U.S. stocks rallied on Wednesday to have now fully recouped the big losses from late last week – the ubiquitously called flash crash.  Another 1.2% pick-up and all of last week’s decline is gained back.  More government back-stopping (this time from the EU), a few click of the heels, and voila the worries from just seven days back go poof.  Man that was easy. 

Stocks picked up momentum after a Portuguese bond sale went well, Spain announced a measure to cut their deficit and the UK election results offered optimism that the new coalition government will make progress on their debt situation. More on this below.

Tech, industrials and basic material shares were the top-performing groups yesterday.  Tech has really benefited from the equipment-spending snap back after businesses froze spending for most of 2009; Chinese stimulus measures have also played a major role as Asia is the growth engine, for now.  Health-care and consumer staples -- the traditional areas of safety -- were the laggards, but all 10 major groups did gain ground.

Market Activity for May 12, 2010

Europe’s Newfound Austerity

The fact that the Portuguese bond sale went well and there are at least signs that European countries are beginning to think about getting their fiscal houses in order is all very good news.  Although, for me, I’ll wait to see action in this newfound austerity rather than put too much confidence in more talk. 

Beyond that, there are a few things to think about. 

The Portuguese $1 billion auction of 10-year notes found good demand at a yield of 4.52%.  Lock in at 4.52% for 10 years in Portugal, eh?  That seems, oh, just slightly out of place to me – even with the EU backstopping plan, the yield hardly seems to compensate for risk.  Risk is not at all properly priced no matter where you look, which I believe will prove to be harshly conspicuous in time. 

On the improved budget plans from Spain and the UK, these are certainly things that need to occur.  However, one should refrain from getting carried away with excitement; remember that public spending accounts for large percentages of European GDP and personal incomes.  This will hit global GDP as the Eurozone is the second-largest market for the world’s exporters; the Eurozone managed just 0.6% annualized growth in the latest quarter, and that’s before any austerity has been put in. 

Strictly on getting their budgets in order, it’s going to be a tough row to hoe over the intermediate term and it will test Europe’s resolve, which based upon their actions of the past few decades is questionable.  Again, the talk is going in the right direction, and that is a very good thing, but even if they choose the right course, it will cause intense near and intermediate term economic pain in Euroland.  I’m just injecting a little reality here -- how dare I.

Mortgage Applications

The Mortgage Bankers Association reported that its applications index rose for the week ended March 7, but it wasn’t helped by purchases as this data covers the week after. After what?  After the expiration of the home-borrowers’ tax credit -- kind of a big deal. 

Applications to refinance mortgages drove the reading higher as borrowers took advantage of the first sub-5.00% average nationwide 30-year rate since the week of March 12.  Applications to refi jumped 14.8%.  Last week’s run for safety, seeking succor in the Treasury market due to the European crisis, benefited home borrowers – the average contract rate for the 30-year fixed mortgage was 4.96% vs. the 5.02% in the week prior.

Applications to purchase a home fell 9.5% last week. I’ve got a feeling we won’t have to wait very long before the National Association of Realtors goes crying to Congress to extend the tax credit again. 

Trade Figures

The Commerce Department reported that the trade deficit widened in March to -$40.42 billion from -$39.42 billion in February.  March exports increased $4.6 billion from February; March imports increased $5.6 billion for the month.

But the level of the deficit isn’t the most important factor here, it’s the internals of the report that one should concentrate on. Besides, exclude petroleum from the mix, the largest factor in driving our deficit in trade, and we’re talking only a $15 billion shortfall per month – and actually narrowed in March.  That’s right, much of the trade deficit results from our copious restrictions on domestic energy production (which I’m afraid aren’t going to be eased anytime soon after the drilling accident in the Gulf).  Of course, monetary policy has also played quite the role in driving of oil prices higher over the past eight years, so Greenspan and Bernanke are also responsible for the widening in the nominal trade deficit. 

Note: the values are negative numbers so higher represents a narrower deficit. 

On the export side, capital goods were up 1.6%; semiconductors jumped 3.6%; industrial supplies rose 7.0%; and consumer goods were hot, up 5.5%.  We’ll keep a close watch on these export figures over the next few months as weakness may very well ensue with China reining in its stimulus. 

On imports, industrial supplies jumped 7.5% (largely driven by a 13.2% increase in oil imports); autos into the country increased by 7.7%; food & beverage increased 5.5%; computer accessories up 1.5%; and telecom equipment rose 2.2%. 

The March deficit came in very near expectations, so the data should have no effect on the GDP revision that will be released at the end of month.  

Monthly Budget Statement

The Treasury Department released the budget deficit for April, and the results picked up a two-by-four to assault the estimators as the actual figure came in at a deficit of

-$82.7 billion (largest April shortfall on record) vs. the expected -$57.9 billion.  Total receipts (revenue) were down 8% from the year-ago period, while spending was up 14.2%.  Hmm, I’m going to guess that degree of divergence isn’t exactly sustainable.

Fiscal year-to-date, the budget deficit totaled $799.7 billion, right on the heels of last year’s gargantuan shortfall at this point of the fiscal year.  Last year’s budget deficit ended the fiscal period at -$1.4 trillion or 10% of GDP.  Quite the Keynesian experiment.  You’ll all learn to despise contemporary Keynesian policy as much as I do when this is all said and done. 

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900

www.acrinv.com