Why did Tuesday's key releases drive financial markets higher?

Part 2
Why did Tuesday's key releases drive financial markets higher? (Part 2 of 7)

A surprise durable goods order spike drove the S&P 500 to new highs

Defense and transportation orders led a spike in durable goods demand

Durable goods orders are for items meant to last three or more years. The U.S. Census Bureau released the advance durable goods orders report for April on Tuesday, May 27. The report estimated new orders for durable goods at $239.9 billion in April, a 0.8% increase over March, compared to market expectations for a decrease of 0.8%. April’s level also translated to a significant 7.1% year-over-year increase. The better-than-expected figures were largely due to orders for transportation equipment and defense goods, which increased 2.3% and 32.5% respectively.

In response to the consensus beating numbers, the S&P 500 Index (SPY) reached a new high of 1,911.91, rising 0.6%. The spurt in factory orders over the past three months is also likely to contribute significantly to economic growth, which has led to upbeat market expectations.

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Highlights from the advance April estimate

  • Defense goods orders recorded the highest percentage increase—up 32.5% to just over $15.3 billion. Excluding defense goods, durable goods orders declined 0.8% from March’s figures.
  • Transportation equipment increased for the third consecutive month—by $1.7 billion or 2.3% to ~$76.9 billion. Excluding transportation equipment, durable goods orders increased just 0.1%.
  • Non-defense capital goods orders, excluding aircraft, declined 1.2% to $70.1 billion. This critical indicator provides an inkling of the capital expenditure plans for businesses over the coming months. Non-defense capital goods orders had already risen 4.7% in March, which may have impacted April’s figures.
  • Shipments of manufactured durable goods ticked up by $0.6 billion or 0.2% to $237.2 billion in April. Transportation equipment shipments again led the decrease, falling by $0.7 billion or 1% to ~$69.5 billion.
  • Unfilled orders for manufactured durable goods in April increased by $10.4 billion or 1% to $1,081 billion, reaching their highest level since this data series was first published in 1992.
  • Inventories of manufactured durable goods in April increased by $0.3 billion or 0.1% to $393.3 billion. The level was the highest since this data series was first published in 1992.
  • Shipments for non-defense capital goods decreased by $0.4 billion or 0.6% to $76.5 billion in April, while unfilled orders increased by $5.7 billion or 0.9% to $656.1 billion.

Implications for investors

April’s report was dominated by the performance of the defense and transportation sectors, which were the chief factors spurring factory orders. Investors can gain exposure to these sectors by investing in ETFs like the State Street Industrial Select Sector SPDR (XLI), whose holdings include aerospace and defense sector companies like Northrop Grumman (NOC) as well as transportation companies like Norfolk Southern (NSC). An increase in transportation orders is particularly relevant, as this usually leads to output increases in other industries as well.

While output increases translate to economic growth and are beneficial for cyclical industries, interest rates usually increase in periods of accelerating economic growth. However, 2014 has so far been contradictory for the bond market. Economic indicators indicating momentum have been accompanied by decreasing yields, as the demand for safe-haven assets like highly rated U.S. debt has overridden fears of a rate hike.

This is because the Fed has already indicated that it’s not planning to raise the Fed funds rate this year. Besides, geopolitical tensions overseas have increased demand for Treasury securities, which are widely regarded as some of the safest assets in the world. The yields for 30-year U.S. Treasuries (TLT) have fallen by 55 basis points since the start of the year, making longer-term Treasuries some of the better-performing asset classes this year. The iShares 20+ Year Treasury Bond ETF (TLT) has clocked a year-to-date return (as of May 16) of 9.89%, confounding bond sceptics.

In the next part of this series, we’ll discuss the Case-Shiller Home Price Index, which was released on May 27. Please read on.

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