U.S. stocks shook off a housing market that is in full double-dip mode and escalating uncertainty in the Middle East to reverse early losses and scream higher from the day’s nadir.  The broad market was driven by basic material shares as it’s seen as a primary beneficiary of the coming Japanese rebuild. 

But strangely consumer discretionary shares also performed very well.  And here’s why it’s strange:  One constantly hears that housing no longer matters because it accounts for a measly 2.2% of GDP at this point (that’s down from 7% in 2006).  But that take is simplistic as it forgets what continued home-price declines mean for household finances and thus consumer activity, which accounts for 70% of GDP.  The more affluent end of the consumer has the stock market to offset this cruel reality, but sorry to say (even though the higher-end segment accounts for roughly half of spending) much of the consumer base doesn’t have the stock-market wealth effect to fall back on.  

Further, due to the pathetic amount of equity in the home these days (roughly 30% of all mortgages are either underwater or have less than 5% equity, according to CoreLogic) price declines only exacerbate the situation, which means more “walk-aways” and thus more foreclosures – beyond hurting consumer activity it puts pressure on banking-sector earnings, a key driver of overall profit growth. 

And while we’re talking about strange developments, I’m not sure the market has ever been hit by so many various risks.  To wit, we’ve got increased Mideast tensions and who fills the vacuum, EU fiscal mayhem, Japanese radiation levels, domestic debt, housing, a persistent LT unemployment problem, real wages that are about to turn negative again and a coming compression of profit margins – both are function of rising costs. Nevertheless, the market more or less shakes these problems off.  I know Bernanke is there with his QE backstop but when we’re seeing it’s in the process of adding to the problem list I’m not sure how much juice the old strategy has left.   And I’m not focusing on the negative for the fun of it, but a true analysis of the market environment cannot ignore these issues.

Crude is powering higher to $106.36/gallon this morning and the Dollar Index continues to show the buck is losing value again a basket of currencies.  I think it’s important to note that the euro has hardly lost ground again the greenback even as the EU debt contagion shows no sign of waning.

Market Activity for March 23, 2011

Sector Activity for March 23, 2011

 Another Domino

The Portuguese government’s funding cost is rising and in fact has moved to a level that most analysts (and I believe the Portuguese themselves) say is beyond the point at which they can manage the debt situation – that supposed breaking point is 7%.  The yield on Portugal’s 5-year note has traded above that level since February and currently resides at 8.27%.  The bailout is coming, so we can mark Portugal as the third domino to fall – Greece and Ireland were the first two.  If Spain becomes the fourth, that’s when the EU debt crisis hits its crescendo as that economy is twice as large as those other three combined. 

Mortgage Apps

The Mortgage Bankers Association reported that their applications index rose 2.7% as both refinancing and purchase activity rose 2.7% themselves.

Apps to refinance accounted for about 80% of the overall applications index just a few of months ago, but now makes up 66% of the index as that activity has slid 50% since October even the average contract rate on the 30-year fixed mortgage remains below 5% -- ending last week at 4.80%.  However, the housing market has become conditioned to ultra-low rates so it doesn’t take much of a move to shut activity down – the rate bottomed at 4.21% in October. 

Purchase applications also remain weak, down 7% from the already very low levels seen in December and off by 33% since the tax credits spurred home buying last spring. 

New Home Sales

The Commerce Department reported that new-homes sales plunged 16.9% in February to 250,000 at a seasonally-adjusted annual rate (SAAR) – the figure was expected to rise 2.1%.  This sends new homes sales to a new all-time low.  The unadjusted number of new homes sold last month was 19,000 – also a new low. 

So new-homes sales make a new low at 250K SAAR, which is down 28% from the year-ago level.  As we saw with the 10% decline in February existing-home sales, housing has yet to find a bottom despite all of those calls last year that it had. 

The median price of a new home absolutely got crushed in February, down 13.9% to $202,100 from $234,800 in January.  As we’ve talked about for several months now, you could see this coming even as prices held for a few months.  The supply of distressed properties within the existing-home market are simply putting too much pressure on the new-home segment.  We nearly hit a new low in housing starts during February; the reality of this sales data is going to see residential construction make a new all-time low within a couple of months. 

The supply of new homes available for sale fell 3,000 to 183,000 in February, down 20.0% over the past year and off an astounding 67.9% since construction peaked at 572,000 in July of 2006. 

Based on the current sales pace, the months worth of supply rose to 8.9 months worth from 7.4 in January – but well off the peak of 12.1 months worth hit in January 2009. 

Look, there is of course a market-clearing price that gets this market in recovery mode again, but apparently we’re not there yet.  We would be in upswing mode by now in my opinion but the government had to come in with its short-term “fixes” that did nothing but extend the contraction.  One gets the feel that there is a lot of money sitting on the sidelines waiting to bottom fish, but first the market must be allowed to find equilibrium. 

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900