures to show a spike in loan activity over the past two weeks.  We’ll watch to see how much of this increase is due to banks bringing assets back onto the balance sheet and how much is actual new lending – the figures over the next several weeks should provide the answer.  If we begin to see a multi-week run in credit, which will indicate the period of lending contraction has probably run its course, then it will be time to get quite worried that harmful levels of inflation will occur. 

Existing Home Sales

The National Association of Realtors reported that existing home sales rose 6.8% to 5.35 million units at a seasonally-adjusted annual rate (SAAR) in March – economists had expected a 5.5% increase in sales.  This follows three months of decline (two of which were record monthly declines) that erased most of the bounce from the initial phase of the tax credit.  Single-family existing-home sales, which I like to concentrate on, rose 7.3% to 4.68 million units in March -- up 13% from the level a year ago when they bottomed but down 18% from November. 

In terms of region, the Midwest led the way with a 7.2% sales bounce.  The South came in at a close second, registering a 7.1% increase.  The West and Northeast recorded 6.8% and 6.0% increases, respectively.

The median price of a previously-owned home rose 3.7% in March to $170,700 from the five-year cycle low of $164,600 in February – just about flat from the year-ago period and down 26% from the 2006 peak.   

The supply of previously-owned homes, in months worth relative to the current rate of sales, fell to 8.0 from 8.5.

First-time home-borrowers made up 44% of sales in March, up from 42% in February and 40% in January – I talked to NAR yesterday and they told me the historic average is 40%; it peaked at 49% last summer fall when the tax credit was set to expire the first time.  Investors accounted for 19% and repeat buyers the rest.  Distressed sales accounted for 35% and I suspect that figure is going higher as foreclosures are beginning to be processed with a bit more speed. 

We should see a multi-month bounce in existing sales on the tax credit expiry, although the weekly mortgage applications suggests the boost will be significantly weaker than the jump fostered by the initial phase of the credit.  March and April contract signings for an existing home will show up as sales in April, May and June.  After that, what happens; the same slide that occurred the last time the tax credit was set to expire?   The real test for housing lies ahead.

Have a great weekend!

Brent Vondera, Senior Analyst