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Economy Showing Signs of Weakness

Stock prices were held in check today after yesterday’s gains and money moved into U.S. Treasuries with the release of negative economic data from the Commerce Department. The headlines from Reuters said, “Durable Goods Orders Sink Sharply in April” and “New Home Sales Tumble 11.8 Percent.” Orders for durable goods fell 2.9% while the forecast called for a decline of only 0.2%. Some analysts suggest this is simply a correction from strong sales in February and March, but it is also noteworthy that April was the largest decline since September 2002. The second piece of news showed sales of new homes dropping to an annual rate of 1.093 million units while analysts were forecasting a drop to 1.20 million after the record high of 1.239 million in March. Reuters said, “April’s rate was the lowest level of new home sales since November in what is normally the peak season for real estate sales. The decline – the largest monthly drop since January 1994 – could signal the end of a housing boom fueled by the lowest mortgage interest rates since the early 1960’s.” We clearly have to wonder if the declining trends will continue to show a weaker economy moving forward, or if the numbers for April are just a hiccup in an ongoing recovery. I suspect the economy will weaken unless we can get further stimulus from increased government spending, new tax rebates, and more monetary stimulus from the Federal Reserve.

Another thing that caught my attention regarding new home sales is the rate of decline in sales versus the rate of decline of new housing starts. As reported above, new home sales declined to an annual rate of 1.093 million for April and last week it was reported that new home starts fell 2.1% in April to 1.969 million. The builders will need to cut back significantly or the rate of sales will need to rise again. If the annualized numbers don’t get closer, it looks like the builders will get hung with some large inventories of unsold homes. More supply with less demand also implies lower prices in the future. This should be good news if you are looking to buy a home in the next year or two, especially if you can make a large down payment. Home prices will also be pressured by higher interest rates, but affordability could be affected even more by higher monthly payments. It will just depend on how much money you need to borrow.

On a similar note, the Mortgage Bankers Association said its application index fell 3.3% for the week ending May 21^st, the third consecutive weekly decline. The purchase index fell 1% and refinancing fell 6.7%. The refinancing index is now down a whopping 83% from its all-time high during the last week of May, 2003! Earlier I said the economy could struggle without renewed stimulus from loose fiscal and monetary policies, and the mortgage numbers are telling us we have lost the stimulus from cash-out refinancing.

How About a Golf Day!!

For now, stocks have been getting a bounce from their oversold condition that lasted through most of May. This still smells like massive distribution by institutions and insiders which is normally a precursor to a near-term decline. Corporate insiders have sold over $14 billion worth of stock in the first four months of this year and David Coleman of Vickers Weekly Insider Report says, “We have been tracking insider sales since 1971, and in the last few months they have never been higher.” While the insider “smart money” is dumping stock at the highest rate in over three decades, margin debt by individual investors continues to climb. CBS MarketWatch reported margin balances at Ameritrade have more than doubled to $3.4 billion from $1.5 billion in the past year alone and E-Trade’s clients have pushed their margin debt up 22% over the past quarter ending March 31 and a huge 139% from a year ago to $2.1 billion. The total amount of margin debt held by NASD and NYSE firms was $191.5 billion in March, up from the post-bubble low of $136.1 billion in September 2002. This is the mechanism by which the stock market functions as a wealth redistribution machine. The spin-masters on Wall Street have to talk the market higher any way they can just so they can find willing buyers to make the hand-off. Things could get interesting by the time the current distribution is complete. For today, the Dow Jones Industrial Average lost seven points to close at 10,109, the S&P 500 added one point to 1,114 and the NASDAQ Composite grew by 11 points to close at 1,976.

Overall for the day there was very little movement in percentage terms anywhere in the market. The Dow Industrials’ loss was less than one-tenth of one percent, the NASDAQ gained 0.59%, the 10-year Treasury Note added 0.49%, gold fell 0.10%, silver dropped 0.33%, copper was down 0.08%, the euro gained 0.07%, the yen was up 0.02%, the US dollar fell 0.07%, and crude oil was one of the biggest movers with a loss of $0.51 or 1.24% to close at $40.63 per barrel. Of the 43 broad market indexes and indicators I track on a daily basis between stocks, major currencies, bonds and commodities, there were only seven out of the 43 items with a movement greater than one percent. You get the point…the market was comatose! If you’re a professional in the financial industry and you are looking for a good day to play hooky and hit eighteen holes, treasury auction days are perfect for golf…you won’t miss a thing!

I have said this many times in prior WrapUps, so I will once again refrain from sarcasm by simply saying the US Treasury was busy auctioning another $25 billion of two-year notes today. I can’t remember a time when Treasury auctions were ever disturbed by wild market fluctuations. I also find it provocative to hear of credible terrorist threats with zero detail behind them on a day when it would be really convenient to run for the safety of short-dated treasuries. Could it be a little nudge to stimulate demand for the paper at just the right time? Just a thought.

