Fixed Income Weekly

Treasury Market Happenings

This past week was a memorable one for the Treasury market that saw yet another record amount of paper coming to the street in addition to the long awaited end of the Fed’s $300 billion Treasury purchases program.

The supply started on Monday with a $7 billion reopening of the current 5 year TIPS benchmark, that was pretty uneventful. Despite a slew of deflationary factors in the market, inflation protection is in pretty serious demand. The bid/cover ratio was over 3 for the first time since the first 5-year TIPS auction in 1997.

Demand for new paper this week peaked on Tuesday as a record $44 billion in new two-year notes were auctioned with a bid/cover of 3.63 versus a 6 month average of 3.07. This is unbelievable to me. In one day the U.S. Treasury sold debt equal to the size of the GDP of The Dominican Republic, and there was still a line of unfilled buyers out the door. A shift in the source of demand really stood out as domestic investors dominated the auction for the short duration bonds. U.S direct buyers took 26.1% of the auction versus an average of 5.7%. Indirect bidding (or foreign demand) typically takes the largest slice of short term auctions, given the bias foreign central banks have toward the shorter end.

The $41 billion 5-year auction on Wednesday saw demand come back down to more normal levels, and although demand continued to wane on Thursday with the $31 billion seven-year auction, the week was an overall win for the Treasury considering the $123 billion total weekly supply.

The Treasury securities portion of the Fed’s QE also ended on Thursday. As you all are well aware of short term rates are extremely low, and Tuesday’s especially strong two-year auction is good evidence of how far we are from a significant shift in policy that will eventually move the short end, but as we lose a major buyer of intermediate term bonds the longer portion of the curve remains a concern for the market. The housing market is depending heavily on low intermediate term rates, and as the homebuyer credit is slowly phased out, which seems to be likely, low mortgage rates will be the only crutch for credit demand to stand on. The big question now is, “Was the Fed that crutch?”

Housing Market

This week I stumbled upon the graph below from the San Francisco Fed showing the rise and fall of non-agency mortgage backed securitization over the past decade. The graph below shows the distribution of market share of new mortgage origination since 2000.

Source: San Francisco Fed
http://www.frbsf.org/publications/economics/letter/2009/el2009-33.html

Some excerpts from the report:

· According to Federal Reserve flow of funds data, the banking institution share of total mortgage assets declined from a peak of about 75% in the mid-1970s to about 35% in 2008. Much of the decline in banking institution housing portfolios over this period was related to the expansion of the government-sponsored enterprises (GSEs) Fannie Mae, Freddie Mac, and Ginnie Mae.
· At its peak in late 2007, non-agency securitizations accounted for nearly 20% of outstanding mortgage credit.
· Non-agency securitizations were much more likely to involve adjustable-rate mortgages, including option ARMs, to be rated as subprime, and to have less-than-full documentation of borrower income and assets.
· In the fourth quarter of 2006, approximately 10% of originations in our sample were labeled by originators as "subprime." For the entire universe of mortgages, subprime loans are estimated to have made up about 20% of originations in 2006. By the first quarter of 2008, the subprime share was effectively zero. Since then, increased FHA lending—identified here by Ginnie Mae's share—has revived this segment of the market.

The graph is pretty incredible. The rapid growth and even more rapid contraction of the non-agency sector are directly correlated to the rise and fall of real estate prices. The ease with which non-prime borrowers could secure non-traditional forms of financing, proved to be beneficial to all parties involved… as long as property values continued to appreciate. When that segment fell apart during the initial stages of the credit crisis massive amounts deleveraging ensued, affecting more than just housing.

Even though non-agency securitization is still a non-player in mortgage lending, the government has stepped in to pick up the slack. As evidenced by the huge surge in GNMA market share since mid 2007. It tough to be bullish on the prospects for housing outside of the government tax credit programs and government subsidized lending. The sustainability of a recovery in the housing market is dependent on sources of demand that are also sustainable. Reinflating prices, or simply putting a quick floor under prices, provides little to be positive about further out.

Cliff J. Reynolds Jr., Investment Analyst

Lockheed Martin (LMT) is cheap

Shares of Lockheed Martin have been pressured all year by the shake-up in the U.S. defense budget. The firm’s stock has recently traded even lower on weaker-than-expected 2010 guidance, which has caused analysts to take a conservative view on long-term revenue growth and margins.

These concerns have pushed Lockheed’s valuation near historical lows, but the firm’s long-term potential remains intact. Much of Lockheed’s revenue is tied to the baseline defense budget, which is not the focus of U.S. defense spending cuts. The firm’s other main source of revenue is the next-generation F-35 Joint Strike Fighter plane, which serves as a very unique growth driver that other defense contractors envy.

Pension costs are another concern among investors, with significant headwinds likely in 2010 and 2011. However, the majority of pensions costs are covered by the government – pension expense is much less important for defense contractors than in companies with primarily commercial business.

Lockheed’s profitability is top-class. The company’s return on equity is over 50%, which means they generate more than 50 cents worth of profits from each dollar invested by shareholders. For comparison sake, the S&P 500’s trailing 12-month ROE is 3.62%.

The company also generates an impressive $8.74 of free cash flow per share of common equity. Free cash flow allows a company to reinvest in its own business for growth and, in turn, boost shareholder returns. Lockheed also does a great job of returning free cash flow to shareholders through stock buybacks and growing dividend payments.

Trading just above 9 times forward earnings, Lockheed remains very attractive assuming the baseline defense budget remains at least flat and that the outlook for F-35 funding and execution is sound. The baseline budget should remain strong given aging equipment and the need to address new threats. The higher risk lies in F-35 execution (just look at how Boeing’s stock has responded to delays with their new 787 Dreamliner).

Defense valuations are unusually low across the board, even when compared to prior periods of declining defense spending. Despite continual earnings growth and high levels of free cash flow, multiple compression implies a worsening long-term outlook for defense contractors. But defense companies are like insurance: no one knows when the next war or crisis will break out, but when it does, margins and sales rocket.
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Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks recouped Wednesday’s losses and them some as the first look at third-quarter GDP topped the consensus estimate and continuing jobless claims fell substantially. The growth number was very much boosted by government stimulus, two aspects of which have now expired, and it is highly likely the drop in continuing unemployment claims was due to exhaustion of benefits rather than job creation, but hey this is the first positive GDP reading we’ve seen in over a year so the market rejoiced.

The broad market was driven by the sectors that led it lower the day before – financials, basic materials, consumer discretionary and energy. Consumer discretionary and energy shares got clocked Wednesday on concerns that consumer activity will wane again, but the GDP report showed spending was strong thanks to clunker cash, so all is suddenly well. Sorry for the sarcasm, but the especially mercurial nature of the market these days is a bit strange you must admit.

