Fixed Income Recap

The market did a good job absorbing the final chunk of this week’s supply. $28 billion in 7-year notes were sold to the public at a high yield of 3.092%, just .5 bps under the market at the time of the auction’s end, a sign the market was right on top of this one. Other demand measures also showed strength this time around. Bid/cover was 2.74, a little stronger than the 2.61 average for this maturity, and indirect bidders took down 61.2% of the auction, also a strong number.

Many traders were calling for this to be a tough week in bond land. Treasuries held in there last week in the face of strong performance in equities, and some saw a week with $109 billion in new supply as a potential rough period. Well speculators have been wrong so far, as demand for new paper was much stronger than expected.

A second Fed President has now speculated publicly on whether the Fed will need to complete the MBS purchase program as scheduled. Saint Louis Fed President James Bullard said yesterday when speaking to reporters in Little Rock that completing the program on its current schedule may not be necessary. Even though that’s two Fed Presidents in as many days speaking out against the program, the rest of Open Market Committee does not seem to share the same views. The Fed purchased $25.4 billion in MBS last week, much higher than the $23.35 billion weekly average, and over $25 billion for second week in a row. Purchases dropped off in July, only to speed up again in August as the Fed is scaling back the Treasury program. The Fed will need to average just about $25.5 billion a week in order to finish purchasing the remaining $458 in MBS before year end.

Cliff J. Reynolds Jr., Investment Analyst

Fixed Income Recap

A 5-year auction and Fed buying combined for a long end rally and a flatter curve in Wednesday’s trading. Demand for five-year notes was strong yesterday, bid/cover for the auction was 2.51, stronger than the 2.33 average for the past 4 auctions. Only $2.3 billion in long Treasuries were purchased by the Fed yesterday, well under the $3 billion average for that operation. The market will begin to look closely to see if the Fed continues to slow down their Treasury purchases. While we are on the open market operations front, Richmond Fed President Jeffrey Lacker mentioned in a speech this morning that the Fed may not need to purchase the full $1.25 trillion in agency MBS, sighting an economy expected to grow later this year and improving financial conditions. This is the first mention of this that I have heard, and would certainly be a big step towards “the exit” for the Fed if they in fact ended the program early.

In the docket for today is $7 billion in 7-year notes and the release of the Fed’s MBS purchases from the past week. I don’t expect to see any changes going forward in the MBS program despite Lacker’s comments.

Cliff J. Reynolds Jr., Investment Analyst

Daily Insight

U.S. stocks ended flat on Wednesday as comments from Federal Reserve Bank of Atlanta President Dennis Lockhart, warning of a “fragile” recovery, offset housing data that was far better than expected. A durable goods report, while the headline reading was good, also weighed on the market just a bit as the business spending proxy within the report failed to post an increase.

Trading was perfectly divided as five of the S&P 500 major sectors rose, while five declined. Telecom, energy, consumer (both discretionary and staple) and tech shares managed to gain ground. Industrial and basic material shares led the losers.

The market, after catching a bid on the heels of the housing data, which we’ll touch on below, came under pressure after Fed official Lockhart spoke to the likelihood that the FOMC will keep the fed funds rate low for an extended period.

While this is certainly no great revelation, it does put pressure on stocks simply from the standpoint of the economic outlook, something we touched on yesterday with regard to the last leg of this rally in stocks. Lockhart stated his forecast envisions a return to positive GDP growth over the medium term, but weighed down by significant adjustments to our economy – by which he means tighter credit conditions and lower levels of consumer activity.

Market Activity for August 26, 2009
Five-Year Auction

Another Treasury auction goes well as $39 billion in 5-yr notes were sold at a yield of 2.49%, very close to expected, with a bid-to-cover of 2.51 (indication of demand) vs. the avg. of 2.21. Indirect bids (central banks and governments) were strong at 56.4% of the auction vs. 34.6% avg. No problems thus far.

We’ll have another auction of $28 billion in 7-yrs today.

