Despite technology weakness, stocks finished the week mildly higher. For the week, the Dow gained 0.6% and S&P500 gained 0.5%. The Transports added 1.1%, while Utilities rose 1.7%. The Morgan Stanley Cyclical index gained 1.4% and the Morgan Stanley Consumer index added 1.1%. The broader market performed well, as the small cap Russell 2000 and S&P400 Mid-cap indices rose 0.8%. Technology stocks faltered, led by the semiconductors. For the week, the NASDAQ100 fell 1.2% and the Morgan Stanley High Tech index dropped 1.7%. The semiconductors dropped 6.4% for the week. The Street.com Internet Index fell 0.9% and the NASDAQ Telecommunications index retreated 1.2%. The Biotechs were off 0.7%. Financial stocks were mixed, as the Broker/Dealers declined 1.7%, while the banks were slightly positive. With bullion sinking $2.75, the HUI index declined 0.7%.
Today's drubbing took some wind out of the Treasury market's sails. For the week, 2-year Treasury yields rose 8 basis points to 2.57%. Five-year Treasury yields were up 7 basis points to 3.49%. Ten-year yields added 6 basis points to 4.28%. Long-bond yields ended the week at 5.05%, up 4 basis points on the week. Benchmark Fannie Mae MBS yields added 3 basis points, relatively in line with Treasuries. The spread (to 10-year Treasuries) on Fannie's 4 3/8% 2013 note widened 1 to 32, and the spread on Freddie's 4 ½ 2013 note was about unchanged at 30. The 10-year dollar swap spread added 1.5 to 47.75. Corporate bond spreads were again little changed for the week and continue to perform well. The implied yield on 3-month December Eurodollars jumped 10 basis points to a one-month high 2.315%.
September 3 - Bloomberg (David Russell): "Procter & Gamble Co. and SBC Communications Inc. led borrowers of almost $39 billion in the U.S. last month, the most in an August since 2001, as companies took advantage of a drop in borrowing costs to four-month lows."
Corporate debt issuance was virtually nonexistent this week. Investment grade issuers included Metlife $450 million.
Junk bond funds reported inflows of $269 million for the week (from AMG), with two-week inflows a notable $533 million.
September 3 - Bloomberg (Eddie Baeb): "Municipal bond mutual funds had their first week of cash inflow from investors since March as returns improved because concern has lessened that that Federal Reserve will raise interest rates rapidly. Municipal bond funds had net inflows of $91 million for the week...(from) AMG... after 22 weeks of consecutive outflows when investors pulled a cumulative $9.46 billion out of municipal bond funds."
September 2 - Bloomberg (Ed Leefeldt): "Bank of America Corp. is among lenders seeking investors for $9.75 billion in financing for General Growth Properties amid record demand for high-risk, high-yield loans in the U.S. General Growth Properties, the second-largest owner of shopping malls, is borrowing to fund its $7.2 billion purchase of the Rouse Co. and to refinance existing debt."
Japanese 10-year JGB yields declined 3 basis points to 1.54%. Brazilian benchmark bond yields declined 7 basis points to 9.42%. Mexican govt. yields dropped 5 basis points this week to 5.39%. Russian 10-year Eurobond yields added one basis point to 6.27%.
Freddie Mac posted 30-year fixed mortgage rates declined 5 basis points this week to 5.77%. This is the lowest level since the first week of April and down 67 basis points from one year ago. Fifteen-year fixed mortgage rates were down 6 basis points to 5.15%. One-year adjustable-rate mortgages could be had at 3.97%, down 8 basis points for the week to the lowest level in 14 weeks. The Mortgage Bankers Association Purchase application index was about unchanged last week. Purchase applications were up 12% from one year ago, with dollar volume up 28%. Refi applications dipped 1%. The average Purchase mortgage was for $215,900, and the average ARM was $293,500. ARMs accounted for 33.1% of applications last week.
Broad money supply (M3) surged $36.5 billion (week of August 23). Year-to-date (34 weeks), broad money is up $496.9 billion, or 8.6% annualized. For the week, Currency added $1.3 billion. Demand & Checkable Deposits jumped $18.3 billion. Savings Deposits declined $10.4 billion. Saving Deposits have expanded $267.9 billion so far this year (13% annualized). Small Denominated Deposits gained $0.8 billion. Retail Money Fund deposits rose $4.3 billion. Institutional Money Fund deposits increased $4.8 billion. Large Denominated Deposits rose $9.3 billion, increasing at a 26% rate so far this year. Repurchase Agreements gained $6.1 billion, while Eurodollar deposits added $2.1 billion.