Watch the Pattern & the Spin

Since I usually write every Wednesday, which happens to be the most common day for auctions, I have made a consistent observation. It seems more obvious when the bigger auctions take place such as the quarterly refunding that usually take place on a Tuesday, Wednesday and Thursday right in the middle of the quarter. The last one happened Tuesday 5/11 through Thursday 5/13. In the weeks prior to the auction we seem to get really positive economic news with new jobs, good sales numbers, and strong growth overall along with worries of inflation. This would cause bond prices to drop making them more desirable as the auction approaches. The markets go into a coma during the debt sales, and then voila!! Like magic we start getting negative economic reports such as weaker job numbers, poor sales for durable goods, bad housing numbers, and threats of potential terrorist attacks that would all be good for bonds, pushing prices higher. The lower yields also work to weaken the dollar. The spin we should start to hear is all about how a lower dollar along with lower interest rates will be good for stocks by improving exports and adding to corporate earnings.

This could certainly be a coincidence, but the pattern seems to repeat on a regular basis. Based on the pattern, it seems to me the investment strategy would be moving into a short bond fund in the weeks leading up to a big auction and flip it to a long bond fund for a couple weeks following the auctions. For confirmation, just listen to the spin in the main-stream media to see if this is truly the case. Predictability within a reasonable degree of certainty is a beautiful thing in this business of money management. I’m not necessarily professing this to be the correct strategy, but watch the pattern to see if you can profit from it.

Spin on Commodities

Lately we have been hearing about all the pressure on commodity prices and specifically building materials due to the booming economy in China. The home building industry here in the US has certainly added some competition for available resources, but there is also added demand from the war efforts. According to the World Affairs Brief by Joel Skousen, “Building materials are also in short supply primarily because of the huge increase in US military purchases of materials heading for Iraq. The US has 14 US military bases under construction in Iraq, plus hundreds of Iraqi reconstruction projects. So, not only is the American taxpayer footing the bill for the war directly, but he is having to pay billions in accumulated higher prices for American products.” We are paying for the bombs and bullets to blow them up, paying to rebuild the destruction and paying for facilities to leave our troops in the desert. It’s too bad we can’t spend the money on more productive purposes here at home.

The other spin we have heard way too much about is the reasons for the higher cost of oil. While oil companies are working at a fever pitch to pump oil out of the ground, our policy makers are working harder to pump a portion of it right back into the ground. We have heard comments from the democrats that Mr. Bush should release oil from the Strategic Petroleum Reserve to help lower the cost of energy products, but there’s more to it than the surface dialogue. I first learned some of the details about the SPR from the World Affairs Brief mentioned above, but out of curiosity I found more information with an internet search.

According to the Pacific Business News in Honolulu, “Oil companies that hold offshore drilling leases on the Gulf of Mexico pay for the leases, not with cash, but by pumping some of the oil they produce into manmade 2,000-foot-deep salt caverns along the Gulf Coast. Each one holds about 10 million barrels of oil and there are 70 of them, so total storage capacity is 700 million barrels. Current volume is 659 million barrels, the most ever.” The Air Transport Association, representing the airline industry, has said, “Don’t drain the SPR, but stop filling them for a while…Since up to 10% of total US oil production goes into the reserves, ATA argues that this alone may be enough to bring oil prices down. ‘We agree that the strategic reserve is an investment in the nation’s future,’ ATA President Jim May said. ‘However, any investor will tell you that you buy low, sell high. Unfortunately, the government is doing just the opposite by accelerating the rate at which it’s filling the SPR at a time when oil prices are sky high.’”

I’d prefer to stay out of politics, so rather than state an opinion I have to say the administration must know an awful lot more about the overall situation than we do. It tells me the war predicament we are in could be worse than we know, since topping-off the SPR is such a big priority with record high prices. The news today of renewed terrorist threats reminded me of an article I received on Saturday via email titled, “Al Qaeda’s Next Strike” by Fred Burton of Stratfor Intelligence. “Concerns over the safety of US citizens are legitimate. Well-placed US government counterterrorism sources have confirmed the presence of Al Qaeda ‘sleeper cells’ within the country.” The article goes on to detail potential terrorist plans to attack America’s oil infrastructure in Houston, Texas or possible attacks on oil platforms in the Gulf or supertankers in Houston’s shipping lanes similar to the attack on the USS Cole with a rubber boat filled with explosives. I suppose I mention this, because it ties in with the building of the Strategic Petroleum Reserve and also because I didn’t really consider these types of threats, but anything is possible. It’s not easy to connect all the dots.

This is not all the warm-fuzzy news we want to hear, but I suspect these are real concerns. If we get a large event as some analysts suggest, the stock market will suffer. It’s probably wise to follow the lead of all the “insider” sellers, and take some profits out of the stock market. These are troubled times we live in. Better to be safe than sorry.

That’s it for today…

Mike Hartman

Chart courtesy of StockCharts.com

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