Why the rally at the end there? Well, it appeared to be a comment from Princeton professor Paul Krugman in which he stated not to be surprised if the official end of the recession ends up being sometime this summer. If this was the reason for the reversal in stocks, it probably shouldn’t be much of a surprise that the rally fizzled in a matter of 30 minutes as it was just on Friday in which the Nobel laureate stated he had a hard time seeing what might drive a “full” economic recovery, and that the economy was not recovering, but just that “things were getting worse more slowly,” as quoted by Bloomberg News.
Anyway, it was a quiet day as we were without an economic release so the market can have a tendency to vacillate on even the slightest of comments and that appears to be what occurred on Monday.
In terms of breadth, volume was light as just 1.1 billion shares traded on the Big Board, roughly 20% below the three-month average. Two stocks fell for every one rose on the NYSE.
Market Activity for June 8, 2009
Chrysler Deal Stayed
Bondholders have successfully put a halt to the Chrysler sale (if you can call it that, Fiat is putting up no money for the assets, just what they call technology sharing) as junior creditors were put in front of senior creditors – a clear violation of contract law. Justice Ginsburg has issued a stay order until the Supreme Court decides. We should commend the creditors who have staged this injunction. Surely they are engaging in this process because of their duty to get the most for their investors, but in the meantime they are also making a stand for contract law – you start messing with contract law and property rights and this system is in big trouble.
The Potential Interest-Rate Wall
The bond market is putting it to Bernanke as traders push Treasury rates higher (not that rates are high, they are most certainly not, but we’re talking about the degree of the move) and threaten to crush what appears to be the first broader-based improvement in the home sales since the housing market correction began. The purchase data within mortgage applications, the pending home sales figures and possibly even evidence within actual home sales offer optimism that some bounce from very low levels of activity is on the horizon.
But concerns over fiscal policy have brought back the bond vigilantes and as a result the yield on the 10-year Treasury note has jumped to 3.85% from 2.20% at the start of 2009. The good news is the spread between mortgage rates and Treasury yields (and the narrowing of corporate bond spreads too, as we touched on last week, even if they remain historically wide) has narrowed dramatically. But it doesn’t take much to shut down any nascent bounce in housing at this point. The 30-year mortgage rate will likely hit 5.50% this week, up from 4.70% in late April. This means home prices will have to fall further to offset the move in rates and keep affordability extremely advantageous – and an extreme advantage with regard to affordability is necessary right now as the very fragile labor market will continue to weigh on the housing market and economy as a whole.
So the question is, will Bernanke and Co. increase their Treasury and mortgage-backed security purchases, or hold off? My bet is they will signal an increase in these purchases within a few weeks and thus take quantitative easing to another level. If they do, rates may just trend down again in the very short term as traders seek to make quick profits in the Treasury market. However, these decisions will have costs to bear down the road and the market will eventually overwhelm the Fed’s actions and push rates higher. It will take some time for interest rates to get to levels that cause real economic damage, but the ingredients seem to be there – a brew that will send rates much higher over the next couple of years.
The investor needs to be careful not to get too carried away, you must keep your guard up. We may just see some high-powered corporate profit growth a couple of quarters out, as businesses have slashed and burned expenses – it will take very little increase in demand to drive the bottom line. That’s the good news. But the potential interest-rate wall the economy will likely have to deal with will make an economic expansion short-lived. (Of course, there’s a caveat with everything. We have heightened geopolitical risks that may very well keep rates low despite policy that screams higher rates to those who have studied these things. But if some sort of event is sparked, this is yet another reason to remain cautious.) If anything, what I’m trying to say here is, as has been the message over the past couple of weeks, we may enter into a period that gets people juiced but beware of taking on too much risk; there is the natural tendency to take on more risk when things get rolling, but this is not the typical business cycle; this is not the typical investing environment. The economy and stock market will face substantial headwinds over the next couple of years
In my view higher rates are needed in order to wash out what has become an improper assessment of risk within the market place (as investors hunt, in some cases in a panic, for yield due to the Fed’s very easy policy stance). While this will cause economic damage, likely shutting down what I see will be a four-quarter rebound in economic growth beginning slowing in the third-quarter of 2009 and picking up some steam by the fourth, this will also present an opportunity for fixed income investing. We are likely to see the most attractive yields on this side of the portfolio in a decade.
Today we begin a three-day series of auctions as $65 billion of three, 10 and 30-year Treasurys are issued. I suspect these auctions will enjoy plenty of demand, but certainly these events are accompanied by a level of anxiety within the marketplace that has not been seen in 30 years. Eventually though, it’s tough to see how the market does not demand higher yields as both fiscal and monetary policy are not conducive for a stable dollar value.
This Week’s Data
We were without an economic release yesterday, but get back to it today and some very important data later in the week.
This morning the Commerce Department releases April wholesale inventories, and while this data has a substantial lag to it, it’s important as it will bring the first broad-based look at inventory management for the first month of the current quarter. Inventory liquidation has been one of the main drags on GDP over the past two quarters and we’ll see how that dynamic is shaping up for this period. Odds are we’ll see stockpiles were scaled back some more during April, although at a reduced rates relative to the past few months. By June we believe there’s a good shot that production will pick up as firms begin the rebuilding process.
On Wednesday we get the trade balance for April and the monthly budget statement for May.
The trade figures will be closely watched as investors look for clues that the Pacific Rim is bouncing back. China’s large and infrastructure-focused spending should help the region rebound and evidence will show up in our exports to the region. It may be a bit early to expect much, positive developments are likely a couple of months out, but this is why we watch the data – a positive surprise will be big for this market.
The budget numbers will show we’re on pace for a fiscal 2009 budget shortfall of $1.5 trillion, marking a post-WWII deficit-to-GDP record that surpasses the previous mark by double.
On Thursday, we get the always important jobless claims data. We look for another mild reduction in claims, yet the figure will probably hold above the very elevated 600k level.
Another big report on Thursday will be retail sales for May. It will take some time for the consumer to get things right again. The debt amassed over the past decade was manageable, very manageable in many cases when unemployment was at 5% and incomes were growing at a nice clip. But that has changed, and coupled with the crushing blow to the consumer’s two largest savings vehicles, it’s going to take a while for consumer activity to begin a sustained upward trajectory again. In the meantime we’ll see ebbs and flows and let’s hope May posts a good reading after five of the past eight months have posted huge monthly declines.
On Friday we round things out with the University of Michigan’s consumer confidence reading for June. The consumer confidence numbers over the past two months have bounced from deep depths. The market will need to see additional progress is being made.
Have a great day!
Brent Vondera
1 comment:
With regard to interest and mortgage rates, it's just not in the mix for anything beyond a modest recovery. the bond vigilante's are merely responding the the current and anticipated volume of paper that's going to have to be sold. Krugman is likely correct that the recession will end in the next several months, and our deficit spending may be enough to drag us out of recession (and avoid deeper trouble), but it's not going to be able to spur a more robust recovery.
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