U.S. stocks remained under some pressure yesterday due to the chance of higher rates in China as that government seeks to head off inflation.  There was some easing of concerns regarding Europe’s debt problems as it’s clear an Irish bailout is coming but this doesn’t exactly solve the problem (liquidity doesn’t fix insolvency), just kicks it down the road.

The broad market managed to hold positive territory for much of the session, but a slide in the final hour erased the advance; the S&P 500 closed essentially flat.

Consumer discretionary and energy shares (first gain in four days for energy) were the session’s best performers.  Health-care and consumer staples ended the day flat with the market.  Financials were the hardest hit. 

The Federal Reserve will conduct another round of “stress tests” before allowing the 19 largest banks to begin raising their dividend payouts.  These banks must show they can absorb losses under a number of adverse economic scenarios (although specifics weren’t released).  The Fed ordered the largest banks to all but eliminate their dividends during the first quarter of 2009 as capital was evaporating due to massive loan deterioration. 

I’ll be interested to see the specifics of these tests, but that may not be necessary as the housing market is going to be testing the banks in real time as the rubber of a glut in home supply meets the road of very weak sales activity – that is, home prices will retest the cycle low hit in February 2010 and certainly could make new lows. 

Market Activity for November 17, 2010

Mortgage Apps

The Mortgage Bankers Association reported that their applications index got clocked last week; it slid 14.4% as the average contract interest rate for the 30-year fixed mortgage jumped to 4.46% from 4.28% in the prior week – the low of 4.21% was hit in the week ended October 8.

Refinancing activity, which currently accounts for 80% of the index, plunged 16.5%.  Applications to purchase a home fell 5.0%.  And mortgage loan activity certainly has declined again this week (next week’s release).  Based on the current Fannie Mae Commitment Rate, we’re looking at a market interest rate on the 30-year mortgage that closes in on 4.70%.

Consumer Price Index

The Consumer Price Index (CPI) rose 0.2% for October, below the 0.3% expected.  For the past 12 months CPI is up 1.2%.  The core rate, which is a ridiculous figure for the central bank to focus upon as it removes the necessities (food and energy) that consumers cannot escape purchasing – but the Fed is an insular group, so they see no problem in removing these necessities -- was unchanged for the third-straight month.  Year-over-year, core CPI is up just 0.6%.

Many of the components of CPI did post a decline for the month; the big move to the upside was energy.  As the Fed’s continued policy of monetary easing has pushed the value of the dollar down over the past three months, the price of oil jumped.  The energy component within CPI is up for the past four months as a result – higher by 25% at an annual rate. 

It’s not that inflation is raging, but we all know from everyday life that the cost of living is higher than the 1.2% CPI has measured for the past year.  The headline reading is held back by a housing component that accounts for 42% of the index (specifically the owners equivalent rent segment of that housing component, which accounts for 25% of CPI).  Exclude shelter and CPI remains tame, up just 1.8% for the past 12 months, but is 50% higher than the headline reading.  When the other components do begin to pick up again, headline CPI may post readings of 2.5%-3.0% when they are really 4.0-5.0% excluding that housing component – a component that will remain depressed along with the housing market.

The conventional inflation measures give the Fed cover to continue along their unprecedented easing path, a road that is going to eventually lead to harmful levels of inflation.  The timing of which depends on the degree of structural economic weakness. 

Housing Starts

The Commerce Department reported that builders broke ground on a number of new homes that was significantly lower than expected – dragged down by a 43.5% decline in multi-family starts. 

Housing starts fell 11.7% in October, coming in at a 519,000 seasonally-adjusted annual rate (SAAR) -- well below the 568,000 expected and the lowest level since April 2009 when the all-time low was put in.  Additionally, the prior month’s reading was revised lower to show starts of 588K vs. the initially reported reading of 610K. 

Building permits came in pretty much flat, up just 0.5% to 550,000 units (expected to come in at 568K) after the upwardly revised 547,000 for September. 

Unfortunately, this is what needs to occur.  Residential construction will need to remain floored until we get the economic activity, and subsequent job growth, that allows for sales to absorb the glut of home supply – a supply that is very must exacerbated by a fat pipeline of foreclosures. 

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900