U.S. stocks began the session lower, falling 1.1% 30 minutes into the session, but rallied in the afternoon to close higher as traders may see current valuations as attractive even as the data continues to show economic growth is eroding. 

The broad market slid 7% over the past two weeks, putting the P/E on the S&P 500 at 14 times trailing and 12 times the earnings estimate for the next four quarters.  Profit expectations are a trick thing though, especially in an environment with which revenues are weak, profits are boosted by massive payroll slashing and the already weak growth appears to be intensely short-lived.  We’ll see how those expectations for 10-12% profit growth over the next year turn out. 

Seven of the 10 major industry groups gained ground on the session, led by consumer discretionary shares – if one can’t laugh at that then you’re completely oblivious to wants going on in consumer-land.  Health-care and telecoms also led the way.  Energy was the worst-performing group. 

Treasury yields rose (prices were down) after initially rallying in the morning after dismal economic reports – durable goods orders and new home sales missed big and the latest on mortgage apps showed there’s still little desire/ability to buy houses.  The yield on the 10-year hit 2.44%yesterday morning, but finished at 2.54% (if that degree of movement in yield doesn’t explain the chaos that’s going on out there nothing will). 

Market Activity for August 25, 2010

Quickly on Oil

The price of crude rose 1.24% to $72.52/ barrel yesterday even after yesterday’s weekly energy report showed a big build in stockpiles as demand fell.  Crude inventories surged 4.1 million barrels (expected to climb just 300K), gasoline inventories jumped 2.3 million barrels (expected to fall 450K), and distillates rose 1.8 million (expected to rise 1 million).  

Just as basically every other aspect of the marketplace, you’re never really sure when a move is based on fundamentals or is actually quite removed.  Such is the reality when the Fed engages in unprecedented levels of monetary easing. And based on very weak economic realities the market perceives, and rightly so, that Bernanke & Co. will engage in another $ trillion-plus quantitative easing campaign.  With all of this money sloshing around, and the expectations that there is more to come, you get extremely distorted markets.  Be careful out there because when this is in play, the rug can be pulled out from under your feet very quickly. 

Mortgage Apps

The Mortgage Bankers Association reported that its applications index rose for a fourth-straight week, up 4.9% after the prior week’s 13.0% bounce.  The problem is the results have been driven by refinancing activity; apps to purchase a home remain very weak. 

Refis rose 5.7% during the week ended August 20 after a 17.1% jump in the previous week.  The average contract interest rate on the 30-year fixed mortgage fell to a new postwar record of 4.55% from 4.60% in the prior week. 

The same people continue to refi at lower and lower rates. Those who need to in order to make payments more affordable can’t as they don’t have the equity – in many cases the mortgage is underwater. 

Purchases rose just 0.6% after the 3.4% decline in the previous week. 

Durable Goods Orders

The Commerce Department reported that durable goods orders for July rose just 0.3% (expected to rise 3.0%) but the June figure was revised up to show orders fell just

0.1%, not the 1.0% initial estimated.

Excluding transportation equipment, which is the number to watch as the very volatile commercial aircraft component distorts the overall reading, orders slid 3.8% (expected to rise 0.5%) after June’s 0.2% increase (initially reported as a 0.6% decline last month). 

Transportation equipment, as the difference between the overall and ex-trans figures suggested, was just about the only segment to post a gain in July – fueled by a 76% jump in commercial aircraft and 5.3% increase in vehicles & parts.  I remain very concerned that the auto production of late will not be absorbed by sales.  If this turns out to be the case, the manufacturing figures are going to reflect it as we hit the fourth quarter. 

The all-important business spending component of the report (technically known as non-defense capital goods ex-aircraft) plunged 8.0% in July, more than erasing the prior two months worth of increase. 

We’ll have to watch for a trend to emerge within the business spending component, but the results for July (assuming not revised higher) are clearly not good.  If the segment bounces over the ensuing couple of months, we may be able to manage slight positive prints on GDP through 2010.  However, if business spending turns down because executives are worried about the immediate future, then we’ll see negative GDP by the fourth quarter. 

New Home Sales

Sales of new homes fell 12.4% in July to a seasonally-adjusted annual rate of 276,000 units, a new all-time low.   Sales were expected to hold flat to June’s 315,000 units – that June reading was revised down from initially being reported at 330,000.  On an unadjusted basis, 25,000 new homes sold in the U.S. last month, down from 29,000 in June.  The peak was 127,000 new-home sales in March 2005.

The months worth of supply figure rose back to 9.1 from 8.0 in June.  The record high was 12.1 months worth, hit in January 2009.  Normal market conditions generally accompany 5.5 months worth of supply.

The number of new homes available for sale held steady at 210,000 units. 

The median price of a new home fell to a new cycle low of 204,000, down 5.9% from June’s $217,000.  The price is down 4.6% from the year-ago period and down 22.3% from the peak hit in March 2007.

So new home sales are counted when the contract is signed, unlike existing (or previously-owned) home sales, which are counted when the contract closes.   This obviously means that the new home data is what actually occurred in July (assuming the numbers aren’t revised next month, which is a big assumption). 

This wasn’t supposed to occur as the expected pull back from the tax credit bounce was to last only one month.   But the new home market is contending with distressed sales within the existing home arena and until that market is able to recover, the new home market will continue in a world of hurt.  Let’s hope this is the floor though, I don’t see how they can go lower. 

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900