Advancers trounced decliners by an 8-to-1 margin and volume was fairly strong as 1.4 billion shares traded on the NYSE Composite – roughly 8% more than the six-month average.

The dollar was abused.

Market Activity for October 29, 2009
Third Quarter GDP

The Commerce Department reported that GDP posted its first positive reading in over a year and thus the “great recession” has ended! That alone is reason to celebrate, and the actual reading offered an even greater celebratory mood as it came in above expectations. However, the party may prove fleeting, which I’ll get to below.

Third-quarter GDP beat expectations of 3.2% growth to post the strongest reading since Q3 2007 of 3.5% at a real annual rate. This ends the longest and most severe recession in the post-WWII era.

The biggest contributor to GDP was the largest component of the figure – personal consumption. PC roared at a 3.4% annual rate, contributing 2.36 percentage points of the 3.5% GDP increase. Without doubt, this figure was fueled by car and home sales as clunker cash, the homebuyers’ tax credit and fed induced rock-bottom interest rates encouraged buying even as households struggle to repair balance sheets.

The next largest contributor was gross private investment, accounting for 1.22 percentage points of the 3.5% GDP gain. The 11.5% jump in private investment was largely driven by a huge 23.4% rise in home building (residential fixed investment, if you want the technical term). This marked the first contribution from housing in 16 quarters. The business side of things was lacking as non residential structures fell 9% (which followed crater-like declines of 17.3% and 43.6% in the prior two quarters, respectively). Equipment and software investment rose just 1.1% (following declines of 4.9% and 36.4% in the previous two quarters, respectively). It would be nice to see this figure driven by business investment, but we knew this wasn’t the case by the data that’s been released.

Inventories contributed to GDP after the record slashing in stockpiles that took place in the previous quarter. The change in inventories added 0.94 percentage point to GDP (this is part of the overall gross private investment figure). However, I’ll note that inventories did not rise – the rebuilding process has yet to take place. They simply declined at a slower pace than the previous quarter (which wasn’t hard to do) and that’s all it takes for this component to contribute*. (If not for the unprecedented, since these records began in 1947, pace of slashing in the previous quarter the decline in inventories in Q3 would be the all-time record).

And then we have the government, which contributed 0.48 percentage points to Q3 GDP as federal spending offset a decline in state and local government spending.

Surprisingly, net exports failed to contribute, subtracting 0.53 percentage points. Thus, the Fed’s crushing of the dollar via their massive easing campaign provided zero benefit.

To summarize, economic growth expanded at a strong pace due to short-term government stimulus that boosted purchases of cars and homes. The car sales, specifically in one month (August), certainly helped fire up the quarter’s consumption reading and also assisted in the inventory figure adding to GDP. The tax credit fueled home sales, which allowed for some homebuilding. However, the hangover effect that will result will be tough to deal with, we have only delayed the repair to household balance sheets that needs to occur as debt levels remain high and the very weak labor market makes this situation especially difficult.

I remain quite concerned that Congress will become desperate as the 2010 elections draw nearer and the jobless rate remains very elevated and growth subdued. One should always be aware of the collective ignorance of Washington and their unshakable ability to cause things to deteriorate as they lurch for more short-term growth. To put this in more erudite terms, it’s what Hayek termed the “pretense of knowledge.” Every time Washington intervenes by attempting to drive the economy in the direction they see fit, stepping in front of the market’s natural job of price discovery and resource allocation (albeit messy and choppy at times), it fails.

The next GDP report should get another bounce from inventories – although the jury is still out as to whether stockpiles will actually rise and the degree to which this component boosts GDP – but after this large pick up in personal consumption, even in the face of huge headwinds, it means that the fourth quarter will likely receive little if any help from the largest component of GDP.

Initial Jobless Claims

The Labor Department reported that initial jobless claims fell 1,000 to 530,000 in the week ended October 24 – economists had expected claims to fall to 525K. The four-week average, which smoothes this volatile data out, fell 6,000 to 526,250.

Continuing claims fell a large 148,000 to 5.797 million and the extended and emergency compensation claims both fell as well. However, with the duration of unemployment at record levels one has to assume that this decline in continuing claims is completely due to benefits expiring.

Have no fear though Washington is riding to the rescue – there’s a bill moving through Congress, the same one that has the homebuyers’ tax credit extension attached to it, that will extend jobless benefits for another 20 weeks. Hooray!


Have a great weekend!


Brent Vondera, Senior Analyst

Afternoon Review: GDP and Lockheed Martin (LMT)

A bigger-than-expected GDP reading lifted markets today, but two items provide what could be a temporary boost.

First, personal consumption expenditures jumped 3.4% thanks to a pop in car sales, which were aided by the temporary cash-for-clunkers program. Cash-for-clunkers brought buyers to the market that normally would have waited to make a car purchase in the future, thus the program borrowed from future demand. As a result, we can’t expect to see car sales – which accounted for a full percentage point of the overall increasing GDP for the quarter – to provide this type of boost again anytime soon.

Second, homebuilding soared 23.5%, adding a half percentage point to GDP growth. This too may be a temporary as the federal homebuyer’s tax credit stirred demand. It appears the tax credit will be extended, but it can’t last forever.

The last few days I have talked about consumer headwinds and potential consequences for the economy. The first story in today’s quick hit explains that inventories will take over for the consumer in the coming quarters. Let’s hope that happens.


On a totally different note…I can’t help but notice how cheap Lockheed Martin (LMT) shares are looking.

LMT’s guidance showed us that 2010 will be weaker-than-expected, which is causing analysts to rein in long-term revenue growth and margins estimates. But LMT’s program positions, which are tied to the baseline defense budget (which doesn’t include wars in Iraq and Afghanistan) and the F-35 Joint Strike Fighter (the next-gen fighter plane), keep their long-term potential intact.

LMT trades at a whopping 47% discount to the S&P 500. Yet the firm generates $8.74 of free cash flow per share of common equity, has a return on equity over 50%, and pays a 3.6% dividend that grows more than 20% annually.

Defense valuations are unusually low across the board, even when compared to prior periods of declining defense spending. But, defense companies are like insurance: no one knows when the next war or crisis will break, but when it does, margins and sales rocket. Now is your chance to buy them cheap.

More to come on LMT tomorrow…


Quick Hits

• Inventories May Take Over From U.S. Consumers as Engine of Economic Growth
• Fed Ending Treasury Purchases That Held Down Yields, Stabilized Housing
• Weak Dollar Is ‘Welcome Change’ for Profits
  

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Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks extended their losing streak to four sessions and Wednesday’s losses accelerated to the close, but looking on the bright side the downside was nothing when considering yesterday was the 80th Anni of the two days that kicked off the 1929 crash.

