U.S. stocks extended the latest bounce as traders continue to watch for the next easy “fix,” and it seems the ECB (European central bank) is in the process of delivering just that.  The gains of the past two days have recovered about half of what the S&P 500 lost last week.

It wasn’t a straight up shot yesterday though as U.S. and European bourse had to get past some weakness about an hour into our trading session.  (It didn’t seem all that volatile of a session if you weren’t watching closely, but it was as European bourses and U.S. futures were up big prior to our open only to slide about an hour into our session – Europe nearly erased 3-4% gains with just an hour left in their trading day. But then this talk of sweeping the debt problems under the rug for a bit longer began to surface and markets on both continents rallied.)

During this current trading range in which we’ve seen stock prices vacillate between 1120-1220 on the S&P 500, we’ve now tested that low-end 1120 level three times now.

As readers of this letter are surely aware, I expect the broad market to slide well below that 1120 level (be prepared for 900-950 on the index, which I see as fair value) – something I’ve talked about mentally preparing for since late 2009 when the S&P 500 powered to the 1160 mark, which is exactly where we sit this morning.  However, we’ve bounced back off of that recent low yet again and that has offered some confidence for traders to step up and do some buying.

That latest quick “fix” that’s being talked about is a proposal to create a European Investment Bank that issues debt to purchase government debt – that’s right, issuing debt to buy debt – and increase the EFSF (eurozone bailout fund), which means issuing even more debt, to recapitalize the banking system.  Keep in mind that the EFSF is already of fund of debt as it borrows the money needed to bailout the PIIGS.

More below…

Market Activity for September 26, 2011

Sector Activity for September 26, 2011

The only thing I see saving the EU from tying itself into this quadruple knot of debt is that parliamentary approval from all 17 euro-zone countries will be needed to change the EFSF into something bigger and leveraged.  Since they’re having trouble ratifying the July 21 proposal to expand the EFSF, it seems pretty unlikely we’ll get this latest iteration.

Thus, what we’ll get next week at the ECB’s next meeting is likely that cover-bond proposal we talked about yesterday – that is, in addition to buying government debt, the ECB will return to buying covered bonds from banks’ balance sheets.

All of these proposals are really more of the same, they just goe by different names.  The ECB, the EFSF, or both will be accepting collateral that consists of bonds that are backed by the very junk that has Europe in so much trouble, and distribute euro cash to the banking system in return.  But nothing will be solved simply because these are the same actions we’ve implemented since the financial crisis began, and here we sit with the same problem, and probably larger at this point.  The shell game goes on.

CFNAI

The Chicago Fed’s National Activity Index (CFNAI) printed a reading of -0.43 for August, which follows an upwardly revised +0.02 for July – that July number was initially reported at -0.06.  The index draws on 85 economic indicators and a reading below zero suggests the economy is growing below trend.

But since we already know that, the number that’s really important is the index’s three-month average.  At this stage of the game, with growth extremely weak now just two years into the recovery, the level we watch for is -0.70 on that three-month average.  That number, or worse, is the level that is supposed to indicate that a recession has begun.

The reading continues to hold above that level as it printed -0.28 for the three months ending in August, and the worst we’ve seen thus far is the -0.56 hit in June.  I’ve got a feeling we’ll make another run at -0.70 over the next several months, so we’ll watch and report on this measure each month.

New Home Sales

The Commerce Department reported that new home sales fell 2.3% to 295,000 at a seasonally-adjusted annual rate (SAAR) in August after selling 302,000 SAAR in July, a number that was revised up from 298K.  The all-time low of 278K SAAR was hit in August 2010.

On an unadjusted basis, 26,000 new homes sold in August.  The all-time low for the month was 23,000 sales, which occurred in August 2010.

The months’ worth of supply of new homes ticked up slightly to 6.6, but this is a level that normally suggests a healthy market.  The problem is new homes must compete with a previously-owned home supply, which when one adds in the shadow inventory of seriously-delinquent mortgages and foreclosures the supply figures for the market on the whole are much too high for the current pace of sales.

The median price of a new home slid 7.7% in August to $209,100, reflecting that competition squeeze from the previously-owned market – down 20.4% from the peak hit in March 2007.  The cycle low of $204,200 was hit in October 2010.  Ultimately, that median price will either make a new low or builders will break ground on even fewer homes – a number that is already at extreme historical lows.  Either way, more hardship for home builders will ensue.

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900