Mortgage Applications

The Mortgage Bankers Association reported that its mortgage apps index rose 7.5% in the week ended August 21, which follows the nice move of 5.6% in the previous week. Purchases rose 1% in the week and refinancing activity jumped 12.7% after a 6.9% pick up in the week prior.

The August purchases are rebounding after this reading showed a July decline of 2.1%. So, we may see a pullback in the actual August home sales figures (what occurs in this apps index generally flows through to the next month’s worth of official sales) followed by one final push in home sales as result of the refundable tax credit just before it expires.

I’ve heard people talk about how the tax credit-driven sales have run their course as people generally move prior to the school season beginning, but I doubt most first-time homebuyers (must be a first-timer to be eligible for the credit) have children. There has been speculation over the past few days that the credit will be extended to other purchases, or even through 2010. We’ll see. In any event, based on what is currently known, the demand induction from the credit will soon run its course.

The 30-year fixed mortgage rate rose last week to 5.24% from 5.15%.


Durable Goods Orders (July)

The Commerce Department reported that durable goods orders rose 4.9% in July after a 1.3% decline in June (a number that was revised up from the initial estimate of a 2.5% decline). The gauge was fueled by a huge move in commercial aircraft orders (the most volatile component of this data), which jumped 107.2% for the month.

The ex-transportation reading rose 0.8% last month, which followed a 2.5% increase for June (an upward revision from the 1.1% rise estimated last month). This figure has increased for three straight months, up 16% at an annual rate.

Other nice gains came from electrical equipment (up 5.3%), primary metals (up 2.6%) and computers & electronics (up1.6%). Auto & parts also picked up a bit, but less than I was expecting, up just 0.9%. This segment will likely show a nice move when the August durables number is released as the CARS program has driven auto inventories low.

The unfortunate aspect of the report, and the likely reason the equity markets didn’t catch a bid on the higher reading, was the business spending figure. Non-defense capital goods ex-aircraft (the business spending proxy) fell 0.3% in July. This followed two months of gain after the drilling the segment took in the months prior.

The year-over-year decline in this business spending segment is still down 20.4% on a year-over-year basis, but an improvement from the 27.3% cycle low hit in April.

Over the past three months non-defense capital goods ex-aircraft are up 30.9% at an annual rate off of that cycle low hit in April. That was a big time low, with business spending off by 35% at an annual rate over the six months that preceded that low mark. (Go back a full year and this business spending reading was off by 52% as of that April low, but it was a totally different world pre-September 2008, so I don’t find it worthwhile to match the current state of things relative to pre-Lehman/financial collapse data – I bring it up just to offer some clarity).

Manufacturers’ inventories of durable goods do remain elevated at 1.81 months worth – the long-term average is 1.56 months. This figure has me questioning the timeline of the GDP boost via inventory rebuilding. It may take a bit longer to occur than I currently expect.

The shipments of durable goods (and again, these are goods meant to last at least three years) jumped 2.0%, marking the second month of gain as the June figure rose 0.7%. Recall that last month we explained that shipments would rise due to the 2.5% increase in ex-transportation durables orders from June. This gets the third-quarter growth figure off to a good start – durable goods shipments is what flows to the GDP report.

The current quarter will end the year-long contraction in GDP. The inventory dynamic will take over (again the timing of this is in question) as the catalyst and should propel GDP for the next two quarters. After that, we will need final demand to come back to keep the ball rolling; the replenishment of stockpiles, after two quarters of record reductions, cannot catalyze GDP by itself in a sustained manner.

New Home Sales

New homes sales leapt in July, up 9.6% (a rise of just 1.6% was expected), to 433,000 units. The level of sales remains depressed, off of the 27-year low but still well-below the 40-year average of 724K units. So we’ve left the cycle low behind, but it may be a very slow turnaround period back to levels that approach the average. It will be very interesting to watch how sales react when the first-time credit comes off and we move past the best period for home sales.