Certainly, the 5% pullback since the near-term high hit on October 19 (also a meaningful date – the day of the 1987 crash) is hardly consequential considering the significant 60% rally from the March lows. Undoubtedly we’ll get an actual correction, even with the Fed’s unprecedented monetary stimulus that has encouraged money to flow into everything from stocks, to bonds (gov’t and corporate), to gold, oil and copper – it’s unlikely we have ever seen such correlation before. But this move to the downside cannot be defined as a correction yet – a decline of 10% or more is needed to use this term to define the trend.

The broad market began the session slightly lower but the slide was on once the new home sales data printed a number that was not even close to expectations, which added to concerns that stock prices have gotten ahead of the realities on the ground.

The Dow Transportation Average continues to get slammed and this time, unlike the slight pullback in June-early/July, the trannies have declined at twice the pace of the overall market. Transports are a very good indication with regard to the degree of the cycle and their earnings reports show things have bounced from the doldrums but the underlying businesses remain weak, which is why the prices are taking a hit. The group may be portending more weakness to come over the very near term for the broad market.

Financials was the worst-performing sector on the day, not far behind were basic material, energy and consumer discretionary shares. Telecoms were the only sector to buck the day’s trend after Qwest reported good results at its business-markets unit.


The bad news buck has rallied for five days now. As we keep saying, and I don’t enjoy typing such things, the safety trade and overall concerns regarding the pace of expansion is all the U.S. dollar has going for it at this time.

Market Activity for October 28, 2009
Earnings Season

Third-quarter earnings season results are quietly eroding as reports from the sectors that have been hardest hit by this economic maelstrom roll in (I’m referring to industrials, energy and basic material sectors). Overall earnings results, which appeared to be holding in at single-digit declines, have moved to the negative teens (down 17% thus far regarding ex-financial results).

Based on the percentage of hardest hit sectors that still have to report Q3 results will end up roughly 16% lower (down 22%-23% on the ex-financial reading). We’ve concentrated on the ex-financial sector reading for two years now as bank earnings were crushed by the bursting of the housing market bubble. Now the sector is being temporarily propped up by the Fed’s ZIRP (zero interest-rate policy) as it helps to mask credit-quality woes. So, the ex-financial reading remains the figure to concentrate on.

Indeed, 80% of S&P 500 members that have reported thus far have beat expectations, but those were low-ball estimates. S&P 500 profits have declined for nine-straight quarters now, a post-WWII record. At this stage of the game, profits should be down in the low single-digits at worst, especially since firms have aggressively shed costs as payrolls have been slashed. The fact that earnings declines remain much worse is quite telling.

Mortgage Applications

The Mortgage Bankers Association’s index of applications fell for a third straight week, with large declines over the past two weeks. Apps fell 12.3% in the week ended October 23, following a 13.7% decline in the prior week.

The index was led lower by a 16.2% plunge in refinancing activity (which was down 16.8% in the previous week) as the 30-year fixed rate mortgage remained above 5.00%. And maybe it’s more than that, possibly the vast majority of homeowners who can refi already have. Purchases fell 5.2%, after a 7.6% drop in the previous week and a 5.0% decline in the week ended October 9.


Durable Goods Orders

The Commerce Department reported that durable goods orders rose 1.0% in September (in line with expectations), following a rather large 2.6% decline in August. Excluding transportation (which is an especially volatile aspect of the report), orders rose 0.9% -- also right in line with expectations.

Transportation orders rose 1.1% as defense orders jumped 12.5% in September. Vehicles and parts fell 0.1% and commercial aircraft orders were down 2%.

Ex-trans orders were boosted by a nice 7.9% bounce in machinery orders (following a 0.8% rise in August and a 7.7% decline in July), but was weighed down by a 0.2% decline in computer, electronic orders and a 0.9% drop in electrical equipment orders.

The shipments of durable goods, not the orders, is what flows into the GDP report and that figure rose 0.8% in September and 6.6% at an annual rate for the third quarter. So, durable goods will contribute to the GDP report for Q3, which we’ll get today. The business spending side won’t though, as this figure fell 8.3% at an annual rate during Q3. It should, however, help out in the fourth quarter as orders for this segment rose, so the shipments should show up in the Q4 GDP reading.

The report also showed that manufacturers continue to cut inventories – the durable goods inventory-to-shipments ratio fell to 1.77 from 1.80 months worth. The pace of inventory liquidation was significantly slighter than that of the previous quarter (almost impossible not to be as the inventory slashing that occurred in the second quarter set a record – this data goes back to 1947) and that’s all it takes for inventories to make a statistical contribution to GDP.

New Home Sales

New home sales unexpectedly declined for the first time in five months in September, a sign that the housing recovery will loss momentum as the tax credit currently in place has essentially expired. (The expiration is officially November 30 right now, but the contract needs to close by that date and originations in back-half of September would have had little chance of meeting that date – so potential buyers didn’t chance it.) This decline ended a four-month streak of increasing home sales.

Sales fell to 402,000 at an annual rate, or 3.6%, after printing 417,000 in August. The market had expected new home sales to jump to 440,000 for September, so quite a large miss.

The figure was led lower by a 10% drop in the South and a 10.6% decline in the West. These are the two main regions for new homes, making up 70% of the market. Surely, the expiration of California’s new home tax credit in August resulted in the pullback in the West region. New home sales jumped 34% in the Midwest (this region makes up 17% of the market) and were flat in the Northeast (makes up just 10% of the new home market).

The median price of a new home rose 2.5% for the month (which didn’t prove very helpful for sales) but is down 9.1% from the year-ago period, coming in at $204,800 vs. $225,200 in September 2008.

The supply of new homes, relative to the pace of sales, was unchanged at 7.5 months worth of supply.

In short, the first-time homebuyers federal tax credit and the California new home tax credit certainly front-loaded sales and I believe it is reasonable to believe that there will be a degree of hangover that must be dealt with over the next few months as a result. This sums up basically every policy actions Washington has taken to combat the housing and economic recessions – there will be blowbacks to deal with as the agenda is extremely short-term in nature.

Today’s Data

This morning we get the first look at Q3 GDP along with initial jobless claims.

