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January 25, 2013 - What is Driving Stocks Higher? - By Zacks Investment Research
Stock market investing these days is more like fishing in an aquarium than baiting the hooks out on the vast seas.
Because investing success happens more because the aquarium's caretaker (aka the Fed) wants you to succeed, and less because your positions were sharply chosen. The Fed feeds mortgage and treasury markets money each month to make sure stock prices grow and you keep invested.
This article shows you a little how that process worked in January.
Unemployment Claims -- Lower than Expected in Mid-January
Last week's unemployment claims recorded a low of 335,000, a full 10% lower than what the market was looking for. This represented a five-year low for claims -- good news for the U.S. economy. Companies work on a budget cycle, and January is a good hiring month.
The stock market has been seeing the jobs market and economy improvements coming, as stock prices have been going up for some time.
There is evidence of an improvement in the economy coming from this claims number. But broad improvement takes time for the fuller process to work. Unemployment is a lagging indicator. Its full effect should take place in a few months. Income from the freshly employed needs to come in the door; time must pass to pay down debts from the unemployment period; and for them to regain confidence. Getting a job also takes the worker off the state's unemployment claims budget; another benefit to the macro economy.
We think the decrease in claims is helped by a rise in housing starts.
Housing Starts - Strength in December
Housing strength is one good reason to explain why job losses are coming down. A boom-let in housing often helps smaller outfits. Buying, furnishing and remodeling a home is a domestic, locally-driven exercise. Housing activity makes the overall pie larger, because of these local idiosyncrasies.
There has been no strong macro recovery without a housing recovery taking root. The stock market is betting on this continuing. That is why we are seeing new 5-year highs on the stock market.
Private home starts and permits for December 2012 came out last week too. They were +30% stronger than last year at this time, which meant they were +200,000 units above last year. Permits were up +33% for the Midwest region. All of this is good news for both the regional Midwest and the national economies.
Housing activity is filling in the gaps in employment. We saw 903,000 permits issued, well above the 700,000 of last year. Further down the construction chain, we saw 954,000 housing starts, well above the consensus for 890,000 starts.
A major key to recovery here? -- The overall price structure in houses is starting to appreciate.
A price appraisal, for the first time in years, will show that a person is going to be able to profitably sell their house in a year or two.
What also helps housing starts are low mortgage rates, while housing helps bring the jobs back to the U.S. economy. Could housing starts fall back? We think the answer is "No". Not unless we see 2.5% to 3.0% interest rates arrive on the 10-year U.S. Treasury bonds too fast. Mortgage rates set up 1.5% above these rates.
In turn, mortgage servicers are one of the highest Zacks Ranked Industries.
Refreshing the Strength -- the Fed Buys $85 billion in Bonds Each Month
Don't forget this is happening. If Fed bond buying each month continues at its current rate, its balance sheet will swell to $3 trillion by the end of 2013, and $4 trillion in 2014. Mortgage rates are falling or stabilizing, in turn, which means more home building and more construction jobs. We, and the Fed, hope this ends in an economy with 6.5% unemployment. At this rate, the U.S. economy is knocking -0.5% a year in unemployment right now. That means we are a couple years away from getting there, since we are at 7.8% unemployment now.
What is supporting the housing and jobs recovery is Fed and ECB bond buying - This could lead to a hair trigger response, where the market dumps bonds very quickly once it stops.
Remember as you invest in these markets, the Fed's positions in Treasury and mortgage-backed securities are huge. There really isn't much of a competitive bond market. Concentration can counter worry on market price movement. In other words, the Fed is monopolizing these markets. New issuance is 80% to 90% Fed purchasing, and there is no limit to the balance sheet they can raise.
Does the Fed have the ability to pull back without disaster? We shall see. Our neutral view says two years out is where that tight moment could happen.
What To Do Next?
Today's overall economic picture is improving. But that doesn't mean that ALL stocks will follow suit. The good news is that our proven Zacks Rank stock-rating system allows you to focus in on the top 5% of stocks set to outperform. Then our experts narrow down that list of top picks to zero in on the best recommendations.