Daily Insight

Wall Street is partying like it’s 1999, the only problem is that this isn’t the second or third time the Dow is flirting with the 10K mark, but the eighth (in terms of closing price). Oh, and differences to the first time we crossed 10K abound: the Dollar Index stood at 101 (now 75 and falling), oil was below $20/barrel (now $75) and the jobless rate stood at 4.4% (now 9.8% and rising). Back then, the Fed was in the process of flooding the financial system with dollars, ahead of the perceived Y2K problem, (just as they have done over the past year) – although interest rates were well-more investor friendly: fed funds at 4.75%; 2-yr Treasury at 4.70%; 10-yr at 5.50%. Such yields would crush this economy and likely send the housing market back to cycle lows.

To be fair, the longer we remain stuck in this stock-market trading range, the more sense the market makes from a longer-term perspective. Dow earnings are 50% higher than in 1999; S&P 500 earnings are 35% higher than 10 years ago. Prices have gone everywhere, but in the end no where over the decade and that means multiple compression. But we still have much to get through before the economy’s issues are resolved and who knows what an overly interventionist government will do before we get there. If past is prologue regarding crises, we have yet to see the extent of the damage Washington can do.

Yesterday’s rally occurred on the heels of Intel’s better-than-expected earnings report and was certainly juiced by a good, solid (and also better-than-expected) retail sales report for September. This move across the 10K mark is certainly a heck of a lot more pleasant than the last time we were crashing through the level (a 370-point plunge on October 6, 2008).

The broad market was driven by shares of financials and industrials. Basic material and energy shares also outpaced the session’s broad-market performance -- oil and metals prices rose again, as the U.S. dollar has gotten clobbered every day this week.

Advancers whipped decliners on the NYSE Composite by an 8-to-1 margin on decent volume (at least by today’s standards) of 1.29 billion shares changed hands – still not much by way of conviction. We’d have to see 1.7-2.0 billion in volume to illustrate conviction. We continue to move higher nonetheless.

Market Activity for October 14, 2009

Mortgage Applications

The Mortgage Bankers Association index of applications fell 1.8% in the week ended October 9 after a large 16.4% increase in the prior week. Purchases fell 5%, driving the index lower as the rush to get in before the first-time homebuyers tax credit has run its course (the contract needs to close by November 30 and that is probably not possible for last week’s signings). We’ll see if Congress extends the credit or not over the next two months. My bet is they will, and they will also extend it to all home buyers. Still, it will have a disruptive effect on home sales activity even if it is extended as it will not be continuous. .

Refinancing activity slipped just 0.1% last week, as the 30-year fixed mortgage rate continues to hover around the 5.00% level – averaging 5.02% last week. Refi activity made up 67.4% of the mortgage apps index as of this latest reading.


Retail Sales

The Commerce Department reported retail sales in September came in much better-than-expected. The headline readings fell 1.5% (a 2.1% decline was expected) after a downwardly revised 2.2% increase in August.

The payback for the cash-for-clunkers program is what pushed overall retail sales lower as motor vehicles & parts fell 10.4% last month. Clunker-cash provided a one and done boost to the auto industry, just as common sense would have led one to believe. The month’s decline in auto sales erases the prior two month’s gains and takes the level of auto sales below the that seen before cash-for-clunkers was implemented.

Excluding autos, retails sales rose more than expected, up 0.5% after a 1.0% rise in August. This is good to see as the previous reading was boosted by back-to-school buying and the sales tax holiday most states had implemented – there is some follow through here.

Furniture (up 1.4% after a falling 0.8% in Aug.), food & beverage (up 0.7% after a 0.8% rise in Aug.), clothing (up 0.5% after a 1.1% rise in Aug.) and general merchandise (up 0.9% after a 1.2% increase in Aug.) all contributed to the ex-auto sales increase.

The electronics component failed to show follow through off of August’s back-to-school bounce. This is not what Intel’s numbers suggested on the surface, but a significant degree of the Intel boost in chip deliveries was due to sales in China – China’s stimulus has not only been infrastructure based but they have also instructed banks to lend; bank loans in China have soared 76.5% over the past year. There has also been a substitution effect occurring, replacing higher-priced laptops with cheaper netbooks (which didn’t hurt Intel as their Atom chip sales soared but does tamp down overall electronics sales).

Excluding autos and gasoline, retail sales rose 0.4% after a 0.6% pick up in August. Removing the distortions clunker-cash had on the reading and gas station receipts (which is always appropriate to remove from the retail sales figures in order to get a better sense of things) retail sales are up 2.4% over the past three months at an annual rate. Not bad but somewhat of a weak bounce from the significant 5% decline in this figure on a year-over-year basis as of June 2009.

Now, a number of segments of the retail sales data have posted nice gains over the past two months, and I’m not trying to take away from that, but a boost in consumer activity does not pass the smell test based on the headwinds the consumer faces. It will take a sustained rebound in the labor market, household incomes and the resultant decline in default rates to push consumer activity higher in a consistent manner. Recall, that we saw a big bad bounce in core retail sales in the beginning of the year off of the cycle low (hit in December). This provided hope for the market, only to deflate again. I would be careful not to replace reality with hope. Nevertheless, consumer activity will offer a nice help to the third-quarter GDP reading.

Business Inventories

The Commerce Department stated that business inventories fell 1.5% in August, marking the 12-straight month of liquidation. This shows the inventory dynamic did not take place in the third quarter so we should expect some actual replacement of stockpiles to boost fourth-quarter GDP in a substantial manner.

Still, inventories will add to GDP when the Q3 report is released as stockpiles are on pace to fall at close to half the rate of decline of that in the previous quarter. (The inventory component to GDP involves the change in inventories. Thus, you do not need an increase in inventories, or non-fixed investment as it is technically known, but they only need to decline less than that of the previous quarter to contribute to growth.

Business inventories were dragged lower by a huge 7.9% reduction in auto stockpiles (down 31.1% y/o/y). Ex-autos, inventories fell just 0.3%, the smallest since March – which I guess isn’t sayin’ all that much. I would expect the September inventory data to show an increase, the first since August 2008.

Business sales rose 1%. As a result, the inventory-to-sales ratio fell to 1.33 months worth from 1.36. The reading has now moved meaningfully below the 15-year average for the first time since the chaos began with the Lehman collapse.


Correction, and Commentary on Option Adjustable Rate Mortgages:

In yesterday’s letter I stated: 46% of IO (interest-only) mortgages are at least 30 days delinquent, even though just 12% of these loans have reset. That is wrong. The correct figure is 46% of option ARMs are 30 days late, as of the September data, according to Fitch Solutions.

Interest-only loans make up just one of the choices in the option ARM market. The choices are: make a full payment of principal and interest, a payment equivalent to interest only, or a payment less than the total amount of interest due (Pick-A-Pay).

Payment-option mortgage loans are heavily concentrated in the worst-hit regions of the housing market (75% of these loans are on collateral located in California, Florida, Nevada and Arizona), making these loans much more vulnerable to declining property values. Since these were the heaviest areas of speculation, many of these borrowers are likely just walking away. Many of these loans have loan-to-value ratios of 126%, according to Fitch, meaning a significant number of these borrowers will be unable to refinance to avoid the rate shock – until the government comes in to rescue them. .

Option ARM loans are a much smaller percentage of the total mortgage market than subprime loans, but the point of discussing this topic is that it adds incrementally to the headwinds consumer activity faces.



Have a great day!


Brent Vondera, Senior Analyst