GDP is going to show that the longest and most severe recession in the post-WWII era has ended, so we can be thankful for that. The number is expected to show economic growth came in at a 3.2% real annual rate. I think it is likely we’ll get a number even better than this, a range of 3.5%-4.0% is definitely possibly as the one-time/one-quarter events of “cash for clunkers” and the homebuyers’ tax credit (which led sales higher and fomented an increase in home building) propelled GDP. The latest out of Washington on the home tax credit front is the $8,000 credit will be extended to April 30 and even people who have lived in a home for five years will be offered a $6500 tax credit if they choose to move. This is just more front-loading though and makes the hangover that much worse. For the fourth quarter GDP, we better start to see a big pick up in inventory rebuilding or the next economic figure will disappoint – of course you need final demand to make a comeback before firms aggressively rebuild stockpiles and demand will prove lacking due to the aggressive nature of job cuts and overall languid labor market.

The jobless claims figures will need to show a trend down to 500K, currently stuck in the 525K-550K range. If these two figures beat expectations the market should find reason to rally, especially after the recent pullback. However, if both fail to meet or beat the recent return to the safety trade will continue.


Have a great day!


Brent Vondera, Senior Analyst

Odds stacked against the consumer

Yesterday I briefly mentioned the relief consumers got last year from falling energy prices and how that “stimulus” at the pump is fading as gasoline nudges up against $3 a gallon. Today, I am noticing that breakfast in America is getting pricier as well with tea, cocoa, sugar, and coffee prices all hitting multi-year highs. In addition, bad weather in the U.S. Midwest may put some upward pressure on corn and soybean prices. All of these rising costs leave less cash for discretionary spending.

This trend couldn’t occur at a worst time with holiday shopping season just around the corner. Many businesses rely on holiday sales to hit their quarterly and/or annual targets, so the prospects of dismal holiday spending is concerning. It is possible consumers will unleash some pent-up demand after spending two years forgoing purchases to bolster savings, but recent surveys aren’t giving much hope.

The NPD Group shows in its survey that 30% of adults are going to be cutting holiday spending this year from last year’s very low levels. Meanwhile, Deloitte Consulting concluded from their broad survey that “U.S. shoppers will buy fewer gifts and spend more on items such as clothes, entertaining and home furnishings during the holiday season.” Surveys like these make it impossible to get excited about the strength of consumer spending.

Earlier in the week the Conference Board’s measure of consumer confidence came in at 47.7, which is not only abysmal but also doesn’t match up well to past recoveries. According to Gluskin-Sheff:

• The average level of consumer confidence at the end of a recession is 71.5 (data back to 1967, cover 7 cycles).
• The average level during recession is 72.0 and even excluding the latest downturn, the average was 65.9.
• The average level during an expansion is at 102.0.
• The average consumer confidence is 90.5 during periods when the S&P 500 has gained 60% or more.
  

All of the above makes it difficult to believe that the nascent recovery is sustainable if consumer spending, which makes up 70% of GDP, remains low.

On the other hand, evaluating a recovery’s sustainability with consumer spending is tricky because consumer spending doesn’t always snapback quickly. Consider these facts (complements of J.P. Morgan):

• Over 60% of the time, consumer spending in the first quarter of an expansion is less than 5% growth; and 30% of the time, consumer spending is down 1% to flat.
• 75% of recoveries see consumer spending growth lower than overall GDP growth during the first nine months of the expansion (typically investment spending leads).
• In 25% of recoveries, consumer spending averages 2.3% growth in the first nine months, yet GDP during that time grows 3.1%.
  

I would argue that the consumer is in a worse position today than in past cycles, but at least these statistics provide a glimmer of hope.

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Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks declined for a third-straight session but held in there quite well considering an abysmal consumer confidence reading and an awesome two-year Treasury auction. Demand was too awesome in fact as it illustrated the bond market has zero belief in the strong recovery musings. (I’ve talked about the concern of demand drying up. What occurred yesterday was exactly the opposite as investors made like the entrance at Wal-Mart the day after Thanksgiving and virtually trampled each other to get in on two-years at roughly a 1% yield; the safety trade looks set to roll again.)

IBM’s announcement that they’ll increase their stock buyback program helped buoy the market as the latest regional factory survey and consumer confidence readings for October missed expectations by wide margins. A little bounce in oil prices helped most energy shares. Overall, telecom, energy and health-care shares helped to offset weakness in consumer discretionary, industrial and tech shares.

The transportation index has led stocks lower over this three-day decline and got hit hard yesterday, down almost 2%. While the broad market is down just 3% from its recent peak, the Dow Jones Transportation Index is off by 8.4% -- the reports we’ve seen from the rails and on-road shippers show their underlying businesses remain weak; this is not a good economic vibe.

The Dow Industrial Average managed a slight gain as shares of Exxon and Chevron kept the index of 30 stocks above water.

As mentioned, the $44 billion two-year note auction, yes that is correct $44 billion, saw an inundation of demand (bid-to-cover at 3.63, highest in more than two years). Indirect bidders (which includes foreign governments) totaled 44.5%, in line with the past several auctions. The yield was three basis points below where when issued was traded (auction came in at a yield of 1.02%). Needless to say, the bond market appears to think the V-shaped recovery delusion is on a collision course with the inconvenience of reality.

Decliners beat advancers by more than a two-to-one margin on the NYSE Composite -- volume was decent, at least for these days, as 1.34 billion shares traded on the Big Board, which is in line with the six-month average.

Market Activity for October 27, 2009
S&P CaseShiller Home Price Index

The CaseShiller HPI, not the most geographically diverse but certainly the most watched housing market survey, showed home prices in the 20 U.S. metro areas it tracks rose 1.18% in August. This follows a 1.64% increase for July and marks the fourth-straight month of increase – a streak that ended a 33-month stretch of decline. This headline reading on CaseShiller is not seasonally adjusted. When you adjust for seasonal factors the index is up for three months in a row. Home prices are down 11.32% from the year-ago period, according to CaseShiller -- a bit better than the -11.90% expected.

Price increases in L.A., San Francisco and New York accounted for 50% of the month’s gain in the overall index – these three cities account for 42% of the total index. California is benefiting (if you can call it that) from the foreclosure wave as an outsized decline in prices has encouraged buying. The state also offers a tax credit for buyers of new homes, which has combined with the federal government’s first-time homebuyers’ credit. That California credit ended in August.

Seventeen of the 20 cities tracked posted price advances during August, which is slightly down from the 18 for July. Las Vegas, Charlotte and Cleveland were the three posting declines (Seattle and Vegas were the two losers in the previous month). Twelve of the 20 posted declines of at least 10% from a year ago. The best individual city year-over-year changes are Dallas (down just 1.22%), Denver (down just 1.94%) and Cleveland (down just 2.82%).

On an annualized basis, CaseShiller has home prices up 18.38% over the past three months, an improvement from the 15.31% increase for July.

The index has home prices down 29.30% from the cycle peak, which was hit in July 2006. For perspective, the existing home sales data that comes from the National Association of Realtors (NAR) has home prices down 24% from the cycle peak. The average U.S. home price resides at the level seen in the fall of 2003.

