U.S. stocks declined on Wednesday and outside of a brief bounce in positive territory about five minutes into trading spent the entire of the session lower.  The latest durable goods orders report erased what pre-market futures were showing to be mild trader optimism, and prices weakened following the latest economic report from the Federal Reserve that portrayed a slowing economy slowed over the past six weeks.

Health-care, financials and tech led the market lower.  Consumer staples and utilities were in the middle of the pack, performing a bit better than the overall index. 

Telecom shares were the only group of the major 10 to close higher.  Energy and industrials also performed well on a relative basis.

The Treasury auctioned $37 billion in five-year notes (another $104 billion of federal debt being offered this week in total) and demand shows that the bond market is a non-believer with regard to the prospects of this recovery turning into an actual expansion. Much like Tuesday’s auction when those two-year notes were sold at a new all-time low yield of 0.665%, yesterday’s five-year was met by a huge 3.06 bid-to-cover (gauge of demand), which was above the four-auction average of 2.58.  The notes were sold at 1.796% -- yes, that’s for five years. 

Market Activity for July 28, 2010

Mortgage Apps

The Mortgage Bankers Association reported that their index of mortgage applications fell 4.4% last week, driven lower by a 5.9% decline in refinancing activity – refis currently account for 78% of the overall index.  A slight increase in the average contract interest rate on the 30-year fixed mortgage caused the pullback in refis – even though the current 4.69% is stupid low, just off of  the postwar low, of 4.59%.

Purchases rose for a second-straight week, inching up 2.0% after the previous week’s 3.4% increase.  Applications to purchase a home plunged nearly 44% in the first 10 weeks following the April 30 expiration of the tax credit.  With the paltry gains of the past two weeks, purchase apps are currently down 41% from that date.  The tax credit did nothing but pull activity forward. 

The cure to so many of our current economic problems (federal debt, household debt, loan quality and credit contraction, state & local government revenue, the housing market and final demand) is job growth.  It’s as simple as that.  Implement the policies that drive incentives, reduce uncertainty within the small-business arena, and get the corporate sector to unlock their huge cash positions and the level of job growth necessary to drive the jobless rates down to reasonable levels will arrive.  Or don’t, by continuing along with this central planning focus, and the jobless rate will remain harmfully high. 

Durable Goods Orders

The Commerce Department reported that headline durable goods orders fell 1.0% in June (expected to rise 1.0%) after the upwardly revised 0.8% decline in May (previously estimated at -1.0%).  Excluding transportation, which is done to remove the extremely volatile component that is commercial aircraft, and orders fell 0.6% (expected to rise 0.4%), following an upwardly revised 1.2% increase in May.

The components of the report that registered order declines in June: computers & electronics, machinery, primary metals and non-defense aircraft.  Those that recorded orders increases: electrical equipment, vehicles & parts and fabricated metals. 

Frankly, I find the four-month jump in auto-related orders a bit disturbing.  Maybe auto sales trend higher, but I doubt it as there is likely to be a payback from the increased sales in the spring.  If so, the auto production over the past several months will lead to plant idling several months ahead—we shall see.

Non-defense capital goods ex-aircraft (the proxy for business-equipment spending) rose 0.6% in June.  The figure looks pretty good for the second quarter relative to the first (thanks to May’s 4.6% increase) and that’s what counts for the GDP report – we get the initial look at Q2 GDP tomorrow.  The year-over-year percentage change has shown some weakening; we’ll keep a close eye on it.

We’ll need this segment of the economy to help boost GDP growth; the estimate for Q2 GDP is already down to 2.5%.  That will bring the real annualized economic growth figure to roughly 3.25% now a year removed from the last negative reading.  This number should be set to approach 6%-8% growth, so again we’ll need all the help we can get. 

Beige Book

The Federal Reserve’s latest Beige Book (the report on economic conditions within the 12 Fed districts, released a couple of weeks prior to the subsequent FOMC meeting) underscored what Bernanke & Co. expressed via their previous meeting minutes:  The economy continues to grow, but the rate of expansion has slowed.  This comes as no surprise after the past four weeks of data we’ve received. 

You don’t have to delve beyond the opening statement of the report to find that the Fed’s anecdotal commentary has changed to a more bearish tone.  Instead of stating that activity continues to improve across all district – as was the case in the prior Beige Book, this time they noted that activity increased “on balance” (key term) and that four districts reported activity either held steady or slowed.

• Manufacturing continued to expand, although several districts started it has slowed or leveled off – and that’s the best part of the economy.
• Retail sales reports rose in general, but focused on necessities as big-ticket items were weak -- auto sales decline in recent weeks, which is exactly what we’ve been worried about as mentioned in the durable goods commentary. 
• Residential real estate was sluggish in most districts and commercial RE remained weak; vacancy rates were flat to increased, continuing to put downward pressure on rents
• Banking conditions varied across districts, with most districts reporting flat or decreasing loan demand; credit remained tight in most districts
• Overall labor market conditions improved modestly across all districts (that’s good news after the spoiler of the June jobs report); temporary hiring appears to the be the brightest spot
• Price were stable in most districts – this will remain the case, in general, until credit (lending) begins to expand and all of those dollars the Fed has pumped into the system, turn from sitting fallow to becoming high powered

Have a great day!

Brent Vondera, Senior Analyst