The major market indices finished the week moderately higher as investors took advantage of the recent pullback to do some bargain hunting. The catalysts for the strength seemed to be fading concerns over the European debt crisis and a growing realization that fear may have outpaced fundamentals.
Last week's strength pushed the Dow back above the psychologically important 10K mark, although all of the major U.S. benchmarks still remain below their technically important 200-day moving averages.
Despite the gains, we continue to believe the markets are locked in a period of price discovery as investors try to gauge what is reflected in stock prices and what is coming to the forefront. This process will likely remain in play until further clarity emerges on how the European financial crisis has impacted the global economy.
This could take several weeks and will likely be centered on second quarter earnings season (which unofficially kicks off on July 12), when it will become clearer if the problems in Europe have filtered through to corporate earnings.
Bernanke testimony. At a testimony before the House Budget Committee, Federal Reserve Chairman Ben Bernanke reiterated that the economic recovery remained intact (albeit at a moderate pace) and that the Fed will act as needed to aid financial stability and economic growth. Bernanke also noted that the unemployment rate will likely remain stubbornly high, although he still believes the economy remains on track for 3.5% growth in 2010. Bernanke's testimony was generally shrugged off by the marketplace as most of the rhetoric was deemed old news.
| Index | Closing Price 6/11/2010 |
Week Ending 6/11/2010 |
Year to date through 6/11/2010 |
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| Dow Jones Industrial Average | 10211.07 | 2.81% | -2.08% | ||
| Wilshire 5000 Total Market | 11294.49 | 2.51% | -1.11% | ||
| S&P 500 | 1091.60 | 2.51% | -2.11% | ||
| NASDAQ Composite | 2243.60 | 1.10% | -1.13% | ||
| S&P/TSX Composite | 1166.92 | 0.84% | -0.67% | ||
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Beige Book report. On Wednesday, the Fed released the Beige Book. The report, published eight times annually, is a summary of anecdotal economic conditions in the 12 regional Fed districts. The Beige Book showed that all 12 districts expanded during the period. While the majority of districts categorized growth as "modest," this was the first time since 2007 that all regions reported growth, a sign that the economic recovery is starting broaden out. The report noted that consumer spending and tourism activity generally increased, while business spending also rose, on net. Labour market conditions generally improved, while pricing pressures were subdued.
Contagion fears fading. Fears that the European debt crisis could lead to a global slowdown appear to have faded slightly last week. There were also subtle signs that confidence may be returning to the European markets. Last Thursday, China reported that exports in May climbed by a very robust 48.5% on a year-over-year basis, well ahead of the low-30% rate expected by economists. With China being looked at as a major engine of global economic growth, the report seemed to ease concerns over a global slowdown. Meanwhile, the head of China's national pension fund, said the euro would weather Europe's debt crisis. This was also echoed by comments from Banco Santandar Chairman Emilio Botin, who stated that the crisis in Spain has been blown out of proportion. In addition, last week several European counties were able to successfully raise funds in the bond market. Spain, Portugal, Italy and Ireland were able to sell debt, although borrowing costs were elevated relative to several weeks ago, but the overall demand for the paper was solid. The bond auctions may be an early sign of building confidence and that the austerity measures adopted by many of these nations are the right medicine to help cure their ills.
Mortgage applications plunge. Despite mortgage rates falling to near record lows, mortgage applications continue to plunge, raising concerns of a double dip in the housing market. Last week the Mortgage Bankers Association reported that mortgage applications during the week ended June 4 fell by 12.2%. Both the Purchase Index (-5.7%) and the Refinancing component (-14.3%) contributed to the weakness. Purchase applications have declined for five straight weeks and now are sitting at their lowest level since early 1997. The plunge in purchase applications is likely partially explained by the ending of the homebuyer tax credit, which seems to have cannibalized future sales.
The dip in refinance applications was the first in a month. Refinancing activity may weaken further as many borrowers may not qualify from a credit perspective or due to the fact that the value of their home may be underwater relative to the amount they owe. According to an update from real estate consulting firm CoreLogic, 11.2 million, or 24% of all residential properties with mortgages, were in a negative equity position at the end of the first quarter. CoreLogic also stated that it could take between five to seven years for homeowners to regain the lost equity.
Economic data. While the recent batch of economic data indicated that the economic recovery is intact, there were fleeting signs that we may be hitting a near-term soft patch. For example, the Commerce Department reported that Retail Sales during the month of May fell 1.2%, well short of the 0.2% gain expected by the Bloomberg consensus. While much of the decline can be explained by a sharp reversal in building material sales (-9.3), while auto sales and gas station receipts also contributed to the weakness. With that said, overall retails sales were up 6.9% on a year-over-year basis, well ahead of the 10-year monthly average of 3.0%. This was the first dip in retail sales in eight months and highlights that the road to recovery is never a straight line and often contains speed bumps along the way.
Other reports of note from last week included The Conference Board's Employment Trend Index (ETI). The ETI -- a basket of eight labour market indicators -- rose for a ninth consecutive month suggesting, according to The Conference Board, that the disappointing nonfarm payroll growth in May could just be a one-month blip, and that jobs will likely expand further in the next several months. Meanwhile, the Manpower Employment Outlook Survey indicated continued momentum in the U.S. hiring outlook. The survey found U.S. employers anticipate favourable hiring plans for third quarter, marking three straight quarters of positive intentions.
In another sign that the underlying tone of the labour market is improving, the Labor Department reported that the number of people quitting their jobs is on the rise. Historically this has been a signal that people are gaining confidence in the labour market recovery. In April, the latest month for which data is available, "quits" rose 3.4% -- the fourth consecutive monthly increase. The level of quits as a share of total employment remained at 1.5% -- a clear improvement from the 1.3% back in the fall of 2009.
Mutual fund flows. The Investment Company Institute (ICI) reported that domestic equity mutual funds in the United States experienced a fifth consecutive week of outflows and have now seen net redemption of almost US$25 billion during that period. Unfortunately, these redemptions are coming at a time when mutual fund cash holdings are at record lows. The situation appears to be causing a negative feedback loop as mutual fund managers need to liquidate holdings (and therefore contributing to the selling pressure) to raise cash. On a positive note, this week's outflows of US$1.1 billion were well off the US$13.4-billion pace during the prior week, and may be hinting at sellers' exhaustion.
