U.S. stocks rallied yesterday, more than erasing Monday’s declines, as the market continues to be whipsawed. A nice move by the dollar, which helped to push oil prices lower, combined with what may have been a favorable view of Merrill Lynch’s decision to unload mortgage-related securities at a fire-sale price sparked the rally. More on that Merrill news below.
The price of crude for August delivery moved to its lowest level since May, which sent consumer discretionary shares higher – this is the theme these days. When the market rallies, financials and consumer discretionary shares generally lead the way.
Information technology and industrial shares enjoyed a nice day too as better-than-expected earnings results sent the sectors higher.
Market Activity for July 28, 2008
Information technology profits are up 21% with 60% of those names reporting. The capital goods segment of the industrial sector looks good too and may just return to double-digit growth if the business spending trends of the past couple of months continues.
Profit results for eight of the 10 major industry groups remain in positive territory – three have recorded double-digit growth, two have posted 9% or better and another three have recorded earnings growth in a range of 4%-7%. The weakness has occurred in financials and consumer discretionary, down 86.8% (no that’s not a typo) and 21.7%, respectively.
The dollar gained good ground yesterday after the latest home price index showed price declines eased and the July consumer confidence reading improved slightly. Neither report was good, but both were better-than-expected. The dollar’s gain likely was due more to the home price data, which we’ll get to below, than the confidence number, which has proved to be a worthless indicator of future spending for a long time, but I mention it nonetheless.
Oil prices dropped 2.04%, or $2.54 per barrel, to $122.19. With the exception of constructive action out of Congress regarding the self-imposed barriers to production, we need the dollar to rally in order for crude to fall back to desired levels. Fed and tax policy can go a long way in pushing the dollar higher, but this looks quite unlikely for now. So we just have economic data that will drive the $ and oil in the meantime – Thursday’s GDP number will beat current estimates, and the dollar should rally. However, we get non-farm payrolls (NFP) on Friday, which may put pressure on the greenback. So we may be looking at offsetting effects. This increases the importance of the August 5 FOMC meeting; the Fed has a major opportunity to put a dazed oil trade on the mat.
In other news, Merrill Lynch announced they’ll take another $5.7 billion in write-downs in the third quarter – largely from selling $30.6 billion of bonds at a fifth of their face value. This follows $9 billion in write-downs just three weeks ago when they reported second-quarter results. (Merrill had previously valued the $30.6 billion (face value) in bonds at $11 billion. This sale brings the value down to roughly $6.8 billion.)
While these are huge numbers, and carry tremendous costs to existing shareholders, this is a good sign. Merrill is taking their medicine and getting this stuff behind them. One shouldn’t miss that for every loser, there is a winner -- the buyers of these mortgage-related bonds should make out big over time, picking these positions up at 22 cents on the dollar. Absent these fire-sale prices, the losses would have only dragged on.
On the economic front, we received the latest figure from the S&P Case/Shiller Home Price Index for May, which showed a year-over-year decline of 15.78%. On a monthly basis, the index showed prices fell 0.86% (that’s for May from the April reading) and 15.91% at an annualized rate for the three months ended in May.
While these are large declines, the index did offer evidence the degree of price declines may be decelerating. For instance, the three-month annualized figure has eased from down 25% in March and the month-over-month decline has eased from -2.63% in February.
Further, keep in mind that this Case/Shiller index only captures activity among the largest 20 U.S. cities. The largest price declines have taken place in what we’re referring to as speculative areas -- San Diego, LA, Phoenix, Las Vegas and Miami. Detroit has been another major decliner, but this is due to other factors such as auto-sector woes and higher tax rates that have pushed businesses out of Michigan.
Seven of the 20 cities actually showed home price rose in May – Boston, Dallas, Charlotte, Denver, Atlanta, Minneapolis and Portland. So, there was some good news, but the overall point is that Case/Shiller is not a broad index. It does a good job of showing the direction of home prices, but exacerbates the degree to which prices have moved.
The broadest home price index is the OFHEO (Office of Federal Housing Enterprise Oversight) index, which shows home prices are down 6% over the past year. This index has its limitations too, as it captures only conforming loans, leaving out the upper-end of the housing market.
So we must factor in all of the data, it is a mistake to look at just one indicator. For a longer-term perspective I’ll leave you with charts of new and existing home prices. Notice that prices remain nicely positive going back to 1999. It’s tough to read on this graph, but existing home prices are 51.82% higher and existing home prices are up 46.7% from the summer of 1999. (I could only go back to 1999 as the existing median home price index began in that year.) Existing home prices are down 6.41% from the peak and new home sales are down 12.12% from the all-time high.
I’ll be on vacation through August 11 so David Ott, among others, will be filling in until then.
On economic watch over the next week will be the first look at Q2 GDP tomorrow and the July jobs report on Friday. Monday, personal income and spending for June will receive focus and then the FOMC meeting on August 5. For new readers, the FOMC stands for Federal Open Market Committee – the group that sets the Fed’s key interest rate.
We have seen some dissent within the FOMC of late. That is, more members have expressed the need to raise fed funds, gently for now – 20% year-over-year increases in import prices, a 10% jump in producer prices and 5% CPI will have that effect. Anyway, with oil $24 off its record high the Fed may have been lulled into a false sense of security regarding price stability and their comments on August 5 may turn dovish. If so, I believe they’ll be making a huge mistake and oil may rise again. (There are several other factors that determine the price of oil, but one thing at a time for now.)
However, if they show they’re serious about price stability – even with the credit-market challenges that confront the group – we may just see crude forced closer to the $110 level. This presents an awesome opportunity for the Fed and could bring with it a stock market rally, increased consumer consumption numbers and one serious risk removed from the market. It will be interesting to watch this play out.
