The Housing Market

Home sales dipped last month by about 1%, even with the good weather that should have helped; but I am sure we are getting close to a bottom despite the shadow inventory of 1.6 million homes in some stage of foreclosure. First, as I bid on short-sales in Orlando, there are now multiple offers along with mine. Demand for the bottom of the market is strong, meaning a floor is being set. That doesn’t mean prices are going up any time soon. Second, the median priced home is now 156k which is 2.8 times the average household’s income, which means homes are ubiquitously affordable again. It may take another year or two for the inventory to be worked off, but now is the time to buy a house, I think, if you have a 20% down payment. And, that is the rub. The average household does not have the 20% for a conventional loan---- it will take time to save it. That is another reason prices won’t take off in the next two years.  As a footnote, 33% of the sales last month were cash sales to investors; and I was one of them. 

-Alan Moore (03/22/2012)

Furthermore, the housing data released earlier this week came in essentially in line with expectations. Total Housing Starts have been steadily rising and give an appearance of an improving housing market but after looking at these numbers with increased granularity such optimism wanes. Below is a chart of the Housing Starts, seasonally adjusted, data broken up in to single and multi-unit structures. Single unit structures are single family homes and actually relevant for actual housing demand while multi-unit structures are those that are built with the purpose of being rented out.  Clearly the trend has switch from buying to renting. Single units structures have basically flat-lined for the past two year while multi-unit structures have been clearly trending higher.  This trend may simply be explained because of how easier it is to qualify for a renting lease than a mortgage. The final chart show seasonally adjusted single-unit completions which are not fairing any better as growth is abysmal and this January’s number was lower than eleven out of the twelve months in 2011.

-Charles (03/22/2012)

Parabolic Rise In Equities Is Unsustainable

Interest rates and the stock market went up over the last month because of the reduced European risk and the rise in consumer confidence due to better employment data. Going forward, that leaves corporate earnings as the driver and they will not show improvement this quarter over 4th quarter 2011 because of margin squeeze. No longer can companies cut costs and improve profits, it is up to top line revenue growth now, which will force them to add people. GDP is forecasted to come in at 3% this quarter, but only a third of that growth is due to consumer spending, the rest will come from inventory buildup. I still think we are stuck in a slow growth economy and that stock prices are high. Real estate is a better deal than stocks if you are able to capitalize on it by buying foreclosures and renting them. 

The Fed announced today that they made record profit of $77B from their acquisition of the all the subprime mortgages in the bailouts. With no money, and just the power to create deposits to buy assets worth over two trillion dollars, they made a profit, on paper----- it’s all paper anyway. My only question is why do they stop at $2T, why not $50-trillion, then they can book enough profit to balance the budget. 

Greece has been saved to default another day. Don’t you think Spain, Portugal and Ireland are going to lobby to be saved the same way? I do, and for that reason I believe the European crisis is not over. Crucial elections are coming up in Europe in April and May and the people want a change in leadership. 

-Alan Moore (03/21/2012)

Important Euro-news Today

“Creditors accept lower rate on Greek debt: FRANKFURT (MarketWatch) -- Private-sector lenders are ready to accept a coupon rate of less than 4% on new Greek bonds that will be issued in a voluntary debt swap, according to a story in Greek newspaper Ethnos, Dow Jones Newswires reported on Thursday.” 

This is the deal that is supposed to pave the way for Greece to get another draw from the Stability Fund on March 20th. It will result in Greek bonds being written down by almost 65% at the banks holding them. Overnight, the Greek debt to GDP ratio will fall from 150% to 120%; but this year’s deficit will be at least 9%, with no real way to close it with austerity. A write-down is a rational reaction to the market-reality. In this case, a Greek default would be too contagious to contain. However, it is doubtful the Greek people will take the prescribed medicine and the default bug will continue to infect the PIIG economies. 

-Alan Moore

Greece: 'The Only Thing Left of Value is the Ruins'

Today on page A13 in the Wall Street Journal, this is what the IMF says is necessary to fix Europe: “There are three imperatives, one is stronger growth, two is larger firewalls; three, deeper integration is needed,” Ms. Lagarde said. All I can say is: duh-------- but where are the details? These sound bites of wisdom are totally worthless. How can they get stronger growth when spending is being cut and government workers are being laid off in droves? Who is going to pony up the extra money to create this “larger firewall”, which is really just a bailout fund-----Can the ECB become like our Fed and just assume all the bad loans in Europe and make them disappear on their balance sheet, which is a joint liability owned by the EU members?  Are the other countries in the EU going to let Germany dictate their sovereign budgets, which is what Ms. Lagarde really means by deeper integration?    The bottom line is Europe is already in a recession and there will be no growth in 2012, no jobs created and no effective integration. There will be more debt created to address the bank problem and Greece will cram-down a 60%-plus write off of their sovereign bonds held by the private sector. The cram-down will be a quasi-default that won’t walk their country back to health because Greek deficits will continue to mount until Mount Olympus is sold in an asset dump--------- The ruins are the only thing left of value in Greece.

-Alan Moore

Alan Moore End of Year Commentary

Christmas was here last week and it wasn’t any different this time. People spent heavily on bargains trying to manage their credit card deficits, which doesn’t say much for profit margins in the retail sector. Here is one story about that. 

