U.S. stocks rallied yesterday and the gains were solidified by the latest FOMC statement that expressed the entire $600 billion in QE2 will spent – not much of a surprise but those engaging in what’s been termed the “Bernank” trade like to hear it straight from the horse’s mouth.  The Dow crossed the 12K mark for the first time since crashing below it in June 2008 and the S&P 500 flirted with 1300 for the first time since August of that tumultuous year.  A little late-session weakness delayed a 12K close.

The broad market looked like it would erase opening session gains by midday after a member of China’s central bank expressed the need to extend interest-rate increases to avoid fueling asset bubbles.  He went on to say that real estate prices are the “biggest danger” to China’s economy, “a thousand times worse than inflation.”  It appears he’s learned something from our little escapade with an overheated housing market.  But Bernanke offset that concern later in the day with the aforementioned statement – he doesn’t concern himself with asset bubbles. 

The most QE-sensitive sectors, energy and basic materials, led the broad market higher.  These groups outpaced the increase in the S&P 500 by a factor of five.  The traditional areas of safety – utilities, consumer staples and health care were the session’s laggards.  Financials also closed lower. 

The Dollar Index spent some time in positive territory yesterday, just to remember what it’s like to flash green, but weakened again after the Fed statement – down 11 of the past 13 sessions. 

Market Activity for January 26, 2011

Mortgage Apps

The Mortgage Bankers Association (MBA) reported that their applications index plunged 12.9% last week as both refinancing and purchase activity declined.  This ends three weeks of gains for the overall index, which were entirely propelled by refi activity. 

Refinancing applications slid 15.3% in this latest week.  Applications to purchase a home dropped 8.7% to mark the fourth-straight week of decline.   The average contract rate on the 30-year mortgage inched up to 4.80% from 4.77% in the prior week.

Home-buying activity has returned to hibernation mode of late as the MBA’s purchase index looks like it will test the all-time low, sliding 18% over the past seven weeks.  Applications to purchase a home had bounced in November as the 30-year mortgage rate hit its record low of 4.21% in mid October and averaged 4.30% in the six weeks that ended November 12.  However, as the rate has moved back up to the high 4% handle, we’re seeing it doesn’t take much for this market to shut down again.  Such is reality when the Federal Reserve conditions the market to ultra-low rates and payroll growth is insufficient to meaningfully ameliorate joblessness. 

New Home Sales (Goosed from the Cali Tax Credit)

The Commerce Department reported that new homes sales jumped 17.5% in December from the near-record low in November – new home sales were stuck below the 300K SAAR mark for two straight months so the sales increase is more a relative figure than something one should view as an absolute victory. 

Sales rose to 329,000 at a seasonally-adjusted annual rate (better than the 300K expected); activity came in at 280,000 during October and November. 

Sales were flat in the Northeast and Midwest and up in the South (the largest regional market for new homes) and West regions.  It was really the West that drove the overall reading as the South recorded just a 1.8% increase; new-home sales in the West rallied 72% -- no, that isn’t a typo, sales were goosed as a $10K California state tax credit expired on December 31.   (Although it didn’t take much to drive such a huge increase as only 4,000 homes were sold in the West on an unadjusted basis during November.)

Expounding on the unadjusted figures (not adjusted for seasonality or annualized), 22,000 new homes were sold in December, up from the record low of 20,000 in November.  (Strictly for December, this result does make a new low as it takes out the previous low mark of 23,000 sales in December 1966 – the record high was 87,000 in December 2005.)

While new-home sales remain at deep levels, the industry has made huge progress on the supply side of things, too bad the existing-home supply figures are a complete mess.  (Standard & Poors recently released their estimate on shadow supply, which put the figure at 49 months worth.  Holy gee, even if S&P’s estimate is way wrong and the figure is only half that level Bernanke’s going to be propping up bank earnings for a long time.)

The number of new homes available for sale fell 5,000 to 191,000 units.

And the 6.9 months worth of supply at the current sales pace (down from 8.4 in November) has nearly returned to the long-term average of 6.2.

FOMC Statement

No surprises in the FOMC’s statement that followed the close of their two-day policy meeting.  The members continue to state that progress toward their objective of faster economic activity has been disappointingly slow.  

The statement was essentially unchanged from the preceding December 14 release.  They reiterated: Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, while investment in nonresidential structures is still weak.  Employers remain reluctant to add payrolls.  The housing sector continues to be depressed.  Although commodity prices have risen (only real change in the statement as they didn’t mention commodities last time), longer-term inflation expectations have remained stable, and measures of underlying inflation have been trending downward.

They explained that the $600 billion in QE2 will run its course through June as scheduled and they’ll continue to reinvest paydowns from mortgage securities into Treasuries.  Of course, if the QE portion of this unprecedented monetary easing policy remains intact, then the fed funds rate will remain at virtual zero, which the Fed also stated. 

The voting was unanimous.  This is the first meeting in which there hasn’t been a dissention since December 2009 as lone dissenter Thomas Hoenig (KC Fed) rotated out of the Committee.  He was replaced with policy hawks Richard Fischer (Dallas Fed) and Charles Plosser (Philly Fed), but apparently they aren’t all that hawkish as they went with the flow.  Maybe they just don’t want to rock the boat just yet. 

Things get interesting as we approach that June 22 meeting as QE2 is scheduled to have run its course on June 30.  As we get closer to the Fed halting this QE game, it will be interesting to watch the direction of stocks – assuming another shock doesn’t occur beforehand that allows Bernanke to justify more QE.  

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900