Market focus on the economy can turn on a dime.  Last week, market attention was on the consumer with the decline in consumer sentiment.  That all turned around this week with more positive news net on housing as equity traders’ glum mood turned into moderate optimism that a housing recovery has already begun, with the economy in tow.  A cold, hard look at the housing fundamentals and overall economic data suggests that the truth is somewhere in between.

Recap of US Markets

STOCKS

The week started out looking very ugly as the prior Friday’s drop in consumer sentiment left equities in a gloomy mood.  Stocks continued to decline sharply in line with the gray atmosphere.  And a lower-than-expected rise in Japan GDP undercut the view that Asia would help the U.S. pull out of recession.

Equities started a four-day rebound with overseas news that German confidence was up.  Also lifting spirits and equities was good news on the earnings front as retailers Home Depot and Target beat estimates on earnings.  A boost in single-family housing starts also supported equity gains.  On Wednesday, the economic news boosting stocks was lower oil inventories and higher oil prices, boosting demand for energy patch stocks.

Later in the week, jobless claims rose but equities traders chose to focus on a better-than-expected Philly Fed manufacturing index.  The big boost for the week came on Friday’s sharp jump in existing home sales.  Also on Friday, Fed chief Bernanke stated that the economy is on the path to recovery, also improving the mood of equities traders.  Overall, the markets decided that both housing and manufacturing were back to positive growth which more than offset earlier worries about the consumer.

The Dow ended with the week with its highest close since November.

Equities were up this past week. The Dow was up 2.0 percent; the S&P 500, up 2.2 percent; the Nasdaq, up 1.8 percent; and the Russell 2000, up 3.1 percent.

For the year-to-date, major indexes are up as follows: the Dow, up 8.3 percent; the S&P 500, up 13.6 percent; the Nasdaq, up 28.1 percent; and the Russell 2000, up 16.4 percent.

Markets at a Glance

Weekly percent change column reflects percent changes for all components except interest rates. Interest rate changes are reflected in simple differences.

BONDS

Treasury yields were mixed and little changed this past week.  But rates were trending downward the first four days of the week, only to be reversed on Friday’s strong report on existing home sales plus Fed Chairman Bernanke’s comments that recovery is close.

Flight to safety was the issue early in the week as Friday’s drop on consumer sentiment sent equities down.  The Fed also jumped into the market for medium-term T-notes, pushing up prices.  After a mild firming in rates on Tuesday from a gain in single-family housing starts, a drop in China’s Shanghai Composite Index sent investors running to U.S. Treasuries.  A boost in jobless claims softened yields on Thursday. 

But after a spike in existing home sales on Friday and double-digit basis point gains for all but short maturities, rates were little changed for the week.

For this past week Treasury rates were mixed as follows: 3-month T-bill, down 1 basis point; the 2-year note, up 3 basis points; the 5-year note, up 5 basis points; the 7-year note, up 3 basis points; the 10-year bond, unchanged; and the 30-year bond, down 6 basis points.

Over the last few months, Treasury yields have stayed in a relatively tight range.  Recent trends reflect short rates still held hostage to easy monetary policy by the Fed. Note rates are still soft because the recovery is expected to be sluggish.  The long bond yield has been steady but up notably from late last year when flight to safety was so strong.  Also, the reality of high federal deficits has sunk in.

OIL PRICES

Crude oil prices rose sharply this past week on increased belief that recovery is beginning.  But the week started in the other direction, with Monday trading weighed down by the prior Friday’s drop in consumer sentiment.  But the spot price for West Texas Intermediate turned back up on Tuesday, following the lead of equities after news that single-family housing starts rose for the fifth month in row.  Crude jumped by over $3 at mid-week after the government inventory report showed U.S. stockpiles dropping the most in 15 months.  Mostly favorable economic news boosted oil the rest of the week.  On Thursday, a better-than-expected Philly Fed manufacturing index offset an unexpected rise in unemployment claims.  A surge in existing home sales at week end convinced traders that recovery is underway, leading to a buck a gallon gain in West Texas spot.