The front-loading effect of the tax credit (or credits – plural -- with respect to California) should begin to show up over the next several months. Even though the federal tax credit is likely to be extended it is unlikely to have the same positive effect on home sales as the home buying season has ended. We should be prepared for choppy performance within the housing market simply due to very weak labor-market conditions – Fed-induced rock-bottom interest rates will not be able to completely offset the drag from a 10% jobless rates environment.

On that housing market tax credit, and I should just stop talking about it until Congress finalizes the thing but it was a driver of Monday’s trading activity and thus worth a mention, so since I’ve started here’s the latest: The Senate has moved closer to replacing the existing credit with a slightly smaller one that includes more homebuyers. The Senate’s plan would reduce the credit to $7,290 (there’s a Washington number for you) to be available for home purchases under contract by April 30. We’ll keep you up to speed on the changing nature of this thing.

Consumer Confidence

Just as should have been expected, particularly since the more preliminary UofM look at sentiment suggested, the Conference Board’s gauge of consumer confidence fell in October. The reading got smashed, down to 47.7 from 53.4 in September – the September reading was revised slightly higher from the initial estimate of 53.1. Economists expected this measure of confidence to tick up to 53.5.

The reality that we can’t get consumer confidence to move up to even the lowly level of 60 is quite telling and it seems to me the equity markets are going to have to begin factoring this in. Consumer activity makes up 70% of GDP and with the jobless rate at 9.8% (and will surely test the post-WWII record of 10.8%), stagnant income growth, and a need to pay down debt levels no one should expect the consumer to lead the expansion. What’s likely is that lower levels of consumer activity for a year or more will put pressure on final demand and firms know this. Beyond the way that government policy is scaring business, they have this in the back of their minds too.

(This is why accelerated business equipment expensing and a slashing of corporate tax rates are needed. We may have a populist wave rolling right now, a view that despises the business community, but without business confidence it’s kind of difficult to get job growth moving. Policy makers need to understand that business spending is a major job creator. As firms place orders for plant and equipment, it increases capacity utilization rates in order to produce these goods and that eventually leads to more hiring. Place more burdens on business and they will shrug; the unemployment rate will remain high as a result.)

The overall consumer confidence reading is a collection of respondents ‘ appraisals of current and expected (six months out) business conditions, current and expected employment conditions and expectations regarding household incomes six months out. Here are how a couple of these segments came in.

The present situation index made a new cycle low, posting 20.7 for October after 23.0 in September. For reference, during the market low in March this figure bottomed out at 21.9. The all-time low is 15.8, hit in December 1982.

The expectations reading (view of economic prospects six month out) fell to 65.7 from 73.7 in September. At least the reading seems to have left the cycle low (also the all-time low) in the dust.

The most important segment of this report is the jobs “plentiful” less jobs “hard to get” reading. This is the confidence index’s best indication of future consumer activity trends. The measure made a new cycle low of -46.2. The all-time low is -58.7, hit in December 1982.

The share of consumer stating jobs are “plentiful” fell to 3.4% from 3.6% in the previous month and those stating jobs are “hard to get” increased to 49.6% from 47.0%. Policy makers that believe their efforts will stoke consumer activity, and confidence within the business community, are living a fantasy.


Richmond Fed

The Richmond Federal Reserve Bank’s gauge of factory activity in the region slipped to 7 in October from 14 in the previous month – so the reading remains in expansion mode, but the rate of growth slowed. Another reading of 14 was expected.

The new orders index fell to 7 from 13; the order backlog reading declined to -11 from -5; the average workweek got crushed, falling to -1 from 15 in September. The labor market desperately needs the average workweek numbers to trend higher because until current workers are pushed to the limit, firms obviously are not going to add new ones.

Unfortunately, this reading doesn’t provide an actual gauge of inventories, which is about the most important things to watch right now – the next couple of GDP reports will need a rebuilding in stockpiles in order for the figures to meet expectations.


Have a great day!


Brent Vondera, Senior Analyst

How strong is the recovery?

S&P 500: -3.54 (-0.33%)

Today’s daily returns for the Dow Jones Industrial Index and S&P 500 were on opposite sides of nil. The Dow was able to post a small gain today thanks to large contributions from IBM and oil giants Chevron and Exxon Mobil. Most stocks, however, fell for a third day as stronger-than-expected demand in a Treasury auction and a disappointing consumer confidence reading led investors to question the strength of the economic recovery.

Despite the fact that less than half of the stimulus package money has been spent, it appears that the impact may have already peaked. Meanwhile, monetary stimulus will be retracted as the Fed stops purchasing mortgages and Treasuries.

And consumers aren’t going to bail out the economy anytime soon. Growing mortgage losses at banks are resulting in stricter credit standards, which make obtaining credit more difficult for consumers. Access to credit serves as an important stimulant for a recovery in consumer spending. In addition, the boost consumers received from collapsing energy prices last year has now largely faded.

These are all concerns I have discussed before, but I mention them again today as I see that the extension of the first-time homebuyer credit is moving closer to reality. It’s becoming clear that Congress will find a way to pump more cash into the economy before mid-term elections at any cost. Fiscal stimulus was sufficient in aiding the economy’s exit from the recession, but not much more.

It wasn’t long ago that the media was obsessed with predicting the shape of the recovery using letters of the alphabet such as V, U (or L), and W. Maybe the conversation should have included mathematical operators like the square root sign – flat-lining at a low base.



Quick Hits

• Political Uncertainty Puts Freeze on Small Businesses
• The Challenge in Counting Stimulus Returns
  
  

Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks declined yesterday after suddenly reversing course about halfway through Monday’s morning session on news that the homebuyers’ tax credit will not be fully extended and Bank of America may have to issue shares before paying back the government.

The tax credit thing appeared to be what caused the market’s sudden reversal. Stocks rallied 1.2% right out of the gate, but erased those gains and them some after a Washington research group noted the Reid/Baucus amendment will include a phase out of the credit – it was previously understood that the idea would fully extend the credit through 2010.

It’s not official, but talk is that the phase out will extend the $8,000 credit to March 31 and then be reduced by $2,000 each successive quarter until expiring at year-end 2010.

(The amendment also involves yet another extension to unemployment benefits and the loss “carryback” for business, which allows certain firms that record losses in 2008 and 2009 to get refunds for taxes paid in the previous five years. I love this stuff, as if businesses are going to run out and spend this refund even though they remain cautious. Firms are very concerned about higher tax rates and what that does for economic growth and thus demand for their products. It is the policy direction that Washington is signaling that’s keeping firms hesitant to spend even on inventories. I’m not hopeful this loss “carryback” plan will have a positive effect in the economy.)

