Healthy durables orders, new home sales thump equities
By R. Mark Rogers, Senior Economist, Econoday
May 25, 2007

Last week saw healthy durables orders and an unexpected increase in new home sales. The outlook for interest rate cuts this year by the Fed dimmed and led to a modest dip in equities. Rates had already risen earlier in the week on negative sentiment.

Recap of US Markets

OIL PRICES

Crude oil prices were down net for last week. However, oil prices initially spiked on Monday on concerns over militant activities in Nigeria. Prices fell notably on Tuesday and Thursday due to refinery constraints in the U.S. that are causing a bottleneck in processing crude inventories. The refinery constraints have had opposite effects on distillates and crude. Distillate prices have been rising while crude prices have dipped. Gasoline prices are at record prices, even after adjusting for overall inflation. However, on Friday crude rose notably due to renewed focus on possible disruptions in Nigerian oil supply. Nigeria’s new president is inaugurated on May 29, which may spark more protests and violence by militants.

The spot price per barrel for West Texas Intermediate was down slightly for the week by $0.19 per barrel to close at $64.75 per barrel.

STOCKS

Equities were mixed last week with blue chips ending down. Techs were flat and small caps posted a moderate net gain. On Monday, the Dow slipped despite M&A activity. The S&P 500 passed its record close (1,527.46 set on March 24, 2000) during intraday trading but slipped back by the close. On Tuesday, the Nasdaq hit a new 6-year high. Again the S&P 500 passed its record close during intraday trading but failed to maintain it, falling at close. Stocks were hurt on Wednesday by comments from former Federal Reserve Chairman Greenspan who said he was concerned about a likely contraction in Chinese equities. Interest rate concerns also weighed on stocks with growing belief that the Fed will not ease this year. The S&P 500 passed its old record again during trading but fell back before close. Stocks were down broadly and significantly on Thursday due to interest rate implications of the morning’s reports on durables orders and new home sales. Markets also were still taking in Greenspan’s comments the previous day on a likely correction in Chinese equities. On Friday, in thin trading, stocks did post a broad and moderate rebound, partly due to bargain hunting in the wake of losses earlier in the week.

Last week, the Dow and S&P 500 were down 0.4 percent and 0.5 percent, respectively. The Nasdaq was essentially flat – but encroaching negative territory. The Russell 2000 was up 0.8 percent.

Year-to-date, the Dow is up 8.4 percent; the S&P 500, up 6.9 percent; the Nasdaq, up 5.9 percent; and the Russell 2000 is up 5.4 percent.

BONDS

The yield curve continued to rise last week. But initially on Monday rates edged down in listless trading with some funds going into bonds, coming out of equities. On Tuesday, rates edged up largely on the outlook for the Fed not cutting rates until possibly 2008. Heavy corporate issuance also weighed on bond prices. Rates continued to nudge higher on Wednesday also on negative sentiment and due to pressure from European markets, primarily a sell off of German Bunds on worries over possible rate hikes by the European Central Bank. On Thursday, rates initially edged up on strong durables orders and new home sales but dipped by close on thin pre-holiday trading to close little changed. Sluggish existing home sales had little impact on the last day of the week. Trading also was thin on Friday with rates little changed except for the 3-month T-bill, which edged down.

Net for the week the Treasury yield curve is up. Yields were up as follows: 3-month T-bill, up 7 basis points; 2-year T-note, up 4 basis points; 3-year, up 5 basis points; 5-year, up 6 basis points; the 10-year bond, up 6 basis points; and the 30-year bond, up 4 basis points.

Rates on notes and bonds have been on a gradual firming trend since the second week in May, reflecting the belief that the Fed will not be cutting interest rates soon and perhaps not even during 2007. Long-term rates are now back up to where they were at the end of January.

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.

The Economy

The manufacturing sector is showing renewed, moderate strength while housing is mixed. New home sales came in strong while existing home sales continued to slip.