Net for the week, spot prices for West Texas Intermediate jumped $5.66 per barrel to settle at $73.29.  This week’s settle is the highest crude has been all of 2009 and is the highest settle price since $74.64 for October 20, 2008.

The Economy

Economic news generally was better than expected and came as welcome relief after last week’s dismal consumer sentiment number.  While the news was mostly good, there is no reason to expect a smooth road to recovery.

Housing starts better than headline

There are signs that housing is in recovery—at least outside the multifamily sector. Housing starts in July slipped from June's gain but the important single-family component continued its uptrend.  Homebuilders are cautiously coming off recession lows for turning that first shovel of dirt for new house construction. Housing starts in July edged down 1.0 percent, following a 6.5 percent boost the month before. The July pace of 0.581 million units annualized was down 37.7 percent year-on-year.

There has been a divergence in trends for the single-family and multifamily components in recent months with single-family rising and multifamily continuing to contract.  And these trends continued in the latest report. The decline in July was led by the multifamily component which dropped 13.3 percent after plunging 26.1 percent the month before.  However, the single-family component rose another 1.7 percent after gaining 17.8 percent in June. Single-family starts have risen five months in a row.  Single-family starts are up 37.3 percent from the recession low most recently set in February 2009—but still have a long way to go for full recovery.  Given the fact that supply on the market is still elevated, it is better that homebuilders expand cautiously and not have to pull back if sales do not follow upward as much. 

Housing permits also slipped on the multifamily component while the single-family components rose further. Overall permits edged down 1.8 percent to 0.560 million units, following a 10.0 percent boost in June. Single-family permits advanced 5.8 percent in the latest month while multifamily starts dropped 25.5 percent.  The bottom line is that single-family housing is on a very modest recovery track.

Existing home sales surge in July

Another sign of housing recovery is four consecutive gains in existing home sales. The latest month showed notable improvement as existing home sales rose a spectacular 7.2 percent to a 5.24 million annual unit rate. The July surge was the largest on record for the total existing-home sales series dating back to 1999.

July's gain was especially strong for condos, at 12.5 percent to a 630,000 rate, while single-family homes showed a very strong 6.5 percent gain to 4.61 million. Single-family sales are actually 5.0 percent higher than the 4.39 million-unit level in July 2008.

Distressed sales are still a key factor behind recent sales gains. Distressed sales in July were 31 percent of total sales but were no worse than June and much better than 50 percent rates earlier this year.  

Prices are coming down due to foreclosures and distressed sales. Distressed sales tend to have prices 15 to 20 percent lower than otherwise.  The median sales price dipped another 2.0 percent in July to $178,400 and was down 15.1 percent year-on-year.

Foreclosures and an uptick in optimism about sales have boosted the number of homes being put on the market which rose 7.3 percent to 4.09 million.  The supply relative to sales was unchanged at 9.4 months—still elevated but much improved from earlier in the recession.

But the road ahead is likely to be volatile. The new tax credit for home purchases by first-time buyers ends November 30—the deadline for closing.  We may see further gains in sales through October (November contracts likely will be too late for closing by November 30), but without an extension of the $8,000 credit and without a notably improved jobs market, sales may slump afterwards.

Empire State and Philly Fed manufacturing indexes turn positive

Two key regional manufacturing surveys are pointing to possible recovery in manufacturing as both the Philly Fed and New York Fed reported growth in this sector for August.

Manufacturing in the mid-Atlantic region is growing again as the Philly Fed's general business conditions index climbed sharply from minus 7.5 in July to plus 4.2 in August, breaking over zero which is this report's break-even level. And there likely is further improvement ahead as the new orders index also pulled up and over breakeven—rising to plus 4.2 from minus 2.2 in July. A key factor in overall improvement and for new orders has been the extended drawdown in inventories.

Manufacturing in New York State also may be out of recession as the Empire State index jumped to 12.08 from July's minus 0.55 for its best reading since the start of the U.S. recession. The near-term outlook is good as new orders showed a second month of actual month-to-month growth at 13.43—up sharply from July's 5.89.

Both reports showed some firming in prices paid, likely centered in energy and commodities. But both also posted declines in prices received indexes—indicating little pricing power by manufacturers.

