U.S. stocks spent most of the session lower, until the Fed signaled they’re prepared to embark on the next round of quantitative easing (more Treasury security buying along with other measures meant to pump liquidity into the system) and the market rallied.  Oh, and the coming second round of QE will likely be accompanied by an upward shift in the FOMC’s inflation comfort zone so to send the message they’re unlikely to reverse course until both employment and inflation rise a great deal from here. 

However, the FOMC-induced rally in stocks, what I’ll call silly time, was short-lived as the market erased those gains – although it did close slightly above the lows of the day. 

While stocks failed to hold their silly time gains, one certainly gets the feeling that traders have the mentality: Who needs economic growth when we’ve got the Fed willing to take even unprecedented action to a whole new level?  Well, the labor market needs growth; the housing market needs growth; and soon we’ll find that yes, corporate profits need economic growth too.  The problem is Bernanke & Co. are helpless at this point in sparking durable improvement within these areas, which the Fed Chairman all but acknowledged at Jackson Hole last month.  What they can do is pump the stock market as a way to buoy household wealth, for a while at least. 

Telecoms, industrials and health-care were the winners on the session -- the only of the 10 major groups to close on the plus side.  Financials were the biggest loser, down 1.03% for the session. 

Unsurprisingly, the long-end of the curve rallied hard as the yield on the 10-year slid 12 basis points (bps), back down to 2.58% -- and even more this morning, down another 4 bps to 2.53%. 

Market Activity for September 21, 2010

Housing Starts and Permits

The Commerce Department reported that housing starts jumped 10.5% in August to 598,000 units seasonally-adjusted at an annual rate (SAAR) – surpassing the 550K estimate.  This follows a downwardly revised 0.4% increase in July (541K units vs. the initial 546K reported).  While this level of housing construction remains pretty much floored, I’m not sure the sales data justifies even light levels of building, and the total supply figures certainly don’t.

Breaking it down:

Single-family starts rose 4.3% to 438,000 units SAAR after three months of decline that totaled a 25% plunge in construction starts

Multi-family unit construction surged 32.2% to 160,000 units SAAR, which follows a 36% jump in July.

Permits, a gauge of future building, rose 1.8%.  Single-family permits fell 1.2% (fifth-straight month of decline), while multi-family increased 9.8%.

I listened to an economist on air get all excited about this increase in home construction, but unless sales increase in a substantial and consistent manner I don’t think the euphoria is going to last very long.  Housing construction is going to have a very tough time getting off the mat due to the supply overhang – official and especially shadow inventory. 

And on that shadow inventory, I’ve recently learned that the average amount of time a loan in the foreclosure process has been delinquent is 470 days, according to Lender Processing Services. (One wonders how much weaker consumer activity would be without 2-3 million home-dwellers living rent-free for 15 months on average).  The delay in the foreclosure process is something we’ve talked about many times, but I was under the impression the average length of time was something closer to nine months. 

What banks, servicers and government are doing is attempting to manage the supply overhang.  This makes sense but you cannot completely manage this level of trouble and certainly an attempt to completely mitigate (sweep under the rug) the problem only comes back to haunt.  This supply must hit the market and the level of delay only extends the housing-market contraction.  Supply and demand must be allowed to equilibrate and that means lower prices.

This issue has serious repercussions for the economy in general.  One of my main concerns has been what looks like an “extend and pretend” strategy by the banks, hoping that home prices rebound so their loan book improves.  But this hope appears to be quite removed from reality and thus as home prices engage in another round of decline, the banks will be adding back to loan-loss provisions, thus reducing earnings and thwarting a rebound in credit. 

FOMC

The FOMC, in its statement following the close of yesterday’s meeting, announced that they are prepared to ease further.   They explained an environment in which employers remain reluctant to add to payrolls, housing starts are at depressed levels, and bank lending has continued to contract.  These comments match the prior meeting’s pretty negative statement.  What changed was the comment on inflation: “Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.”  This comment is the QE 2 signal.

Expect QE2, if not by the next meeting (November 3), at which time they’ll most likely further prepare the market for the event, but most certainly (unless some very positive economic trend develops) by the December 14 meeting – and it may be huge (maybe $2 trillion plus) as the Fed is telling us their objective is to manufacture inflation. 

Signals from the Fed that they’ll be engaging in even more unprecedented money pumping and interest-rate depressing policy is certainly favorable for stock-market traders.  At some point though, this action turns and beats the market as additional easing moves by the Fed illustrates just how poorly the economy is doing despite unprecedented monetary actions.   Such is life in an ex-post debt-led recession environment. 

And Then There Was One:  TurboTax Tim

President Obama’s best economic advisor (relative statement) is leaving to return to Harvard.  The conventional view is that the president will choose someone from the business community as the next Director of the National Economic Council, simply because it would send a signal that they’ll become friendlier to the private sector.  But one can’t count out Laura D’Andrea Tyson, always a top choice for any Democrat.  She’s currently Professor of Economics at UC-Berkeley, sits on several boards and is already an outside advisor to President Obama.

So this leaves just one original member of the main economic team:  Tim Geithner.

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900