MarketView for June 25

 

 

Summary 

 

Wall Street started out on the road to recovery on Tuesday with the major equity indexes rising sharply on data indicating that business investment and the housing industry’s growth rate continued apace, reassuring the Street that its concerns that the Federal Reserve's plans to reduce its massive monetary stimulus were overblown.

 

The day’s gains were driven by a mix of buyers: hedge funds and both small and wealthy retail clients attracted by the market's recent decline. Position trimming by institutions due to recent volatility pulled the market back from its highs in the final minutes of trading.

 

The gains, led largely by financial stocks, came even as the latest drop in bond prices indicated higher interest rates. A lightly bid two-year government debt auction disappointed bond traders who were looking for bargain-minded investors to buy Treasuries hard hit in the recent market selloff.

 

The S&P 500's gain of just less than 1 percent was the largest since June 13 and was the market's most broad-based advance since Federal Reserve Chairman Ben Bernanke sparked a global rout in financial markets by laying out a roadmap for the end of $85 billion a month in bond purchases.

 

The declines have been broad and have come on heavy volume, indicating selling has been initiated by investors with large positions. Even with Tuesday's gain, the S&P 500 is down 4.9 percent from its all-time closing high of 1,669 reached on May 21.

 

Data on durable goods orders, sales of new homes and consumer confidence all exceeded expectations, along with the April Case/Shiller report on home prices. A continuation of these strong economic figures will mollify concerns many have about what will happen when the Fed tapers off its support of the economy.

 

Housing stocks were among the day’s strongest due in part to the strong earnings number posted by Lennar. Lennar’s shares ended the day up 0.7 percent to close at $35.23.

 

Wells Fargo rose 1.25 percent to end the day at $40.30. Citigroup led the gains by large-cap banks with a 3.4 percent rise.

 

While the S&P is up 11.2 percent in 2013, we cannot lose track of the fact that the recent trend has been negative, with the benchmark index dropping below both its 14-day and 50-day moving averages, seen as signs of near-term market direction. The S&P is down about 2.7 percent in June.

 

China's central bank said the country's banks need to do a better job of managing their cash. On Tuesday, the People's Bank of China said it would not press banks too hard in its efforts to curb easy credit and prevent a possible banking crisis.

 

Carnival rose 5 percent to $34.89 after the cruise ship operator named a new chief executive and affirmed its full-year profit outlook.

 

On the downside, Walgreen fell 5.9 percent to $45.22 as the worst performer on the S&P 500 after reporting weaker-than-expected results, citing slow front-end sales and a challenging economy.

 

SolarCity gained 9.2 percent to $36.01 after Wal-Mart announced 10 new solar installations in Maryland.

 

Durable Goods Orders Up

 

Orders for long-lasting manufactured goods rose more than expected in May and a gauge of planned business spending increased for a third straight month, the latest signs of a pick-up in economic activity.

 

According to a report released Tuesday morning by the Commerce Department, durable goods orders increased 3.6 percent on goods ranging from aircraft to machinery. Orders for these goods, which range from toasters to aircraft, were up 3.6 percent in April.

 

Non-defense capital goods orders excluding aircraft, a closely watched proxy for business spending plans, increased 1.1 percent. Orders for the so-called core capital goods had increased 1.2 percent in April. Core capital goods shipments, used to calculate equipment and software spending in the gross domestic product report, rebounded 1.7 percent. That followed a 2.0 percent drop in April.

 

The increase in shipments of core capital goods pointed to moderate growth in business spending on capital equipment.

 

Demand for transportation equipment rose 10.2 percent last month, buoyed by a surge in orders for civilian aircraft. Boeing received orders for 232 aircraft, up from 51 in April, according to information posted on its website. Orders for motor vehicles, however, fell 1.2 percent after rising 2.4 percent.

 

Outside transportation there were gains in orders for machinery, computers and electronic products, primary metals and electrical equipment, appliances and components.

 

Other details of the report were also supportive of manufacturing. Unfilled orders for durable goods rose 0.8 percent and were up by the same margin excluding transportation. Overall shipments of durable goods rebounded 1.2 percent after falling 0.6 percent in April.

 

Inventories of unsold durable goods edged up 0.1 percent, which should help the sector in the long run.

 

Consumer Confidence Up Sharply

 

Consumer confidence jumped in June to its highest level in over five years as Americans were more optimistic about business and labor market conditions, according to a private sector report released on Tuesday.

 

The Conference Board, an industry group, said its index of consumer attitudes rose to 81.4 from a downwardly revised 74.3 the month before. It was the highest since January 2008 and beat expectations for 75.4. May was originally reported as 76.2.