Durable goods orders post moderate gain

Durable goods orders continued to show healthy growth in April, rising 0.6 percent in April, following a 5.0 percent boost in March. Excluding the volatile transportation component, new orders rose 1.5 percent, also following a 1.5 percent advance in March.

Strength in orders in April was mixed.  Industry categories posting gains in April were primary metals, fabricated metal products, and electrical equipment. Industry categories showing declines in April were machinery, computers & electronics, and transportation. The dip in transportation orders reflected a drop in orders for nondefense aircraft and also a decline in orders for motor vehicles. Nondefense capital goods slipped 0.8 percent in April but the decline was aircraft related. Excluding aircraft, nondefense capital goods orders rose 1.2 percent in April, following a 4.4 percent jump in March. Hence, it seems that investment in producers’ durable equipment is beginning to pick back up.

New durables orders in April were up 2.8 percent on a year-on-year basis, compared to down 1.7 percent in March.

Unfilled durables orders rose 1.8 percent in April, indicating continuing momentum for durables manufacturing. Unfilled orders for durables are up 19.8 percent on a year-on-year basis and compared to 19.6 percent in March.

New home sales post unexpected surge

New home sales jumped 16.2 percent in April to an annual unit rate of 981,000. April’s spike was the largest since a 16.4 percent surge in April 1993. The year-on-year decline eased back to 10.6 percent, showing improvement from a year-and-a-half stretch of often 20 percent declines and sometimes nearly 30 percent declines.

The month's big gain helped supply, which fell a record year-on-year 4.8 percent. On a months' basis, supply fell to 6.5 months from 8.1 in March.

The median price eased, down 11 percent in the month to $229,000 for a year-on-year decline of 10.9 percent.

Existing home sales lose ground

Existing home sales retreated further in April, declining 2.6 percent in the month to an annual rate of 5.990 million. The year-on-year decline is 10.7 percent, the second straight double-digit drop. Sales have retreated from a brief pick up earlier this year and are now at cycle lows. Sub-prime lending problems have led to tightened lending standards which has reduced the supply of buyers. The supply of new homes jumped in April to 8.4 months from 7.4 months in March and will likely weigh on prices in coming months. For now, the median sales price held steady at $220,900, up 1.6 percent month-on-month and down 0.8 percent on the year. 

Rate sentiment shifts

Over the last two weeks market sentiment over the likelihood of the Fed cutting interest rates this year has become more negative due to data indicating that the economy is not likely slowing as much as the Fed had hoped. While traders in the fed funds futures market had just a few weeks ago expected the Fed to cut short-term interest rates in the fourth quarter of this year, that is no longer the case. On average, traders in the fed funds futures market do not expect a Fed rate cut before the end of January 2008.

The bottom line

Manufacturing is showing further signs of improvement while housing remains mixed. Nonetheless, the economy seems to be strong enough to keep the Fed nervous about inflation remaining too high.

Looking Ahead: Week of May 28 through June 1

This week makes up for last week’s light schedule. Lots of heavy duty indicators are on deck. But before the market moving indicators start coming out on Thursday we get to see on Wednesday afternoon FOMC minutes of the May 9 meeting. During the latter part of the week, a GDP revision comes out for the first quarter, and on Friday the markets will get to soak in and sort out a barrage of data including the employment report, personal income, and the ISM manufacturing index, among others.

Monday

Memorial Day holiday.  Markets in the U.S. are closed.

Tuesday

The Conference Board's consumer confidence index in April fell 4.2 percentage points to 104.0 while 12-month inflation expectations rose 3 tenths to 5.2 percent. 

Consumer confidence Consensus Forecast for May 07: 105.0
Range: 101.5 to 107.0

Wednesday

The minutes of the May 9 FOMC meeting will be released Wednesday afternoon.

Thursday

GDP slowed to an annualized 1.3 percent from the 2.5 percent pace in the fourth quarter. More recent data point to a downward revision. On the inflation front, the GDP price index jumped to 4.0 percent due to the impact of higher oil prices, following a 1.7 percent increase in the fourth quarter. 

