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Is the U.S. economic recovery sustainable? How long can it continue? What will happen if it aborts? What are likely to be the biggest surprises for investors in 2010?
Key News
* U.S. Economy: Consumer Spending, Confidence Fall on Job Worries (Bloomberg)
* U.K. Nationwide House Prices Post First Annual Gain Since 2008 (Bloomberg)
* China Will Sustain Growth Rebound, Central Bank Says (Bloomberg)
* Fed Ends Treasury Buys That Capped Rates, Stabilized Housing (Bloomberg)
The Event Agenda
Morning Run-Down
The Pavlovians that have systematically bought the dip and been immediately rewarded over past months are in for some punishment. Yesterday’s aggressive retracement following a fairly meaningless GDP report likely got them even more aggressive and convicted– perhaps even more inclined to keep adding into stock market weakness.
But the trends have broken and the risk environment has changed. All of the sudden people fell less comfortable about the state of the world, more concerned about sustainability of growth.
The VIX, a proxy for traders’ perception of risk and uncertainty, is up 54% in six days. The VIX is the one place that offered the best risk/reward opportunity for a double. Market participants clearly were underpricing risk as every tick higher in stocks translated into more optimism about recovery and a lower moving VIX.
A falling stock market can quickly dismiss blind optimism and bring the reality of the challenges to global economies back into focus. That means higher risk aversion, lower stocks, lower commodities and a stronger dollar.
Here is a snapshot of markets going into the close…
Stocks (lines 1-3) followed the biggest rally since July with the biggest sell-off since July. Crude oil (line 4) fully retraced yesterday’s strength, now 6% off of last week’s highs. Commodity currencies and yen crosses were the biggest currency movers of the day, reflective of global demand concerns and rising risk.
Here’s a look at some long term charts for perspective on the crisis-driven declines and the extent of retracements over the past eight months…
Key Charts
The S&P 500 dropped 58% from its highs in 2007 to its low in 2008. Even following a 65% rise from the bottom, stocks remain in a long term downtrend.
The New Zealand dollar contracted at a sharper rate than the US economy and is expected to have a weaker recovery in 2010, yet the New Zealand dollar retraced 83% of its crisis driven losses in just eight months. Look out below.
Though commodities have had a shallow bounce off of the bottom, global demand remains massively depressed.
The VIX (the fear gauge) settled in to pre-Lehman levels and is now surging higher.
Key News
* Norway Set to Be First European Country to Raise Rates Tomorrow (Bloomberg)
* ECB reveals first fall in household loans (Bloomberg)
* Consumer Confidence in U.S. Unexpectedly Decreases (Bloomberg)
* South Korean Economy Expands (WSJ)
The Event Agenda
Afternoon Run-Down
The broader stock market is continuing the weakness from last Friday and that’s carrying over to other asset classes, global stocks and emerging market currencies. The disconnect between the rise in asset prices and economic fundamentals become a focus when stocks point south. The weak consumer confidence and disappointing Richmond Fed data this morning were more fuel for an already shaky risk environment. The descending trendline in the S&P 500 that describes the entire decline from the October 2007 highs has so far contained an exhaustive (and exhausting) 8-month rally in risk assets (see the chart below).
After a few days of uncharacteristic downdrafts in stocks a couple of conveniently timed bearish pieces made the rounds this morning. Bill Gross of Pimco is calling a top in the risk trade in his monthly letter. Gross points out the obvious circular feeding frenzy of the past eight months that has driven asset prices: Hope and optimism have fed into higher stock prices … higher stock prices have fed into more hope and optimism … which has, in turn, fed even higher prices.
Here are a couple of interesting excerpts…
He says… “Asset prices are embedded not only in our psyche, but the actual growth rate of our economy. If they don’t go up – economies don’t do well, and when they go down, the economy can be horrid.”
The Fed is trying to …“keep the capitalistic patient alive through asset price support”
And for those that have been on the risky asset joy- ride…“ the risks outweigh the rewards at this point.”