On top of that, the news that the government wants Bank of America to increase its capital ratio before it repays TARP money also weighed on the market. Reports that regulators want the bank to raise $45 billion via a new capital offering (which would substantially dilute current shareholders) before repaying the government renewed concerns other big banks may have to do; this put pressure on the entire sector. A downgrade of Fifth-Third, SunTrust and U.S. Bancorp by Dick Bove also pressured shares. If that’s not enough we’ve got financial regulations entering center stage and the chairman of the House Financial Services Committee is expected to unveil his “to big to fail” proposal today.

We’ve talked about issues for the banking industry for some time. It’s not just that credit-quality is a mess, but the government can come along and make a decision at anytime that puts more screws to the sector. At least in terms of credit quality, it seems that more people are beginning to consider that maybe the financial sector is not exactly in up and away mode. You think about the commercial defaults coming down the pike and it only adds on to what we’re seeing in residential and consumer credit losses.

It seems quite remarkable that the equity market continues to hold up so well considering these headwinds. But then, the market is juiced on the easy-money trade. It’s not just that traditional banks can borrow from the Fed at basically zero and buy stocks. Don’t forget that firms like Goldman Sachs were made commercial banks at the height of the crisis in the name of “too big to fail.” I guess it shouldn’t be all that surprising stocks continue to push aside troubles as the cost of money is zilch.

This zero-interest rate policy also provides vast amounts of liquidity and it causes people to become irrational as it takes the fixed income side of things out of the game – you have people saying they hate bond yields and decide to take more risk than they otherwise would within the stock market as a result.

Market Activity for October 26, 2009
Bond Market

This week we’ll get $123 billion in government bond issuance (adding to the $1.1 trillion in net sales this year), so the relatively heightened anxiety with regard to auctions will certainly continue. (The anxiety is just relative at this point, normally there is zero anxiety over Treasury bond auctions, but I’m expecting it will continue to increase over the next 12-18 months.)

There has been a lot of talk about how the Fed will begin to remove liquidity. This is the Fed’s way of getting expectations moving regarding this liquidity drain, certainly they must engage in this first step before actually doing so. But as the central bank completes their purchases of Treasury securities (assuming they don’t shift and actually end up increase purchases in the near future due to a deteriorating economic environment, which is a pretty big caveat right now) this will put added pressure on auctions and may be the trigger that increases anxiety – an anxiety level that would flow into stocks.

For now, demand for U.S. government debt remains strong. If the erosion in credit-quality continues, and banks therefore must continue to hold capital dear, the economy will have a rough time expanding and thus a run for safety will keep demand for Treasury securities elevated. But at some point, and I’m not talking years here, one has to assume that the market will demand a higher return to absorb evermore debt issuance. When the Fed can no longer risk damage to the dollar and thus will no longer be there for backstop support, these auctions are likely to run into some trouble.

On the dollar, it rallied hard yesterday. Just as stocks reversed to erase gains, the dollar reversed course and rallied to erase its early-session losses. Bad news is the only thing the greenback has going for it and that’s not going to change so long as the Fed keeps monetary policy aggressively easy.

Dallas Manufacturing

The Dallas Federal Reserve Bank’s survey on manufacturing activity came in worse-than-expected, posting it 24th month in contraction. The reading for October posted -3.3, a reading of -0.5 was expected.

I’ll note that this is not a major economic release and is not even one of the main regional factory gauges, but it was our only data release yesterday and therefore worth a mention. Six of the eight sub-indices of the report weakened dramatically. Production fell to -8.0 from -0.5; capacity utilization fell to -11.3 from -4.8; new orders declined to -2.8 from +8.0 (which happened to be its first positive reading since 2007); volume shipments dropped to -16.1 from +0.3.

The aspect of the report that I found most important was the inventory gauge, it showed what a couple of other regionals have shown for October: the rebuilding of stockpiles has yet to take place. Dallas’ inventory gauge remained mired in contraction mode, coming in at -24.2 after a -25.6 print in September. (The Philly and New York factory reports also showed inventories remained in contraction mode, the Philly number showed big deterioration and New York reported some improvement, but still contraction.)

The six month outlook for inventory rebuilding (and I’m back on the Dallas number) also worsened, printing -2.3 from -1.1. Again, firms remain very cautious – and will likely continue to exhibit a heightened level of caution until they see policy turn to make more sense regarding a multi-year perspective.

This Week’s Data

The rest of the week will be very busy on the economic data front. Today we get the CaseShiller Home Price Index for August and Consumer Confidence for October.

On CaseShiller, while this data has a huge lag to it, the release is the most watched home-price measure. It is expected to post a fourth-straight month of gains, coming off of the cycle low hit in April. The rush to get in before the homebuyers’ tax credit expires (must close on the contract by November 30 – and it is taking six weeks on average to close these days) will help the reading post another increase.

Also, CaseShiller is heavily weighted to regions that have the highest foreclosure rates, so the areas that got pounded several months back are naturally showing the largest degree of rebound. This number will get interesting as the October figures are released as it may just show the rebound in prices is a short-lived event.

Shifting to consumer Confidence, the reading is expected to show an increase from the September reading of 53.1: however, if the confidence reading from the University of Michigan is any indication, this latest figure will disappoint. (For clarity, there are two confidence readings, one from the U of M and the other, and the most-watched, from the Conference Board). The rebound in consumer confidence from the cycle low has been touted as a big development, but the bounce has been from deep lows, the current reading in the low 50s remains well below the long-term average of 96. The current level matches that of past recessions, so the bounce just gets us back to something that resembles a normal recession. If gasoline prices continue to rise, you can forget about a bounce to more normal levels.

Later in the week, we get durable goods orders, new home sales, jobless claims, the initial reading to third-quarter GDP and personal income and savings.

October durable goods orders are expected to rise a bit after a pretty big decline in September. What we’ll watch is the business spending gauge within the report. If this doesn’t begin to show some life, it will spell trouble for those expecting big GDP readings over the next couple of quarters.

Thursday’s initial jobless claims figure remains one of the most watched releases out there. This number has to trend down to 500K (currently stuck in a range of 525K-550K) in order to offer some evidence that the pace of job additions is beginning to outpace that of job losses.

The first look at third-quarter GDP will show the technical end to this deep (and longest in the post-WWII era) recession. Economists expect a reading of 3.2%, which will be driven by a lot of government support, namely the clunker-cash program, which was a one-and-done event. Under normal circumstances, a bounce of 6%-8% GDP growth for a couple of quarters would emerge from such a deep contraction. This will not be the case this time. I think we have a shot at a 4%-5% reading sometime over the next couple of quarters, but this will be a function of inventory rebuilding, but this offers a very short-term pop to GDP. Eventually you need final demand to come back and necessary conditions for this are more jobs and increased business confidence.

