U.S. stocks recovered some of Tuesday’s losses as strong quarterly earnings results continue to stream in and the Fed signaled ZIRP remains in place, which helped to ease concerns that led to the prior session’s sell off – the European debt woes and the intermediate term hit to global growth that will result.

Profits-by-massive cost cutting remain a good storyline for stocks.  For the quarter, with 40% of S&P 500 members in thus far, total first-quarter profit results are up 52.8% --  up 35.8% excluding financials.   These big bang earnings results we talked about that would occur, a message we first touched on last July,  are here – I remind everyone of this early prediction for the second time this week as it’s easy to forget since I’ve struck such a tone of pessimism over the past several months.  But the prediction also included a caveat: the profit growth story will be a short one as it’s nearly all based on the easiest year-ago comparisons in the postwar era and massive payroll slashing.  Things will become very difficult for the corporate bottom line as we head into 2011.  

The latest twist in the European sovereign debt saga is that the IMF is considering stepping up its share of the bailout to keep Greece from defaulting as Germany holds the rescue plan up – the Germans try to delay a formal commitment before the May 7 elections.  The IMF may increase their planned share of the bailout to around $30 billion from what was initially thought to be $20 billion.  This means a larger IMF role in the rescue than the EU-member countries themselves will have in the game.  But this is all unofficial right now.  The IMF also stated that Greece will ultimately need an aid package that is three times the $45 billion figure currently being thrown around.

While a larger IMF role will demand more austere budget constraints than EU ministers would either demand, or more importantly enforce (which would be good for Greece’s longer-term prospects), I’m not sure the European citizens have what it takes to deal with substantial budget cuts after 40 years of safety-net dependency.  So, this means more government-employee strikes, and since the public sector makes up a large percentage of the overall workforce they can virtually shut down an already anemic economy.  Now factor in Portugal, Spain and you can’t rule out Italy and we’ve all got a problem on our hands. 

Market Activity for April 28, 2010

Mortgage Applications

The latest from the Mortgage Bankers Association showed their applications index fell 2.9% in the week ended April 23 as refinancing activity weighed on the index.  This decline follows a 13.6% bounce in the previous week.

Applications to refinance a mortgage slipped 8.8% after increasing 15.8% in the prior week.  The average 30-year fixed mortgage rate has been stuck above 5.00% over the last seven weeks and for this period refi activity is down 30%.  The average contract rate for the 30-year fixed increased to 5.08% from 5.04% in the prior week.

But the importance of this applications report right now is purchases, and they increased for a second-straight week – up 7.4% last week after a 10.1% rise in the week ended April 16.  This is the final week for the home-borrowers tax credit, must have the contract signed by April 30, so we should see another bounce in next week’s mortgage apps report.  From there, one more crutch will be removed and that is when the real test for housing begins. 

FOMC (The market’s best friend…for now)

The FOMC’s two-day meeting concluded yesterday.  In normal times this six-week event would result in a building anticipation as all eyes are glued to the Bloomberg screen, awaiting the rate decision.  But these are not normal times and a change in the fed funds rate has been off the table, and will remain that way for a while as Dr. Zero & Co. kept their “exceptionally low level of the federal funds rate for an extended period” phrase.  Thus, everyone focuses on the language – the statement that follows the meeting’s close. 

And on that language, they gave us absolutely nothing different except for some mild massaging on how they explain the economy is improving, albeit quite slowly. 

When I refer to Dr. Zero & Co., I exclude KC Fed Bank President Hoenig from the group.  This rotating member of the FOMC remained the lone dissenter for the third-consecutive meeting.  He stated, “that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period could lead to the buildup of future imbalances and increase risks to longer-run macroeconomic and financial stability.”  He also correctly added that this limits the ability to increase rates in modest fashion when they do get to removing this unprecedented level of monetary stimulus.  Bingo!

So, the Fed continues to hold the fed funds rate below the rate of inflation, meaning real (inflation-adjusted) short-term rates are negative.  Real fed funds has been negative for four of the last 7 ½ years and this foments a serious misallocation of resources.  In previous years this meant that capital flooded into the housing and commodity markets, until the unsustainable increase in prices collapsed.  Now, it is occurring in high-risk bonds and the stock market as the Fed pushes investors into these assets; the search for yield rolls on.  The longer they hold to this policy, the harsher the payback event when they eventually unwind.  Let’s hope when the next plunge occurs, policymakers refrain from their populism-by-convenience ways and point the finger and force changes in the right direction.  I’ll say it again:  It’s the Fed, stupid. 

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900