The Reserve Bank of New Zealand meets tomorrow to set rates. They are expected to keep rates at 2.5%. Because Australia made a first post-crisis rate hike last month, speculation has been stirring around New Zealand’s rate prospects. But a closer examination of the RNBZ’s statement last month sheds a fairly clear light on the central banks cautious position.
“the Bank took a number of steps to
enhance its liquidity facilities to improve credit flows, and
most recently, communicated its expectation that the
OCR will be kept at or below the current level through
until the latter part of 2010. These two measures are
aimed at helping the transmission of the lower OCR to
the interest rates faced by households and businesses”
With yesterday’s move higher in the dollar, lower in stocks, lower in crude oil, the contra-risk trade day finally got market participants concerned about complacency. Implied volatilities (a good measure of market uncertainty) started rising in stocks and currencies.
Here’s a look at some interesting charts…
Key Charts
The dollar index breached an eight month descending trend line today…
I showed this chart of the euro on Friday and pointed to the significance of the $1.50 level. The first attempts at $1.50 starting back in 2007 failed three times until finally charging through in early 2008 to ultimately reach $1.60. And now, $1.50 has proven again a difficult objective. The euro posted a bearish daily reversal signal yesterday.
The S&P 500 has run into big trendline resistance of the entire move down from the 2007 highs. Now, trendline support of the 65% move off of the March lows is testing. A break here and a sharp slide would be a quick sentiment deflator … i.e. risk aversion round 2.
If the S&P breaks down expect the Canadian dollar to take a equally if not more aggressive hit…
Could these charts spell the next phase of a broader-longer term global instability/risk aversion theme?
The latest S&P/Case-Shiller home price index figures were just released. On a month-over-month basis, prices were up 1.2% in 20 top metropolitan areas in August. That marked the fourth consecutive monthly gain. On a year-over-year basis, home prices were down 11.3%. That was better than the 11.9% decline economists were expecting and an improvement from the 13.3% drop in July. All 20 cities are still showing YOY declines, but the rate of depreciation is moderating. The best market? Dallas at -1.2%. The worst? Las Vegas at -29.9%.
Key News
* U.K. Economy Shrinks (WSJ)
* September Sales of U.S. Existing Homes Jump More Than Forecast (Bloomberg)
* Bernanke Says Financial Firms Should Pay for Closings (Bloomberg)
* Eurozone economic activity surges (FT)
The Event Agenda
Morning Run-Down
Third quarter GDP out of the UK shocked the market this morning. The market expectations were for growth of 0.2% for the third quarter, yet the number showed contraction of 0.4%. That makes six consecutive quarters of economic decline.
The pound plunged over 350 points. The UK story has been volatile. It’s been a yo-yo of optimism and pessimism. Before this morning’s GDP number optimism had taken hold for the last nine trading days taking the pound 6% higher. With a higher pound came growing support for the recovery scenario and a new confidence that the quantitative easing was taking hold.
But the fact remains the UK economy is underperforming all major economies right now. The quantitative easing program is larger than the U.S. as a percent of GDP and it’s looking probable that it will be expanded again. That’s all bad news for the pound.
There’s daily speculation and prodding by the media for clues on when major central banks will begin reversing the easy money conditions. Yet prices are continuing to fall in most of the top developed countries, demand remains depressed and economies have a ton of excess capacity…all reasons the interest rate market is showing no signs of inflation concerns. Plus central banks have made clear that rates will remain low for some time, but that is apparently not good enough for the drama appetite of the financial journalist community.
The FT ran an article today implying that Fed officials were mulling over ways to change the language in their next statement to soften the message that rates would remain low “for an extended period of time.” That gave interest rates and the dollar a little nudge today.
Overall, stocks and crude oil are off more than 1% today. The dollar is nicely higher and the pound is the biggest currency mover of the day.
Downside in stocks will get dollar bears nervous. It’s a question of how much downside is necessary before they run for the exits. For those that fear the dollar is in crisis, the implied volatility in currencies (where uncertainty is expressed) has been in a slow decline back to pre-Lehman levels. Ho-hum. And traders are buying protection against a reversal in the dollar at increasing rates. Neither of these are signs of any panic or crisis in a currency.