Bank Credit expanded $15.7 billion for the week of August 25 to $6.61 Trillion. Bank Credit has expanded $336.8 billion during the first 34 weeks of the year, or 8.2% annualized. Securities holdings declined $7.1 billion, while Loans & Leases jumped $22.8 billion. Commercial & Industrial loans gained $4.9 billion, while Real Estate loans added $0.5 billion. Real Estate loans are up $190.1 billion y-t-d, or 13.0% annualized. Consumer loans rose $4.1 billion for the week, while Securities loans added $2.2 billion. Other loans declined $1.3 billion. Elsewhere, Total Commercial Paper rose $2.3 billion to $1.363 Trillion (up $13.6bn over 2 weeks). Financial CP gained $3.3 billion to $1.234 Trillion, expanding at a 9.4% rate thus far this year to the highest level since May 2001. Non-financial CP dipped $1.0 billion (up 28.1% annualized y-t-d). Year-to-date, Total CP is up $94 billion, or 11.0% annualized.
Year-to-date ABS issuance increased to $401.2 billion, 39% ahead of comparable 2003. Year-to-date Home Equity ABS issuance of $248.8 billion is running 82% above a year ago.
Fed Foreign "Custody" Holdings of Treasury, Agency Debt rose $4.9 billion to $1.283 Trillion. Year-to-date, Custody Holdings are up $215.9 billion, or 30% annualized. Federal Reserve Credit jumped almost $9 billion last week to $764 billion, raising y-t-d gains to $17.5 billion (3.5% annualized).
Today's nearly 1% gain took the dollar index back to almost even for another volatile week in the currency markets. The South African rand gained 2%, while the Canadian dollar and Brazilian real increased 1% against the dollar. On the downside, the Australian dollar declined 1.7% and the New Zealand dollar 1%, while the Mexican peso and British pound dipped nearly 1%.
It was another wild week in commodity trading. But despite today's decline, the CRB jumped 1.2% this week, increasing y-t-d gains to 7.1%. With October crude gaining 81 cents to $43.99, the Goldman Sachs Commodities index added 0.5% (year-to-date gains of 15.2%).
September 3 - Bloomberg (Wing-Gar Cheng): "China's economy may grow 9 percent in the third quarter, the Ministry of Commerce said, slowing from the previous three months as government efforts to curb lending to industries such as steel and cement take effect. The world's seventh-largest economy, which expanded at a 9.6 percent rate in the second quarter, is still growing at a 'fast pace,' the ministry said..."
August 30 - Bloomberg (Amit Prakash): "Chinese demand for commodities, including coal and steel, pushed global shipping prices to a four-month high, signaling that government-imposed lending limits aren't abruptly slowing China's economy. The Baltic Dry Index, which measures the cost of shipping coal, iron ore and other raw materials globally, has risen 61 percent since June 22. China will account for 36 percent of this year's worldwide demand for iron ore, the main raw ingredient in steel..."
August 30 - XFN: "China is expected to invest a massive 4.64 trillion yuan in the power sector by 2010 to boost installed generating capacity and to resolve a critical energy shortage, the official Xinhua news agency reported. The official news agency, citing Wang Yonggan, the general secretary of the China Electricity Council, said that the nation is expected to spend an average 658.8 billion yuan a year between 2003 and 2010, with investment growing at an annual rate of 25%."
August 30 - Bloomberg (Allen T. Cheng): "China's stockpile of automobiles rose to a record last month, the Worker's Daily reported, citing a study from the China Automobile Industry Association. The number of unsold cars held by automakers and dealers was more than 620,000 at the end of July..."
Asia Inflation Watch:
September 3 - Bloomberg (Theresa Tang): "Taiwan's foreign-currency reserves, the third-highest in the world, rose in August for the 38th month to a record $231.6 billion, the central bank said. The reserves, which rank behind those of Japan and China, rose 0.5 percent from $230.4 billion in July..."
