Week's Journey Begins With a Step Back

Xerox's earnings and rising bond yields overshadow M&A news and record-setting housing data.
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A week in which more than 100 of the

S&P 500

(SPX)

companies are expected to post earnings didn't exactly start with a bang. Major averages closed in the red after

Xerox's

(XRX) - Get Report

second-quarter results and third-quarter guidance disappointed Wall Street, and investors also warily eyed rising long-term Treasury yields.

The

Dow Jones Industrial Average

I:DJI

fell 54.7 points, or 0.5%, to 10,596.48. The S&P 500 dropped 4.65 points, or 0.4%, to 1229.03, and the

Nasdaq Composite

(NASDAQ)

fell 13 points, or 0.6%, to 2166.74.

Other firms reporting earnings Monday, such as

American Express

(AXP) - Get Report

and

BellSouth

(BLS)

, beat expectations. (After the close,

Texas Instruments

(TXN) - Get Report

reported

better than expected second-quarter results and its shares were recently up 4% in after-hours trading.)

Merger news provided some early support for shares after news that

Maytag

(MYG)

said a takeover offer from

Whirlpool

(WHR) - Get Report

provided more value than a rival bid by a private consortium. And

Teva Pharmaceutical

(TEVA) - Get Report

said it had agreed to buy

Ivax

(IVX)

for $7.4 billion.

The market also rose briefly after news that

sales of existing homes reached a new record in June. But even housing stocks, which reached new highs last week, then sold off. The sector, along with financial shares, is coming under increasing pressure as bond yields have kept climbing since late June.

The benchmark 10-year Treasury bond fell 7/32 and its yield rose to 4.24%, as the impact of China's first step toward revaluating the yuan continues to be assessed by the market.

It seems that after the China move, long-term interest rates are finally poised to rise in a sustained manner.

End of the (Housing) Affair?

Some economists believe the Chinese move could spell the end of what

Federal Reserve

Chairman Alan Greenspan had called a conundrum -- long-term rates remaining low in spite of the Fed's sustained campaign to raise short-term rates.

And yields had already started rising from 3.9% in late June, as investors began pricing in the likelihood that the Fed will continue raising short-term rates for longer than previously expected.

That may explain why housing stocks sold off Monday, even after news that existing-home sales reached a new high of 7.33 million in June, up 2.7% from 7.14 million in May. That was above the consensus forecast of decidedly cautious economists, who expected sales of 7.15 million.

The average sales price also rose to a new record of $219,000, up 14.7% year over year. That's the sharpest price increase since November 1980.

After the data, the Philadelphia Stock Exchange Housing Sector Index, which hit a new high last week, fell 2.6%. Homebuilders

KB Home

(KBH) - Get Report

fell 4.13% and

Toll Brothers

(TOL) - Get Report

fell 3.77%.

When looking at a graph comparing the Philadelphia housing index and the 10-year bond yield over the past two years, the close inverse-correlation is hard to miss. As the yield fell, which has been pretty often over the past two years, housing stocks rose accordingly.

Once again, doomsday scenarios about the housing market are being spun. But this time, and contrary to similar -- and wrong -- calls made over the past two years, they might be worth heeding, if only because long-term rates do seem to be finally rising.

Lehman Brothers economist Joseph Abate, for one, chose to ring the alarm bells on the possibility of regional housing busts. Many bullish analysts on housing have dismissed the risks in the current housing market by saying that real estate bubbles remain localized, arguing that prices could not fall on a national basis.

To Abate, however, this sounds too much like recognizable symptoms of denial.

"There is a strong sense that the U.S. national housing market is immune from the boom-bust cycles that characterize other countries," he wrote in a research note.

Based on a recent study of global home-price cycles, Abate found that regional markets in the U.S. show a very similar pattern to smaller countries such as Denmark, Finland and Italy, which have experienced booms -- followed by busts.

Such localized busts tend to lead to price declines of about 6% on average in the first year, and continue for five to seven years, leading to average real decline in prices of 27%.

But worst of all, there is nothing in recent history that supports the prevalent idea that prices can't come down nationally because they haven't done so in the past 30 years, Abate says, noting: "There has not a boom of this magnitude nationally in more than 30 years."

In fact, national real home prices (adjusted for inflation) are in boom territory for the first time in 30 years, according to the Office of Federal Housing Enterprise Oversight. And of course, "never before has easy credit and speculative buying dominated during a

U.S. boom," he says.

Bank of America market strategist Thomas McManus believes that the behavior seen in the U.S. housing market is symptomatic of a broader market trend. "We remain concerned about the valuation of the broad market at current levels, wary of the symbiotic relationship between housing wealth, equity wealth and retail sales," he wrote to clients.

To view Aaron Task's video take on today's market, click here

.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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to send him an email.