Friday’s personal income and spending numbers for September will be key to see what direction the savings rate takes. Overall spending is expected to decline for September after August’s data showed spending hugely outpaced that of the rise in incomes – incomes managed a 0.2% increase, yet clunker-cash and the back-to-school season drove spending higher by 1.3%. The cash savings rates made it back to 5.9% in May, but has been falling again, hitting 3.0% in August. This number needs to go to 6%-8%, that’s just the reality after home and stock prices have been hammered (stocks still 30% off the peak and homes down nearly 25%) and this means lower levels of spending. The longer it takes to get to these percentages the longer it will take for consumer spending to rebound in a sustained manner.



Have a great day!


Brent Vondera, Senior Analyst

Dissecting the declining dollar

Nearly everyone agrees that the dollar’s recent drop was due to an increase in investor risk-taking, a trend that began once the Armageddon scenario for financial markets was off the table.

Yet, many investors remain spooked by the possibility of a collapse in the U.S. dollar. These fears culminate from expectations for an increasing disparity between U.S. and foreign interest rates, as well as concerns about U.S. deficits and inflation. Also hurting is uncertainty regarding the role of the dollar in the world reserve system (I will touch on this more below).

Thankfully we haven’t seen signs of a disorderly decline, such as a significant sell-off in long-term Treasuries or a run-up in inflation expectations. Instead, the dollar’s decline has been gradual and marked by lower volatility in key bilateral currency markets. In addition, risk premiums on a wide range of dollar assets have fallen and there is no evidence of a rise in the cost of borrowing from the U.S. government.

The U.S. government appears to be operating under the theory that dollar weakness will benefit the U.S. by inflating our way out of debt and causing more exports. However, this thinking is flawed in that it assumes that capital stays put while the dollar devalues.

There is no shortage of unhappy campers. The Chinese are upset because their significant holding of U.S. debt will be paid back in devalued currency. The Europeans are worried since a stronger euro threatens to squash the export growth they are depending on to fuel their own economic recovery. Thus, weak dollar policies risk driving away America’s largest creditors just as the Treasury relies more than ever on foreign investors to fund enormous spending programs.

But as much as some foreign leaders want to replace the dollar as the world’s reserve currency, there is no suitable substitute. The euro is widely respected, but lacks backing from a single sovereign debt market. China’s renminbi is out of the question since it is pegged to the dollar and not fully convertible. The Russian ruble isn’t a candidate because there is not enough of the currency to handle the volume of world trade and it can’t be relied upon to holds its value, especially if oil prices collapse. Other minor currencies couldn’t handle large inflows without becoming quickly overvalued.

The fact of the matter is that the Treasury market remained highly liquid throughout the financial crisis despite shattered confidence in other U.S. credit markets. Thus the dollar functioned as advertised, as a global haven, proving that U.S. government bills are still the best assets to have in a crisis.

I’m sure everyone would breathe a little easier if the Fed raised interest rates or Congress addressed its spending addiction. Regardless, it’s hard to imagine the dollar’s role in the world’s currency system changing anytime soon. If there ever is to be a change to the world’s reserve currency, it is perhaps more reasonable to expect a gradual shift to a basket approach in which the euro and renminbi play a more substantial role supplementing the dollar.

--

Peter J. Lazaroff, Investment Analyst

Bond Market Weekly

This week was a big one for Fedspeak and speculation on the timing of the turnaround in monetary policy. A move to just an accommodative level of interest rates from the current environment where 0% interest rates has been and continues to be the breathing machine keeping the economy barely alive, will be a significant movement. And even though more people seem to be jumping into the “sooner rather than later” boat, a real turnaround in rates doesn’t appear to be much of a near term reality.

Fedspeak

San Francisco Fed President Janet Yellen used her appearance on Tuesday as an opportunity to comment on news of the Fed testing reverse repos with firms other than primary dealers. Reverse repos are used by the Fed to tighten money policy. Bernanke & Co. have spent most of 2009 buying everything in sight and leaving the market flush with cash and entering into reverse repos would lend out those same securities in exchange for cash. It’s not much different than just selling the securities for cash, but repos can be done on terms as short as overnight.

First of all, the fact that the Fed is looking beyond the 18 firms it is already set up to trade with is somewhat notable. The Fed wants the program to stay as liquid as possible, and expanding the number of firms the Fed trades with definitely achieves that goal, but the market may have started to get ahead of itself. The short end of the curve didn’t really react to the release, thanks to Janet Yellen’s speech, but street chatter was heavy as the market continues to gain more insight into how the Fed will unwind its balance sheet.

Excerpt from Yellen’s comments Tuesday:

“We don’t want anyone to question the bank’s ability and willingness to tighten monetary conditions when the time comes… Not now… We want to be absolutely certain that this is something we can do.”

Yellen is a voting member and her comments coincide with most of the voting membership of the FOMC, but views from outside the voting membership differ considerably.

Philadelphia Fed President Charles Plosser, who won’t get a FOMC vote until 2011, spoke on the same day as Yellen, but expressed a different stance. Plosser’s comments focused on the large lean toward riskier assets on the Fed’s balance sheet, including TALF and even the $1.25 trillion in agency MBS that the Fed will finish purchasing net week.

Excerpt from Plosser’s comments:

“My fear is that we are going to do things during the transition that never allow us to get out to a successful point at the end of the day… It’s more difficult this time because of the composition of our balance sheet.”

This begins to make me wonder. What kind of impact is the composition of the voting membership having on its policy? Do they have some information that non-voting members don’t have, or is Plosser just making outrageous comments from outside? Such a fragmented committee adds to the complexity of the Fed’s policy turnaround, whenever the decision is made.

Differing Views

A new perspective surfaced this morning in a Financial Times article saying that some FOMC members are considering removing the “extended period of time” wording that we have all gotten so used to seeing since March. This contradicts Fed comments from earlier this week. Gauging by what the market did this morning after the FT article surfaced, more credence is being given to speculation on what the Fed might do the language of the meeting statements than actual comments from voting members of the committee. The 2-year moved above 1% for the first time since September and closed there for the first time since August 28.

