U.S. stocks rebounded to recover nearly half of Monday’s declines, but I’m not sure exactly what drove us higher.   We did get better-than-expected earnings results from JNJ and Goldman Sachs; however, a pharmaceutical/consumer staple stock isn’t really one to drive the entire market and there were concerns about the sustainability of GS’s profit story -- that stock declined for the session.  The market actually slid into negative territory late in the mornings but quickly rebounded and held that momentum to the close – it’s that afternoon move that wasn’t as explainable as is generally the case.

Basic material, energy and health-care shares led the broad market higher.  Telecom was the only industry group to close negative, but utilities and consumer-related shares (both staples and discretionary) underperformed too.

The Dollar Index gave back half of Monday’s run-for-safety gains, as is getting crushed this morning to a near post-crisis low.  The CRB Index bounced too, led by the prices of precious metals, crude, nat. gas, coffee and cattle.   Crude is rallying to the $110 level this morning.  It’s been a year now since the BP Macondo field explosion in the Gulf of Mexico.  That event has had a terrible effect on Gulf production as it is down 13% due to restrictions. 

Treasury yields fell a bit too – bonds and stocks rally together is just part of the strange world Bernanke has created.  They fell Monday even after that news S&P went to a “negative” watch on U.S. debt – which can actually be explained as it was a risk-off session – and they fall again yesterday even though there was a move back to risk-on.  No one can really explain what’s going on in the bond market other than the Fed is massively manipulating that market and bond traders are unwilling to overwhelm the central bank due to the weak economic fundamentals…more on these yields and monetary policy below. 

Market Activity for April 19, 2011

Sector Activity for April 19, 2011

Will They Unwind QE or Freak Out?

Well, we’re now a week from the next FOMC statement – the text of which is released after the close of each of the eight policy meeting per year.  This one will be especially closely watched as most expect Bernanke & Co. to explain that QE2 will expire on June 30 as originally scheduled.   The expectations is also that the Fed will continue to reinvest maturing bonds into Treasurys, thus holding their balance sheet steady at $2.65 trillion – the central bank has pumped roughly $2 trillion into the financial system via their QE (quantitative easing) escapade. 

There will be two tests for the stock market as the Fed shifts their course – assuming they actually do so.  The first will be the end of money pumping, which will arrive on June 30 when QE2 ends.  This proved to be a big test, one that pretty much failed last spring as QE1 ended and the S&P 500 summarily slid 16%.  The next test will then arrive when the Fed actually begins to shrink their balance sheet by mopping liquidity from the system.  It’s at this point they can finally begin to end ZIRP (zero interest-rate policy) and get fed funds back to 1.00% -- a level that used to be viewed as aggressive the Fed would get prior to the ZIRP/QE foray. 

It’s my view we won’t actually make it to these final stages, not yet, as the Fed will end up freaking out at how the stock market reacts.  Contrary to what many believe, the bond market may very well rally -- yields drop -- as QE2 ends.  Recall this also occurred as QE1 ended as the run for safety was on (see chart below).  So yes, another round of QE is probably in our future, but eventually the Fed will be forced to end this game. 

Housing Starts and Permits

The Commerce Department reported that housing starts (beginning construction on residential units) bounced 7.2% in March to 549,000 at a seasonally-adjusted annual rate (SAAR). This follows an 18.5% decline in February (revised up from the -22.5% initially reported last month).

Single-family unit starts rose 7.7% in March, after an 8.8% decline in February, and multi-family starts increased 5.8%, after the 39.4% slide in February. 

So, the National Association of Home Builders’ gauge of confidence remains at depressed levels – as Monday’s release showed, this gauge remains stuck at reading of 16 when anything below 50 means that the majority of respondents believe conditions are poor – yet construction on new homes rise.  While it is true the level of construction remains all but historically floored (as the chart above illustrates), we hardly need more houses hitting the market.   And even though 18% of this new construction involves rental units (and we’re going to have many more renters over the next few years) assuming the CPI’s gauge of rent prices, which has been flat over the past 12 months, is even close to correct it shows we hardly have a lack of supply on our hands. 

Housing permits (a gauge of future construction) bounced 11.2% after two months of decline (down 5.2% in Feb. and 10.2% in Jan.) that wiped out the 15.3% in jump in December.

I’ve got a feeling what’s been occurring will continue to occur.  We see a month in which housing starts bounce, only to see that activity essentially wiped out by declines in the following months.  Such is the nature of a housing market that is dealing with a major supply glut and a flood of distressed properties that continue to pressure prices – thereby making the building of new home unprofitable.  Once this supply clears the residential construction market will begin to meaningfully add to GDP again, but not before. 

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900