Producer prices plunge

Inflation at the producer level in July declined sharply on both declines in food and energy.  But in energy, gasoline was not the culprit. The overall PPI dropped 0.9 percent after spiking 1.8 percent in June. The fall in the latest month was led by a 2.4 percent decrease in energy with food prices declining 1.5 percent. Meanwhile the core PPI rate eased sharply to 0.1 percent dip, following a 0.5 percent surge in June.

The July drop in energy prices was not due to gasoline but to a 10.2 percent plunge in heating oil costs. Gasoline prices actually rose 3.3 percent while residential electricity was unchanged.

The core rate in July eased largely on a 0.7 percent drop in prices for light trucks. Passenger car prices edged up 0.1 percent. However, the July PPI numbers were collected prior to the cash for clunkers program.

For the overall PPI, the year-on-year rate fell to minus 6.4 percent from minus 4.3 percent in June (seasonally adjusted). The core rate year-ago pace declined to up 2.6 percent from up 3.4 percent the prior month. On a not seasonally adjusted basis, the year-ago decline for the headline PPI was 6.8 percent while the core was up 2.6 percent.

Leading indicators rise four months in a row

Odds have risen that recovery has already started or will in the next month or two. The index of leading economic indicators rose 0.6 percent in July, following a 0.8 percent boost in June. The latest gain—the fourth in a row—was lifted by rising long rates, the prior dip in initial jobless claims, and the rise in the factory workweek.

But the recovery is still likely to be weak.  Next month’s leading indicators may be on the soft side. We already have down numbers for several components, including consumer expectations, money supply, and building permits.

Has the recession ended' Maybe—as the index of coincident indicators was unchanged July for the first non-negative reading since October. It will be many months before there is an official declaration that the recession is over but when the National Bureau of Economic Research does, it will be heavily based on the coincident index.  Revisions could bump the July coincident index into either a positive or negative.  Given that annual revisions to payroll employment tend to be down during recession (substituting actual numbers for new small businesses for initial projections), July’s coincident index probably will end up negative.  So, now, the end of recession is more likely to be August than July.

The bottom line

Financial markets got a nice lift this past week from a boost in single-family housing starts and existing home sales.  These have been on an uptrend for several months.  This is good news for the economy.  Looking ahead, the recovery in housing is going to be bumpy.  Yes, there has been other good news such as a recent rise in the MBA purchase index.  Mortgage rates eased 25 basis points over the latest week—partly due to Fed purchases of mortgage-backed securities. 

But there also has been considerable negative news.  Jobless claims rose in the latest week and unemployment is driving foreclosure rates up.  According to the MBA, the share of loans with one or more payments overdue rose to 9.24 percent of all mortgages, a record high. Also, the number of homes in foreclosure is at the highest in three decades.  The rise in foreclosures suggests that more empty homes will be hitting the market in distress and this will weigh on home prices.  In turn, lower prices will make houses more affordable but trickier to get financing if appraisals are not high enough to cover the loan value.

Is housing in recovery'  Probably—but after tax credits for first-time buyers run out, it probably is going to be choppy.  Is the economy in recovery'  There still is a good chance it started in July or August but it’s going to be hard to tell for many months.

Looking Ahead: Week of August 24 through 28 

Vacationing traders will be checking their Blackberries and iPhones a lot this week. The traditional market movers start with durables orders on Wednesday and include the GDP Q2 revision on Thursday and personal income on Friday.  But there is plenty of heightened attention for others—consumer confidence on Tuesday, new home sales on Wednesday, and consumer sentiment on Friday.

Tuesday

The Conference Board's consumer confidence index, reflecting a rattled consumer, fell a sizable 2.7 points to 46.6 in July. Consumers were most worried about the job picture as 48.1 percent of consumers said jobs were hard to get, up from 44.8 percent in June and 43.9 percent in May. Don’t look for any significant improvement for August—the marginal decline in the unemployment rate in July was a technical fluke and initial jobless claims remain high.

