U.S. stocks ended mixed on Wednesday, as the Dow and NASDAQ closed higher with the broad S&P 500 inching down.   Mid and smalls fell for a second-straight session.  That’s 7 Up for the Dow, falling seven down sessions…Big Ben, Parliament. 

Futures were looking pretty early yesterday morning on the heels of that Intel report, but the market was unable to completely withstand a number of less-than-desirable economic releases. Reports on mortgage app, retail sale, business inventories and then lower guidance on economic growth from the Fed all damaged the early excitement. 

A late session rally erased a 0.7% decline in the final 90 minutes of trading.  Stocks traded down immediately following the release of the April 27-28 meeting minutes, but then summarily rallied back as the comments make it even more clear that ZIRP will remain in place for a long time and QE2 is likely on the horizon.  The hunt for return continues, and this may just be the largest consequence of ZIRP when it’s all said and done – call it the Wile E. Coyote moment.

Tech, industrials and consumer staples (there’s that combination of cyclical stocks moving in tandem with a traditional area of safety again) led the gainers.  Financials, consumer discretionary and energy were the three groups that lost ground for the session. 

Market Activity for July 14, 2010

Mortgage Apps

The Mortgage Bankers Association reported that their applications index fell 2.9% during the week of July 9, brought lower by both refinancing activity and purchases.

Refinancing activity fell 2.9% even as the rate on the 30-year fixed mortgage remained at super-duper low levels, inching up just slightly to 4.69% from the average 4.67% in the week prior. 

Purchases fell another 3.1%, marking the eight decline over the past nine weeks – nine weeks ago the tax credit expired. 

Holy cow!  Even a housing bear as myself thought applications to purchase a house would have bounced a bit by this latest reading, after nearly a 40% plunge following the expiry of the tax credit.   Now apps to purchase are down 42.1% over this nine week stretch.  Those thinking the housing market is in rebound…well, living in their la la land must be nice.

Import Prices

The Labor Department reported that import prices slid in June, off by 1.3% after the 0.5% drop in May.  Much of the decline was due to the petroleum component (ex-petro prices were down 0.5%) but just about all components fell for the month.

This back-to-back decline is going to get Bernanke very antsy about deflation (again, I recommend that those interested read his 2002 speech Deflation: Making Sure “It” Doesn’t Happen Here and you’ll get a sense of just how likely we’ll have another round of QE coming).   If CPI posts its second-straight negative reading when the June figure is released, the Fed head will be consumed by his deflation paranoia. 

Retail Sales

The Commerce Department reported that headline retail sales fell 0.5% (-0.3% was expected) in June after a 1.1% decline in May (revised up from -1.2%).  Excluding autos, retail sales fell 0.1% (right in line with expectations).  Excluding just gasoline, sales fell 0.3%.  Excluding autos, gas and building materials (also called the core rate as this number is plugged into the GDP report), sales rose 0.2% after a 0.2% decline in May.

On the negative side:

A 2.3% decline in auto sales had the largest drag on overall retail sales, we’ve been talking about a payback period in this area – this follows a 0.6% decline in May after a huge two-month increase in March-April.  Furniture sales were also down big, falling 1.1%.  This segment has turned ugly again over the past three reporting months --February and March furniture sales were boosted by the home buyers’ tax credit.)  And building materials got hammered again (home-building rebound? I think not), down 1.0% after the 9.0% crushing in May.  Gasoline station receipts were down 2.0% in June, following the 2.5% drop in May – some of this is reduced demand, but most is probably price driven.

On the positive side:

Clothing sales rose 0.6% after May’s 0.4% drop; electronics sales jumped 1.3% after a 0.9% increase in May; general merchandise was up 0.2% after a 1.0% slide in May; non-store retail remained strong, up 1.0% after the same increase in May.

All in all, this is not a horrible report, but shows that there is a payback period from the artificially stimulated spending earlier in the year.  While the core reading was up in June, the three-month average is down meaningfully from the prior quarter and as a result will place some level of drag on second quarter GDP -- expect a more substantial drag in Q3.

Business Inventories

Commerce reported that business inventories rose 0.1% for May (a 0.2% increase was expected) and the all-important sales data fell 0.9%, marking the first decline since March 2009 -- confirming what the wholesale inventories data showed from last week. 

So, inventories continue to pick up but the boost from the inventory dynamic is waning.  One can’t get too worried about sales falling for the month – one month does not make a trend – but if this is followed by a decline when June is reported and inconsistent sales activity beyond that then inventories are not going to help GDP in the back half of the year and that’s when the cruel reality of this slow growth period – a rate of growth that is not sufficient to engender the degree of jobs growth needed – becomes evident to all. 

It is good though that the inventory/sales ratio remains close to the record low.  It means that even a trend down in sales will not result in a lot of drag from inventories – but you can probably forget about much more growth boost as the inventory dynamic will have run its course without the sales to back it up.

(On overall economic activity and policy: I’ve heard and read that an increasing number of the Congressional majority are thinking about holding current tax rates in place.  For as much as these rates have been vilified, I wouldn’t give this rumor/speculation/whatever you want to call it too much credence at this point.  But if current rates on income, capital gains, dividends and overseas profits are not increased then that will be a big help.  There are still structural dislocations that must first be resolved, dislocations that occurred via the credit crisis, and the massive job losses that followed – and of course Congress has an overall agenda that is not exactly beneficial to growth prospects.  But a decision to hold current tax rates in place will do a lot of good in removing the worst-case scenario. We’ll see how it goes.)

FOMC Minutes

In the minutes (notes) from the April 27-28 Fed meeting, committee members saw no reason to boost stimulus to the economy at this time but they did trim their forecast for growth, mentioning risks to the recovery increased.  So, as we’ve mentioned on a couple of occasions over the past several weeks, after revising their growth forecasts up in the previous meeting, they’ll be adjusting those estimates down; this marks the third revision in about six months from the old Fed.

They also stated that it would take some time for economic growth and the unemployment rate to hit levels they view as optimal.  How long is “some time?”  According to the members of the FOMC, it will take no more than 5-6 years.  And no, that’s not a typo – and it’s unlikely to be a smooth slow-growth ride.

The FOMC is clearly worried about stubbornly high unemployment and the low level of growth.  The existence of these realities despite an unprecedented monetary easing has them collectively confounded.  QE version 2 is coming, probably early 2011 by my guess. 

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900