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Bonds Recoil, Stocks Await Jobs

Liz Rappaport

This week's economic data is hinting at a bottom in housing and suggesting the rest of the economy isn't heading over a cliff. In an odd twist, the stock market remained unconvinced Wednesday, while the bond market bought the argument.

A jump in mortgage applications and mortgage refinancing combined with two employment reports to fuel hopes that the economy is headed for a soft landing rather than a hard one.

The bond market, which veers toward worrying about a hard landing, pulled back Wednesday on the news.

Stocks, which tend to embrace the notion that the economy could reaccelerate, weakened as year-end performance-chasing muddles the trends.

"Bonds didn't have much more room to go" on the upside, says James Paulsen, chief investment strategist at Wells Capital Management. "It would take a real disastrous number to keep going down from the 4.42% yield on the 10-year."

The 30-year bond dropped 12/32 in price while its yield climbed to 4.6%. The 10-year note fell 10/32 to yield 4.48% and the two-year note slipped 4/32 to yield 4.57%. Bond prices move inversely to yields.

The Dow Jones Industrial Average slipped 0.2% to close at 12,309.25 while the S&P 500 finished down a hair at 1412.90 and the Nasdaq Composite lost 0.3% to close at 2445.86.

The proof of this week's upbeat economic message will come in Friday's payrolls report. The consensus estimates are that the U.S. added 105,000 jobs In November, up from October's 92,000 new jobs.

"The answer to whether or not weakness in autos is bleeding into the service sector is 'no,' " says Paulsen, citing the stronger-than-expected ISM services report Tuesday. "And if you can still have about 125,000 new jobs each month even with the housing downturn, the consumer isn't going away either."

Meanwhile, clues are rolling in to suggest the labor market will remain robust. Also, after the government's downward revision to wage inflation data earlier this week, it seems likely that employers might not shy away from hiring. Indeed, payroll services processor ADP, in connection with Macroeconomic Advisers, reported Wednesday that 158,000 jobs were added in November, in its national employment report.

Strategists note that the ADP report has had some conspicuous "misses" this year in terms of forecasting the government payroll data. But the report may be more accurate when taking into account the many revisions to payrolls over the past two months. In a perfect world, economists would tack on the ADP report to their estimate of new government jobs, as the ADP report calculates only private sector jobs.

"Such prints would be consistent with job gains at the top end of the ranges estimated by the Fed as being consistent with full, stable, employment," writes Mark Chandler, fixed-income strategist at RBC Capital Markets.

Bond traders also mentioned that the Hudson Employment Index jumped to its highest reading since April, as workers report greater optimism about their personal finances, as well as expectations their employers will be adding new jobs.

Consumers might be feeling better because mortgage rates are at their lowest levels in 13 months, as more data support a possible bottoming in residential real estate. The Mortgage Bankers Association reported that mortgage applications in the week ending Wednesday jumped 8.1%, and refinancing activity increased 13.7% from the prior week.

The report was doubly encouraging regarding consumer stability, as the week's mortgage activity suggests people are locking in low long-term rates and not opting for adjustable-rate mortgages. The average 30-year mortgage rate fell to 5.98%, according to the MBA, the lowest rate since October 2005. Mortgage refinancing activity reached levels not seen since April 2004, and the amount of adjustable-rate mortgage activity decreased to its lowest level since 2003, according to the MBA.

The irony is that the bond market's exuberant rally and subsequent low rates are the catalyst for the mortgage activity and the homebuilding-stock resurgence. So, any large jump in rates could spark a plunge in housing once again.

For now, the next wave of Wall Street support for the homebuilders washed up Wednesday as Citigroup published a report increasing price targets for several homebuilders, and suggesting investors get in while they are still inexpensive. The upgrade came a day after Toll Brothers'(TOL Quote) CEO Robert Toll saying he sees a bottom in several residential real estate markets around the country.

The Philadelphia Housing Sector Index jumped 1.6% Wednesday. It is up 4.1% this week. Shares of Hovnanian(HOV Quote), Meritage Homes(MTH Quote) and Ryland(RYL Quote) climbed between 1.7% and 3.3% Wednesday. Shares of Toll Brothers gained 0.4% Wednesday, but are also up 4% thus far this week.

Contributing to the heaviness in the Nasdaq on Wednesday was Yahoo!'s(YHOO Quote) management shake-up, which dragged its shares down 2.1%.

In addition, Novell (NOVL Quote) shed 5.4% after the business software developer posted disappointing quarterly results, and Oracle (ORCL Quote) lost 5.2% following some cautious comments from Lehman Brothers.

On the flip side, Ciena (CIEN Quote) jumped 6.7% after saying Verizon (VZ Quote) is using its equipment to offer additional services to phone customers.

In the Dow, Merck(MRK Quote) providend in-line earnings guidance for 2007 and said its restructuring is on track. But its shares couldn't get off the ground, falling 0.8%.

Elsewhere, Biovail (BVF Quote) jumped 9.6% after tripling its dividend and paring its sales force, while Burlington Northern (BNI Quote) shed 3.2% following a Merrill Lynch downgrade.

Otherwise, stocks mostly languished in an uncomfortable gray zone awaiting more reasons to rally. Thursday brings the weekly initial jobless claims -- another clue for Friday's consequential payrolls report.