After spending most of the day on the plus side U.S. stocks failed to hold positive territory, falling below the cut line in the final 40 minutes of trading.  You can’t say it was a mirror image of Tuesday’s session, when stocks erased a 3% plunge to close mildly positive, but it was close.  At its intraday peak, the S&P 500 was higher by 1.54%, but momentum began to fade at about 1:00 CDT and completely fell apart as we headed for the close.

There was a report from the Financial Times, out about the time that stocks went negative, stating that China may begin reducing their positions in European government bonds.  Obviously, and it shows just how skittish this market is for it to react this way, the Chinese are not going to announce such a strategy to the world; they hold $630 billion in euro-zone bonds, they’re not going to want to see those positions summarily crushed.  But from a wider perspective, such action would put immense pressure on the European banking system since they have significant exposure to these bonds.  Actually, the exposure is more likely massive, but I don’t have the number in front of me so I’ll call it significant for now. 

The EU banking system is in trouble anyway you look at it.  The central bank and various euro-zone governments can delay the damage, but they can’t ultimately erase what only good policy and time can cure.

The day’s economic reports were mixed with the April durable goods report beating expectations on the headline number, but missed via the more reliable ex-transportation reading.  New home sales for April jumped, destroying the consensus estimate, but as the prior three weeks of mortgage apps have shown, the tax credit simply stole sales from the future…more on these data below.

Nine of the 10 major industry groups closed down for the session, industrials being the only survivor – the S&P 500 index that tracks these shares was up as much as 2.5%, but ended just 0.25% higher .  Telecom and tech led to the downside, both were also positive earlier in the session. 

Market Activity for May 26, 2010

Shoot to Kill

BP attempted what they call a “top kill” yesterday as they use yet another strategy to plug the spewing well.  Success means that BP will see a reprieve to the assault on its stock price in the short term – even if they’ll still run into massive lawsuits and reputational damage well beyond this event.  If, on the other hand, the shot fails to plug the kill line, their stock price will continue to get hammered.  We should know the results within a couple of days.  It’s do or die time for BP, literally.

Mortgage Applications

The Mortgage Bankers Association reported that their applications index jumped 11.3% for the week ended May 21, but for the second week in a row the results were actually quite worse than the headline reading suggested.

For the second-straight week, the applications index was totally driven by refinancing activity – up 17.0% last week after a 14.5% increase in the week prior.  This is due to the decline in the 30-year fixed mortgage rate, which fell to an average of 4.80% from 4.83%; the rate has been below 5% for three weeks now.

However, application to purchase a home fell for a third-straight week.  Like clockwork, purchase activity has retreated directly following the expiration of the tax credit.  Purchases fell 3.3% for the week ended May 21, which follows a 27.1% plunge and a 9.5% decline in the prior two weeks.

Durable Goods

The Commerce Department reported that overall durable goods orders rose 2.9% in April (an increase of 1.3% was expected), fueled by a 16.1% increase in transportation orders – commercial aircraft orders surged 228% after a 71.2% slide in March.  The March data was revised up to show no change vs. the 1.3% decline reported last month.

That huge volatility within the commercial aircraft segment is exactly why one focuses on the ex-transportation reading.  Durable goods orders ex-transportation fell 1.0% in April (expected to rise 0.5%) after big increases in March and February of 4.8% and 2.1%, respectively. 

The business spending proxy of the report, technically known as non-defense capital goods ex-aircraft, fell 2.4% after strong increases in March and February of 6.5% and 3.0%.  Driving this very important reading lower was a 6.9% decline in electrical equipment and a 5.9% drop in machinery orders.  Computers and electronics orders were up for a second-straight month though, increasing 2.2% after March’s 5.2% rise.

Overall, this is a weak report, but it doesn’t make it a bad one as what occurred is largely just a respite in new orders following two strong months.  So long as durable goods orders show a continued trend higher when the May report is released, things are fine within this segment of the economy, for now.  I do feel though that debt-related challenges, which are becoming clearer by the week, will lead to another decline in durable goods orders and business spending in general a few months out; the household and sovereign debt problems will damage what has been a slight uptick in business confidence.  One shouldn’t expect a decline in business spending like the record postwar reductions that occurred in 2009, but those expecting that this is a normal recovery will be surprised by the degree of weakness. 

New Home Sales

The Commerce Department also released new home sales data for April, showing a jump of 14.8% to 504,000 units at a seasonally-adjusted annual rate (SAAR) – blowing away the out-in-left field estimate for a rise of just 3.4%.  This follows the big 29.9% jump in March, which was revised up (initially reported as a 26.9%).  One would normally term these moves as gargantuan but since they are off of nearly record lows hit in February and are stealing sales from the rest of the spring/summer, I’ll just term these increases “big.”

New-home sales are recorded when the contract is signed, so this will be the cycle peak month for this data as result of the tax credit that expired April 30 – previously-owned homes sales are not counted until the contract closes, so those sales will witness the height of the second iteration of the tax credit-induced boost in May or June. 

By region, the Midwest led the way with a 31.6% increase in sales; new-home sales rose 21.7% in the West; sales were up 10.8% in the South (which accounts for 55% of the new-home market); sales were flat in the Northeast. 

Outside of the tax credit, a large 9.7% m/o/m decline in the median price of a new home helped sales.  The housing market has leaned on low down payment FHA backed loans and this is probably why builders had to accept such a lower price point. 

The tax credit has certainly helped the inventory data, which has returned to low levels.  The months worth of supply at the current sales pace slid to 5.0 months in April from 6.2 months worth in March and that’s down from 8.2 months worth in February. 

Again, this is relative to the pace of sales, which are very likely to retreat again when the May figures are released.   At which point, builders better be careful not to engage in much activity over the next couple of quarter as the market will be without the crutch of the subsidy (very low interest rates alone have not proven enough to boost home sales as the jobless rate remains near record postwar levels; the tax credit has provided the boost). 

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900