U.S. stocks rose despite the day’s economic reports that were less than helpful and news that Iran planned to send two warships through the Suez Canal en route to Syria – a major threat to Israel. 

Energy and basic material names got back on their horse after yesterday’s pullback, leading the broad market higher.  The areas of safety were the laggards as utilities and telecoms lost ground and consumer staples underperformed even though the group did close in positive territory.

The CRB Index rose as cotton prices continued to make new highs.  Sugar, OJ, and the energy complex also rose (wholesale gasoline moved to a 30-month high, oil still chillin’ in the mid $80s)

It appears the Fed’s actions, while certainly boosting stock prices, are working against the economy in a number of other ways.  While Bernanke & Co. desperately attempt to fuel the housing market, their actions in reality are fueling all the wrong areas – namely, those commodity prices.  These rising input costs compress profit margins, and may do so in an intense manner over the next couple of quarters as firms have little pricing power in this economic environment.  As business costs rise, firms are less likely to substantially add to their highest cost component – payrolls.  And absent strong payroll growth, you can forget about a durable increase in home sales – a necessary condition to keep housing from another round of price declines. 

In addition, if Bernanke’s policy stance does push the official inflation gauges to more troubling levels, the rates on the long-end of the curve will rise, pushing mortgage rates higher adding another obstacle to home sales. 

The plan is clearly Bernankfiring and while I obviously can’t time when the stock market will feel the effects of this reality, among others, each passing day brings us closer to that event. 

Market Activity for February 16, 2011

Sector Activity for February 16, 2011

Mortgage Apps

The Mortgage Bankers Association reported that its applications index slid 9.5% last week as both purchase and refinancing activity declined – the drop in the overall index marks the third in the past four weeks. 

Applications to refinance a mortgage fell 11.4%, which follows a 7.7% drop in the prior week, as the average contract interest rate on the 30-year fixed mortgage remained above 5% -- actually down two ticks to 5.12% following the prior week’s 5.14% average rate.  It’s not all about rate though.  According to analytics firm CoreLogic, more than 50% of outstanding mortgages have rates that are 100 basis points above current rates.  This shows that there is also an equity problem – a lack of equity in the home, which is a topic we’ve talked about for a long time now.

Apps to purchase show that sales activity as returned to comatose status again, falling 17% over the past 10 weeks with the latest week’s 5.9% decline.  These apps will show up in the official existing-home sales data a couple of months out. 

Producer Prices

The producer price index (PPI) rose 0.8% in January, matching the expectation, following a downwardly revised 0.9% for December.  Excluding food and energy, a figure the Fed chooses to focus on, PPI was up 0.5%, more than twice the rate expected.   That’s the biggest monthly increase since the summer of 2008’s commodity-price spike. 

For the year, overall PPI is up 3.6%, and 9.6% at an annual rate over the past three months.  The core rate, which excludes food and energy components, is up just 1.6% over the past 12 months, but up 3.5% over the past three months annualized. 

The inflation in the pipeline really shows up in the crude goods component (goods used in the initial stages of production) of PPI.  That figure was up 3.3% for the month, up 10.0% year-over-year, and 54.4% over the past three months annualized – up from 18.5% as recently as November.  These costs (if they hold up) will either show up in much higher consumer prices or have to be eaten by firms, thus compressing profit margins. 

Housing Starts

Housing starts (breaking ground on new home construction) jumped 14.6% in January to 596,000 units at a seasonally-adjusted annual rate (SAAR) – the figure was expected to rise just 1.9%. 

This follows a downwardly revised 520K in starts for December, previously reported at 529K.   Wait a second, I thought the snowstorms were behind the very weak payroll growth for January, yet housing starts jumped?   Something’s not adding up.

The figure was totally propelled by multifamily construction (construction on condo and rental units), which rose 77.7% in January and follows a 10.8% bounce in December – a rebound that followed a 43% slide in the prior three months.  Single-family units fell 1.0% in January after December’s 8.4% decline.

The chart below illustrates that a 14% jump in starts doesn’t amount to much as activity remains severely depressed – and we certainly don’t need more homes coming onto the market anyway as distressed properties within the existing home segment are adding much more supply than current sales activity can absorb. 

Permits, an indication of next month’s starts, fell 10.4% in January. 

Industrial Production

Industrial production (IP) slipped 0.1% in January (a big miss as 0.5% increase was expected), marking the first decline since the economy pulled out of recession in June 2009.  The utility segment dragged the index lower.  This followed an upwardly revised 1.2% increase for December, previously reported at 0.8%. 

The more important manufacturing component (accounts for 75% of the IP index) posted a 0.3% production increase thanks to an outsized 3.2% in motor vehicle & parts production.  Exclude the segment and manufacturing production was up only 0.1% last month.  That’s really the only possible indicator of weakness to come, but one can’t tell by taking just one month.

It’s not that utility production isn’t important, it is as it illustrates the state of the commercial property market.  We know that market remains weak, as capacity utilization rates within the utility arena remains below normal (chart below).  But the January decline within the segment was probably more a function of the warming from frigid temps in December.

Capacity utilization rates (plant usage) remain below average.  This is one of the things the Fed keeps close watch on, so they’ll be reluctant to change course until this number moves above the average rate.

Total capacity utilization came in at 76.1% in January, down from 76.2% in December – the first decline since the recession.  (The white lines represent the average rates of plant usage for the following charts.)

For the manufacturing sector:

For the utility sector:

FOMC Minutes

The release of the minutes from the January 25-26 FOMC meeting showed a more positive tone among the members in general even as they believe it will take five years or longer for the jobless rate to return to a normal level as the problems within the labor market are structural.  (The term “structural” means that there are mismatches in characteristics between workers’ skills, or lack thereof, and available jobs.  I don’t completely agree this argument, but that’s for another day.)

The main points of the minutes were:

The Fed boosted its 2011 GDP forecast to range between 3.4-3.9%, compared to the previous forecast range 3.0-3.6%.  (I recall the last time the Fed boosted their growth estimate, about this time last year, they spent the next six months twice lowering that estimate.)  They believe the unemployment rate will range 8.8-9.0% by the end of the year, down from 8.9-9.1%.  And on inflation, they stuck to their belief that increases in commodity prices will not filter into broader inflation permanently.  (This is such a stupid comment as inflation is never permanent, unless their policy remains permanently reckless.)  They expect core inflation to range 1.0-1.3% for 2011, which resulted in a tightening of their previous range that varied 0.9-1.6%. 

On QE, a few members noted that additional data pointing to a sufficiently strong recovery could make it appropriate to consider reducing the pace of overall size of the bond-purchase program.  However, those members are outnumbered at this time and as former Fed Governor Lawrence Meyer’s firm Macroeconomic Advisors has stated on its blog, “the Chairman owns the room” – and The Bernank is determined to let QE2 runs its course.  The real question:  Will he convince the FOMC members to engage in further QE measures? 

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I’ll be out for the next week; have a good one!

Brent Vondera, Senior Analyst

Phone: 636-449-4900