U.S. stocks bounced on Tuesday as the ECB’s new liquidity program officially began and yields on Spanish and Italian sovereigns slid (prices up).  A better-than-expected housing starts number also helped to juice traders’ optimism…we get into the details and the flawed interpretation of the report beyond the click.  Yesterday’s rally was enough to erase the losses of the past week, sending the broad just above where it closed a week ago Monday.

Energy (as oil jumped back above $97/bbl), basic materials and financials led the rally.  Consumer staples, telecoms and health care were the laggards – but even these groups bounced by roughly 2%.

So Tuesday’s letter was titled Draghi-ed Lower as ECB President Draghi’s comments on the state of the eurozone economy was a drag on stocks.  But yesterday was another day as his latest liquidity injection program (can you call it liquidity when this funding last for three full years now?) officially kicked off.  (And this morning we find that euro-zone banks took €489 billion in the largest ever single ECB operation yet.)

In addition to those negative comments on the state of the continent’s economic situation, Draghi also reminded euro-zone banks that they can use the funding via the new three-year liquidity program to buy sovereign debt (wink wink).  For one day the plan is worked as long-term Spanish and Italian yields fell and short-term yields plunged.  For instance, Spanish three-month bills rallied to the point that sent the yield to 1.74% from nearly 5% a week ago.  Italian bills didn’t improve quite so much, but still substantially, as those yields fell from 4.50% to 2.30%. 

Continued below the click…

Market Activity for December 20, 2011

Sector Activity for December 20, 2011

Now, this doesn’t exactly solve the problem.  What banks will do is borrow from the ECB, by pledging the lowest quality collateral the ECB will accept (which is about anything at this point) to buy Spanish and Italian debt, sending these yields lower.  But I can’t see the banks continuing this process for very long, which is why those yields are back up (prices falling) already again this morning.  Remember, those banks were just in the process of reducing their exposure to these securities, simply because the market demanded it by sending their share prices to 2009 lows, pulling money out of these institutions and freezing up short-term funding channels.

In the meantime, the ECB is saddled with the worst-quality paper.  The Draghi balance sheet has exploded to €2.49 trillion (or $3.2 trillion), which makes it more bloated than the Fed’s at $2.9 trillion.

So can you call the decline in Spanish and Italian yields improvement when the central bank is this active?  You couldn’t even call it that for the one day in which yields fell.  And they surely can’t stop there or sovereign yields will quickly soar to new heights. In fact, with their new lending facility extended to three full years it’s anyone’s guess how bloating with suspect assets this balance sheet will become – the chart below does not include the €489 billion injected this morning.   Oh, the eventual unwind -- and it will be unwound as these are repo agreements -- will be a doozy.

Housing Starts

The Commerce Department reported that housing starts rose 9.3% in November, up to 685,000 units at a seasonally-adjusted annual rate (SAAR) from the 627,000 unit rate in October – the consensus estimate was for a rise to 635K.

This data doesn’t carry much importance at these levels (the simple fact is they can rally substantially from here but it will offer little boost to GDP) as activity is just too depressed.  Nevertheless, since this was yesterday’s only economic release, why not touch on it.

The overall number was driven by multi-family housing construction (rental units), as that segment jumped 25.3%  month-over-month to 238,000 units SAAR.  Year-over-year, this segment is up 145%.

Builders broke ground on just 447,000 single-family units, which results in an increase of 2.3% relative to October’s activity.  Year-over-year, the segment is down 1.5%.

So, overall it’s nice to see this data improve but no one should get excited just yet, although people did.  I drew that horizontal line on the first chart just to show we’ve hit this level before during this period of housing-market morass only to get smashed down again.

Further, the improvement is very largely due to the multi-family unit construction.  That’s fine on the surface as activity is activity.   But what it illustrates is that many more people are turning into renters (no surprise indeed).  And there’s nothing wrong with that, renting has been unjustifiably frowned upon over the past decade.   The point is, this report suggests that buyers aren’t coming back into the market, which is kind of what home prices desperately need.

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900