September 1 - Bloomberg (Joshua Fellman): "Hong Kong-based toy manufacturers are facing 'heavy monetary losses' because of rising raw materials prices and shortages of labor and electricity at their factories in China, according to industry association officials. The prices of common plastic raw materials used to make toys have risen more than 30 percent in about the past month, after most toy orders were placed earlier in the year, Hong Kong Toys Council Chairman Samson Chan said..."
September 1 - UPI: "South Korea's consumer prices in August climbed 4.8 percent year-on-year, reaching a 37-month high, a government report said... The sharp increase is raising concerns about stagflation as consumer price hikes accompany a stagnant economy. The August consumer price index was 4.8 percent higher than a year earlier, the biggest rise since the year preceding July 2001..."
August 31 - Bloomberg (Anuchit Nguyen): "Thailand's factory production grew more than expected in July as electronics manufacturers boosted production to meet rising overseas orders. Manufacturing production expanded 9.3 percent from a year earlier, faster than June's revised 9.2 percent increase..."
August 30 - UPI: "The Philippines economy expanded 6.2 percent in the second quarter, slightly above the government's target of 6.0 percent. Romulo Virola of the National Statistical Coordination Board said Monday the economy was boosted by growth in personal consumption and the services sector. Personal consumption jumped 6.0 percent while services rose 7.3 percent..."
September 2 - Bloomberg (Stephanie Phang): "Malaysia's exports unexpectedly accelerated in July as manufacturers such as Unisem (M) Bhd. shipped more computer chips and other electrical and electronics goods to the U.S., Asia and Europe. Stocks rose. Exports surged 29 percent from a year earlier to 42.63 billion ringgit ($11 billion), the quickest pace in seven months..."
September 3 - Bloomberg (Cherian Thomas): "India's inflation rate accelerated for a fourth week in five as food prices rose and increasing fuel costs pushed up prices of manufactured goods, intensifying pressure on the central bank to raise interest rates. Wholesale prices rose 8.17 percent from a year earlier...up from a 7.94 percent gain in the previous week and the biggest increase since Feb. 17, 2001 ..."
September 1 - Bloomberg (Kartik Goyal): "India's tax revenue rose 20 percent in the first four months of the fiscal year from a year earlier as companies increased production, boosting incomes, the Controller General of Accounts said..."
August 30 - Bloomberg (Gautam Chakravorthy): "India's central bank expects bank loans to expand by as much as 16.5 percent in the year to March 31, 2005, on increased demand for credit to fund public works such as roads and electricity plants. 'The industrial recovery currently underway has been broad-based and qualitatively robust,' the Reserve Bank of India said in its annual assessment of the economy."
Global Reflation Watch:
August 31 - Bloomberg (Greg Quinn): "Canada's economic growth accelerated to a 4.3 percent annual rate in the second quarter, the fastest in two years, and the government increased its estimate of expansion in the first three months of the year. Surging exports pushed Canada's gross domestic product, the sum of goods and services produced by the world's eighth-largest economy, to an annualized C$1.12 trillion ($851 billion) between April and June..."
September 2 - Dow Jones: "European securitization is on track for another record year, after six months of record activity in the asset-backed market. Issuance of securitized debt reached EUR125.6 billion in the first half of the year, easily outstripping 2003's EUR95.1 billion total by 32.2%, the European Securitization Forum said Thursday."
September 1 - MarketNews: "Home construction in France remained buoyant in July, as three-month housing starts posted a 15.1% rise on the year, while permits for the same period were up 23.5%, according to non-seasonally adjusted data released Tuesday by the Construction Ministry. For the month of July alone, starts were up 14.2% on the year..."
August 31 - Bloomberg (Fergal O'Brien): "Irish mortgage lending growth rose at a record annual pace in July, as the lowest borrowing costs in 50 years boosts demand for property... Mortgage lending grew an annual 31.7 percent in July compared with 27.3 percent in June, Ireland's central bank said..."
August 31 - Bloomberg (Gonzalo Vina): "U.K. home loans rose at their slowest pace in almost a year in July and fewer mortgages were approved than at any time since November 2000, suggesting higher borrowing costs are beginning to damp the housing market."
September 3 - Bloomberg (Sam Fleming): "U.K. house prices fell for the first time in two years in August, HBOS Plc said, indicating that five interest-rate increases since November are beginning to damp property demand. House prices fell 0.6 percent from July, the first drop since August 2002, leaving the price of an average house at 160,565 pounds ($286,921), according to the U.K.'s biggest mortgage lender."
