U.S. stocks reversed course as the latest economic survey from the Fed reported that companies became more pessimistic about growth prospects and plans to tackle Europe’s debt crisis stalled yet again.  I think it’s been three times now in as many weeks that we’ve watched the market get all juiced following a rumor that EU leaders were about to roll out a new and improved bailout plan only to see the hopium fade.  I’m sure this won’t be the last.

Utilities, consumer staples and health care shares outperformed – utilities being the only sector to close higher.  Basic materials, tech and financials led the market lower.

Each day I struggle to determine which aspect of the EFSF (EU bailout fund) is the most bizarre.  Is it the fantasyland idea that a debt problem can be solved by taking on more debt, or the fact that the countries (such as Italy and Spain) that seek to be saved by the bailout fund are the same countries that backstop its very commitments?   And now we have one part of the eurozone’s dynamic duo (France) watching its bond spreads super-spike, which if history is any guide a credit rating cut will soon follow – and there goes the AAA rating on those quasi euro bonds that are meant to replace the bad debt, which is a fundamental requirement for the direction they want to take the EFSF.  I can’t see what could possibly go wrong.  In any event, by the way things are playing out we may not have to worry about it as EU leaders fight over the specifics yet again.

More below the click…

Market Activity for October 19, 2011

Sector Activity for October 19, 2011

In a little twist, Euro-zone banks vowed yesterday to sell $1.06 trillion in assets over the next two years in an effort to prevent governments from re-capitalizing them via public funds as such a move would dilute investors and further crush their share prices.  They’ll have a hard time convincing the authorities though as they probably don’t have the luxury of a two-year timeline.  And even if the banks are allowed to get their balance sheets in order on their own -- which is the desire of those who care that what’s left of capitalism lives on -- this will involve selling many of their assets at deep discounts.  Either way, there’s trouble ahead but at least the private-sector version of unloading assets voluntarily will finally get this all behind us and back on the road to real recovery.

Mortgage Apps

The Mortgage Bankers Association reported that their applications index slid 14.9% last week (largest decline since December) as both purchases and refinancing activity plunged.

All it took was an eight-basis point increase in the average contract rate on the 30-year fixed mortgage to more than reverse the past month’s worth of gains in the apps index.  (This is one of the things I’m talking about when referring to the economic distortions the Fed is creating by conditioning the market to ultralow rates.  And this isn’t even the larger problem, which is how the economy in general reacts as debt servicing costs surge when interest rates return just to historical norms – it’s no wonder the Fed will do all they can to keep rates very low for a very long time.)

Apps to purchase a home fell 8.8% last week after the previous week’s 1.1% increase, completely wiping out the advance of the previous four weeks.  Refinancing apps tumbled 16.6%.

CPI

The Consumer Price Index (CPI) rose 0.3% in September, which was in line with expectations.  (This increase cuts in half that core retail sales number for the month – a number we received last week; a number GDP was counting on as the July and August readings were flat in real terms.)

On a year-over-year basis, CPI ticked higher again, up to 3.9%.  But excluding food and energy, which is what the Fed focuses on, CPI was up just 0.1% for Septermber (below the +0.2% expected) and is higher by just 2.0% over the past year (unchanged from the previous month).

So the Fed continues to watch ex-food and energy inflation reading, but it is exactly those two components that are driving the overall gauge higher – and these are also the two components that consumer cannot escape.

And from an income standpoint, inflation continues to eat into real earnings.  Hourly earnings are up 2.5% over the past 12 months, but CPI is up 3.9%.  The wage & salary component of personal income is up 3.3%, which still lags official inflation.  And real take-home pay (after-tax income minus inflation) is up just 0.3% over the past year – and that’s only positive because of the payroll tax cut, which drives Social Security underfunding further in the hole.

Housing Starts

The Commerce Department reported that builders broke ground on 658,000 housing units at a seasonally-adjusted annual rate (SAAR) in September, up 15% from the 572K SAAR in August.  The figure was expected to come in at just 590K.

A 51.3% surge in multi-family units led the measure higher; single-family construction was up just 1.7%.

With the jump, total housing starts closed in on the three-year peak of 690K that was hit in April 2010.  But as the long-term chart below illustrates, new-home construction remains pretty much floored – a good thing in an unfortunate way as we don’t need more units hitting the market, we’re getting enough of that via foreclosure.

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900