David Joy: Perspective on housing, oil and inflation

Despite failing to establish another new record weekly close, stocks managed to hold onto most of the gains from the previous week’s record. A range of economic reports contained mostly good news last week, with the notable exception of the pace of personal consumption in May, which raised some concern over the state of the consumer sector. Otherwise, the data was mostly encouraging, and reinforced the idea that second quarter activity may have rebounded to a 3.0-3.5% annualized pace. The flip side of the consumer spending report showed a rise in disposable personal income, which pushed the national savings rate to 4.8%, its highest since last September.

An uptick in housing
The pickup in housing activity for May was particularly encouraging. Both new and existing home sales exceeded expectations, as did pending home sales. How much of that rebound is delayed activity from the cold weather, and how much of it is sustainable longer-term remains to be seen. Mortgage rates remain attractive for those who qualify, averaging 4.33% nationwide for a 30-year conforming fixed mortgage, yet applications to purchase have dropped over the past several weeks.

Oil prices and consumer confidence
Offsetting these questions to some extent was a rise in consumer confidence in June, as measured both by the Conference Board and the University of Michigan surveys. Perhaps contributing to that improving outlook is the relative stability of gasoline prices as the peak summer driving season is underway, despite the recent rise in crude oil. According to AAA, the national average price of a gallon of regular unleaded was $3.68 on June 30. That is $0.19 higher than one year ago, but only $0.02 higher from one month ago, during which time West Texas Intermediate (WTI) has risen $2.60 a barrel, and the Brent Blend has climbed $3.84 on fears of supply disruptions in Iraq. Fortunately, both benchmark prices have declined in the past few sessions as disruption fears have receded.

The May report on durable goods orders contained some encouraging news for those searching for evidence of an upturn on capital spending. The pace of new orders for non-defense capital goods ex-aircraft, an admittedly volatile proxy for business spending, rose 0.7%, after declining in April. And the Markit® flash composite PMI reached a new cycle high in June.

Inflation and Fed policy
A modest rise in inflation also captured investor attention. The Personal Consumption Deflator rose 1.8% year-over-year in May. In February the pace was 0.8%. The core rate, after stripping out food and energy prices, rose 1.5%, compared to 1.1% February. And while both measures are still below the Fed’s 2.0% long-term target, the direction and rate of change are notable. Noteworthy was St. Louis Fed President Bullard’s observation that the Fed’s first rate hike could come as early as the end of Q1 2015, several months before general expectations, since he anticipates that inflation could be running above the Fed’s target by early 2015, and unemployment may be below 6.0%. Nevertheless, the yield on the ten-year note fell eight basis points on the week to 2.53%, back to where it was at the start of June. The yield on the two-year note also fell.

The ability of stock prices to remain firmly focused on the fundamentals, and to discount the impact of external worries will be tested in the week ahead. On Thursday the Labor Department will release the June jobs report, which is expected to show the creation of 215,000 new non-farm jobs with the rate of unemployment remaining unchanged at 6.3%. And ISM Manufacturing Index readings on both manufacturing and service sector activity are expected to remain firm. With the close of the second quarter on Monday, attention will soon shift to earnings season. Factset now anticipates growth in the quarter of 5.1%, down from 6.8% expected at the start of the quarter, a more modest downward adjustment than typically occurs during the quarter. Alcoa officially kicks things off on Tuesday, July 8.

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