Is The Glass Half Full Or Half Empty
We enter Q2 earnings season in an awkward fashion amid conflicting indications and risks. Second quarter activity saw a boom in interest rates starting in May and only relaxing of late. Associated with this are the record dollars flowing out of bond funds pushing down prices and lifting yields. Then we saw a U.S. dollar gyration spiking down through May, and then spiking up through June. Stocks saw the future of tapered QE in later May and into June, but are making new highs currently in July. Developing country currencies fell against the U.S. dollar while China's economy stepped back.
Some have attributed increasing interest rates to increasing demand driven by growth. Others say interest increases are due to excess liquidity that hasn't spurred demand, but rather increased systemic market risk once the liquidity tap is turned off. It appears both arguments have foundation. But the latter argument has more "real life" support over the other.
Q1 saw lackluster economic performance among indicators. GDP started at a decent 2.4% growth, but inevitably was revised to reflect indicators ending up at 1.8%. For many, this was not surprising given data out of China, Q4 Japan recessionary pressure and of course Europe.
Q2 Started With Weak April Data, Except Housing
April started weaker off of March's minor rally. Dallas Fed Manufacturing Survey, for instance, pulled a positive 7.4 points in March for business activity and a good 9.4 for production. But when April came, the floor fell with business activity at -15.6....real pessimism....and production -.5 points. Construction spending in April fell -1.7% against a March gain of 1.5% with public outlays leading a decline. Retail sales were abysmal and import/export prices showed deflation. April's factory orders data (reflecting March activity) were down -4.8%.
April's other Fed regional indexes also demonstrated disappointment in manufacturing. Of the regional indexes that were positive, they were only hanging on while others remained in contraction. Durable goods orders were all negative and industrial production was teetering to negative.
Only silver lining was the Fed's $40B per month purchases of mortgage backed securities. Contrasting pessimistic data was April's existing home sales, up 10.3% in March and 9.7% in April year over year. Median time for an existing home to stay on the market for sale fell to 42 days from 62 days in March. Banks were obviously producing mortgages to feed the Fed. Pricing advanced 6.2% in March and another 4.8% in April with annual pricing up 11%.
New home sales witnessed similar results with sales up 2.3% in April despite constrained demand. Demand against supply saw new home prices rise 14.9% annually in April. Appears that while mortgage lending was occurring, construction loans to builders remained tight.
Consumer sentiment also elevated in April probably due to more friends of friends buying houses and employment improving. Employment situation report of April exceeded expectations adding 165,000 jobs in April. Market expected 153, 000 jobs to be added while March saw only 138,000 new jobs. Also a factor is the dangerously euphoric equities market. IRA's and 401(k)'s increase giving a feeling of improved retirement security. But euphoric parties come to an end.
Despite other economic indicators, homes and consumer sentiment advanced in April. This dynamic carried through to May and is now seen in June data being revealed today in July. Further, the positives in homes and consumer sentiment are penetrating other indicators positively. Domestic demand has picked up.
May's Housing Data Continued, Other Indicators Improved and Interest Rates Shot Up
Firstly, May saw interest rates start an aggressive increase with spreads between high yield and investment grade widening. U.S. dollar strolled up to the 84.40 level by mid May only to crash into 80.60 by mid June. May 22 saw Fed FOMC minutes that shook equities down, only for deep drops come Bernanke's post FOMC press conference of June 19. That event dramatically dropped equities. All the while, money flowed out of developing currencies, and therefore markets. There interest rates are being cut, while U.S. interest rates increase.
For economic indicators, May saw productivity and cost indicators look better, factory orders (reflecting April) gained 1% against a previous -4.7% loss. Retail sales showed a 4.3% gain year over year with auto sales being important as always with a gain of 1.8% for a second consecutive monthly advance. Industrial production held its own at 0, avoiding more declines. Durable goods orders grew. Interestingly, essentially all Fed regional manufacturing indexes picked up considerably, save for Kansas City, perhaps due to some devastating tornadoes.
Employment advanced with an additional 175,00 jobs versus market expectations of only adding 167,000. But a tenaciously high unemployment rate didn't relent and stayed at 7.6%.
Real source of raising all ships in May is, of course, homes. Existing home sales advanced 12.9% year over year and beat market expectations by 180,000 ending up at 5.18M versus April's 4.97M. This amounted to a highest sales rate since 2009's home purchase stimulus credit. Prices went up 15.4% year over year, perhaps too much, though supply showed a respectable increase over April.
New home sales are similar. Sales of new homes grew in May to 476,000 versus prior month of 466,000 and market expectations of growth at only 460,000. New home supply increased by builders apparently finding additional funding ability to better balance supply with supply going to 4.1 months in May versus 4.0 months in April. Despite a moderate fall of 3.2% in new homes prices in May, perhaps due to elevated pricing, year over year pricing showed a 10.3% gain against April's 14.9%.
Consumer sentiment advanced going from April of 76.4 to May's 83.7, with the market expecting 78.0. Suggestion is increasing home values, people buying homes again and perhaps a more stable jobs market.
Ending Q2, Starting Q3 Data Looks Strong, But Caution Due to Mortgage Rates And Weakened Forward Looking Housing Data
Entering June involved all the dynamics mentioned above, but bolstered by Fed members convincing markets of dovishness. This occurred essentially by June 25, when equities started a climb, after getting spooked on June 19 by Bernanke's remarks . The U.S. dollar started its climb off its bottom on June 19. Meanwhile, between June 17 and 25, the 10 year treasury yield spiked up. Indicated is division in markets and growing weight on dollar and interest rate movements versus a progressively unconvincing rise in equities.
Current economic indicators show optimistic propositions. Employment reveals a gain of 195,000 jobs for the most recent report, demonstrating a three month real advance in numbers. Industrial production is up, along with capacity utilization and manufacturing. Fed regional manufacturing indexes look very good so far with Empire State at a positive 9.46 points and new orders positive though softer than last month at 3.77. Philadelphia Fed Survey is at a strong 19.8 points with new orders a convincing 10.2 positive points.
Threat to what appears to be leading this economic advance is a fall for June, reported in July, of housing starts and permits. Housing starts were an adjusted 928M in May with June coming in lower at 836M, when the market wanted to see an advance of 951M. June's starts to home construction is down 9.9% month over month versus an increase of 8.9% in May. Still, housing starts stay vigorous at a 10.4% increase year over year. Permits for home building also disappointed on July 17th with the report showing June's numbers at 911M versus May's 985M and a market expectation of a high 990M.
Q2's economic rise was Fed money eventually trickling down to real home purchases. All of this was accomplished by banks ensuring strict Basil III reserves while also loaning on mortgages. Consumers became more confident due to rising home values and perhaps stock invested accounts. This dynamic punched through into other indicators of U.S. domestic demand. Result is currently growing strength in domestic demand. This occurs while global demand is weak.
While domestic demand appears to be gaining strength, cause for demand essentially originates out of housing. Unconventional Fed intervention explains advances in housing markets. Increases in demand outside of housing are now only starting and, therefore, do not explain increasing interest rates. A fragile economic environment that hasn't really found broad based support despite Fed intervention probably more so explains rising rates.
Weakness to watch is a fall in housing starts and permits. Caution comes from increasing mortgage rates, bank risk aversion and poor global economic performance. If Q2 trends continue into Q3, hopefully some stable economic growth will take hold.
