Personally, the rally over the past few days seems to be driven more by growing expectations mark-to-market will be modified. Each day we get more comments on the issue and the latest talk out of FASB has many believing we’ll break the link between this accounting rule (put in place in November 2007) and regulatory bank capital. This would be a huge development and the market is trading ahead of an official statement. Although these days more than ever, you can’t go too much on words – they have to follow it up with action or stocks will fall even quicker than they’ve risen of late.
What’s really nice is to see how broad-based the rallies have been, and even more so yesterday as you can see all sectors advanced. Hopefully, we’ll stage an assault on the 825-830 range (S&P 500) and erase the latest move down (a month-long 24% slide until this latest rally stopped it cold) – one step at a time though.
Market Activity for March 17, 2009
Crude-Oil
Crude has made a move back to $50 per barrel, an upward trend over the past four sessions reversed what looked to be a move back below $40 just one week ago. Some of what’s been going over the past few days may be trading based on the expiration of the April contract. Oil futures are in contango, meaning future month contracts trade higher than the front month.
In addition, that strong rebound in February housing starts increased expectations the economy will come back to life sooner than previously anticipated, and this belief obviously drives oil demand expectations. Oil is trading on GDP expectations more than ever right now. (We’ll touch on the housing starts data below)
Traders will also be keeping a close eye on the weekly Energy Department report this morning. The expectation is for a build of 1.5 million barrels. If the supply numbers don’t draw down over the next couple of weeks crude may move higher. This sounds confusing as it should have the opposite affect, but many are viewing rising inventories as a sign OPEC members are cheating (not abiding by lower production quotas). This may cause the cartel to implement an aggressive reduction in production, which will send crude higher. I’m not convinced they’ll do so in this weak economic environment but I do believe there’s a better chance of crude heading higher over the next several months rather than the other direction.
The Economy
Producer Price Index
Overall producer prices (PPI) fell 0.1% for February – food prices fell 1.6% last month and energy rose 1.3%, boosted by an 8.7% rise in gasoline.
Over the past year, PPI is down 1.3%, but the core rate is up 4.0%.
The decline in food prices, along with a 4.5% drop in computer prices (great time to buy electronic goods) pushed the overall reading lower for the month.
However, we see evidence of prices remaining sticky in a number of categories. Those convinced that under-utilization rates in both labor and capital make it impossible for inflation to rise (yes, there are economists – many of whom reside in our Federal Reserve system -- who continue to grasp to this NAIRUist model even though the 1970s steamrolled the idea) should focus on the 3.6% rise in core PPI over the past three months. We’re starting at a pretty high base for this stage in the business cycle. If the Fed’s action, along with massive fiscal spending spark inflation it may be quite an event 12-18 months out.
Prices for consumer goods have increased the past two months (and the consumer goods core figure is up 4.1% past three months); light trucks haven’t shown a decline yet; capital goods prices are up for the third-straight month. Deflation fears are highly overblown and as the fiscal stimulus rolls out (I find it interesting how those “shovel-ready” jobs aren’t quite that ready, which is what a number of people warned about a month back) and the Fed continues to print money, we’ll find those still concerned about deflation are not quite in the game.
Housing Starts
The Commerce Department reported housing rebounded big in February, jumping 22% to 583,000 units (at an annual rate) from an upwardly revised 477,000 units in January -- previously reported at 466,000 units. Multi-family starts surged 82.3% last month; single-family starts rose just 1.1%.
A couple of things here.
One, January weather was pretty harsh in most parts of the country and thus this drove the housing starts figure to extremely depressed levels, making another new low in fact. So the February bounce back has to be seen as a function of that weather-related extreme weakness.
Two, most of the gain came from the multi-family segment (condos, apartments and townhouses) – jumping 82%. This is a very volatile segment of the report and should not be viewed as a trend.
I decided to add the longer-term chart below just to show how depressed housing starts have been. Despite the comments above that suggest we should not view this one month worth of data as a sign residential construction is on the rebound one has to believe that the level of residential activity has become so low that a bottoming has occurred. Certainly the drag this area has on GDP should diminish – which has already occurred simply because it makes up just 3% of GDP today, down from 6% in 2006.
The permits data looked good, up 11% for single-family units, and the three-month change is moving in the right direction relative to the 12-month change. Overall permits were held back (up only 3%) as multi-family permits to build fell 10.8%. But one thing at a time, we’ll take the increase in single-family for now. The increase in single-family permits may be signaling a bottom has been reached, but because of the weather-related rebound in housing starts we’ll have to wait for the March data before conviction can arrive.
FOMC Meeting and Statement
The market awaits the end of the Fed’s two-day meeting this afternoon, and most importantly the statement that ensues, to learn what they are thinking regarding their latest attempt at quantitative easing. Some believe the FOMC will follow the Bank of England down the path of government debt purchases, but we think this is unlikely just yet. Instead, they may concentrate specifically on mortgage rates and signal an increase in purchases of agency (Freddie, Fannie, Federal Home Loan) debt and mortgage-backed bonds.
The Bank of England is in the process of buying $150 billion in gilts (UK Treasuries) and if the U.S. Fed were to go at this on the same scale it means they’d push their balance sheet to 30% of GDP, or roughly double where it is today – and that’s on top of already doubling over the past several months! Read this as printing money on a massive scale and I don’t believe the Fed wants to put the U.S. dollar in the gallows just yet. They will engage in Treasury purchases only as a last resort.
While the dollar is strong right now, at least relative to its lows hit last summer (it’s gotten a boost from the safety trade, or the flood into the Treasury market), printing money on such a huge scale, in addition to $2.0 trillion in Treasury debt issuance this year, will very likely send it back to those lows over time. Not saying investors and traders will flee the greenback for the euro or pound, those economies have major issues too, which can mean only one thing – hard assets anyone?
We will have a better idea of the direction Bernanke and Co. will take at 1:15CT.
Have a great day!
Brent Vondera, Senior Analyst
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