The Overnight Report: Trouble At Home

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By Greg Peel

The Dow fell 133 points or 1.3% while the S&P fell 1.5% to 1051 and the Nasdaq dropped 1.7%.

With double-dip fears embracing Wall Street, there are three data points this week causing anxiety. One is the first revision of second quarter GDP, due on Friday. Another is July new home sales, due tonight. The third is July existing home sales, and that was released last night.

Economists had expected a drop in sales in July to 4.70m from 5.26m in June to reflect the earlier expiry of the government's tax credits for first-time home buyers. The actual fall to 3.83m (seasonally adjusted) came as a bit of a shock. That represents a drop of 27.2% which is the biggest on record.

Inventories of unsold existing homes rose by 2.5% in July to 3.98m to represent 12.5 months of typical supply. That's the highest level since 1999. The specific level of unsold single family home inventory is now at its highest since 1982.

The double-dip cry is getting louder. The suggestion is that US housing market weakness is entering Phase 2. Phase 1 represented foreclosures based on doomed-to-default subprime mortgages. Phase 2 is all about a simple matter of unemployment. While mortgage lenders can attempt to arrange “work-out” refinancing for mortgagors stuck with unserviceable subprime obligations, they can't provide jobs to those who simply cannot service even a refinanced prime mortgage.

Wall Street is still polarised between those assuming a double-dip is inevitable and those who believe low, slow growth is still the worst case scenario. But a third view is probably more accurate, and that is one which suggests the US economy realistically has been in a continuous recession since 2008. We are not looking at a “double-dip”, merely an ongoing “dip”. Fiscal and monetary stimulus along with the 2009 inventory restocking cycle only served to artificially pump up the US economy into expansion in previous quarters.

A similar impact is being felt in Australia, and one only has to look at recent Big Bank earnings results to see the evidence. I have now long argued that while the Australian resource sector is booming thanks to China, the rest of the Australian economy has been in recession since the GFC. While fiscal stimulus has now mostly expired in both the US and Australia, monetary policy in Australia is back to “normal” in response to mineral export inflation drivers while policy in the US remains as stimulatory as it has been. The Australian housing market is now weakening.

Much is made of recession definitions such as “two consecutive quarters of negative growth” but these are just semantics. The bottom line is that if you feel like you're in a recession, you are. Try telling the 17% of Americans out of work (which includes the 9.5% registered as seeking work) that the US economy is growing.

Last night's home sales number was released before the bell, and on the open the Dow plunged 183 points to dip below 10,000. Recent sessions have featured intra-day turnarounds, such that buying always finds the sellers and selling always finds the buyers. Indeed, last night the Dow spent all session recovering to be only 70-odd down, until the last half hour. This time the sellers returned and affected a close of down 133 as negative momentum gained.

It's still summer-session stuff, and while slightly better than the last few sessions, volume was still low.

Volumes were not, however, low in the financial market du jour – US Treasury bonds. Last night the Treasury auctioned US$37bn of two-year notes which saw solid demand, settling at a historical record low yield of 0.498%. The benchmark ten-year yield fell a solid 11 basis points to 2.49% – the lowest level in 18 months. With Japanese-style deflation being argued as America's greatest current threat, investors are continuing to ignore “bond bubble” calls.

Demand for US Treasuries as a safe haven has a positive impact on the US dollar, but so too does the continuing unwinding of yen carry trades. With Tokyo failing to make any suggestion of currency intervention, the yen also jumped last night. The US dollar index thus only ticked up slightly to 83.32, but the Aussie dollar risk indicator fell 0.9 of a cent to US$0.8821.

The weak home sales number was more fuel to the fire of those expecting the Fed will be forced to step up its quantitative easing program, which is another reason US ten-year bonds were again highly sought after. So too was gold, but it had to battle against the stronger dollar to add US$4.50 to US$1230.40/oz.

Weak data was nevertheless a simple equation for commodities, such that oil fell US$1.47 to US$71.63/bbl and base metals fell 1-3%.

The SPI Overnight fell 57 points or 1.3%.

There were shades of Australian politics in Washington last night as a Republican senator called for the resignation of Treasury secretary Timothy Geithner given his “failure” to manage the US economy. No doubt the posturing has now begun ahead of the November mid-term elections in which the Obama Administration is in danger of losing any control in the Senate. Many of the anti-socialists on Wall Street (ideologically, not behaviorally speaking) are hoping such a result will be the trigger that “saves” the stock market. In the meantime, September-October looms.

It's another huge day of earnings results in Australia today including the biggie – BHP Billiton ((BHP)).

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