 

New Home Sales Near 5-Year High

 

Sales of new single-family homes rose to their highest level in nearly five years in May, confirming the housing market's strengthening tone. The Commerce Department said on Tuesday sales increased 2.1 percent to a seasonally adjusted annual rate of 476,000 units - the highest level since July 2008. It was the third straight month of gains in new home sales. Sales increased 3.3 percent in April. Compared with May 2012, sales were up 29 percent.

 

The housing market recovery, which is helping to soften the blow on the economy from tight fiscal policy, has been largely driven by record-low mortgage rates, thanks to the Federal Reserve's generous monetary stimulus.

 

The Fed last week said it expected to start slowing the pace of its bond-buying program later this year, bringing it to a halt around the middle of 2014. That has pushed up mortgage rates, which had already been rising since early May. As a result, sales numbers will be closely watched in the coming months for signs of strain from the rise in rates.

 

Meanwhile, confidence among home builders spiked to a seven-year high in June and they were upbeat about sales over the next six months and prospective buyer traffic. Last month, the inventory of new homes on the market increased 2.5 percent to 161,000, making it the highest level of new homes since August 2011.

 

Still, supply remains tight, putting upward pressure on prices. The median new home price increased 10.3 percent from a year ago. At May's sales pace it would take 4.1 months to clear the houses on the market, up from 4.0 months in April. A supply of 6.0 months is normally considered as a healthy balance between supply and demand.

 

Sales last month were up in the Northeast, Midwest and West. They fell in the South. Sales in the Midwest were the highest since November 2007.

 

Fed Officials Imply QE3 is Alive and Well

 

Less than a week after the Federal Reserve set off a cascade of selling in global markets, two top members of the Fed downplayed the notion of an imminent end to monetary stimulus and said on Monday the market reaction was not yet cause for concern.

 

The Fed is center stage after Chairman Ben Bernanke indicated last week that the Fed is considering reducing its bond-buying later this year and to end it altogether by mid-2014 if the economy continues to improve.

 

Bernanke's road map to the end of the Fed's third round of quantitative easing, or QE3, left ample room for adjustment and interpretation - and his colleagues provided a bit of their own on Monday, appearing to try to assuage fears in the marketplace.

 

Minneapolis Fed President Narayana Kocherlakota said investors, who drove stock and bond prices lower in the last few days, were wrong to view the central bank as having moved to tighten policy.

 

"I thought there was a sense out there ... that the committee had taken more of a hawkish turn in terms of thinking about policy... I thought that was a misperception that should be clarified," Kocherlakota said.

 

Perhaps the most dovish of the Fed's 19 policymakers, he highlighted underlying messages in both Bernanke's comments and the Fed's policy statement that were "pretty accommodative," including the central bank's expectation that it will not sell off its mortgage bonds in the years ahead.

 

The resulting rise in longer-term bond yields is "not a cause for concern" so far, Kocherlakota added. "But obviously, if these higher yields were to harden over a longer period of time, that would be restrictive to economic conditions.

 

Richard Fisher, the hawkish head of the Dallas Fed, said of the market reaction that the "big money" investors appear cautious after a 30-year bull market in bonds, adding the strength of the U.S. dollar reflects confidence in the economy.

 

Fisher strongly backed Bernanke's timetable for QE3, repeating the unprecedented stimulus should be slowly removed. He added that the Fed's ultimate "exit strategy" is still a ways out in the future.

 

"Even if we reach a situation this year where we dial back (stimulus), we will still be running an accommodative policy," he said. In a favorite line, Fisher repeated: "I'm not in favor of going from wild turkey to cold turkey overnight.

 

As it stands now, the Fed is buying $85 billion in Treasury paper and mortgage-backed securities each month to stimulate investment, hiring and economic growth.

 

Since Bernanke's comments on Wednesday, financial markets have pulled forward the date when they expect the Fed to start raising interest rates, currently near zero, to around September 2014, even though a majority of Fed policymakers do not expect lift-off in rates until 2015.

 

William Dudley, who heads the New York Federal Reserve Bank, did not comment specifically on the current policy stance but spoke generally about the need for policies to be "more accommodative than otherwise" in the wake of financial crises.

 

The Fed must consider financial instability when formulating its policies, Dudley said in comments that gave a brief boost to U.S. bond markets in early trading.

 

"The stance of monetary policy needs to be judged in light of how well the transmission channels of monetary policy are operating," Dudley said.

 

"When financial instability has disrupted the monetary policy transmission channels, following simple rules based on long-term historical relationships can lead to an inappropriately tight monetary policy.

 

Dudley, who repeated that the Fed has fallen short of its employment and inflation objectives, is a close ally of Bernanke and a strong backer of the unprecedented efforts to accelerate the economic recovery from the 2007-2009 recession.

 

While neither Kocherlakota nor Fisher have votes on the Fed's policy committee this year, Dudley has a permanent vote.