Wednesday, September 19, 2007

Light at the End of the Tunnel...Part III

Is the light at the end of the tunnel an oncoming train bringing inflation down the tracks?

Marcelo is certainly right that the goings on in the housing market are exactly what needs to and should happen. Prices are falling and eventually they will fall to a market clearing price. Falling interest rates could also hasten that process. One fly in the ointment though is that the rates which most affect mortgage rates are not falling yet. The 10 year Treasury Note yield actually went up yesterday and is up again today. I don't expect that to continue but as long as it does, mortgage rates are not likely to fall much.

Why are rates on longer term paper not falling? My guess is that the bond vigilantes of old are making a comeback of sorts. The Fed cut interest rates yesterday to spur growth but in doing so they may also be feeding future inflation. Gold rallied almost 9% this month as the market anticipated the rate cuts. Oil is making new highs. This story sounds familiar to those of us who lived through the leisure suits and inflation of the 70s (something that Marcelo didn't have to endure).

I have said that reflation by the Fed will work and I'm sure that it will. We still have deflationary tendencies at the consumer level due to low cost imports and that allows the Fed to cut rates. The price for that cut is asset inflation for now but somewhere in the future, it will turn into actual consumer inflation (assuming the government doesn't find some new way to mask the increase through another manipulation of the CPI). I don't think we are there yet, but it will arrive someday.

As for the housing market, I think Marcelo is right - there is light at the end of the tunnel. We are probably not at a bottom yet, but if our cycle goes anything like the recent cycles in Australia and the UK, we are likely to see at least some stabilization as the Fed cuts rates. We aren't headed back to the recent past of rapidly rising prices, but we could at least begin to see some of the inventory cleared out over the next six months or so. My stance all along has been that the housing mess will not cause a recession and the Fed's rate cut yesterday just reinforces that opinion.

Light At The End of The Tunnel...Part II

The Commerce Department released its monthly Housing report for August today. To no one's surprise, it was a little bit negative, with US housing starts decreasing by 2.6%. Building permits also came in a little low, falling off by 5.9%. At first glance, the numbers seem pretty bad, but there's a good in just about everything.

The numbers indicate a weakening in future residential construction in the US. That's ok, because everbody expects this to happen. Foreclosures are on the rise, adding to the glut of excess inventory in the market, where there is a 9.2 month supply of single-family homes. This has to sell off in order for the housing market to rebound. Prices also must fall. It is how the markets work. If supply exceeds demand, something has to give in order for the market to reach a state of equilibrium. Prices will fall. Inventories will fall as a result. There is evidence clearly suggesting that we are in the midst of this normal correction. According to the widely regarded Case-Shiller Home Price Index, home prices fell an average of 3.2% in the second quarter, and it will likely continue until inventories have been reduced sufficiently.

To further our bullish sentiment on real estate, falling interest rates will once again spur demand for housing. And as we all know, the Fed cut its benchmark rate by 0.5% yesterday, to 4.75%. Banks can now lend money to potential home-seekers at lower interest rates, which in turn, will provide steam for our economic engine.

Although this will all happen over the course of years, not weeks or months, the future seems bright for a heavily beaten-down sector. If only we can get out of it alive...

Friday, September 14, 2007

Light at The End of The Tunnel?

The US economy slowly limps forward, as the September 18th Federal Reserve meeting, a meeting where many hope and expect the Fed to cut rates, quickly approaches. The economic turmoil that has engulfed the markets is certainly giving the cause for a 0.25% or 0.5% cut a nice lift. And the economic reports released today are also doing their part.

The Retail and Food Sales number came in at a less than expected 0.3% increase. Economists projected that number closer to 0.5%, with estimates ranging from 0.1% to 1.2%. Purchases excluding automobiles came in even worse, falling unexpectedly by 0.4%. It was forecast to increase by 0.2 percentage points. Retail sales, which has been relatively strong for the past few months, appear to be stalling a bit. That is terrible news for an economy growing at a slow-to-moderate pace, trying to fight off the demons of a worsening housing market and a pending credit crunch.

"The consumer is pulling back a bit. Maybe some of the issues in financial markets and housing are starting to limit the upside."- Peter Kretzmer, Senior Economist at Banc of America Securities LCC.

The retail sales number will most definitely impact the decision that the Fed will take on during the September 18 meeting . It strengthens the case for an interest rate cut in order to promote growth and prevent the looming recession.

The Labor Department also released the Import Prices report today. The price of all goods imported into the US fell unexpectedly in August by 0.3 percentage points, the first drop since January. The drop will probably be short-lived though. The number was caused by a drop in the price of oil and natural gas in August. Commodity prices have risen since then, so we can expect that number to rise once again.

Thursday, September 13, 2007

Headline Risk

The WSJ Economics blog has an interesting post about Joe Carson, Alliance Bernstein's economist. He believes, as I do, that the US economy will not fall into recession. As evidence he cites some headlines:

Market Watch: Bracing For Mortgage Losses
Despite Late Rally, Dow Ends A Bad Week Lower
Shift To Capital Markets From Banks Brings Tumult
Crisis Goes Beyond The Balance Sheet
Banks Tighten Some Loan Terms
Commercial-Mortgage Issuers Are Locked In A Deep Freeze
Recession Fears Dominate
Market Turmoil Hits Luxury Home Sales
Heavy Spenders Take A Break
Decade of Moral Hazard
Emerging-Market Investors Get Full-Fledged Drubbing

The punchline is that the headlines are from September and October of 1998. In other words, we've been here before and a recession is not inevitable.