September 1 - Bloomberg (Mark Bentley): "Turkey's exports increased 22 percent in August from a year earlier, the Turkish Exporters' Association said... The country had exports of $4.7 billion in the month... Exports for the January-August period jumped 34 percent from 2003 to about $40 billion."
August 31 - Bloomberg (Romina Nicaretta): "Brazil's economy expanded at its fastest pace in almost eight years in the second quarter... Gross domestic product, the broadest measure of a country's production of goods and services, grew 5.7 percent from a year earlier after expanding 2.7 percent in the first quarter, the government said."
August 31 - Bloomberg (Guillermo Parra-Bernal and Katia Cortes): "Brazilian President Luiz Inacio Lula da Silva will ask lawmakers to increase spending by 15 percent next year to pay for higher state wages, road construction and new schools and hospitals, Planning Minister Guido Mantega said."
U.S. Bubble Economy Watch:
September 2 - Bloomberg (James Kraus): "Starbucks Corp., the largest U.S. coffee-shop chain, plans to raise its prices for the first time in four years to cover higher rent, health insurance costs and higher milk prices, the Wall Street Journal reported, citing chairman Howard Schultz."
September 2 - UPI: "Texans like to say everything is bigger in their state, and when it comes to monthly car and truck payments, they're correct. Houston and Dallas lead the country in the size of auto loans and payments, averaging $441 in Houston and $424 in Dallas, according to a review of 3 million consumer profiles by Experian Consumer Direct."
September 3 - Bloomberg (Dianne Finch): "Massachusetts tax receipts reached $1.19 billion in August, an increase of 9.4 percent from a year earlier and $16 million more than budget forecasts, the Boston Herald reported. Income tax receipts rose 8 percent to $650 million and sales tax receipts increased 7 percent to $334 million, the newspaper reported."
Personal Income was up a weak 0.1% for the month of July, although Compensation was up 0.4% (Transfer Payments down 0.8%, Proprietors Income down 0.5% and Rental Income down 0.6%). Yet Personal Income is up 4.9% y-o-y. This compares to July 2003's 3.1% y-o-y increase, 2002's 1.9% y-o-y rise, and 2001's 2.8%. Personal Spending was up a notable 0.8% during July, with a year-over-year gain of 5.9%.
Mortgage Finance Bubble Watch:
September 2 - Dow Jones (Christine Richard and David Feldheim): "Given the boom in mortgage funding on Wall Street, it was only a matter of time before negative amortization mortgages made a reappearance. Considered one of the most aggressive loan structures on the market, these loans currently are being made in sufficient numbers to back billion dollar-plus securitized bond transactions. This week, Pasadena, Calif.-based IndyMac Bancorp, Inc. completed the sale of $1.2 billion in bonds backed by negative amortization mortgages, and ...Washington Mutual, Inc. sold $1.25 billion in bonds backed by such loans. ...Countrywide Financial Corp. included some negative amortization mortgages in two mortgage securitizations sold in recent weeks totaling $4.5 billion."
September 3 - Bloomberg (James Tyson): "Former Freddie Mac Chief Executive Leland Brendsel urged a judge not to delay release of more than $50 million in compensation withheld during a probe into a $5 billion earnings restatement by the mortgage-finance company. A prolonged freeze on Brendsel's assets would prevent him from selling his Freddie Mac stock and expose him to losses from a possible fall in the share price, Brendsel said in a filing in the U.S. District Court in Washington."
July Construction Spending was reported at a record annualized rate of $997 billion. Year-to-date, Construction Spending is running 8% ahead of last year's record. Total spending was up 9.7% from July 2003. Spending on Residential construction was up 13.9% from one year earlier and was up 26% from July 2002. Nonresidential spending was up 5% y-o-y, with Healthcare up 16.3%, lodging 12.9%, and Power 16.8%. Nonresidential Spending for Public Safety declined 8.5%, Conservation down 6.4%, and Communication down 3.5%.