Consumer confidence Consensus Forecast for August 09: 48.0

Range: 46.0 to 51.0 

Wednesday

Durable goods orders in June dropped sharply, largely on a plunge in civilian aircraft orders.  Overall durable goods orders fell back a revised 2.2 percent in June, following a r boost of 1.3 percent the month before. The big negative in June was transportation which dropped a revised 13.2 percent within which civilian aircraft orders fell 38.6 percent. But excluding the transportation component, new durables orders advanced a revised 1.6 percent, following a 0.8 percent gain in May.  Looking ahead, we may get another advance as the ISM new orders index for July jumped into positive territory again to 55.3 from 49.3 in June.

New orders for durable goods Consensus Forecast for July 09: +2.5 percent

Range: +0.9 percent to +8.0 percent

New home sales jumped 11.0 percent in June to a higher-than-expected annual rate of 384,000 and the highest rate this year. The month-to-month percentage change was the highest in nearly nine years. Most importantly, the strong sales drew down supply which fell from May's 10.2 months to 8.8 months for the lowest reading in nearly two years. Looking ahead, the Housing Market Index from the National Association of Homebuilders indicated that traffic of prospective buyers was flat in June and July but moderately improved from lows seen in late 2008 and early 2009.  Traffic also picked up in August but would not show up in July sales.

New home sales Consensus Forecast for July 09: 390 thousand-unit annual rate

Range: 385 thousand to 420 thousand-unit annual rate

Thursday

GDP for its initial estimate for the second quarter showed the economy contracting by only 1.0 percent, following a revised 6.4 percent drop in the first quarter.  Pulling down GDP in the latest quarter were business fixed investment, housing, personal consumption, and inventories. Strength was found in a sharp narrowing in the trade gap and a rebound in government spending. On the inflation front, the GDP price index rose a meager 0.2 percent after gaining a revised 1.9 percent in the first quarter. 

Real GDP Consensus Forecast for preliminary Q2 09: -1.5 percent annual rate

Range: -1.6 to -1.0 percent annual rate

GDP price index Consensus Forecast for preliminary Q2 09: +0.2 percent annual rate

Range: +0.2 to +0.3 percent annual rate

Initial jobless claims for the August 15 week rose 15,000 to 576,000. Continuing claims for the August 8 week rose 2,000 to 6.241 million for a second increase in three weeks. There were no special factors skewing the data.

Jobless Claims Consensus Forecast for 8/22/09: 565,000

Range: 560,000 to 570,000

Friday

Personal income fell a sharp 1.3 percent after jumping a revised 1.3 percent in May. June's fall was primarily due to a 5.9 percent fall in transfer payments which had spiked 8.0 percent in May. In the latest month, the wages and salaries component dropped 0.4 percent after dipping 0.1 percent in May.  Consumer spending jumped 0.4 percent after edging up 0.1 percent in May. However, June's gain was price related from higher gasoline prices.  PCE inflation made a strong comeback on energy costs as headline PCE price index spiked 0.5 percent, following a 0.1 percent uptick in May. Meanwhile, the core PCE price index firmed to a 0.2 percent increase in June after edging up 0.1 percent in May.  Looking ahead, at least the wages and salaries component of personal income should rebound in July as aggregate weekly earnings rose 0.5 percent for the month, according to the employment report.  The durables and nondurables components of PCEs will likely be soft based on a 0.1 percent dip in retail sales in July.  But better estimates of motor vehicles sales could lead to a positive for durables in PCEs.  Look for low inflation numbers—the headline CPI was flat in July while the core CPI rose only 0.1 percent.

Personal income Consensus Forecast for June 09: +0.1 percent

Range: -0.1 to +0.4 percent

Personal consumption expenditures Consensus Forecast for June 09: +0.3 percent

Range: -0.1 to +0.5 percent

Core PCE price index Consensus Forecast for June 09: +0.1 percent

Range: +0.1 to +0.2 percent

The Reuter's/University of Michigan's Consumer sentiment index in early August dropped nearly 3 points to 63.2. Weakness was centered in the current conditions component which fell to 64.9 from 70.5 at the end of July. Consumers were less optimistic about their role in recovery as the expectations component slipped to 62.1 from 63.2 in July.

Consumer sentiment Consensus Forecast for final August 09: 64.0

Range: 63.0 to 66.0

Econoday Senior Writer Mark Pender contributed to this article.