We had a nice midweek rally when financials Bank of America and Wachovia reported that their second quarter performance wasn’t as bad as expected. That helped push those banks up 10 percent and almost 14 percent for the week, respectively, and generated additional buying interest in other players.

The US House of Representatives also approved aid to Fannie Mae and Freddie Mac. A 272-152 vote authorized the body to extend unlimited credit to the two troubled mortgage lenders. The measure will also allow the government to insure up to $300 billion in refinanced mortgages and extended as much as a $7,500 tax break for first-time homebuyers.

Although the Senate still needs to sign off on the bill, it’s expected to pass with little opposition after President Bush dropped his threat to veto the bill’s $4 billion allowance for local government to buy foreclosed properties.

It’s probably not time to break out the bubbly yet for financials. Although their second quarter results may not have been the worst news possible, it still wasn’t good. The banks still have broad exposure to problematic mortgage markets. Wachovia is struggling to refinance borrowers out of questionable negative amortization loans that came with its purchase of Golden West, and Bank of America will certainly have further problems related to its acquisition of Countrywide.

More writedowns are in the offing across the board because, even with the bailout of the government-sponsored enterprises (GSE), home values will continue to fall in coming months. And it’s likely we’ll see more bank seizures on a regional scale before the credit crisis works itself out.

First-time filings for unemployment benefits spiked unexpectedly last week, jumping by 34,000 to 406,000 claims. The previous week’s numbers were also revised sharply upward, from 366,000 to 372,000. Higher input costs and a weakened economy continue to put pressure on the labor force, with unemployment claims once again near their September 2005 highs. The four-week moving average of claims has increased to 382,500 from 378,000.

Continuing claims extended their decline, though, falling to 3.107 million from a downward revision of 3.116 million. That’s helped keep the unemployment rate among workers eligible for benefits at 2.3 percent.

Again, it’s too soon to say that more laid off workers are finding jobs--especially because, based on the timing of the downturn, this could simply be the result of benefits running out, despite the House extension. And in the latest jobs report, 37 states reported an increase in filings, with only 16 reporting a decrease.

Some good news this week came in the form of impressive gains in durable goods orders, fueled by a weak dollar. Even though orders were forecast to drop 0.3 percent in June, they actually jumped by 0.8 percent over May. Excluding transportation-related orders (or lack thereof), durable goods orders increased 2 percent. Orders for nondefense capital goods--a fairly reliable measure of business investment--were up 1.4 percent.

So despite the Federal Reserve’s Beige Book report that manufacturers in several of the 12 covered districts were anticipating weakness in business, it appears the wheels of industry will continue to turn. Right now the weak dollar remains the stronghold for the sector, but the broader concern is that workers remain on the job.

Finally, both new and existing home sales data were reported this week. Existing home sales came in much lower than expected, with economists forecasting strong buying interest in foreclosures to help boost numbers. But continued expectations for further price drops pushed sales down 2.6 percent, setting an annual pace of 4.86 million units sold--a 10-year low. That sales rate implies that 11.1 months’ worth of supply is sitting on the market as the number of homes for sale bumped up 0.2 percent to 4.49 million.

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New home sales fell 0.6 percent in June to a pace of 530,000 units annually despite builders’ efforts to move inventories through price slashing and other incentives. That creates 10.4 months’ worth of new home inventory at the current sales pace.

We can expect further weakness and declines in home values: The Office of Federal Housing Enterprise Oversight reported its monthly house price index fell another 0.3 percent in May. And RealyTrac reported that foreclosure filings more than doubled in the second quarter, with one in 171 households in some stage of the foreclosure process. That marks a 121 percent increase from the prior year and a 14 percent jump from the first quarter.

With the glut of real estate coming onto the market, a weak consumer outlook and greater difficulty in securing mortgage financing, the future for real estate looks grim in the coming months.

