U.S. stocks ran into a little headwind yesterday even as the day’s economic reports were mixed.  Analysts’ downgrades of Microsoft and Alcoa dimmed the outlook regarding the near-term future of the economy – Deutsche Bank recommended selling shares of Alcoa, which is traditionally the first company to report quarterly earnings; third-quarter earnings season will begin later this week, but not in earnest until next week.

The mercurial nature of this market makes me wonder why I write such things as: future prospects for the economy have dimmed, or future prospects have improved.  Such mindsets change on a dime these days, but that was the tone for the session, so I’ve got to state it. 

The day’s economic releases were of little help.  The August factory orders report printed a decline, and while the business spending component appears to remain on an upward trajectory both headline and ex-transportation orders have declined since the spring.  The latest on pending home sales (contract signings) rebounded by 4.3% for August, but it’s of little consolation after the historic beating this data took a couple of reporting months back – the chart below paints the picture. 

Further, the ongoing and apparently growing foreclosure chaos (allegedly fraudulently signed affidavits, questions over who owns the title, etc.) is likely to suspend distressed property sales – a segment of the market that currently accounts for 30% of sales.

All 10 major industry groups lost ground for the session.  The relative winners were telecoms, consumer discretionary and utilities.  Huh? Consumer discretionary, on a day of weakness and run to the traditional areas of safety?  Why am I surprised?  Basic materials, industrials and energy shares were biggest drags on the broad market.

Volume was extremely weak again, 26% below the six-month average.  Down days, up days, no real conviction either way.  A bunch of algorithmic HFT programs trading among each other, pretty much as the official report on the May 6 flash crash had alluded.

While stocks were down yesterday, Big Ben came to the rescue last night as he removed any doubt (if there were any doubter than remained at this point) by laying the final groundwork that QE2 is coming.  Stock index futures, treasury securities, base metals and oil are all up this morning.  We’ll make additional comments on this topic in tomorrow’s letter.

Market Activity for October 4, 2010

Factory Orders

The Commerce Department reported that factory orders fell 0.5% (expected to fall 0.4%) following an upwardly revised 0.5% in July, which was initially reported as just a 0.1% rise. 

What this factory orders report shows us that the durables report doesn’t pick up (the report on durable goods always precedes factory orders by one weeks) is the orders flow for things such as food, petroleum and chemicals – non-durable items.  Non-durable goods were up 0.3% in August after four months of decline.  Durable goods (items meant to last at least three years) orders fell 1.5% in August after a 1.2% increase in July.

The other reason to eye the factory orders report is the revision it presents regarding non-defense capital goods ex-aircraft (the proxy for business spending) and on that front orders were revised higher to show an increase of 5.1% in August (the durables report showed this measure rose just 4.1%) – so it came close to offsetting the 5.3% decline in the previous month.

The inventory/sales ratio for all manufacturing industries rose for a seventh month in eight but remains at a historically low level of 1.27 months worth – so no worry there; if orders fall off significantly in the months ahead, it shouldn’t create a persistent problem on the production side of things. 

However, transportation inventories have trended higher for eight months.  If car sales don’t hold up (and frankly they probably need to pick up the pace a bit) we’re going to have a production problem on our hands within that industry.  That’s what has me concerned regarding future manufacturing activity as vehicle production is a large component of factory output. 

In total the report wasn’t all bad.  The decline in overall factory orders did erase the previous month’s gain and orders haven’t increased since April – down 7.0% at an annual pace since April.  Excluding transportation equipment, orders haven’t increased since March – in fact they are down 5.3% at an annual pace for this time frame.  However, the business spending component continues to hold up (only two monthly pullbacks in the past seven months and up a strong 28% at an annual rate over this stretch).  We need businesses to keep spending as the other areas are looking pretty weak. 

Pending Home Sales

The National Association of Realtors (NAR) reported that pending home sales rose 4.3% in August, which was much better than the expected 2.5% increase, but off of a lower base as the July reading was revised down to a 4.5% increase (previously reported at 5.2%).  Contracts to purchase a previously–owned home are up for two-straight month now, coming off of the tax credit-led hangover over the previous two months (May and June). 

These signings will show up as official existing-home sales (when the contracts close) in September and October.  Three of the four regions reported a rise in contracts, led by a 6.7% jump in the South.  Signings rose 6.4% in the West and 2.1% in the Midwest, but fell 2.9% in the Northeast. 

Based on the year-ago period, pending sales were down 18.4% in August.  In August 2009 sales were on the rise as the initial phase of the tax credit spurred buying by pulling sales forward.  On the index chart below, the twin peaks represent the first and second iterations of the homebuyers tax credit. 

It’s nice to see the bounce off of the bottom, but we need much more than this to absorb the current, and coming, supply of homes.  It will ultimately take substantial job growth for the housing market to ultimately heal, record low interest rates alone are not enough.  \

As if the housing market problems weren’t prevalent enough, lawsuits abound as delinquent borrowers take advantage of an overwhelmed system – amazingly the current 470 day average of mortgage delinquent-to-default timeline is going higher. 

As a result of the overwhelmed system, you’ve got affidavits (verifying borrower is in default) being signed even though it’s unlikely the documents have been verified.  Due to the securitization process doubt has increased over who exactly owns the title (multiple lenders claiming ownership).  And further, title companies are stating they won’t insure bank-owned sales.  If you can’t get title insurance on distressed properties then it makes it kind of tough to sell that property.   

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900