U.S. stocks rallied in the final hour of trading to close higher on Wednesday even as the day’s economic reports showed factory activity -- what’s been the most powerful sector of the economy -- is slowing. 

In addition to the market holding up even as key manufacturing indicators waned, stock prices also withstood comments from former Fed Chairman Greenspan – that is, if anyone still pays attention to him.   While he stated that an economic double dip is unlikely, the former chairman repeated his caveat that if home prices drop again “all bets are off.”  This mean all bets are off because home prices have another leg lower. 

Safety was the theme though as health-care and consumer-staple shares were the best-performing groups.  Energy, utility and basic material shares were the laggards, all down for the session.   Safety has reigned since the S&P 500 hit its 19-month high in April as telecom, utility and consumer-staple shares have outperformed since April 23 – all the top dividend-yielding sectors as well.

The big international news of the day was the Bank of Japan (BOJ) intervening for the first time since 2004 to halt the massive rally in the yen – a rally that had pushed the $/yen pair to 83.04, the highest level for the Japanese currency in 15 years.   As a result of the intervention, the yen backed up to 85.60 (85.6 per U.S. dollar) yesterday.   The efficacy of this intervention may prove short lived as it’s likely to be thwarted when the Fed engages in QE2. 

We talked about the yen rally a couple of weeks back, specifically with regard to U.S. stocks.  Generally, when the yen is in rally mode it means stocks are going lower because the move to the Japanese currency signals risk aversion within the market place – the three-month yen rally was one of the strongest in history, yet stocks held up.  The divergence between activity in the yen and that of U.S. stocks remains the widest since March 2008.

Market Activity for September 15, 2010

Mortgage Apps

The Mortgage Bankers Association reported that their applications index fell for a second week straight, driven lower by another decline in refinancing activity – refis currently account for 81% of all apps.

Applications to refinance fell 8.9% in the week ended September 3 even as the average contract rate on the 30-year fixed mortgage fell back below 4.5% to 4.47%.  But the same people continue to refi as those stuck in higher rates can’t due to a lack (or complete absence) of equity.  If my take on the mortgage environment is close to what the market is thinking (and this comes from a perspective of already having a low rate of 5%), then most people are waiting for 4.00-4.30% to refi again.  (I’ll note Freddie Mac has a program that allows borrowers a one-time refi without an appraisal and up to 125% LTV – 125% LTV?  Yow!)

Applications to purchase of home slipped 0.4% last week, which follows a 6.3% in the week prior.  Purchase apps have risen seven of the past nine weeks, but the increase has been paltry and hardly enough to make a dent in the 44% slide endured during the 10 weeks that followed expiration of the tax credit.

Empire Manufacturing

Factory activity within the second Federal Reserve district (New York Fed Bank’s region) decelerated to a reading of 4.14 in September (half the 8.00 expected) from 7.10 in August.  This is the first regional report we have for the month and shows the deterioration we’ve expected, although not as bad as I expected.  This latest print is the lowest reading since July 2009 and the degree of optimism regarding the six-month outlook fell to the lowest level since early 2009.

New orders, which are the best indicator of forward progress, bounced back to positive territory after returning to a negative print in August for the first time since April 2009, increasing to 4.33 from -2.71 in July – but a reading of 4 is well below the longer-term average of 11.   

Delivery times and unfilled orders both printed negative readings – unfilled orders have been in contraction mode for six months and delivery times has printed a negative reading four times in the past eight months.  These components show that there is very little room for weakness in new orders, as it means there’s no backlog to cushion a slowdown in orders. 

The inventories reading held up, coming in at 1.49 from 2.86 – anything positive on this reading is good.  However, the ratio between new orders and inventories has deteriorated, showing that if orders fail to bounce in a significant manner then stockpile rebuilding will falter – and other indicators are suggesting the inventory cycle has largely run its course.

The employment measures continue to look good within the Empire survey, although we need something big bang from manufacturing employment to offset weakness in other areas of the labor market.

Again, this is the first regional for September and obviously sets the tone.  For several months I had been expecting factory activity to show deterioration beginning this month and weaken further to the end of the year when it will go back to contraction mode by December.  The bounce in new orders indicates that my assessment may be a bit premature.  We get a better indication from Philly today and Richmond in about 10 days.

Industrial Production

The Federal Reserve reported that industrial production (IP) has flattened out over the past three months as the latest reading (August) increased 0.2%, following a 0.6% increase for July (downwardly revised from initially being reported as a 1.0% increase).  The figure rose just 0.1% in June.

Manufacturing production, which accounts for 78% of the IP index, came in at 0.2% after July’s 0.7% increase – the figure was held back by on outsized decline of 5.0% in motor vehicle production.  (This is what’s concerned me.  Auto production has been outpacing dealers’ sales for a few months now and without a sales boost automakers will have to curtail production so not to create an overhang.)  Excluding autos, manufacturing production rose 0.5% as machinery and electronics output looked good – up 0.4% and 0.7%, respectively.  

Utility production (accounts for 10% of the total index) fell 1.5% due to mild weather.  Mining activity kept rolling, up 1.2%, thanks to supportive metals prices.

Capacity utilization (CU) -- % of total plant capacity that is being used -- ticked up to 74.7% (expected to hit 75.0%) from a downwardly revised 74.6% in July – the long-term average is 81%.

Manufacturing-sector CU inched up to 72.2% from 72.1% in July – the long term average is 79.5%; the current level is in past recession territory.

Utility CU fell to 81.0% from 82.4% in July – the long-term average is 87.4%.

Mining CU jumped a full percentage point to 86.3% -- closing in on the long-term average of 87.4%.

Sign up to receive the Daily Insight and other Acropolis publications here.

Have a great day!

Brent Vondera, Senior Analyst