In my view this is the just the Fed testing the waters a little bit. The Fed Funds Target Rate is still being defined by a range (0-.25%) so the rate as it trades right now, (.12%) could still double and remain within the target range. So if you factor in the time it will take the Fed to end the buying programs, which is next week for Treasuries and most likely Q1 2010 for MBS, the gradual movement of statement language toward that of a Fed looking to begin tightening monetary policy and the need for at least a partial move in the market rate for Fed Funds, we are looking at a late 2010 rate hike at the earliest.
Cliff J. Reynolds Jr., Investment Analyst

Daily Insight

U.S. stocks lost ground on Friday, wiping out the weekly gain on the S&P 500. A decline in commodity prices and an earnings miss from railroad giant Burlington Northern sent shares of basic material, energy and industrial shares lower.

The Burlington Northern news signaled that freight demand has yet to rebound and this reversed some pre-market excitement that had stocks looking up before the official trading session opened – that early morning enthusiasm was fueled by strong results from Amazon.com.

All 10 of the major sectors lost ground on the session, with basic material share as the worst-performing group and tech as the best – the S&P 500 that tracks technology shares declined just 0.31%.

Plans to increase regulations on the banking industry are really kicking up too, there was a lot of talk about the Fed taking control of keeping banks in line – that’s enough to scare anyone -- and this may have also weighed on the market. We already have an issue with a lack of credit expansion, and even though this is a natural and frankly needed occurrence with credit quality in the tank, if medium and small businesses can’t get the financing they need it will burden job creation. If the regulatory regime goes too far, credit expansion will be suppressed -- yet another issue for this recovery.

Market Activity for October 23, 2009
Britain’s Surprise, the Dollar, and the Fed

Friday I noted that the U.K unexpectedly remained in recession during the third quarter, marking the sixth quarter of contraction – the longest since these records began in 1955.

This reality may cause the Bank of England to expand its quantitative easing campaign (purchases of government bonds – gilts in the U.K.), which would be a reversal from comments BofE Governor King made early this week when suggesting the central bank would pull back from QE. As a result, the pound got pounded (it had rallied hard earlier in the week on the King statements, but gave back all of those gains Friday morning).

The greenback got a nice boost as a result, rising against the euro and rallying hard against the pound.

As we mentioned early last week, it was going to be interesting to listen to Fed comments as various Fed officials were giving a total of nine speeches over the past several days – two of those coming from Chairman Bernanke. It’s interesting because there is quite a bit of contention going on within the Fed, some want to begin to gently raise rates and others say it is way too soon. The speeches revealed that this divergence in opinion remains the case.

From a short-term perspective, it is way too soon to raise rates, but if things get out of control and the greenback moves down to DEFCON 3 (solidly into the 74 handle on the Dollar Index – which we’re very close to at 75.30 on DXY this morning) and then to DEFCON 2 (matching the all-time low of 71 on Dollar Index) we won’t have the luxury of keeping monetary policy floored and the Fed will have to reverse course swiftly and abruptly – that will throw us back into a nasty situation.

Bernanke and Vice Chairman Kohn are the most dovish, as measured by their statements. If the other members of the FOMC (the Fed’s rate-setting committee) fail to convince Bernanke that he better start talking mildly higher rates and then get to gently increasing fed funds to 1.00% in short order, we may see DEFCON 2 sooner than most currently imagine. We need to remember that 1.00% fed funds is still very accommodative and it is ridiculous to remain at emergency levels (zero interest rate policy) or there will be other emergencies that arise. The dollar can’t depend on weakness within other currencies as the thing that helps it rally.

There is no way to get ourselves out of this corner without taking some punishment (and the Fed is backed into a corner here). However, the longer we cower in the corner, afraid to take some jabs and undoubtedly a couple of body blows, the more likely it is that we’ll get thrashed with a series of very heavy head shots. The Fed needs to act, it won’t be pleasant, but it will be worse the longer they wait.

Existing Home Sales

The rush to take advantage of the first-time homebuyers’ tax credit boosted existing home sales to the highest level in more than two years. Purchases of existing homes jumped 9.4% to 5.57 million units at a seasonally-adjusted annual rate (SAAR), outpacing the consensus estimate by 220,000 units. Purchases of single-family units only also rose 9.4%, to 4.89 million SAAR.

I’m using single-family only for the charts below because the headline number includes condos and those figures only go back to 1999.


While this increase is absorbing some supply, we’ll see over the next couple of months worth of data that the tax credit, in large part, front-loaded home purchases, borrowing sales from the future. We’ll wait to see if the credit is extended, and maybe even expanded (possibly to all homebuyers and the amount of the credit increased as the industry is begging Congress), but for now the primary determinant of home sales will fall back on its key element – labor market conditions.

I’ll also point out that these home sales figures are seasonally adjusted. This is appropriate in most cases, but if there ever was a time to look at the non-seasonally adjusted reading it is this time. Why? Because home sales normally fall significantly in September as the seasonal buying season (May-August) ends. This September though the non-seasonally adjusted decline in sales was not as severe – no doubt because the tax credit essentially extended the home-buying season. Hence, when adjusting to seasonality it makes the increase appear more substantial.

The supply of existing homes has tumbled (as measured by the pace of sales) back to 7.8 months’ worth at an annual rate from a 22-year high of 11.3 months’ worth back in June 2008. (For clarity, in case anyone is interested, the supply of homes was just as elevated back in early-mid 1980s as the 1981-82 recession affected home sales in the early part of that decade and interest rates remained in double-digit territory until crashing below 10% in 1985).

We have accomplished erasing much of the excess supply, but the trend is unlikely to continue; the supply of homes will rise again before eventually trending lower in a sustained manner. If sales decline due to the expiration of the tax credit, and supply is boosted by another wave of foreclosures, also a likely scenario, we’ll see some increase in the figure again.

The median price of a single-family existing home fell 1.2% in September, falling to $174,900 from $177,100 in August. From the year-ago period, the median price has declined 8% and is 24.5% off of the peak ($230,900) hit in July 2006.


Futures

Stock-index futures are higher this morning as traders look to do some buying after Friday’s sell-off. International bourses have also helped pre-market trading in the U.S. Futures were flat very early this morning but as Asian stocks shook off some of their early-session weakness to move positive that compelled European stocks to advance and is helping U.S. stock futures.

As we get ready to say hello again to $3 gasoline (unless the U.S. dollar catches a bid), adding yet another challenge to the consumer, and another major commercial real estate lender has filed for bankruptcy it’s remarkable that stocks are higher in pre-market.

The increasing troubles in commercial real estate are not sneaking up on anyone, yet stocks seem to have an aloof attitude to this reality. If an inability to refinance debt continues, we’ll see plenty more bankruptcies on the commercial side. It’s going to take a while to get through the problems in overall real estate markets, and that may surprise some people who think we’re on a sustainable upward trajectory, specifically with regard to the residential side of things. Surely, everyone understands the commercial side has much deeper losses to deal with still.

Have a great day!


Brent Vondera, Senior Analyst