Put those 10K hats back in the desk drawer, again; it looks like we’ll revisit the 9K handle.  Yesterday’s session low was 9,992, but that was only after it was incorrectly reported that the latest regional manufacturing figure went negative.  The figure was actually positive and better-than-expected and stocks bounced off that low. 

While stocks recovered a bit from the session’s nadir, traders were clearly running for safety as Treasury yields continue to slide.  Monday’s sell off marked the fourth-straight decline for the broad market, which is currently 13.5% off the April 23 19-month high. 

Utilities and telecom stocks were the out-performers, the only sectors to gain ground on the session.  Basic material and health-care shares led the losers, posting 2% plus declines.

The yield on the 10-year Treasury hit 2.47%, the lowest level since March 2009 when the S&P 500 hit the nefarious 666, before closing at 2.50%. 

The discrepancy between Treasury yields and stock prices are the widest since May 2008, and we know what happened just a few months thereafter as stocks eventually followed what the bond market was signaling.  Some of what is occurring in the bond market is the unwinding of steepener trades and growing expectations that the Fed is going to implement another massive bond-buying program.  But clearly, bonds are also showing that it’s the end of the line for this recovery.

As stated a couple of times now over the past few weeks, there is boom out there waiting to occur – one that may rival the 1980s/1990s expansions.   Businesses are streamlined like never before and eventually policy will turn to a stance that incentives growth.  However, this scenario is probably a couple of years out still – below I explain some of the reasons why.  I’m sorry to say, there is another round of downside risks investors must first guard against and endure.

Market Activity for August 24, 2010

Big Ben, Parliament

Since I’ve been out, the market has essentially gone nowhere – down 3% but the trading range remains intact.  It’s done the Clark Griswold; circling the round-a-bout again and again as it can’t get beyond the traffic of a weakening economy.  It can fight off what is coming economically and hold this trading range for a while but must eventually reflect the realities on the ground.  Even at these low valuations, it won’t be able to fight what is very likely to be a double dip (another contraction after just several quarters of positive GDP readings).  What looks like strong earnings results now, and low P/Es, is going to change for the worse as the profits-by-massive layoffs are only a transitory story and what has been juiced by artificial stimulus is now waning. 

And on the job front, the situation has eroded of late – and even when the labor market was improving, it wasn’t all that to begin with.  Outside of pretty nice monthly private-sector payroll increases in March and April, the pick up in jobs has been very weak, and getting weaker over the past three reports.  Now, with initial jobless claims returning to 500K (and that latest claims report was the one that coincides with the August jobs survey) it appears we may even see another decline in private payrolls.  So the short-lived nature of job gains appears to be playing out.  They won’t contract consecutively, not at roughly 10% unemployment, but the gains will be so soft that it really doesn’t matter. 

And on manufacturing, what has been the strongest aspect of the economy over this recovery period, it appears the view that even this sector will retrench soon is playing out as well.  The regional reports got off to a bad start for August reporting as Empire held in there for August, posting a positive print, but the new orders index (the indicator of future production) went negative for the first time since June 2009.  Then we had Philly a couple of days ago print a negative 7.7, followed by a decent reading from Richmond that slowed although it didn’t show the weakness the others had.  I’m sticking to the view that all of the regionals will show factory activity has run out of steam via the September reporting.

And then of course we have housing, and all of the delinquencies, defaults and bank-loan problems that go with it (one in seven mortgage are either delinquent or in the foreclosure process, as of the second quarter). 

So nothing has changed in stock-land over the past couple of weeks.  But I’m concerned as we progress to year end that the combination of policy and a weakening economy will adversely affect the prices of stocks (and that means the public pension problem grows -- it’s key to understand the magnitude of state and local government financial woes).  And all of those individual investors who have rushed into corporate bonds for 4-6% yields (getting paid very little for the risks they have accepted) may end up being the hardest hit of all when it’s all said and done. 

Existing Home Sales

So the consensus was that we bottomed out on housing in early 2009, but yesterday’s existing homes data for July showed that thought to be quite delusional – the typical head-in-the-sand mentality we’ve seen for some time now.  But assuming the very likely 2011 recession isn’t deep, this should be the floor.

Previously-owned home sales for July plunged 27.2%, according to the National Association of Realtors (NAR), to 3.83 million units at a seasonally-adjusted annual rate (SAAR).  That was twice as bad as expected.   And it was off of an even lower comparison as the June number was revised down to 5.26 million from the initial estimate of 5.37 million.

What we’re witnessing here is the result of government interventions that provoked the market to steal sales from the future back when the tax credit was in play.  However, July’s 3.8 million SAAR existing sales is not the intrinsic market condition, just as 5.8 million in sales didn’t match with fundamentals either as interventions propped up activity.  What we have, again assuming some shock that really rocks the economy, is more like a 4.5 million unit environment.  That’s not enough to absorb current and coming supply, but it’s not the 3 handle either.

The supply of homes relative to the pace of sales exploded, hitting a new cycle high of 12.5 months worth from 8.9 months in June and beyond the previous cycle high of 11.2 in July 2008.  This figure should come back below 10 months worth over the next couple of months, but any sales bounce is likely to be weak and that’s still a very high supply figure.  For single-family only, the months worth of supply came in at 11.9 from 8.6 in June – the previous cycle high was 11.0 hit in June 2008.

The price of an existing home actually rose 1.0% for all segments to 232,200 from 230,000.  For single-family only, the median prices held at $183,400 after $183,500 in June    I heard someone state that the upper-end home seller stayed in the market, while the lower-end dropped out and this explained why prices held steady.  Regardless, the supply/demand fundamentals more than suggest prices are going lower.

I wonder if the Fed’s going to get it.  The 30-year mortgage rate can go to 4.00%, but it will have little effect on sales until the job market improves markedly and potential buyers (particularly those buying with cash) see the number of distressed homes beginning to wane and suggest prices have a chance of rising in a durable fashion.  It’s not the Fed’s job to recommend tax policy to the White House, but they undoubtedly need the help.  This is a very special and serious economic environment, and thus Bernanke better be pushing policymakers toward growth-enhancing strategies because the Fed is in a box and only durable economic and job growth will eventually repair the housing market.

Have a great day!

Brent Vondera, Senior Analyst