Housing and Banking May Improve Yet
07/15/08
Money managers walk a fine line: Some clients prefer active management, others detest "excessive" turnover. Some see active trading as a manager's way of taking care of their account, others see high levels of turnover as "increasing expenses" and as poor investment management. Some people see "cash" as building opportunity, some see "cash" as missing an opportunity. Money managers walk that fine line between 20/20 hindsight, trend-following without being a member of the herd that follows and anticipating market turns without becoming faked out by every twist and turn. In that regard I venture to say that the month of June was tough for everybody. Trend-followers and mean reversion traders were faked out just like momentum investors and value investors were forced to abandon strategies. Even energy stocks could not safe you. The entire market, every sector and size lost money in June. In fact, it was the worst June since 1929.
As if all this was not enough, the second half of the year started where the first had left off. Further stress in the banking sector, sharp declines in Fannie Mae and Freddie Mac shares, kept the focus squarely on the financial crisis. US officials have judged that the solvency of these two government-sponsored agencies are too important to the financial system that if necessary they will be "nationalized" if that is what is required. And even though the impact extended far beyond the US, the US dollar remained the chief victim in the currency markets. All news was bad news and needed to be sold. So how much longer until we reach Armageddon?
First of all: Things are bad. IndyMac was taken over by the Federal Deposit Insurance Corp. just last Friday. It was the second largest bank failure in U.S. history. Naturally the rumor mongers were out in full force after that.
Second and more importantly, things are not uniformly bad. In fact silver linings are visible, if you care to look.
The first chart above shows that retail sales benefitted from the econmic stimulus checks being sent out in June. Retail sales rose 0.1% in June but dropped 0.5% if one excludes gasoline sales. Still, retail sales have held up well the past three months. Let's see if they can sustain it without government rebate checks. The second chart shows the Institute for Supply Management chart. Purchasing managers picked up the pace somewhat. The index inched over the 50% expansion line in June. The same is true here: sustainability is key. Both charts show weakness but certainly no crash in the industrial part or the consumer part of the economy.
Some more hopeful news is coming from the housing market. Barron's ran a cover story on Monday proclaiming that "This Real-Estate Rout May Be Short-Lived". Jonathan Laing writes that "sales of existing homes are showing tentative signs of increasing, while the plunge in prices is nearing an end." He adds that inventories, while still high, are off the peak levels and at least are moving in the right direction: Home prices in eight of the twenty districts surveyed by the Case-Shiller index rose last month. And the Case-Shiller index is overly pessimistic he says because sub prime housing, although less than 10% of total housing, is a far larger share of current volume due to banks dumping repossessed real-estate onto the market. Chip Case of the aforementioned index thinks home prices may be nearing a bottom. He notes housing starts in April were 975,000 down from a January 2006 peak of 2.27 million. A decline of this magnitude, from over two million to under one million, has occurred three times in the past 35 years. "Every time ...housing activity has rebounded within a quarter and caught experts by surprise." Mark Zandi of Moody's Economy.com has been bearish on housing for a while and he sees some better signs as well. He figures the ratio of home prices to annual incomes is well off its high of 2.39, and is back to its 17 year average of 1.88 to 1.
A report this week showed U.S. homebuilder sentiment dropped to a record low in July, a reminder of the troubled housing market's drag on the economy. It seems to me a good sign when the traditional cheerleaders of the housing industry are finally admitting defeat. It probably means that sales have reached a low and investories a high from which we can work our way back towards a normal housing market environment. The chart above shows you the 8 markets that seem to be on the mend. The second chart shows existing home sales (blue), inventory of unsold homes (red) and and the number of months supply at the current sales pace. As you can see, sales have flattened out and have not significantly deteriorated for about nine months now.
And then there is the price of oil: crude oil prices dropped sharply for a second day on Wednesday after a U.S. government report showed a surprise increase in inventories and continued weak demand in the world's top consumer nation. The price decline of almost $13 marked the biggest two-day loss in percentage terms since January 2007 and helped stocks on Wall Street regain some of the ground lost in recent days on fears over the health of the U.S. banking sector. Wednesday's losses came after the U.S. Energy Information Administration reported crude inventories rose by 3.0 million barrels last week -- countering expectations for a decline -- alongside builds in gasoline and distillate stocks. The widely watched government report also showed U.S. oil products demand running 2% percent below year-ago levels, another sign that soaring prices are cutting into consumer demand for fuel. So it becomes more and more obvious that demand destruction is happening. Faithful readers know that I have been calling for falling oil prices for over two months now. They will also know that I have been early (WRONG) for just as long. It seems that we are now seeing the beginning of a significant correction in the price of oil. The reduced U.S. demand of some 2% amounts to about 500,000 barrels/day. This easily offsets a 7% increase in Chinese demand. I believe that oil prices are going to see $100 or below sometime this year. This should also help consumers and their bankers. The banking crisis may not be over, but we caught a significant brake this week. Wells Fargo reported better than expected earnings, which caused the KBW Bank Index to experience the biggest gain in the index history. As they say, it is always darkest just before dawn.
Hermann Vohs
Hermann Vohs is president of Cales Investments, Inc., a registered Broker-Dealer. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Hermann Vohs and/or the staff at Cales Investments, inc. may or may not have investments in any of the markets cited above. Hermann Vohs can be reached at 303-765-5600.
This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities.