"OFHEO House Price Index Shows Largest One Year Increase Since 1970's:" "Average U.S. home prices increased 9.36 percent from the second quarter of 2003 through the second quarter of 2004," the strongest rise since inflationary year 1979. Second quarter inflation of 2.21% was up from the first quarter's 1.45%, while the 5-year national gain increased to 43.59%. "The House Price Index is based on transactions involving conforming, conventional mortgages purchases or securitized by Fannie Mae or Freddie Mac... The conforming limit for single-family homes in 2004 is $333,700." It is worth noting that this methodology misses much of the housing inflation in California (up 4.85% for the quarter and 18.39% y-o-y), especially throughout Southern CA. Still, consequences of the California housing Bubble are apparent in neighboring Nevada's (#1 state price gains) 7.53% second quarter price gain (22.92% over one year; 53.06% over 5 years). Even Oregon (up 2.38% for the quarter) and Washington (2.43%), states underperforming economically, posted strong price gains. Also benefiting, prices in Arizona were up 2.61% for the quarter and 1.84% in New Mexico.
Following Nevada, Hawaii was number two at an 18.9% 12-month gain. California was third, followed by Rhode Island's 17.86% rise. The comes the District of Columbia (16.07%), Maryland (15.4%), Florida (14.23%), New Jersey (12.75%), Virginia (12.21%), Maine (12.01%), Vermont (11.78%), Delaware (11.52%), New York (10.95%), Connecticut (10.7%), New Hampshire (10.39%) and Massachusetts (9.79%).
Still the Financial Market "Horse" and Economy "Cart"?
I apologize, but an unavoidable time constraint today has made this an especially feeble "holiday edition" CBB. But, then again, for the long weekend there are better uses of one's time than reading a rambling Bulletin.
Curiously, an apparent slowdown in economic growth has had minimal impact on economically-sensitive stocks. The Dow Jones Transportation Average has posted a nearly 5% y-t-d gain. The S&P Homebuilding index is up 9% y-t-d and the S&P Retailing index has gained 6%. The Morgan Stanley Cyclical index has a 2004 gain of better than 2%. Why are stocks resilient in the face of disappointing economic news? Well, I will argue that financial markets continue to act as the "horse" and the economy the "cart." Despite today's backup in rates, ten-year government bond yields are almost 50 basis points below highs from three months ago. Mortgage borrowing costs have sunk right back to quite attractive levels, and it is not unreasonable to expect mortgage Credit growth to continue to surprise on the upside.
Today's employment report and upward revisions suggests the economy is not slowing significantly. Prior to February's gain, manufacturing jobs had been lost for 42 consecutive weeks. Over this period, manufacturing payrolls had declined by over 3 million. This year, manufacturing has gained jobs in 6 of 8 months, although only 97,000 have been added to manufacturing payrolls. It is also worth noting that August's 144,000 payroll increase compares to a decline of 25,000 from one year ago, 11,000 added during August 2002, 141,000 lost during August 2001, and 28,000 added during August 2000.
And although the 144,000 increase in non-farm payrolls was about in line with expectations, hypersensitive financial markets (ex-equities) nonetheless responded as if there was some big surprise. Ten-year Treasury yields jumped 16 basis points, the euro and other major currencies dropped better than 1%, gold sank $6, and commodities were hammered. I would argue that the payroll data was especially important to the markets, not for what is suggested about the economy but rather for what it conveyed about near-term financial stability. Until some type of development reins in Credit system excess, the financial "horse" appears determined to drag the "cart" along for the ride.
I have attempted to develop analysis that "Trouble at the Core" has fostered an historic episode of Monetary Disorder. My thinking is that Mortgage Finance Bubble "blow-off" excesses and requisite massive foreign central bank ballooning of dollar reserves have created quite powerful and unusual dynamics. For one, liquidity excess emanating from The Core has over-liquefied the Periphery (globally and domestically). Moreover, it appears at this point that even heightened stress at The Core tends only to exacerbate this dynamic (flows to the Periphery). It was certainly a curious situation today when a meaningful U.S. bond market decline was met with yawns throughout the emerging markets. It was not that long ago that emerging bonds would have been hammered on a day like today.