By region, sales surged 32% in the Northeast (although this is a low level market for new homes, making up just 10% of the total); purchases jumped 16% in the South (the largest new home market, making up 51% of the total); sales ticked up 1% in the West and fell 7.6% in the Midwest.

The median price of a new home was virtually flat for the month, down just 0.14% -- median price is down 12% from the year-ago level, $210,100 vs. $237,300 in July 2008.

The supply figures are really looking good, much better than for existing homes. The number of new home available for sale is down 35% from the year-ago period at 271,000 units – the lowest level since March 1993.

The inventory-to-sales figure (months worth of supply at current sales pace) has declined to 7.5.


Have a great day!


Brent Vondera, Senior Analyst

Quick Hits

• Dollar to Gain Near Term But Losing Influence
• How Does Bernanke Rate as the Top U.S. Deal Maker
• Applying Roubini Wisdom to Stocks Means Missing Out

Cash for Clunkers Part II: Home Appliances

Giving consumers cash for their old cars when they bought new ones was a wild success. Now the government is turning their attention towards subsidizing purchases of high-efficiency home appliances like refrigerators, washing machines, dishwashers, furnaces, and air-conditioning systems.

Details are still being worked out, but the program is expected to be capped at $300 million taxpayer dollars, and will give consumers $50 to $200 for their old home appliances when they purchase high-efficiency upgrades. Unlike the Cash for Automobile Clunkers, consumers won’t get the discount at the point of sale, but instead will have to apply for a rebate.

While the program is being funded by federal dollars, each state is able to determine which appliances will be on the rebate list. The items will most likely have to be Energy Star rated. State plans will be reviewed by the Department of Energy starting in late October, and money could start flowing to consumers by November.

Just as the government program to stimulate auto demand ran out of money in the first week, this program will likely be exhausted quickly. Still, the program should provide a temporary boost to appliance makers and retailers that have struggled.

Here are a few of our Approved List stocks that could receive a short-term boost in revenue from this new program:

Wal-Mart (WMT) – retailer of appliances
General Electric (GE) – appliances
Ingersoll-Rand (IR) – Trane heating, ventilating, air-conditioning systems
United Technologies (UTX) – Carrier heating and refrigeration equipment
Johnson Controls (JCI) – heating, ventilating, air-conditioning contractors


For those looking to take advantage of some government money (errr…I mean your money) the American Recovery and Reinvestment Act of 2009 extended many consumer energy tax incentives for included a number of tax breaks, which you can see by clicking here. Businesses, utilities, and governments are also eligible for these tax credits.

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Peter J. Lazaroff, Investment Analyst

Fixed Income Recap

The Treasury’s $42 billion 2-year auction was an overall positive to the bond market on Tuesday. Demand measures were just under the recent average for 2-year notes – bid/cover was 2.68 – but the yield came in just 1 basis point higher than the market. Bonds had sold off going into the auction but managed to rally on the results and better prospects for the remainder of this week’s supply.

A heavy selloff in crude oil (-3.12%) hurt TIPS today as breakevens tightened 8 basis points for second day in a row to 174 basis points – essentially where they were before their rally last week. I mentioned late last week that TIPS looked like they got a little ahead of themselves but I was suspecting a selloff in Treasuries to be the catalyst for the TIPS correction. Instead it was much better than expected Consumer Confidence Survey results that boosted the dollar and drove dollar hedges out of oil which in turn hurt TIPS. What a domino effect huh?

The Fed is scheduled to purchase Treasuries maturing between 8/15/2026 and 8/15/2039, a sector that stretches to the very back end of the curve. The Fed has averaged $3 billion in backend purchases per operation but most in the market has come to realize that the Fed will soon need to slow down their purchases significantly. I have heard estimates as low as $1.5 to $2 billion. I’m not sure how much these operations are affecting the market these days anyway, especially when they are accompanied with new Treasury supply and meaningful economic data.

