U.S. stocks rallied on Wednesday, recouping most of the losses incurred during the previous three sessions.  Of course, as the positive correlation between stocks and commodities is about perfect thanks to Fed policy… well, you know what that means. 

Basic material, energy and consumer discretionary shares led the way as the cyclical trade made a comeback.  Utilities being the only of the major sectors to lose ground, but consumer staples and telecoms also lagged the broad market. 

The CRB Index rose for the first day in four as the agricultural commodities continue to run and the energy complex rebounded.  Wheat, corn, cotton and soybeans all rallied. 

The price of oil found some life, rising back to $100/bbl as the weekly energy report showed crude supplies fell for the first week in four.  Now, supplies declined just 15,000 barrels after a 13-million barrel build over the previous three weeks but this just shows that crude doesn’t need much to get the push going again.  Wholesale gasoline rose a few cents to $2.96.   The national average pump price is down to $3.90 this morning from $3.98 a week ago. 

So the CRB Index is currently just 7% below its post-crisis high after all that has occurred within the energy complex over the past couple of weeks.  This is the problem if the stock market is going to be juiced by the Fed – and as far as I’m concerned traders believe another round of QE is coming on any meaningful drop in stock values. 

Market Activity for May 18, 2011

Sector Activity for May 18, 2011

“Never put off until tomorrow what you can do the day after tomorrow.”  -- Mark Twain

ECB officials are contemplating what to do about Greece as that government can’t return to the markets to sell debt at levels anywhere near what they can afford.  As a result, finance ministers will attempt to get bond holders to agree to a re-scheduling of debt – extending maturities out (10-year debt becomes 20-year, for instance) – as EU officials rejected the debt re-structuring (cutting principal payments and interest rates) that the political leaders of these troubled countries are begging for. 

EU ministers are unwilling to face the hit to the banking system that a re-structuring would bring.  For instance, Italian banks own $2.6 billion of Greek debt, UK holds $3.2 billion, France holds $19.8 billion, Germany $26.3 billion – get the picture?  And when we think about Portugal’s, Ireland’s, Spain’s and Italy’s financial troubles it gets much worse.  The sad truth is that a re-scheduling doesn’t solve the problem at all; it simply means that EU banks will hold even more dead assets for a very long time. 

This unwillingness to deal with harsh realities and pushing the inevitable off evermore is exactly what leads to very long periods of economic malaise – look no further than Japan where nominal GDP has literally gone nowhere in 20 years. 

Mortgage Apps

The Mortgage Bankers Association reported that their applications index rose for a third-straight week, but unfortunately it was not driven by purchases, which declined during the week that ended May 13.

The overall index rose 7.8% after the 8.2% gain in the previous week.  But unlike that previous week’s gain, this one was completely driven by refinancing activity. Apps to refi a mortgage jumped 13.2% as the average contract interest rate on the 30-year fixed mortgage fell 7 basis points to 4.60% (lowest level since November). 

However, the low rate wasn’t enough to boost purchases, even in the sweet spot of the buying season, as there are deep structural issues weighing on the market (high joblessness, negative equity that impedes transactions, and continued price declines that lead to the expectation they’ll keep falling); apps to purchase an existing home fell 3.2%.

Fed Minutes

I’ve long found the release of the FOMC meeting minutes boring as it’s old news with a few exceptions.  That is, there are some things to glean from this text on occasion but the economic commentary is stale as we go over the data each day. 

What I found interesting/funny about this latest release (the musings of the Committee members during the previous meeting) was that they all appeared to agree than the strategy to reverse the unprecedented degree of monetary easy should begin with a shrinking of their balance sheet by halting the reinvestment of paydowns from their current portfolio of holdings (a natural run off via maturities) before they actually begin to raise fed funds – they would then begin to actually sell assets and shrink the balance sheet in earnest, but that’s way off in the distance. 

This alone isn’t funny, as that’s been the expectation for anyone who thinks about such things.  The funny part is that it was right around this time last year when the Committee members began to muse about their reversal strategy, only to later take the balance sheet to yet another level by rolling out QE version 2 after the S&P 500 slid 16%. 

I’m feeling a little déjà vu. 

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Have a great day!

Brent Vondera, Senior Analyst