It’s almost over. Just one more week before we close the books on a truly awful year. Based on the market action of the last several weeks, it is easy to conclude that many investors have already called it a year. The Christmas shortened trading week was again a fairly boring affair that has become all too familiar lately. The stock market averages were down slightly for the week as volatility continued to subside and the economic news was again, as expected, lousy. There were glimmers of hope in some of the economic data, but one had to dig deep to find them.
The Dow closed the week down 0.74% and the S&P 500 fell 1.29%. The volatility index fell slightly, continuing a trend that started in late October:
The VIX is generally used as a contrary indicator. During the great bull market that started in 1982, almost any reading above 30 had the bulls coming back to the party. There were some exceptions such as the ‘87 crash that saw the VIX peak over 100, but even that episode was over relatively quickly.
The same can’t be said for this spike which has now spent 3 months and counting over the 30 level. Will it fall back to more normal levels in the New Year? I have my doubts. While many claim some comfort from the diversity of opinions apparent in President elect Obama’s cabinet choices, I think it will just add to the uncertainty surrounding future policy. Will Obama heed the advice of Christina Romer, who with her husband David authored a paper on tax policy that concluded:
The resulting estimates indicate that tax increases are highly contractionary. The effects are strongly significant, highly robust, and much larger than those obtained using broader measures of tax changes. The large effect stems in considerable part from a powerful negative effect of tax increases on investment.
Or will he be more attentive to Carole Browner who is itching to impose a cap and trade system that is nothing more than a disguised carbon tax? I suppose it is possible that he embraces both and enacts cap and trade and offsets it with tax cuts elsewhere, but I have my doubts. And those doubts are shared by everyone in the market. Until there is some clarity on domestic policy, the volatility is likely to continue.
The economic data released this week was again weak, although some encouraging signs could be found. New home sales were down 2.9% month to month and 35% year over year. On the bright side, inventories continued to fall. Existing home sales were also down, falling 8.6% in November. The median price fell to its lowest level since 2004. That sounds bad but actually means that we are closer to the bottom. Sales are rising in the so called “sand states” where prices have fallen the most.
Personal income and outlays were also down in November with income falling 0.2% and consumption falling 0.6%. The good news is that real (adjusted for inflation) income and consumption were actually up 1% and 0.6% respectively. Falling prices are not a bad thing. That’s the first rise in real spending since May. The savings rate continued to rise as well, up to 2.8%. Unfortunately, it looks like spending fell further in December. Master card reported that sales fell 8% in December despite big price cuts.
In other economic news, jobless claims rose again. I expect the December jobs report to be very ugly. Durable goods orders fell 1%, but that was a lot better than last month which was distorted by the Boeing (BA) strike. There was actually quite a bit of good news in the report:
- Excluding transportation new orders were up 1.2%
- Machinery new orders were up 4.1%
- Computer and electronic equipment new orders were up 5.9%
- Computer and related equipment new orders were up 12%
- Capital goods new orders were up 0.2%
- Non defense capital goods excluding aircraft new orders were up 4.7%
On the other hand, inventories rose by 0.5%. That is now 16 of the last 17 months where inventories have risen. With inventories at their highest level since 1992, a rise in orders may not translate into increased producion.
The trend in gold and the dollar continued this week. Gold managed to close the week over its 200 day moving average:
The Euro rose slightly against the dollar:
An emerging trend I’ve been tracking is the mortgage REIT market. With the Fed announcing its intention to purchase large quantities of mortgages in the new year, traders have been getting ahead of that future demand. The mortgage REIT ETF from iShares (REM) has rallied off its lows and looks set for further gains.
The largest holding in the fund is Annaly Capital (NLY):
Mortgage rates are falling and applications are soaring. The Mortgage Bankers Association reported that its mortgage application index rose 48% last week. The vast majority of those applications were for refinancing, but even purchase applications rose 10.6%. Mortgage rates have fallen to about 5%. I have some mixed feelings about this. On the one hand, it is obviously good that rates have fallen. That will allow some homeowners to refinance at lower rates and increase their purchasing power. It also helps to lower the cost of buying and that could go a long way toward reducing the inventory overhang. On the other hand, it is hard to forget that artificially low interest rates played a large role in the housing bubble that got us in this mess to begin with.
We will usher in a new year next week and while things are far from normal, some improvement has been seen. Corporate and high yield bonds have risen off their lows. Municipal bonds have recovered from the depths of October. Stocks seem able to absorb the bad economic news. Here’s hoping the momentum carries over to the New Year!
Disclosure: Alhambra Investment Management has positions in IAU (iShares gold index), REM (iShares Mortgage REIT index) and NLY (Annaly Capital).