Ben Bernanke was nominated by President Obama for a second term as Chairman of the Federal Reserve Board while being praised for his “calm and wisdom” during the financial crisis. But monetary policy must come full circle before Bernanke’s story is finished. Reappointing Bernanke for the sake of continuity during this cycle removes a hurdle, albeit a small one.


Cliff J. Reynolds Jr., Investment Analyst

Daily Insight

U.S. stocks gained ground Tuesday after the day’s home price data and consumer confidence readings came in better than expected. A successful $42 billion auction of two-year notes (an activity that garners increased anxiety these days) also surely helped the equity markets. More of that to come though, $39 billion in five-year notes today, $28 billion of seven-years on Thursday and trillions more to come over the next couple of years at least – such is the heightened cost for the way we’re attacking the economic deterioration..

However, stocks retreated from late-morning session highs as traders had time to think about the level at which consumer confidence stands and the headwinds the largest segment of the economy still has to endure.

Consumer discretionary shares led the broad market higher on that bounce in the consumer confidence reading. Energy shares led the three sectors that lost ground on the session, as oil prices pulled back to the $71 handle.

Just over one billion shares traded on the Big Board, 8% below even the meager three-month average.

Market Activity for August 25, 2009
The Dollar

The U.S. dollar managed to shake off the reappointment of Chairman Bernanke by managing a mild gain. His easy money ways are no friend of old green; in fairness, the pilot of this cash-dropping helicopter doesn’t have much choice here, which is kind of why some view the latest leg of this stock market rally with skepticism, as the economy needs this easy money crutch. My main criticism is with the Fed policy of the past that played a major role in creating the debt-laden/housing bubble/mispricing of risk scenario that brought us to this state.


S&P CaseShiller Home Price Index

The most-watched home price index showed the June data improved markedly, posting a 1.4% increase – this marks the second month in which this gauge has shown home prices to rise and the June increase was the best since June 2005.

On a year-over-year basis, CaseShiller has home prices lower by 15.4%, which is also the best reading since April 2008. While this remains a harsh decline from the year-ago period, we’ll take the improvement.

The table below shows the vast improvement that has occurred within most cities (focus on current month-over-month vs. previous).


This is great news, but one needs to refrain from getting too excited about this move and surmising the housing market is on a sustained move in the direction needed. (I need to be careful when explaining these things, taking a cautious approach and warning against the tendency to view this as an “out of the woods” indication is dangerous for me at this point as many very likely see those “green shoots.” But I’m sorry; the foreclosure readings are showing the trouble is spreading from the sub-prime area of the mortgage market to the prime segment. We’re seeing prime mortgage delinquency rates move higher as the very weak job market situation will have this affect on things.)

The foreclosure reality will likely put pressure on home prices again as we move to the end of the year (and away from what is almost always the best quarter for home sales, especially so for CaseShiller as it does not seasonally adjust its monthly price data). If the market is going to take the approach that the price declines have completely run their course, there remains an outsized chance that equity values will react harshly to data that shows this not to be the case a couple of months out.

In the end, I have to see some improvement in the job market, an improvement that shows the monthly payroll declines ease from current levels that are commensurate with the peaks seen during the typical recession (that is, monthly job losses need to move below 100K – currently they remain at -250K, much better than we endured a few months prior but still deep losses). We also need to see the housing market show some ability to stand on its own – refundable tax credits and fed-induced interest rates are providing a large boost right now.

Consumer Confidence

The Conference Board’s consumer confidence survey showed a bounce back to 54.1 from 47.4 – halting a two month retrenchment after it appeared as if the reading was on a sustained rise from the record lows hit in March. The reading for August brings us nearly back to the level hit in May, a point that puts the reading closer to the pre-Lehman fallout point of 61.4.

For clarity, the overall confidence survey is an average of respondents’ appraisals of current business conditions, business conditions six months out, current employment conditions, employment conditions six month out, and total family income expectations six months out.