Tuesday, September 11, 2007

Exports - Our Saving Grace

The markets were in desperate need of good news today, after a tumultuous past week where the Dow Jones Industrial Average lost 1.82%. Early in the morning, the markets received just that, when the July Trade Deficit report was released. The good news came in the form of a shrinking trade deficit and record export numbers.

The US trade gap narrowed by 0.3% in July, mainly due to a jump in exports. It fell to $59.2 billion, from a revised June number of $59.4 billion. Exports rose to a record $137.7 billion for the month. The percentage gain of 2.7% was the highest since March 2004, or more than three years. Imports also rose to record levels, inching up 1.8% to $196.9 billion.

Although imports rose significantly, the export number is very positive. In today's sluggish economy, exports are still booming, giving a lift to US corporations and the economy as a whole, despite the slowdown and pending credit crunch. Better yet, exports are not likely to decrease in the near future, due to strong overseas growth and the unceasing devaluation of the American dollar. Exports are acting as a cushion for the economy in these uncertain times, while providing a platform from which it can take off in the future.

Sunday, September 09, 2007

Market Update

Our latest tactical update is available by clicking on the link above. Here's an excerpt:

In August of 2007, America awoke wearing a lampshade of Miami pre-construction condos, a throbbing liar loan headache, sucker written on her forehead in lipstick and a sub-prime mortgage stuck to her shoe. This mighty hangover has only one cure according to Jim Cramer and various other self interested parties: a little hair of the dog; a Bloody Mary mix of lower interest rates and newly printed dollars to inflate the next bubble in this ongoing Fed sponsored orgy of irresponsibility. Rather than remove the punchbowl, America, like a drunk who won’t leave the party, wants the Fed to get us a refill.

Those of us who stayed away from the punchbowl can now finally gloat about the fools who are losing their deposits on condos for which no greater fool appeared. We can revel in the knowledge that the condo flippers were, in many cases, the same folks who thought they could quit real jobs and day trade their way to untold riches. Unfortunately, our schadenfreude can be only temporary for there are real consequences even for those who stayed sober during the recent real estate bacchanalia.

One thing we can count on though; the Fed is always around to spike the punch anew and get the party going again. They’ve already started by opening the discount window a little wider by accepting some dubious collateral in exchange for some crisp new dollars. The Fed created this mess by cheapening our money to the point that banks had no qualms about loaning it out to folks with grand but dubious plans. The banks didn’t much care who they lent to since they didn’t intend to keep the loans any longer than it took them to package it up, get it rubber stamped AAA by a rating agency and sell it off to a hedge fund run by a slick salesman with an algorithm in his pocket.

Wednesday, September 05, 2007

Is It Over Yet?

Today, the markets received a flurry of economic reports that puzzled even the most seasoned investors. The first of these reports, the MBA Mortgage Application Survey, pointed towards a stabilizing housing market. It showed a seasonally adjusted 1.3% increase in the number of mortgage applications filed last week compared with the prior week. Refinance applications increased a seasonally adjusted 2.3%, while loan applications to buy homes increased only slightly, up 0.4%.

The good news stopped there. The Challenger Layoffs Report, a monthly tally of layoff notices, was released soon after the MBA report. Tens of thousands of jobs were lost in the month of August. Layoff announcements surged 85%, to a tune of 79,459. 35,752 jobs were lost within the financial sector alone, where the cuts were attributed to the credit crisis and the housing slowdown. Corporations such as American Home Mortgage, First Magnus, Lehman Bros, and Accredited Home Lenders led the surge by laying off a significant percentage of their workforce within their respective mortgage lending and servicing units.

Although the markets opened lower following the release of both reports, the pending home sales report completely rattled the markets, setting the stage for a bearish Wednesday. The index for pending home resales, or the number of contracts signed for the purchase of a previously owned home, dropped an unexpected 12.2% for the month of July. It fell to 89.9, the lowest number since records began in September 2001.

The report points toward a continuing housing slump and contradicts the previous MBA survey. So a burning question arises: have we reached the bottom of the dreaded housing slowdown, or are we in the midst of something worse? There really is no definite answer at this point in time, but these coming weeks will be very telling.

Sunday, September 02, 2007


Friday, the Wall Street Journal opened their lead editorial with a faux prayer to Bernanke:

And so did a cry of lamentation arise from the multitudes unto Bernanke: Spare us, Oh Lord, from the wrath of subprime.

From the House of Countrywide wailing was heard, from the land of Dodd and Schumer there was gnashing of polls, and from the Kingdoms of Bear, Lehman and Cramer the rending of fine Italian garments: Set your righteous hand, glorious and merciful Fed, against our enemies among the rating agencies, the risk-averse and short-sellers. In your power and majesty, you need only say the word and interest rates shall fall, liquidity like manna shall descend from the skies, and easy credit shall flow once again across the parched and barren land.

Back in 1998, I wrote a similar ode to Greenspan:

O Greenspan my Savior and my Master, I, Thine profitable shareholding servant, with fear and trembling give thanks unto Thy loving goodness for all Thy liquidity Thou hast poured so abundantly upon me, Thy servant. I fall down in adoration before Thee and Thy brethren of the FOMC and offer thee my praises; with fervor I cry to Thee to keep thy monetary spigot wide. O Greenspan, deliver me henceforth from all market adversities and mercifully fulfill in me all the desires of my portfolio. Hear me, I entreat Thee, and have mercy, for Thou art the sole hope of shareholders in the four corners of Thine Earth, and unto Thee be ascribed glory, now and ever, and unto the ages of ages. Amen.