U.S. stocks spent the two-year anniversary of the rally from the fiery depths of SPX 666 in negative territory for most of the session.  The market slid to its intraday low about 10am as oil spiked to $106/barrel, but the jump was short-lived; crude retreated back to $104 and stocks followed to bounce off of the day’s low. 

Utilities, telecoms and consumer staples ruled the session.  Consumer discretionary and health care also closed in the green.  Basic materials and energy were the worst hit.

So much for interest rates spiking, as so many analysts stated was a situation in the making when Treasury yields began to jump from the obscene lows back in October.  Today the yield on the 10-year remains at 3.45%, which is where it’s trended for three months now – actually below the recent high of 3.75% hit in early February and well below the three-year high of 4.00% touched in April 2010. 

One can’t tell these days how much of the demand for Treasurys is for real with the Fed playing its money-pumping games, but yesterday’s auction saw good indirect demand (foreign buyers) so apparently it wasn’t all (“I can just sell these junk yields back to the Fed”) primary dealer-based demand.   Thus, with investors taking these auctions down at currently pathetic yields it shows the bond market doesn’t have much confidence in the sustainable growth story. 

For the equity trader…

Market Activity for March 9, 2011

Sector Activity for March 9, 2011

…it’s not so much about economic prospects as it is Fed liquidity.  Sure, earnings results have bounced big over the past five quarters from the deep lows of 2009.  But one must acknowledge that bank profits continue to be subsidized by the Fed at the expense of the saver.  And for that matter massive stimulus efforts in Asia have fueled profits in the industrial space – now Asian policymakers have begun to reverse this policy and tighten, so we’ll see how that affects industrial-sector profits.  The banks will continue to enjoy the Bernanke subsidy, but they’ve got plenty of other challenges such as mortgage putbacks and managing the supply of foreclosed properties.  Notwithstanding any of this, earnings growth rates will begin to be tested next quarter as comps become much tougher to beat. 

For an investor (not a trader but one looking out a couple of years trying to determine the intrinsic value of this market), I remain really cautious here simply because, at least for the final leg of this rally, the foundation appears to be built on an artificial foundation. 

My fair value range for the SPX (S&P 500) remains 900-950, and when the Fed was in limbo between QE1 and QE2 last spring/summer it looked like we’d fall back to those levels as the index slid from 1220 to 1020…until QE2 came to the rescue.   Will we get additional rounds of QE after the current version expires on June 30?  I don’t know, but I suspect Bernanke will try simply because what even marginally higher rates mean for debt servicing realities.  Nevertheless, eventually the fog of all of this stimulus dissipates and that’s when we find out where exactly fair value resides. 

Mortgage Apps

The Mortgage Bankers Association reported that their applications index jumped last week as both purchases and refinancing activity rallied.  The average contract interest rate on the 30-year mortgage rose nine basis points to 4.93%. 

Applications to refinance a mortgage bounced 17.2% in the week ended March 4 – refi activity has crumbled by 53% since August even with this latest increase.

Purchase applications also bounced, up 12.5% last week.  If this move turns into a trend we’ll be on to something when the April-May official home sales data rolls in – certainly lower prices (see second chart) are bringing people back in, specifically attracted to distressed properties.  But the 18% drop in purchase apps over the previous 12 weeks suggests the February and March data is going to falter. 

The housing market entered a double dip in January as the median price of an existing home dropped to a new cycle low.

Wholesale Inventories

Distributors’ inventories rose 1.1% in January and the sales component jumped 3.4%, led by petroleum (surging prices encourage purchases for fear prices are going higher) and autos.  As a result, the inventory/sales ratio moved to a new record low. 

This report suggests good results for business inventories (the one that really matters) when the figure is released on Friday, which is important for GDP since it needs all the help it can get – inventories subtracted big time from Q4 GDP.  

Are They Serious?  Answer: No

So today we’re going to get the budget deficit figure for February, expected to come in at -$225 billion.  That’s for one month!  And to put it in context, the gap is 40% deeper than the entire budget deficit for fiscal year 2007 when it came in at $160 billion and is half the entire fiscal year 2004 deficit of $427 billion -- termed at the time as an appalling imbalance. 

Even with these pernicious deficits (on track to come in at $1.6 billion for fiscal year 2011, the third-straight year of trillion-plus) and the debt-hating Tea Party rolling and helping to deliver a Republican landslide in November, what do we hear from Congress?  A $61 billion spending reduction proposal for fiscal year 2012.    If they cut 10% of the annual budget ($380 billion) it wouldn’t be enough, so $61 billion is a complete joke. 

The landslide was supposed to engender a massive shift to intellectually-serious budget constraint – at the very least returning spending to pre-2008 levels, which would mean reducing annual outlays by $1 trillion, or 25% (wasn’t this massive jump in spending over the past three fiscal years supposed to be temporary emergency spending anyway?).  Instead they come up with $61 billion, or less than 2% of the budget.  Why do anything at all?  Of course slashing annual spending by a trillion dollars is hardly realistic (it would have to be a multi-year plan to remove the public spending excesses of the past three fiscal years), but it just illustrates how far we’ve traveled down this treacherous fiscal path. 

Next time you hear a politician explain that we need to boost government spending for emergency reasons just remember, it’s more about boosting the baseline than anything that’s temporary.  

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900