And this line of analysis turns only more challenging when it comes to examining Financial Fragility. On the one hand, since financial excesses today primarily emanate from "triple-A" agency securities, ABS, MBS, and Wall Street "structured products" financing inflating real estate assets, there has been to this point an unparalleled Stability of Monetary Disorder (basically unlimited demand for "money-like" Credit instruments - whereby the financial sector in concert with foreign central banks create demand/liquidity for self-sustaining expansion). On the other hand, the dynamics of "blow-off" excess are unstable, dangerous, and unpredictable in the near-term. In this regard, one can look to manic borrowing and home buying in California, along with the leveraging of the REITs and speculators for evidence of precarious "blow-off" dynamics. A strong case can be made that NASDAQ1999-style excesses (financial and economic) have taken firm hold throughout mortgage finance.
But I will make one more attempt at using this "Trouble at the Core" analytical framework to help explain the current market environment. First of all, Mortgage Finance Bubble excess entails unprecedented Credit creation, with attendant risk intermediation and speculative leveraging. The Great Mortgage Spread Trade (shorting Treasuries or borrowing short-term to speculate in higher-yielding mortgage assets) has created acute market distortions, including a massive short position in Treasuries. There has been, as well, a massive creation and transfer of risk to highly leveraged players that rely predominantly on the derivatives market for interest-rate hedging. As the same time, dollar liquidity excesses (trade deficits combined with speculative outflows) necessitate huge foreign official Treasury and agency debt purchases. The end result is an upward bias in the Treasury market ("inflationary bias") that tends to anchor mortgage borrowing costs at an artificially low (and stimulating) level.
As we have witnessed over the past few months, the bond market is sensitive to weaker economic data. Even after the past two days bond sell-off, 10-year Treasury yields are significantly below June highs. Importantly, the bond market rally has exacerbated Mortgage Finance Bubble "blow-off" excess. The environment has added significantly to financial fragility - greater quantities of increasingly risky loans, more speculative leveraging, and heightened systemic leverage, risk intermediation and more vulnerable debt structures. And, in the process, dollar vulnerability has become more acute, although market dynamics also dictate that an abrupt dollar short-squeeze could develop at any time.
The defining feature of contemporary finance is the capacity for the unlimited expansion of perceived money-like dollar Credit instruments. In the process, there are three distinct financial risks created: interest-rate, dollar, and Credit. And while Credit risks are held at bay during this ongoing period of "blow-off" excess and real estate inflation, interest-rate and dollar risks are today prominent. Clearly, massive derivative protection has been acquired, and this "insurance" market now plays an instrumental role in interest-rate and currency market trading dynamics. It is this situation that creates such unsettled trading conditions. This type of environment works as a war of attrition for traders and speculators, with marketplace liquidity suffering along the way.
And while today's employment data was generally "in-line" with expectations, the absence of economic weakness necessitated a reversal of risk hedges. The bond market was under meaningful selling pressure, as were foreign currencies. Market yields rose, along with the dollar. And with a stronger dollar, commodities were under selling pressure. And so goes another week in the world of speculative finance, with trading becoming only further detached from underlying fundamentals.
I believe it was last week that I made reference to the issue "how long market ebb and flow can hold market dislocation at bay?" To be more precise in my analysis, I believe the current Credit Bubble "blow-off" has created an untenable expansion in interest-rate, dollar and Credit risk. Much of this risk now resides in ballooning derivative markets and is "managed" through unsound dynamic trading strategies. At this point, huge buy or sell programs will exacerbate market moves either up or down, especially in the interest-rate and currency markets. But we also know that unprecedented foreign central bank purchases have acted to contain dollar and bond market declines. This exacerbates Credit excess and market risks (interest-rate, dollar, Credit), fostering only greater derivative hedging.
Watching the recent market environment, I am reminded of the 18 months preceding the Argentina financial crisis. There was no doubt in my mind that the Argentine Credit system had become acutely fragile - with an untenable currency derivatives/hedging marketplace. Credit and speculative excess had inflicted great vulnerability upon the financial system and severe structural distortions to the real economy. At the same time, it was impossible to predict how long the authorities and financial players could hold crisis at bay by sustaining excesses. Throughout, very few appreciated either the market dynamics involved or the acute financial and economic fragility that had developed. With so much at risk, extraordinary measures were taken to sustain the boom, support its currency system, and ward off bust. But it was all for not. Indeed, a very strong case could be made that postponing the unavoidable financial and dislocation added greatly to the severity of the Argentine bust. The nature of current U.S. excesses and maladjustment far exceed those that buried Argentina. But, for now, it does seem to be a question of how long the U.S. Financial Sector "Horse" can drag along the Economic "Cart."