The key aspect of this report for me is the jobs “plentiful” minus jobs “hard to get” reading, which rose above the all-time low hit in July. The measure increased to -40.9 last month from the all-time low of -44.8. (Those stating jobs were “plentiful” rose to 4.2% of respondents vs. 3.7% in July. Those stating jobs are “hard to get” fell to 45.1% from 48.5 in July.

The present conditions index remained extremely depressed, registering a reading of 24.9, compared to 23.3 last month. However, the expectations reading (respondents’ expectations six months from now) jumped to 73.5 from 63.4. This is the highest reading since December 2007.

While the rebound in confidence is a good sign, the figures remain low from a long-term perspective. What people need to realize, in my opinion, is that consumer activity as a percentage of GDP will move back to the historic average of 65%. Presently, it remains near 70%, and hit 72% at its peak as very easy credit conditions, historically low unemployment, solid real income gains and the wealth effect (much higher stock and home prices) allowed this to occur. After the situation we have been through, credit standards have moved to a more appropriate stance, and thus one factor that will move personal consumption back to the historic average over time. Another factor is the weak job market (and I fear the jobless rate will remain stubbornly high for a prolonged period due to the current policy path); the consumer will choose to add incrementally to cash savings as a result.

Over the next couple of quarters, the inventory dynamic and government spending will propel GDP growth but the lower level of spending by the consumer will weigh on the expansion. The business side is still a question. We need business spending to rebound in a robust way to help offset consumer weakness, but we have yet to see evidence of this turn taking place.

Maybe we’ll see an early sign of a business spending upswing in this morning’s durable goods orders report, that would be very welcome. However, if durables are solely boosted by auto production, as “cash for clunkers” helped to erase inventories, this will not offer economic assistance outside of a one-two quarter pop.

Richmond Manufacturing Survey

The Richmond Federal Reserve Bank’s survey of factory activity in the region held steady at 14 for August – same reading as in July. This marks the fourth-straight month of expansion.

The shipments index jumped to 21 from 16; the new order volume slipped to 18 from 24 (still nicely in expansion mode though) and the average workweek rose to 16 from 14 – we need to see this figure rise within all of the factory indices.

The unfortunate development, which I also noticed in last week’s Philly Fed reading, was that prices paid have exceed prices received for two months now. This could put pressure on profit margins, but the huge decline in payrolls should ease this development.

Federal Housing and Finance Agency’s (FHFA) Home Price Index

The FHFA reported its home price index rose 0.5% for June after a downwardly revised 0.6% increase for May. On a year-over-year basis, this measure has prices down just 2.2%. This is a very broad measure of home prices, much broader than CaseShiller, but does miss the high end market as it does not capture purchases made with jumbo mortgages and only includes single-family homes that have mortgages backed by Fannie Mae and Freddie Mac.

Equally weight CaseShiller, FHFA and the median home price via the existing home sales data and you get home prices down 10.9% from the year-ago period – a welcome improvement from the cycle trough of 17.5% that took place in January.


Have a great day!


Brent Vondera, Senior Analyst

Four more years of Bernanke

The biggest news today was that Ben Bernanke was nominated for a second term as chairman of the Federal Reserve. Some may view this as a pat on the back from the President for a job well done, but it may also be a move to remove uncertainty from markets.

After all, it’s difficult to judge how well central bankers have performed until many years afterwards. Former chairman Alan Greenspan, for example, received high praise during the dot-com boom, but is now charged with inflating the credit and asset price bubbles that led to the current global financial crisis.

As for Bernanke, he may be remembered as the brilliant student of the Great Depression who averted another one by pulling every lever (and creating some new ones) at the Fed’s disposal. Of course, it’s possible he will be remembered as the man who tripled the size of the Fed’s balance sheet attempting to support financial institutions and, consequently, sparked inflation and destroyed the dollar.

After slashing interest rates to almost zero and pumping $1 trillion into banking system to unfreeze credit markets, Bernanke and Co. must now tackle the difficult task of soaking up liquidity without disturbing the economic recovery. Is growth part of a sustainable recovery or due to a short-term impact of stimulus? This is the question the Fed must answer.

