Confidence, Housing, and Unemployment are All Intertwined

Good Evening: An unexpected drop in consumer confidence today spoiled what investors had hoped would be a rousing finish to an otherwise strong second quarter for U.S. capital markets. Other data points, including those in the all important housing sector, were mixed. How confidence, home prices, mortgage delinquencies, unemployment, and the financial markets interact in the coming months may decide whether the highly touted green shoots take root or whither. And this process will, in turn, affect investor attitudes toward the state of our nation’s financing needs during the second half of 2009. It might turn out that Great Britain’s fate in dealing with a similar set of circumstances will prove to be one of either helpful guidance or cautionary tale.

With end of Q2 party hats affixed, U.S. stock market participants pushed share prices above yesterday’s highs in the early going this morning. Both the Chicago PMI figures and Case-Shiller home price survey results were largely non events when compared to expectations, but the smaller home price drop did cause none other than Robert Shiller himself to sit up and take notice. “At this point, people are thinking the fall is over,” Shiller, co-founder of the home price index that bears his name, said in a Bloomberg Radio interview today. “The market is predicting the declines are over.” (source: Bloomberg article below)

Perhaps the month over month price gains seen in 8 of the 20 cities fueled some of this optimism, as did word late last week that Citi and JP Morgan were beginning to expand their lending to seekers of jumbo mortgages (see below). Slowing price declines and more loan availability at the previously credit starved high end would be welcome news indeed, particularly for U.S. banks and holders of RMBS. It will be a race against time, however, as another story today indicated that the delinquency rate for high quality, prime mortgages doubled to more than 2% in the latest reporting period (see below). As the unemployment rate approaches 10% (we will see June numbers on Thursday), and as at least another 10% of the workforce fears becoming part of those grim statistics, housing might continue to be a source of drag on our economy. How these factors interact and create various feedback loops will be crucial. It might just come down to the critical variable of confidence.


Unfortunately, at least as the Conference Board measures it, consumer confidence was a definite disappointment (see BAC-Merrill’s take below). The whole green shoots theory rests not upon the economic data getting better, only that it gets worse at an ever slower rate. Coming in at 49.3 in June versus expectations as high as 57, the Conference Board’s reading was an incontrovertible step backwards. It is easy to make too much of any one data release, but investors immediately registered their disappointment with this lynchpin indicator by selling equities.

The major averages gave back their early gains and didn’t stop going down until they were off between 1% and 2% as the lunch hour approached. Stocks then settled into a summer-like sideways range for the rest of the session. Both NASDAQ and the Russell 2000 held in relatively well, as did defensive stocks. Risk aversion wasn’t exactly an overwhelming theme, but it was a persistent one. A small rally during the final hour was cut short at the closing bell, leaving the averages down between 0.5% (NAS, RUT) and 1% (Dow, S&P). Treasurys had been down when the confidence data hit the tape, and they recovered to finish with modest losses. Yields were up by 2 to 6 bps as the curve steepened a bit. The dollar benefited from a negative story about the state of finances in the U.K. (more on this below), and the U.S. dollar index advanced 0.4%. This uptick in the greenback didn’t help commodities, but a bearish crop report for corn, wheat, and soybeans was even less helpful. Energy prices also declined, leaving the CRB index the worse for wear by almost 2%.

Today’s market action may or may not have been truly meaningful in terms of future market direction, but there may have been something else bothering Mr. Market other than just a decline in consumer confidence. The final story you see below had some impact today, at least in terms of hurting the British pound. Called the “cable” on dealer desks, the British pound sterling looked a bit frayed by day’s end, and it seems as if the deteriorating finances of the U.K. government are to blame. The overextension of credit during the boom years by eager banks for everything from real estate, to hedge funds, to LBOs left the large British financial institutions in a spot of bother. Showing that dumb lending and clumsy bailouts know no borders, London and New York share more than just a common ocean. In finance, they share the same leveraged language.

The results have been similar, too, as the U.K. just issued its worst GDP report card since 1958. Its propped up banks are struggling to delever, Gilt issuance has soared, and the Bank of England’s version of quantitative easing has created more paper than all the goats in Scotland could consume. According to former Chancellor of the Exchequer, Nigel Lawson, the “solution” of debt issuance is more harm than cure. “The amount of borrowing the government will have to do as a result of the deficit is very worrying.” He says yields on U.K. debt will have to climb to attract buyers. “Bond investors have real doubts about the fiscal stability of the U.K., and they want some kind of risk premium,” he says. (source: Bloomberg article below).

U.S. investors might be tempted to write this story off as “just a problem in Britain”, but we might be headed down a similar path if we don’t soon get our own fiscal house in order. Team Obama agrees that our great nation faces structural deficits that demand attention, but the current order of business is to spend a ton of money now in the hope we can recoup it through stronger growth, lower healthcare costs, and a green energy industry that will have the world beating a path to our door. It had better work — and fairly soon — because we’re attempting to impose massive changes in the middle of a recession. Which takes us full circle back to the interplay between confidence, home prices, mortgage delinquencies, unemployment, and the financial markets.

Today’s consumer confidence reading may actually be meaningful, as will Friday’s nonfarm payroll figures. If unemployment continues to worsen, then mortgage delinquencies among even decent borrowers will continue to rise, putting further pressure on home prices. It could further harm confidence and create a feedback loop that prevents economic growth from gaining a foothold. In such an environment, tax revenues won’t grow, but deficits will, and the whole bill will go on the global credit card known as Treasury auctions. If, like the Bank of England, the Fed feels the need to buy government debt and monetize it, then we’ll just be begging for a currency and/or funding crisis down the road. It’s not a pretty picture; just ask Great Britain. Housing, consumer confidence, and unemployment — these numbers will be particularly important data not only this week, but in the months ahead as well.

— Jack McHugh

U.S. Stocks Decline, Trimming S&P 500’s Best Quarter Since ‘98
Yale’s Shiller Sees ‘Improvement’ in Rate of Home-Price Decline
JPMorgan, Citigroup Expand in ‘Jumbo’ Home Mortgages
Delinquencies Double on Least-Risky Mortgages, U.S. Report Says
Sterling Crisis Looms as U.K. Unraveling Points to Budget Cuts
Confidence drops.pdf

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