Economic Rebound Has Its Drivers

• ByVincent Farrell Jr.,
• On 8:15 am EDT, Wednesday September 23, 2009

We're not "Waiting for the Robert E. Lee" (a Broadway musical and later a movie starring Mickey Rooney and Judy Garland, I think -- and please don't tell me you don't know Rooney or Garland ... I can't be that old), but it seems like that. The Federal Reserve will meet and have an announcement, and the G-20 also will issue a communique. It would be nice to get the process moving a bit faster and the recovery more obvious, but patience is required.

The economy appears to be taking firmer root. We commented on the Index of Leading Indicators on Tuesday, noting that the increase was the fifth in a row and a five-year high. It used to be that three in a row would indicate the end of a recession. It may well this time, as the high holies that determine the start and stop of a recession do so only after a significant time lag.

The Institute for Supply Manufacturing's last reading would be consistent with a 3% growth rate in gross domestic product. With the recent strength from the Empire State Manufacturing Survey and Philadelphia Index, we can expect continued expansion for the ISM. Also, the bulk of the $787 billion stimulus package has yet to be felt, but soon will be as expenditures are catching up with allocations. I mentioned that if inventories stopped being liquidated it would result in a 1.3% pop to GDP on an annualized basis. The economy looks to have some underlying near term-drivers.

With the continued flow of good news, albeit modest, the argument could be made for the Fed to start to exit the stimulus mode. I think it is way too early for that. Unemployment is still rising, and Fed tightening usually begins well after unemployment peaks. The peak rate is still some months ahead of us. If the Fed statement Wednesday afternoon contains the phrase, "Economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period of time," then we know the Fed will continue on its current path for some time. The only possible curveball could involve the program for buying agency debt and mortgage-backed securities. The Fed is committed to buying $1.25 trillion of MBS and it is likely to extend the time frame for so doing. If there were to be language that it would end the program early, it could be construed as the first step toward tightening. That is why it won't be mentioned.

The Federal Housing Finance Agency, or FHFA, issued its mostly ignored report on housing Tuesday. It's mostly ignored since there are so many others like next week's Case-Shiller Index that seem more informative. But the FHFA had good news that is worth passing along. The index was up 0.3%, marking the fifth gain in seven months. Using just this measure, home prices fell 12% (that could be why it's not looked at, since home prices fell so much more), but have now rebounded 1.5%. Use this as a supporting argument that the decline in housing prices might be near an end.

The two-year Treasury auction was well received. The notes were heavily oversubscribed with a bid-to-cover ratio of 3.23 (323 bonds bid for every 100 the Treasury sold) and "indirect" buying, which includes foreign participation, of 45.2%. Recent auctions have seen a 2.78 bid-to-cover and 43.75% indirect buying. Foreign buying of Treasuries continues strong despite the weakness of the dollar and the huge financing schedule for future debt auctions. One explanation for, say, Chinese participation, is that China lends money to us via the route of bond purchases to keep the dollar in a range so their currency does not have to rise. China's export markets are thus protected to some extent.

Despite my own unease about the market's rise, there are arguments for it to continue upward. End-of-the-quarter window dressing is real and probably in full swing. Buying shares of stocks at the end of a quarter and issuing portfolio reports makes it look like you have been in the game. Also, everybody's favorite measure of volatility and risk -- the CBOE Volatility Index, or VIX -- has been anything but volatile. My friend Sydney Williams in a recent piece pointed out that July, August and September of last year saw 30 days of 1.5% moves in the volatility index. This year for the same stretch of time we have had only eight days of 1.5% movement. A lack of volatility is not typical of a market peak, or of a market bottom for that matter.

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Know what you own: Farrell mentioned home prices. Some major U.S. homebuilders include Pulte Homes, D.R. Horton, Lennar, Toll, Hovnanian, KB Home and Orleans Homebuilders.

Buzz up!