If they believe it to be part of a sustainable recovery, then it is sensible to implement exit strategies. If not, then it might be appropriate to wait and see whether growth has taken root, which entails greater risks of inflation. The Fed has historically been slow to remove stimulus, but with maybe Bernanke can be more aggressive now that he has a bit more job security.

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Peter J. Lazaroff, Investment Analyst

Fixed Income Recap

The Fed buoyed the front end of the curve with their $6 billion purchase of 2-3 year notes yesterday. The purchase was right in line with the average for that section of the curve, but a bit higher than expectations. The Fed needs to spread the last $32 billion of the $300 billion over the next 8 weeks, so we should expect less frequent operations or smaller sizes going forward. The Fed announced at the last FOMC meeting that the program will be slowed down to end in October, a month later than originally planned, but has yet to adjust the pace of the program.

TIPS had a rough go of it yesterday, losing ground to nominal coupon Treasuries throughout the day with 10-year breakevens ending the day 8 bps tighter. TIPS ran pretty hot last week despite the selloff in nominals, so most of yesterday’s movement was just a correction. Like everything in bond land lately, TIPS are range bound. The spread between the real yield on 10-year TIPS and the 10-year Treasury’s nominal yield has bounced around the 150-200 basis point range since March, and will probably continue to move within that range as sentiment drifts.

The second batch of Treasury supply is scheduled to begin today with $42 billion in new 2-year notes. Two-years are flat as of this writing.


Cliff J. Reynolds Jr., Investment Analyst

Daily Insight

U.S. stocks ended virtually flat on Monday as the broad market erased early-session gains after SunTrust Bank warned of more financial-sector losses ahead. CEO James Wells stated the industry is a “long way from declaring any sort of victory” as lenders face more credit losses and commercial real estate may falter through 2010. The comments were enough to drain momentum that had carried over from Friday’s rally and an increase in international bourses Sunday night.

The Dow average managed a slight uptick as energy shares enjoyed a strong session on crude’s move above $74 per barrel – a 10-month high. Oil is unlikely to retreat so long as the Fed signals it will keep the easy-monetary policy pedal jammed to the floor.

Six stocks fell for every five that rose on the NYSE. Volume remains lackluster as just 1.1 billion shares traded on the Big Board, although this was pretty good activity relative to what we’ve seen lately. Unless something big begins to take place in either direction, volume will remain tepid as is the case for the final week of August as we head for the Labor Day holiday.

Market Activity for August 24, 2009
Treasury Demand

A couple of days back I noticed a Goldman Sachs’ analyst wrote in a note to clients in which he predicted that U.S. based buyers looking to add to savings will produce demand that is sufficient to gobble up the additional trillion dollars in bond issuance coming over the next 24 months.

This will be true; there will always be demand for Treasury securities, but not at these levels – and certainly not in the economic environment the stock market is currently pricing in; it would take a prolonged period of deep economic weakness for people to remain attracted to these yields.

U.S. household holdings of Treasurys (correct plural spelling) hit a record in 1995; that was when the 10-year Treasury traded at an 8% yield. At such a level, even a range of 6.0%-6.5% these days considering the interest-rate environment we’ve lived through over the past seven years (10-yr has averaged a yield of just 4.2% during this period), Treasury securities should enjoy much attraction from U.S. households. But at the current 2.5% yield on the 5-yr and 3.5% on the 10-yr...well, good luck with that one.


Bernanke to be Reappointed

News broke last night that President Obama will reappoint Bernanke to a second four-year term – the decision will be promulgated this morning. The market should like this move as it means continuity and removes uncertainty. In fact, the move is smart in terms of the market as Bernanke has become its sugar daddy.

I do find the timing of the decision a bit strange. White House Chief of Staff Rahm Emanuel alerted the press last night at 9:00 our time. In addition, the President is vacationing on Martha’s Vineyard and the press has been ordered to give him and his family their privacy. The decision to announce his choice of Fed Chairman makes this increasingly difficult. It just seems like they suddenly chose to make the decision now for whatever reason.

