U.S. stocks were able to shake off the increasingly early signs of government debt-related contagion in Europe as a great durable goods orders report and a bounce in new home sales – albeit from at least a 47-year low – helped the market focus on things more positive.    The gains among the benchmark indices made for the fourth winning session this week and the 11^th of the past 13.

Energy shares were the clear leader, up 2.29% on Friday, as the price of crude has quickly returned to $85/barrel.  Eight of the 10 major industry groups closed higher.  Telecoms and consumer staples were the only groups down on the session. 

For the week, the S&P 500 added 2.10%; the Dow rose 1.68%; and the NASDAQ Composite gained 1.97%.  The S&P 400 (mid cap) rallied 3.56% and the Russell 2000 (small cap) jumped 3.82%.  The S&P 500 has now rallied 80% from the nefarious March 9, 2009 low of 666. 

Greek government-bonds continue to get hit as Germany plays a game of chicken – a game Greece is going to win, but only in the short term.  Germans don’t like bailing Greece out of their troubles because they’ll be on the hook for most of the cost; to begin with, Germans seemed fairly reluctant to go with this Euro System anyway, unwilling to give up their Deutsche Mark all the way up to the Euro’s initial adoption in 1999.  Greek 10-year bond spreads have hit 626 basis points (that’s 6.26 percentage points above German bunds), which means a yield of 9.03%. 

Market Activity for April 23, 2010

Fed Moves? This Isn’t What I Had in Mind

There was news on Friday that six members of the FOMC, the Federal Reserve’s monetary policy setting committee, want the Committee to begin outright sales of its securities – you know, some of the $1.25 trillion in mortgage-backed securities (MBS) they just finished buying on March 31.  The strategy of buying these MBS, part of their quantitative easing campaign, was to push mortgage rates lower, pump money into the system and undoubtedly free up demand for Treasury securities.  (This last goal, the Fed will never admit, but everyone in the business knows it – the proceeds from selling the Fed your MBS have gone right into the Treasury market, yields would otherwise be considerably higher, in my opinion.)

Anyway, I don’t think the market is prepared for these sales, expecting the Fed would engage in all other ways of unwinding their unprecedented level of monetary easing rather than actual asset sales.  Who’s going to buy these MBS?  No one is going to buy them cheap.  Of course, there will be demand, but at what price?  At what yield? 

When I’ve discussed the Fed unwinding policy, which has been an ongoing topic for several months now, the focus has been on the need to do so in a gentle manner, and do it by getting the fed funds rates to 1.00-1.50% from the current emergency-level range of zero-0.25%.  If they do unwind by engaging in asset sales at this time in which the economic environment remains fragile, I don’t think anyone is going to like the outcome.  These are unchartered waters, no one knows how it will play out in the markets – anyone who views this stuff with insouciance is not thinking clearly. 

The FOMC’s latest two-day meeting comes to a close on Wednesday.  Bernanke & Co. are not about to even remove the language (keeping rates at exceptionally low levels for an extended period), much less increase fed funds or sell MBS.  They’ll wait for several months of 100k-150K in private-sector job growth (that’s in addition to the 100K/month census workers, which is very short-term employment) before they remove the language.  But if they do begin to sell MBS anytime soon, and this isn’t just more Fed talk to try to get the markets thinking they’re serious about price stability, it would be a very large mistake. 

Durable Goods Orders

The Commerce Department reported that durable goods orders fell 1.3% (+0.2% was expected) in March after an upwardly revised 1.1% increase in February, but the decline in the headline figure for March was all due to a 67% slide in commercial aircraft orders – those orders had jumped 32.7% and 135% in the previous two months. 

Excluding transportation equipment, which removes the plunge in commercial aircraft, order surged 2.8% -- a huge number that destroyed the expectation for a 0.7% rise.  Shipments of durable goods, which get plugged into the GDP readings, have now posted an increase for the first quarter, up 1.2% in March after declines of 0.5% and 0.1% in the previous two months, respectively. 

Almost all components of the durables report looked really good.  Computer, electronics orders were up 3.4%, after a 1.6% decline in February; orders for electrical equipment jumped 4.9%, after a 0.9% decline in Feb.; machinery orders rallied 8.6% after a 6.9% increase in Feb.; vehicles and parts were up 2.5% after a 1.0% decline.  Outside of commercial aircraft, fabricated metals was the only major component to post of decline in orders, down 1.2% in March but February orders were up 3.5%.

As the aforementioned items suggest, business spending was strong in March.  This figure, technically known as non-defense capital goods ex-aircraft, rose 4.4% last month, after a 2.1% increase in February and a 4.4% decline in January.  That February rise was unable to overcome the January decline, so it was looking like first-quarter business spending may not extend upon the strong numbers in the fourth-quarter of 2009.  Indeed, activity was weaker than in the fourth, but with this March data it is clear now that firms, at least large firms, are beginning to use some of their huge cash positions to increase their business spending – it wasn’t just an end-of-the-year situation. 

In normal circumstances, higher trends in business spending are pretty quickly followed by substantial increases in payrolls.  Everything hinges on job growth; we get the April employment report May 7 and we’ll watch the private-sector results to see if this follow through occurs. 

New Home Sales

The Commerce Department reported that new-home sales surged 26.9% in March to 411,000 units seasonally-adjusted at an annual rate (SAAR), following a 4.1% decline in February.  Remember, new homes sales, unlike existing homes, are counted when a contract is signed, so this is the boost from the tax credit expiring; we should see a boost in April as well.  For existing homes, the full effect of the credit won’t show up until the May and June sales are released – contracts signed in March and April.

This March rebound ended a four month slide in new-home sales that resulted in a new all-time low being put in during February – the 411K units SAAR in March didn’t quite get us back to the near-term peak that resulted from the initial phase of the tax credit last summer/fall, but the April figure should get us there.  From that point, the housing market will lose a major leg of government support as the credit evaporates in a week. 

The increase in sales was also helped by a 3.4% lowering of new-home prices as the median price fell to 214,000 from $221,600 in February; the median price was up 4.4% from the March 2009 five-year low, but down 18.5% from the peak hit in 2007.

The supply of new homes, relative to the sales pace – or the inventory/sales ratio, fell hard to 6.7 months worth of supply from 8.6 in February.  This is a very needed improvement, but we saw this reading decline last summer/fall only to rise again.  The real test lies ahead when the tax credit is no longer in play.

The Calculated Risk blog touched on the gap between existing and new home sales – cleverly referring to this disparity as the “Distressing” Gap.  That is, the number of distressed houses entering the market (foreclosures and short sales) are cannibalizing new-home sales, causing this gap between the two data sets; they have historically moved in relative tandem (I’ve reconstructed the chart below).  While the supply of new homes has come down nicely, the high pipeline of foreclosures will add to distressed sales, which sell at lower prices, and continue to make life even more difficult for new-home sales and possibly the inventory/sales figure. 

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900

www.acrinv.com