U.S. stocks put together a strong day, with broad support taking the S&P 500 above its 50-day moving average and even briefly touching 1100. Although the session’s gains were impressive, trading volume was lacking.

A large slate of economic data helped take the edge off of deflationary fears, but the real headliner was that Potash received and rejected an unsolicited takeover proposal from BHP Billiton.  BHP’s unsolicited bid for Potash and Dell’s acquisition of 3Par on Monday has raised hopes that cash-rich companies could start spending. Publicly traded companies in the U.S. have $2.03 trillion in cash and short-term investments on their balance sheets, according to FactSet Research.

Wal-Mart and Home Depot released quarterly results and forecasts that were a bit mixed.  Deere & Co. and Target are scheduled to announce results before the start of trading today. So far 445 companies in the S&P 500 have reported second-quarter earnings with 75% beating estimates.

Investors embraced risky assets and shunned safe haven assets like Treasury securities.  The 10-year Treasury climbed to 2.65%. The rise in yield comes despite the Fed’s purchase of $2.551 billion in Treasury securities yesterday.  More on the Fed’s buying after the jump.

Market Activity for August 17, 2010

The Fed Goes Shopping

The Fed’s $2.551 billion dollar Treasury purchases were the first since last October.  The plan is to use the proceeds from maturing mortgage-backed securities to buy Treasuries.  Last year’s Treasury purchases were the first outright of the U.S. government debt by the Fed since the 1960s.  These purchases pale in comparison to the $1.7 trillion in Treasuries and mortgages bought over the course of 2008 and 2009. Still, another big investor will keep yields crazy low. 

In addition to low yields, the Fed’s move to buy more bonds is a message to investors that the central bank will do whatever it takes to promote growth and keep deflationary pressures in check.  James Bullard, Federal Reserve Bank of St. Louis President, told the Wall Street Journal yesterday that they Fed may need to buy more assets if inflation keeps slowing.  Bullard has been pretty vocal with this opinion recently, which is notable because he is normally an inflation hawk.

In my opinion, it’s unlikely that the Fed’s Treasury purchases will spur much more spending and lending since rates are already so low.  Also, banks’ willingness to lend remains hindered by the uncertainties from the recently enacted financial-reform package.  It could be that lending will pick up once budgetary and regulatory concerns are eased, but that may take some time.

Producer Prices

Wholesale prices rose in July for the first time in four months on higher prices of raw materials.  PPI for July increased 0.2%, as expected.  Stripping out food and energy, which are more volatile, showed wholesale prices rose by 0.3%, a 0.1% increase had been expected. 

Industrial Production

Industrial production rebounded in July, rising by 1% and more than double than projected as business investment in new equipment kept growing and factories churned out more computers and electronics.  However, the inventory rebuild will fade as consumer spending moderates and overseas export demand wanes, which means that the pace of industrial expansion may slow.  As I mentioned yesterday, manufacturing led the economy out of recession but will likely be a smaller contributor to GDP growth in the future.

Capacity utilization also increased, but still remains well below the average level of 80.8%

Housing Starts

Housing starts increased 1.7%, to a seasonally adjusted annual rate of 546,000.  However, the increase was driven by groundbreakings of homes with five or more units, while key single-family housing starts plunged 4.2%. July building permits dropped 3.1% to an annual rate of 565,000, which indicates lackluster future construction.

Have a great day!

Peter Lazaroff, Investment Analyst

Phone: 636-449-4900