Momentary exuberance?

Highlights

The markets saw dramatic movements last week. US Stocks extended losses on Tuesday sending the Dow below the psychologically critical 10,000 price mark for the first time in 2010. This was after a bigger than expected slump in home sales fuelled concerns that the economy may head back into a recession. Fears accentuated after S&P cut the sovereign Ireland rating one notch down to AA- with a negative outlook on concerns that the cost of supporting its banks is rising at a fast pace. US 10y yields slid to the lowest since 2009, below 2.5% at one time after the durable goods report showed a worse than expected print. Bunds advanced even after German business confidence unexpectedly rose in August.

The dismal week turned upside down after Bernanke’s speech at Jackson Hole. The S&P reacted with a 1.6% jump on Friday closing above 10,150. The 10y Treasury yield selling off dramatically to near 2.64%. Chairman Bernanke assured the markets that the Fed intends to do “all it can” to ensure a US recovery.

Is this the “I get knocked down, but I get up again” phase or is it just a “momentary lapse of reason.”

Bear Roubini, Bull Bernanke

Nouriel Roubini, the New York University economist who predicted the global financial crisis, said U.S. growth will be “well below” 1 percent in the third quarter and put the odds of a renewed recession at 40 percent.

“With growth at a stall speed of 1 percent or below, the stock markets could sharply correct, and credit spreads and interbank spreads widen while global risk aversion sharply increases,” he said. “Thus a negative feedback loop between the real economy and the risky asset prices can easily then tip the economy into a formal double-dip,” he said, referring to two recessions in a quick succession.

Bernanke, on the other hand expressed confidence in the Fed’s ammunition to handle a double dip possibility. “The issue at this stage is not whether we have the tools to help support economic activity and guard against disinflation. We do,” Bernanke said in a speech at the Fed’s annual conference in Jackson Hole, Wyoming, detailing choices that include renewed large-scale securities purchases.

Economics

Purchases of existing homes plunged 27.2 percent to a 3.83 million annual rate, figures from the National Association of Realtors showed today in Washington. The pace compares with the median forecast of a 4.65 million rate, according to a Bloomberg News survey.

The revised forecast for Q2 GDP came in slightly better than expectations of 1.3% but plummeted to 1.6% vs. the previous estimate of 2.4%. “It’s bad…but we were prepared for worse”, was the feeling in the market.

What’s behind the home sales data?

Sales of previously-owned homes, after a good run in March and April, slid in June before crashing in July. Sales last month were down 26% from one year earlier and 27% from June.

I suspect a large portion of this drop is due to the ending of Home-buyer tax credit of $8,000 in April. Clearly, temporary tax credits succeeded in getting buyers to change their behavior. But once the tax credits disappeared, so did the buyers. There is no reason to have signed a contract in May and not in April when you could have gotten an $8,000 tax credit.

What’s less clear is whether stimulus has done anything else to change demand. While mortgage rates continue to fall every week into record territory, the expiration of tax credits shows that housing demand is not much better than it was 18 months ago, when the market was in freefall.

Sure markets were to slide for a couple of months (May and June) after tax credit were finished. But the plummet of July certainly points to lack of structural demand. How long before we say that it not ONLY the lifting of tax credit that has caused demand to fall? I guess may be a month more….max!