Mortgage application activity fell 6.2 percent last week as interest rates crept up across the fixed-rate spectrum. The Mortgage Bankers Association reported that purchase applications fell 6.7 percent and refinancing applications were down 5.6 percent. The average rate for a 30-year, fixed-rate mortgage came up to 6.59 percent from 6.22 percent; 15-year fixed-rate mortgages rose to 6.1 percent from 5.74 percent; and one-year adjustable-rate mortgages held steady at 7.16 percent.

Two key pieces of information will be moving the markets next week: the second quarter GDP number, released Thursday, and the monthly jobs report, released Friday. Right now expectations are for 2 percent GDP and 75,000 less jobs in July, so the markets will likely be volatile. If the numbers are in line with or slightly better than expectations, expect to see a healthy rally. Otherwise, we could have sizable declines.

I’m personally expecting good numbers; the weak dollar is good for exports, which in turn are good for the GDP and jobs. And so far corporate earnings haven’t been that negative, comparatively speaking. Although that doesn’t mean we’re out of the woods, the economic situation doesn’t necessarily justify the level of gloom still out there.

George Kleinman, editor of the free e-zine Commodities Trends, took another look at the oil market this week and examined the recent price action in other commodities. It’s an interesting read and chart intensive, so I would suggest following the link to get the complete picture.

“Oil prices realized their largest weekly drop in history from $145 a barrel down to $129 a barrel. That’s a $16-a-barrel drop. Oil prices are now down $18 a barrel from the July 11 high. Since last Friday, gasoline prices dropped about 40 cents a gallon, and this should show up at the pump in a few weeks.

Soybeans collapsed $1.60 per bushel last week, a 12 percent drop. Remember the Midwest flooding that ravaged the corn crop? Corn is down 19 percent from then to the same prices seen before the flooding began.

The dow jones Industrial Average was up 400 points last week and registered a bullish weekly reversal higher (trading to a new low for the past two years and closing above the previous week’s high). Still, based on our quarterly indicator (see CT, July 7, 2008, Stock Market Success), it’s nowhere close to flashing a new buy signal.
 
Stocks appear to be short-term bullish and certainly could rally another couple hundred points or even double that, but much more than that will be required to turn this bear back into a new bull. And I don’t see that yet.

What about commodities? Oil had the largest weekly price drop in it’s history last week, but that’s in raw terms, not percentage terms.

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From the top, oil prices have corrected 13 percent. Historically, there have been larger percentage breaks; it happened three years ago. The price break in January from $96.50 a barrel to below $85 was also a 13 percent drop.

Back then, folks were very worried that $100 a barrel might be a possibility. Today, even after this 13 percent break, $100 a barrel oil appears cheap. The reason oil prices have risen as high as they have has less to do with US consumption (down about 500,000 barrels per day, or 3 percent) than with the emerging economies that are more than picking up the slack.

Today China is temporarily shutting down entire industries to curb pollution in preparation for the Olympics. However, last week China reported its second quarter GDP rose by 10 percent, and the country is experiencing 20 percent inflation.

India is also experiencing the fastest inflation in 13 years. There's been a lot of talk about how speculators have been pushing up oil prices. Take a look at open interest (orange line, a measure of outstanding futures contracts) on the oil chart above. It’s collapsed in recent weeks, indicating a purging of speculative participation in this market.

It’s now at the lowest level since February 2007 at about $60 a barrel. emerging market energy demand isn’t going to disappear this year, and at some point, the next oil price rally will begin. Sure, oil could drop some more, but don’t expect it to go back under $100 a barrel anytime soon. And after the next higher low is registered, the next price spike will likely be swift and brutal.
 
Soybean prices followed oil sharply lower last week and are now down 12 percent from the all-time highs registered a few weeks ago. Last week’s news announced that the Argentine farmer’s strike was settled and the country will now flood the globe with soybean supplies. Note there was a 12 percent correction in April and an even more dramatic 29 percent correction in March, which turned into premier buying opportunities.

The charts are bearish. The market has carved out a head-and-shoulders top pattern that points to a continued downside objective at 1,338. However, like oil, the majority of the speculative open interest has been purged from this market. The fundamentals are decidedly bullish with the lowest projected carryover supply in history.”