Stocks have gained ground in four of the past five sessions. More likely than some shifting in sentiment between the stimulus plans and what will be a very weak earnings season is that money managers are stepping into the market after stocks have rallied nicely off of the November 20 low.
We are now 24% above that multi-year low on the S&P 500 and 28% for the NYSE Composite and should expect the market to take a breather after a run of this magnitude.
Real estate and financial shares (the sectors that have endured the deepest losses) benefited on the news firms will be able to take losses incurred in 2008 and 2009 to offset tax bills dating back five years. I suppose this means they’ll be refunded, if indeed the plan is implemented as we discussed yesterday.
The tech-sector jumped 3.3% as the group will be a primary beneficiary of higher business-equipment write-off allowances, the most constructive aspect of the Obama overall stimulus proposal.
Market Activity for January 6, 2009
Economic Data
The Institute for Supply Management announced their survey on the service-sector contracted in December for the third-straight month as consumers continue to build up cash savings in the face of a continued decline in home prices and the October/November plunge in stock prices. While the broad market has bounced nicely off of the November 20 low the psychological blow remains in place.
The ISM non-manufacturing index posted a reading of 40.6, a mild improvement from the 37.3 low hit in November. That November reading was the lowest in the survey’s history; although, it only goes back to 1997, so not much history here. The December reading was better-than-expected as further deterioration was anticipated. Still, 50 is the threshold between expansion and contraction, so a reading of 40 illustrates activity remained very weak.
The more forward-looking sub-indices within the report showed a little improvement as well. The new orders index rose to 39.9 from 35.4 in November. The orders backlog index hit 42.5 after 39.5 in the previous month.
We expect the overall reading to improve over the next couple of months. The bounce in stocks, if it holds, should help to relieve some anxiety. Plus, the 65% plunge in gasoline prices has left billions in the pockets of consumers and this extra money should find its way to retail stores. Taking a longer view though, it will be a while (only wish I knew what a while means in months) before we can get to a situation in which the service sector shows sustainable growth as a deteriorating labor market weighs on consumer activity. Mining and utility activity is also part of the index and these sectors should remain depressed for some time still.
On the bright side, the government’s stimulus plan (while I’ve got major issues with its short-term nature and inefficient use of capital) will boost public-sector construction activity, which is also part of the ISM non-manufacturing index. As we head into the third quarter, this segment of the report should offer some life to the index’s readings.
In a separate report, the Commerce Department reported that November factory orders declined 4.6% after plunging 6.0% in October. The back-to-back declines were the largest since records began in 1992.
The business-equipment spending component of the report bounced, rising 3.9% in November after declining for three months – mirroring what the durable goods orders report showed just before the Christmas holiday.
The downside is a 7.4% decline in nondurable goods fully offset the rebound in business spending. This was related to a substantial drop in the price of petroleum products as petro and coal products fell 21% in November.
Finally, in a separate report Commerce reported that pending home sales fell a larger-than-expected 4.0% for November and the October reading was revised much lower to show a 4.2% drop instead of the mild 0.7% decline estimated last month. This large downward revision explains the 8.0% decline in existing home sales for November, a reading we received several days ago.
This data continues to show there is little evidence housing activity has hit a bottom. However, we do believe reversion to the mean (erasing the outsized growth in home prices that occurred 2002-2006), has occurred and may have moved beyond the longer-term average for home prices. Since 2000, the median price of an existing home is up 3% at an annual rate – the long-run average is closer to 5%.
No one should expect the housing market to bounce back quickly as we have foreclosures and a weak labor market to deal with still, but the market has done much work in removing past excesses. Another thing is the meaningful decline in mortgage rates. This should boost sales over the next few months.
The Fed is currently working to lower mortgage spreads (the spread between the 10-year Treasury and the 30-year fixed mortgage rate is traditionally 180 basis points, today that spread is very wide at 250 basis points). The Federal Reserve began to attack this head-on yesterday by buying mortgage-backed securities.
The plan is part of a $600 billion plan that also includes buying GSE (Fannie and Freddie) debt. Mortgage rates would be in the low-to-mid 4% range if spreads were normal and this is the level the Fed will try to bring the fixed rate down to. The downside is they are printing money to fund the plan, which will kick inflation higher 8-12 months down the road – everything has its cost.
Fed Minutes
The Fed released its minutes (notes) yesterday from the previous FOMC meeting. In short, they stated the credit markets have improved but remain under severe stress, the downside risks to economic activity were a serious concern and they will remain very aggressive with regard to their policy.
Their key interest rate is virtually zero, so there’s no firepower left regarding traditional monetary easing. What they’ll do is continue to engage in aggressive quantitative easing, which means they will continue to engage in lending facilities to pump liquidity into the system. Problem with this is they can’t force banks to lend or consumers to borrow. However, when this does begin to occur in a more normal way that liquidity is going to rage throughout the economy.
The FOMC will also continue to print money in order to fund programs like buying mortgage-backed securities we touched on above.
This brings us to the most interesting aspect of the minutes. The Fed seems to think that their decision to pay interest on bank deposits at the Fed will allow them to take back this liquidity quickly so to avoid a troubling inflationary event. They’ll simply increase the interest rate on Fed deposits, which will cause banks to keep a higher level of deposits at the Fed, thus removing money supply from the system.
Problem is it will be difficult to pull this trigger as these higher rates will mean the longer-end of the Treasury curve will sell off, sending those rates higher as well. At which point, what may be a nascent housing market rebound will run into the road block of higher rates, making it very difficult for the Fed to do what it takes to keep inflation in check. But the Fed seems confident they can pull it off.
Good luck with that one.
Have a great day!
Brent Vondera, Senior Analyst
No comments:
Post a Comment