Real GDP Consensus Forecast for preliminary Q1 07: +0.8 percent annual rate

Range: +0.5 to +1.3 percent annual rate

Initial jobless claims rebounded in the week ending May 19, rising by 15,000 to 311,000. But with five consecutive declines in prior weeks, the level is still low. The four-week average reflected the earlier weekly decreases, slipping 3,500 to 302,750 - the lowest level in more than a year.

Jobless Claims Consensus Forecast for 5/26/07: 310,000
Range: 305,000 to 320,000

The NAPM-Chicago purchasing managers’ index fell sharply in April to 52.9 from March's spike at 61.7. Also weak were new orders, backlogs, and inventories. The prices paid index was up sharply due to higher oil prices.

NAPM-Chicago Consensus Forecast for May 07: 54.0
Range: 51.5 to 58.3

Construction spending rose 0.2 percent in March, following a 1.5 percent gain in February. As has been typical in recent months, residential construction fell while nonresidential public construction rose.

Construction spending Consensus Forecast for April 07: 0.0 percent (flat)
Range: -0.5 to +0.5 percent

Friday

Nonfarm payroll employment slowed sharply in April with a modest 88,000 gain, following a 177,000 boost in March. With initial unemployment claims running on the low side, forecasters are expecting job growth to pick up in May. On the inflation front, average hourly earnings rose 0.2 percent in April, following a 0.3 percent boost in March. The civilian unemployment rate edged up 0.1 percentage points but remained low at 4.5 percent – just above the cycle low of 4.4 percent.

Nonfarm payrolls Consensus Forecast for May 07: +135,000
Range: +45,000 to +175,000

Unemployment rate Consensus Forecast for May 07: 4.5 percent
Range: 4.4 to 4.6 percent

Average workweek Consensus Forecast for May 07: 33.8 hours
Range: 33.8 to 33.9 hours

Average hourly earnings Consensus Forecast for May 07: +0.3 percent
Range: +0.2 to +0.4 percent

Personal income was quite robust in March with a 0.7 percent gain – equaling February’s increase. The important wages & salaries component rose 0.7 percent, following a 0.5 percent advance in February. Personal consumption expenditures, however, slowed to a 0.3 percent increase, following a 0.7 percent rise in February. Much of the gain was price related due to a boost in gasoline and heating oil. On the inflation front, the overall PCE deflator was still high with a 0.4 percent gain in March, the same as in the prior month. Higher oil prices boosted both months. However, the core PCE price index (excluding food and energy) eased to no change, following a 0.3 percent rise in February.

Personal income Consensus Forecast for April 07: +0.3 percent
Range: -0.1 to +0.5 percent

The Institute for Supply Management’s manufacturing index jumped 3.8 points in April to 54.7 for its best reading in nearly a year. New orders, backlogs, and employment also were strong. However, prices paid spiked 7.5 points to 73.0, reflecting higher energy prices and possibly higher overall demand for raw materials.

ISM manufacturing index Consensus Forecast for May 07: 54.0
Range: 51.0 to 55.0

The University of Michigan’s Consumer sentiment index edged up to 88.7 in May from 87.1 the prior month. Consumers apparently focused more on the tight job market than on higher gasoline prices.

Consumer sentiment Consensus Forecast for revised May 07: 88.0
Range: 87.0 to 88.7

Motor vehicle sales of manufacturers in the U.S. rose in April to a 12.4 million annual rate from 12.2 million units in March. April’s sales were split between a 5.0 million rate for cars and 7.4 million for light trucks.

Motor vehicle sales Consensus Forecast for May 07: 12.5 million-unit rate
Range: 12.4 to 12.6 million-unit rate

U.S.-made vehicle sales rose in April to a 12.4 million annual rate from 12.2 million units in March. April’s sales were split between a 5.0 million rate for cars and 7.4 million for light trucks.