And speaking of the Fed…

Leaving Something Out, Conveniently

At the Federal Reserve’s annual symposium in Jackson Hole that concluded this weekend, Chairman Bernanke’s speech touched on the number of things that have taken place during and just prior to the credit crisis. He talked fairly specifically about the intensity of the financial crisis, the policy response, and the elements of a classis panic.

His account of what has occurred, and the decisions made to soften the blow, was quite good and I think he managed his speech with remarkable brevity. He also though touched on, more than once, how the Fed effectively saved the world. If not for the Fed response, according to Bernanke, the global financial system would have collapsed. I must say, there were a couple of weeks there at the height of the crisis in which it appeared it just might.

But one cannot prove a counterfactual so it seems pointless to me to bring it up, but the Chairman was campaigning for his job, and on that basis it seems pretty obvious why he would emphasize that he believes the Fed did a bang up job.

The aspect of this that rubs me the wrong way is if the Chairman is going to remind everyone how the decisions of the FOMC saved the system , one would like to see him also acknowledge that is was past FOMC policy mistakes that played a very large role in creating the situation that made the crisis possible. What I’m talking about here is the length of time in which they kept real (inflation adjusted) interest rates negative, a policy direction that encourages massive increases in debt levels.

Now Bernanke doesn’t have to waste time campaigning for his job (the current term ends in December) and can solely focus on managing the situation we are in – again, part of which is the situation both monetary and fiscal policy have and will put us in. He will have to work nothing less than magic to manage this thing appropriately.

Cash for Houses

The cash for clunkers program came to a close yesterday, but there is talk that Congress will expand another program: the refundable tax credit to all homebuyers – to this point, that refundable tax credit was available to first-time buyers only. I haven’t heard whether extending the duration of the program is part of this effort (currently expires November 30) but one would think they’d go through 2010 if this speculation is accurate.


Have a great day!


Brent Vondera, Senior Analyst

Quick Hits

• U,V, or W for recovery?
• Policy Makers Seek to Learn From 1937’s Stalled Comeback
• Investment Mistakes: The View From Behavioral Finance
• Highest Commodity P/Es Hide Bargains as Earnings Forecasts Get No Respect
• Beyond Public Plan Worries, Might Reform Boost Some Health Shares?

Fixed Income Recap

Yields jumped 10 basis points or more across the Treasury curve as better than expected existing home sales data drove investors out of the safety trade. New home buyers rushing to make the November 30 cutoff for the $8000 credit and foreclosure sales helped boost the number that posted a 7.4% increase in July, its 4th straight monthly increase.

Before Friday, yields had been steadily creeping to the lower end of the current range – helped by positive news on the supply front and increased Treasury demand from overseas. Bernanke’s comments also reaffirmed the FOMC’s decision to slow down and bring to an end the Treasury purchasing program, saying again that, “Economic activity appears to be leveling out”. The implementation of QE by the Fed was a true crisis decision, so its unwinding should be seen as a response to improvements in the credit markets, not necessarily an immediate rebound in economic growth.

Cliff J. Reynolds Jr., Investment Analyst

Daily Insight

U.S. stocks rallied on Friday as existing home sales rose for a fourth-straight month and Fed Chairman Bernanke stated “fears of financial collapse have receded substantially.” The move in equity prices pushed the broad market higher by 2.20% for the week. The S&P 500 has jumped nearly 17% over the past six weeks.

Friday’s housing data pushed existing home sales higher by 5% from the year-ago period, the first year-over-year gain since November 2005. One wonders what happens to housing again when the tax credit for first-time homebuyers expires in December and interest rates begin even a mild rise, but the market isn’t interested in such thoughts right now.

On the Bernanke comments, I can’t say it surprises me to see traders push stocks higher on his comments, but the move, if it was actually on those comments, doesn’t make much sense as the preponderant reason for most of the surge from the depths in March is because the “Armageddon” scenario has been removed – the market has already priced in this assumption.

