Daily Insight

U.S. stocks bounced between gain and loss several times Wednesday, but the broad market rallied in the final hour of trading to close higher. The Dow Average failed to follow suit as telecom names AT&T and Verizon, along with shares of 3M held the index back.

Financial, energy and technology shares were the leaders, with telecoms, industrials and utilities the laggards.

The weakness mid-day came on reports that homebuilders are worried that Congress has yet to signal an extension of the homebuyers tax credit. We all know that the housing market needs this credit (along with FHA-backed originations this is just another crutch), although I’m skeptical the beneficial impact its had on home sales will continue as the duration of joblessness continues to climb – having a job is sort of a big factor in buying a home. But you can’t keep a good market down, the performance chasers have come to town.

Volume was fragile again, with just 978 million shares traded on the NYSE Composite, roughly 25% below the three-month average. Got conviction?

Yesterday’s $20 billion auction of reopened 10-year Treasury notes went off without a hitch again. In fact, this is an understatement. The bid-to-cover ratio (gauge of demand) was through the roof at 3.01 (2.56 is the average over the past eight auctions). At this heightened level of over-subscription one would think the government was paying 6, 7 or 8% for 10-year money, instead of the 3.18% locking in for 10 years currently offers.

The Fed was in there again, buying $1.3 billion in Treasury securities, but even so these yields illustrate a view within the bond market that is quite removed from the euphoric optimism currently exhibited within the equity markets. In time we’ll find out which market is correct. It may be that neither are viewing things accurately, but no time to get into this take right now.

Market Activity for October 7, 2009
Mortgage Applications

The Mortgage Bankers Association’s index of applications jumped 16.4% in the week ended October 2 after declining 2.8% in the prior week.

Purchase leapt 13.2% as the rush is on to get in before the first-time homebuyers tax credit expires on November 30 (the contract has to close by that date). This buying is also being helped by FHA-backed loans, which now make up 23% of all originations, up from just 3% in 2006. A borrower need to only put down 3.5% of an FHA-backed purchase.

I guess I don’t have to say what this means for foreclosures if home prices dip again – at the end of June, 8% of FHA-backed loans were 90 days late; 15% are 30 days past due. The writing is on the wall.

Refinancing activity also surged, up 18.2% for the week – this segment made up 66.3% of the mortgage apps index, up from 65.3% the week prior. A 30-year fixed-mortgage rate of 4.89% for the week (lowest level since late May) certainly provided some jet fuel to contract signings and refis.

Weekly Energy Report

The price of oil pulled back a bit yesterday after the Energy Department reported that gasoline and distillate stockpiles jumped last week. Gasoline supplies rose 2.94 million barrels, a build of one million barrels was expected. Distillate inventories (diesel and heating oil) climbed 679,000 barrels, 70% more than the 400,000 expected. The 171.8 million barrels of distillates in inventory is the highest since January 1983 – although if the current temperature track holds it will soon boost demand for heating oil.

Crude stockpiles fell one million barrels, but the current level of inventories is 5% above the five-year average.

The fact that crude prices barely budged on the gasoline and distillate news shows the oil trade is not about supply/demand fundamentals and all about a hedge against a falling dollar and an overall move into commodities fostered by aggressive global monetary easing.

Consumer Credit

The Federal Reserve reported that consumer credit fell in August for a seventh-straight month (down 10 out of the past 11), matching the record streak of decline. The last time consumer credit (which includes both revolving – such as credit cards – and non-revolving – like auto loans) fell for seven-straight months was 1991, although the degree of decline this go around is three times greater. The data goes back to 1943, but it wasn’t really of much significance until the 1970s.

Consumer credit fell $12 billion, or 5.8% at a seasonally-adjusted annual rate, in August after the largest decline on record of $19 billion in July, according to the Fed. A median forecast of 36 economists estimated the figure to drop by $10 billion; projections ranged from an increase of $6.2 billion to a decline of $15 billion. The plunge in July was actually an upward revision from the initial estimate of -$21.6 billion when it was released last month.

The driver of the decline was a $9.9 billion, or 13.1%, drop in revolving credit as credit card lines have been slashed due to rising default rates and consumers pulling back and paying down balances. This is a necessary condition to a meaningful rebound in consumer activity 18-24 months out and is just something we’ll have to work through so long as the labor market remains mired.

Non-revolving credit eased just $2.1 billion, or 1.6% -- it had crashed during the previous two months, falling 12.6% in July and 8.0% in June. The cash-for-clunkers program clearly provided a respite to this continued decline, but like any scheme to boost activity when the consumer needs to repair the aggregate balance sheet, this only delays what is inevitably going to occur.

I suspect large declines in borrowing will continue over the ensuing months, and its natural effect on retail sales figures, now that Uncle Sugar is no longer distributing clunker cash. Domestic auto sales fell back to their pre-clunker cash levels in September, as the chart below illustrates, so next month’s reading on consumer credit won’t get help from the non-revolving side of things – it was a one and done event.

The clunker-cash program is a microcosm of what will occur when the various other types of government stimulus are removed – when the crutches are taken away. And if they are not taken away in an appropriate manner…well, reflation experiments always carry huge costs that must be borne down the road. We seem to live in a world in which more and more people are unaware of this reality and this does have an effect on one’s near-term (call it 18-24 month) expectations. Just as one has to come down from gorging on energy drinks, NoDoz (dang, two 1980s references in two days), or a sugar high (as is PIMCO’s El-Erian’s famous phrase), it must also come down from easy money policy – how quickly we forget.

Futures

Stock-index futures are off to the races this morning, juiced by Alcoa’s earnings results last night. Sales plunged 34% from the year-ago period, but were up 8% sequentially – that is, from the previous quarter. The market generally does not view revenue trends on a quarter-over-quarter basis because they are not good comparisons from a seasonal perspective, but that is all the market has to go on right now as the same-quarter year-ago comparisons remain abysmal.

Earnings came in much better-than-expected, posting a 4-cent profit vs. estimates for an 8-cent loss. The quarter was helped by a 24% jump in the average price of aluminum relative to the pervious quarter. China’s desire for metals has yet to be sated. And the Chinese will remain voracious with regard to their commodity purchases as they seek to offset the damage they are seeing in purchasing power via their U.S. dollar assets.

The firm engaged in another round of massive cost-cutting, slashed its smelting capacity as the firm said prices aren’t yet high enough to warrant restarting these plants. The company stated that global demand remained weak, with the exception of China.

Whether or not the rally we’re seeing in pre-market activity flows into the trading session may very well depend on how the weekly jobless claims data plays out. If claims can break the 540K level, the rally will rumble; if not, it will stumble. We get the number at 7:30 CT.


Have a great day!


Brent Vondera, Senior Analyst