Where concern is more properly placed is for those fragile economies trying to work their way out of recession with a strong currency. It’s bad for the all important exports and that’s why the fuss is intensifying…
Ø The Bank of Canada released its minutes this week and said that the strength of the Canadian dollar is offsetting recovery. The BOC governor also said the intervention is always an option.
Ø The Eurozone finance ministers met this week and reiterated the ill effects of excessive currency volatility.
Ø Central banks in South Korea, Taiwan, the Philippines, Thailand, Indonesia and Hong Kong all intervened to curb currency strength.
Ø And Brazil slapped a 2% tax on foreign investment to help curb the rise in its currency and asset markets.
Growing protectionist measures are a danger for the global recovery. It creates retaliatory responses which further crushes an already weak global demand. This growing contentious behavior is not being priced into the risk-loving, “world returning to normal” theory.
Here’s a look at the charts going into the weekend…
Key Charts
The pound collapsed following the GDP disappointment. It rallied from 1.5708 to 1.6693 over nine days and gave back 387 points today…
The euro made its biggest move against the pound today since February, which kept the euro/dollar exchange rate stable most of the day around the 1.50, as traders bought euros against pounds. The euro/dollar hovers at the 1.50 area, a level that proved very difficult to breach the first time around (left area of the chart).
Commodities have been staging a move higher since the early October but remain well off historic highs, and well contained.
The S&P 500 had a slippery end of day sell off on Wednesday and wasn’t able to regain those levels. Stocks are running into big trendline resistance of the entire move down from the 2007 highs. This area should be resilient and should put the staying power of global risk appetite to the test…
The September existing home sales figures recently hit the tape. Here’s what the numbers looked like:
* Existing home sales jumped 9.4% to a seasonally adjusted annual rate of 5.57 million units from 5.09 million in August. That was twice the gain that was expected and the rate of sales was the highest since July 2007.
* Single-family sales gained 9.4%, while condo and cooperative sales rose 9.7%. By region, sales climbed across the board. They were up 4.4% in the Northeast, 9% in the South, 9.6% in the Midwest, and 13% in the West.
* The raw number of homes for sale dropped 7.5% to 3.63 million units from 3.924 million in August. Supply was off 15% from a year earlier. The months supply at current sales pace indicator of inventory dropped to 7.8 from 9.3. Single family inventory dropped to 7.6 from 9, while condo inventory fell to 11 from 12.1.
* The median price of an existing home fell 1.4% to $174,900 from $177,300 in August. That was off 8.5% from $191,400 in the year-ago period.
September was a blockbuster month for existing home sales. The looming expiration of the tax credit, combined with stabilization in the broader economy and cheap home prices, drove sales to the highest level we’ve seen in a couple of years. The supply of used homes for sale is also steadily declining, an encouraging trend considering that new home inventory has already dropped like a rock.
If there’s a fly in the ointment, it’s concern about the “pull forward” effect. Clearly, some buyers purchased a home this summer because of the tax credit and the tax credit alone. Unless that credit is extended or expanded, we’ll see “give back” in the coming couple of months. I don’t think it derails the overall recovery. That’s being driven by true, fundamental forces, such as the dramatic improvement in housing affordability. But it will be noticeable nonetheless.
Our “What me, Worry?” Fed Chairman Ben Bernanke may not care about the falling dollar. But foreign central banks are getting seriously peeved about the strength in their currencies against the ever-depreciating dollar …
* The Bank of Canada released a statement today saying that “heightened volatility and persistent strength in the Canadian dollar are working to slow growth … the current strength in the dollar is expected, over time, to more than fully offset the favorable developments since July.”
* European Central Bank President Jean-Claude Trichet warned again about “excessive volatility” in exchange rates, while a French economic advisor said the current EURUSD exchange rate is a “disaster for the European economy.”
* In Brazil, the carry trade (borrow cheap dollars, invest the money in higher-risk, higher-yield assets) is so out of control the government just slapped a tax on foreign investors in Brazilian assets. A 2% levy will apply to foreign purchases of Brazilian fixed-income securities and stocks, effective immediately.