This massive rally since the March 9 low has pushed to 54% now. Back in early March just five of the S&P 500 members traded above their 200-day moving average. In a matter of just six months, 457 of the 500 members now trade above their 200-day, according to David Singer. The entire index trades 18% above its 200-day MA, which is double its premium when stocks hit their all-time highs back in the summer of 2007.

Market Activity for August 21, 2009
Existing Home Sales

The National Association of Realtors (NAR) reported that existing home sales jumped 7.2% in July to 5.24 million units at an annual rate. When we separate single-family units from the data, sales were up 6.5% to 4.6 million units at an annual pace – this marks the fourth-straight month of increase off of the 12-year low.

The median price for an existing home fell 2% in July to $178,400 and is down 15% from a year ago -- still ugly, but up from the cycle low of 17.5% in January.

As a result of the sales pick up, the inventory of existing-home supply relative to sales fell to 8.6 months worth of supply, from 8.9 in June. The move from extreme elevation at the end of last year is very welcome, but the current level remains heightened – a number below seven months of supply is consistent with price stability, according to NAR.

This is all good news, but the stock market is pricing in too much optimism in my view. Homes sales are being driven by foreclosure-related price declines (31% of July sales were from foreclosed or distressed properties), tax credits for first-time buyers and mortgage rates that are being artificially held low by the Fed’s mortgage-backed purchases.

Certainly, there is nothing wrong with the sales from the foreclosure-driven price declines; this is the market at work. But the tax credits will expire in three months and the Fed cannot keep buying mortgage securities (pushing the prices higher and the yields lower) for long, at some point this quantitative easing must be reversed. It will be a while (maybe the end of 2010) before this reversal occurs, but I don’t think the labor market will have healed by then and just as their current action has pushed rates lower, the bounce back will be more pronounced as result of these decisions.

The question remains, what happens to home sales at that point? The market will be completely dependent upon labor-market conditions when these programs run out. I think this is something the market needs to begin thinking about.

Mortgage-Security Problems Persist

We put up a chart of mortgage delinquencies on Friday. That picture illustrated that 9.24% of the mortgage market is at least 30-days delinquent, up from 6.24% a year ago and the 30-year average of 4.97%. When you add in loans that are currently in the foreclosure process that number rises to 13.16%, the highest level ever recorded by the Mortgage Bankers Association – this gauge does not go back to the Great Depression, a period in which these figures were much worse.

I found the chart below also interesting. It shows the potential for pent up foreclosures, a situation at least partially due to states placing moratoriums on the foreclosure process. The rest is due to the damage seen within the labor market, exacerbated by too many homebuyers purchasing more home than they could truly afford.

I bring this to your attention after the WSJ ran a story on Friday explaining that banks (and they were talking about smaller banks) have a lot of bad securities in their trading accounts – mortgage-security pools (some with 40% delinquency rates). These positions will have to be written down and will consume some institutions’ entire capital positions.

This is worrisome, but there is one clear way to remedy the situation. We need default rates to substantially slow and real estate prices to rise -- a mild increase is all that is needed. For this we need a burgeoning economy, which will not occur under the current policy path. Instead, we must slash tax rates on labor income, dividends, corporate profits and capital returns; passing all free trade pacts that are currently being blocked by Congress would also be a huge plus. In addition, the implementation of current-year write-down allowance must be made, this will kick-start business spending (which is needed to fill the void from lower consumer activity).

Problem is, these types of policies don’t have a snowball’s chance in hell of occurring right now and this is precisely why caution is required.

Week’s Data

We’ll be quiet today but it will be a big week for economic data releases.

Tomorrow we get two major home prices indices, consumer confidence and another regional manufacturing survey. On Wednesday, we’ll receive durable goods orders for July and new home sales. Thursday will bring the first revision to Q2 GDP and initial jobless claims. We’ll round it out on Friday with the personal income and spending figures.


Have a great day!


Brent Vondera, Senior Analyst