Have a great day!
Brent Vondera, Senior Analyst
The price of crude for August delivery moved to its lowest level since May, which sent consumer discretionary shares higher – this is the theme these days. When the market rallies, financials and consumer discretionary shares generally lead the way.
Information technology and industrial shares enjoyed a nice day too as better-than-expected earnings results sent the sectors higher.
Market Activity for July 28, 2008
Information technology profits are up 21% with 60% of those names reporting. The capital goods segment of the industrial sector looks good too and may just return to double-digit growth if the business spending trends of the past couple of months continues.
Profit results for eight of the 10 major industry groups remain in positive territory – three have recorded double-digit growth, two have posted 9% or better and another three have recorded earnings growth in a range of 4%-7%. The weakness has occurred in financials and consumer discretionary, down 86.8% (no that’s not a typo) and 21.7%, respectively.
The dollar gained good ground yesterday after the latest home price index showed price declines eased and the July consumer confidence reading improved slightly. Neither report was good, but both were better-than-expected. The dollar’s gain likely was due more to the home price data, which we’ll get to below, than the confidence number, which has proved to be a worthless indicator of future spending for a long time, but I mention it nonetheless.
Oil prices dropped 2.04%, or $2.54 per barrel, to $122.19. With the exception of constructive action out of Congress regarding the self-imposed barriers to production, we need the dollar to rally in order for crude to fall back to desired levels. Fed and tax policy can go a long way in pushing the dollar higher, but this looks quite unlikely for now. So we just have economic data that will drive the $ and oil in the meantime – Thursday’s GDP number will beat current estimates, and the dollar should rally. However, we get non-farm payrolls (NFP) on Friday, which may put pressure on the greenback. So we may be looking at offsetting effects. This increases the importance of the August 5 FOMC meeting; the Fed has a major opportunity to put a dazed oil trade on the mat.
In other news, Merrill Lynch announced they’ll take another $5.7 billion in write-downs in the third quarter – largely from selling $30.6 billion of bonds at a fifth of their face value. This follows $9 billion in write-downs just three weeks ago when they reported second-quarter results. (Merrill had previously valued the $30.6 billion (face value) in bonds at $11 billion. This sale brings the value down to roughly $6.8 billion.)
While these are huge numbers, and carry tremendous costs to existing shareholders, this is a good sign. Merrill is taking their medicine and getting this stuff behind them. One shouldn’t miss that for every loser, there is a winner -- the buyers of these mortgage-related bonds should make out big over time, picking these positions up at 22 cents on the dollar. Absent these fire-sale prices, the losses would have only dragged on.
On the economic front, we received the latest figure from the S&P Case/Shiller Home Price Index for May, which showed a year-over-year decline of 15.78%. On a monthly basis, the index showed prices fell 0.86% (that’s for May from the April reading) and 15.91% at an annualized rate for the three months ended in May.
While these are large declines, the index did offer evidence the degree of price declines may be decelerating. For instance, the three-month annualized figure has eased from down 25% in March and the month-over-month decline has eased from -2.63% in February.
Further, keep in mind that this Case/Shiller index only captures activity among the largest 20 U.S. cities. The largest price declines have taken place in what we’re referring to as speculative areas -- San Diego, LA, Phoenix, Las Vegas and Miami. Detroit has been another major decliner, but this is due to other factors such as auto-sector woes and higher tax rates that have pushed businesses out of Michigan.
Seven of the 20 cities actually showed home price rose in May – Boston, Dallas, Charlotte, Denver, Atlanta, Minneapolis and Portland. So, there was some good news, but the overall point is that Case/Shiller is not a broad index. It does a good job of showing the direction of home prices, but exacerbates the degree to which prices have moved.
The broadest home price index is the OFHEO (Office of Federal Housing Enterprise Oversight) index, which shows home prices are down 6% over the past year. This index has its limitations too, as it captures only conforming loans, leaving out the upper-end of the housing market.
So we must factor in all of the data, it is a mistake to look at just one indicator. For a longer-term perspective I’ll leave you with charts of new and existing home prices. Notice that prices remain nicely positive going back to 1999. It’s tough to read on this graph, but existing home prices are 51.82% higher and existing home prices are up 46.7% from the summer of 1999. (I could only go back to 1999 as the existing median home price index began in that year.) Existing home prices are down 6.41% from the peak and new home sales are down 12.12% from the all-time high.
I’ll be on vacation through August 11 so David Ott, among others, will be filling in until then.
On economic watch over the next week will be the first look at Q2 GDP tomorrow and the July jobs report on Friday. Monday, personal income and spending for June will receive focus and then the FOMC meeting on August 5. For new readers, the FOMC stands for Federal Open Market Committee – the group that sets the Fed’s key interest rate.
We have seen some dissent within the FOMC of late. That is, more members have expressed the need to raise fed funds, gently for now – 20% year-over-year increases in import prices, a 10% jump in producer prices and 5% CPI will have that effect. Anyway, with oil $24 off its record high the Fed may have been lulled into a false sense of security regarding price stability and their comments on August 5 may turn dovish. If so, I believe they’ll be making a huge mistake and oil may rise again. (There are several other factors that determine the price of oil, but one thing at a time for now.)
However, if they show they’re serious about price stability – even with the credit-market challenges that confront the group – we may just see crude forced closer to the $110 level. This presents an awesome opportunity for the Fed and could bring with it a stock market rally, increased consumer consumption numbers and one serious risk removed from the market. It will be interesting to watch this play out.
Have a great day!
Brent Vondera, Senior Analyst
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