* Minutes of the latest Reserve Bank of Australia meeting showed that officials were very concerned about the side effects of recklessly easy money. The minutes suggested that a “very expansionary setting of policy was no longer necessary, and possibly imprudent.” The RBA surprised the world recently by becoming the first Group of 20 central bank to raise rates, albeit by a quarter point to 3.25%.
Bottom line: Washington doesn’t care about letting the dollar circle the drain. The Fed may want to keep U.S. rates at effectively zero until the next millennium. But Canada doesn’t much like the surging loonie, the ECB hates the euro surge, Brazil isn’t thrilled about the exploding real, and Australian officials are clearly firing a shot across Bernanke’s bow.
The problem is that unless and until Bernanke signals a policy shift in the interest rate market, they’re spitting in the wind.
One of the topics I discussed in last month’s Dividend Superstars issue was higher costs for higher learning. And while it’s certainly not a cost most retirees face, it does add another example to my long list of soaring prices for many of life’s biggest expenses — regardless of what the CPI shows.
Today, the College Board’s latest survey came out, showing that tuition and fees at private 4-year schools rose 4.4% in the current school year to $26,273. Meanwhile, the price of a 4-year public university education spiked more than 6% for both in-state and out-of state students ($7,020 and $18,548).
Put bluntly, I question whether many of our country’s students are really getting value for their money anymore.
I am certainly saving and investing for my own daughter’s education. But given these trends — and the money to be made from plenty of out-of-the-box careers — I will be giving her the choice to pick her own path.
Heck, would you rather go into business for yourself with a headstart of $30K - $100K or come out with a 4-year degree in the hole? That question gets harder and harder to answer.
We just got the latest data on housing starts and permits. Here’s what the numbers showed:
* September housing starts inched up by 0.5% to a seasonally adjusted annual rate of 590,000 from a downwardly revised 587,000 in August. Single family starts rose 3.9%, while multifamily starts dropped 15.2%. Starts are still down 28.2% from year-earlier levels, but that’s a smaller decline than the 40%+ YOY drops we were seeing in the spring.
* Building permits dipped 1.2% to 573,000 from 580,000 a month earlier. Single family permits dropped 3% … the first decline since March … while multifamily permits gained 6%.
* On a regional basis, starts dropped in 3 out of 4 regions, with the West down 8.8%, the Northeast off 5.5% and the Midwest down 1.8%. Starts rose 7.1% in the South. Permitting activity fell in 2 out of four regions (-1.7% in the South and West), while holding stable in the Northeast and Midwest.
After a steady upward march, the housing market appears to be stopping to catch its breath. Housing starts have leveled off, while single family permits showed their first dip in six months. Builders are growing more hesitant for a few reasons: The “Cash for Cottages” tax credit is about to expire … job growth is MIA … and consumer confidence is cooling a bit.
This doesn’t mean the recovery is over. The sum total of the indicators I follow still suggest the worst of the downturn is behind us (with the exception of home prices — those will likely continue to fall over the next year, albeit at a more gradual pace). But the recovery will be far from vigorous. Rather, it will be a gentle, halting, drawn out affair. Think three steps forward, two steps back here.
The latest National Association of Home Builders index was just released. The index fell to 18 in October from 19 in September. The subindex tracking present sales fell to 17 from 18, the subindex tracking expectations about future sales dropped to 27 from 29, and the subindex measuring prospective buyer traffic slumped to 14 from 17.
Regionally speaking, we saw weakness in three out of four parts of the country. The index that tracks activity in the West fell the most — to 14 from 18 — while the index that tracks activity in the Northeast was the lone bright spot, rising to 25 from 24. Both the Midwest and South indices dipped to 18 from 19.
We saw auto sales slump after the “Cash for Clunkers” program expired. Now we’re seeing a similar hangover in housing thanks to the looming expiration of the “Cash for Cottages” tax credit. Specifically, all three subindices in the NAHB report declined, as did three out of four regional indices.
The overall housing recovery remains on track, with new home inventories falling substantially and low home prices helping to bring some buyers off the sidelines. But these latest figures underscore my belief the recovery will be a drawn out, gradual affair as opposed to a vigorous “V-shaped” rebound.