A wife shopping at the mall on Christmas Eve suddenly noticed her husband was not around and she became upset because he had the credit card. Agitated, she called him on her cell phone and asked ominously: “where are you?” The husband in a calm voice said, "Honey, remember the jewelry store we went into 5 years ago where you fell in love with that diamond necklace that we could not afford and I told you that I would get it for you one day?" His wife, with tears in her eyes, said, "Yes honey, I remember that jewelry store." He said, "Well, I'm in the bar next to it."    

In the Economist magazine on December 3rd was an article called “President Newt”, insinuating that it could happen, given the failure of Obama to turn the economy and deficits around like he promised. Until he got to Iowa, Newt grew in the polls like an E. coli colony on hamburger at room temperature; but in the past, he has always shot-off at the mouth one too many times with a grandiose intellectual idea, like firing all the janitors in the public school system to reduce spending. It will probably happen again, as his PHD gets in the way of his common sense when he gets aroused----he reverts back to his history of temper tantrums and wild accusations. No matter who wins the Republican nomination, Obama will win the debates and the election as long as the economy is still standing at 2%+ growth next November.    

Who wins the election really depends on whether we go back into a recession or not and on the unemployment rate: if it is under 8% Obama will win; over 9% and he will lose; in between 8 and 9, it is up for grabs; and the Republicans lost their grip when Obama won the 2-month, payroll-tax-extension bill.  Soon, in two months, they will get a chance to get it back, but I wouldn’t count on it. The Republicans are getting played: if they keep approving 2-month extensions, they will appear weak and disorganized going into the election. If they block the payroll tax cut, they will lose the election, because the 160-million, affected voters will not appreciate the tax increase. Obama would love to keep the payroll issue in the headlines every two months going into November, because he is on the winning side of the argument, politically, if not financially. The Republicans have boxed themselves into a no-win situation trying to nix the Democrat’s proposed tax on millionaires to pay for a permanent payroll tax cut. Do you really think the average voter cares about what happens to millionaires?             

At the beginning of 2011, the smartest on Wall Street did their forecasts; Goldman Sachs predicted the S&P Index would be 1450 by year end and it will come in around 1250, actually about the same as 12/31/2010. Predictably, no quant really knows much about the future because the models are based on current data melded with historical averages by assumptions, like steady corporate earnings and interest rates. Actual events occurring in the future usually cause the models to miss by a wide margin; albeit, math can only tell us how far the market has strayed from the mean, not what it will do in the future. So having some idea of the market-shaking events that could occur next year is more important than figuring the DOW is at 13 times earnings today and the historical average is 15, then making the call that it will probably rise next year and gravitate to the mean. The flip side of a “probable rise” is the risk that it won’t. Therefore, I will give you my thinking on the negative and positive events that could ruin the Wall Street predictions next year, whatever they may be. 

Negatives in order of importance:

1. A banking crisis in Europe created by a Greek default or collapse of the Union.
2. Recessions in Europe and China which cause a recession or slowdown in the US economy
3. Congress continues to fiddle while the deficits burn up our credibility.
4. Military action against Iran which would destabilize the oil market (or Saudi Arabia has trouble).
5. A trade war with China or perhaps North Korea does something stupid.

Positives:

1. Consumers are continuing to spend and support the economy.
2. France and Germany have at least agreed that they cannot afford to have the Euro fail.
3. Employment is improving, although very slowly.
4. The stock market has proven resilient through the deficit crisis in August and the Europe thing.
5. The banks have improved their capital ratios and could withstand a European bank crash; or at least the Fed would come to their rescue with more quantitative easing.

I have listed 5 good things and 5 bad, which is as fair-and-balanced as you are going to get from me. I saw it that way at the beginning of 2011 and stayed out of the market because I can’t afford a “balanced risk”. Due to my risk tolerance, I need to have the odds in my favor to invest, and the only thing going my way is foreclosed real estate; so I’m currently buying residential property in Orlando and renting it out. Therefore, I had no return on my portfolio for 2011 (being in cash), but neither did the S&P Index to speak of------------in lieu of paltry alpha, I am not going to change my investment plans in 2012, unless the list of negatives gets smaller and the positives remain positive.  In my limited experience, successful investing is primarily a qualitative decision, not a quantitative one. Hence, the macro-economic climate it the first thing to consider before you even get to figuring out which stocks to buy. Complicating the process is the development of the global economy: not only must you determine the potential GDP growth in the United States, but also in Europe and Asia due to the impact they have on our markets. Stock picking is the easy part because it can be done by the numbers gleaned from financial statements; at least an accounting firm passes on them before they are reported. Government reporting comes out of a black hole and is less reliable; you have to ignore a lot of it and just develop a feel for the economy. I feel like it is not getting better, nor is it getting worse----------- albeit, staying the same is as good as it gets in 2012. The Dow has been in a range of 10,500 to 12,600 for more than a year and I don’t expect that to change: a year-end rally has taken it near the top, but I don’t see a breakout coming any time soon. We were at the top the same time last year and what we got were large swings as Europe waffled, politicians bickered and recession fears waned and waxed. So what’s new now?   

For the past four years, the Federal Reserve Bank has distorted the markets using manufactured low-interest rates: therefore, bonds are in a bubble, commodities have been inflated along with stock multiples; all done to save us from more debt liquidation and the resulting bankruptcies. To put that existentially, capitalism without bankruptcy is like religion without hell. You can’t have one without the other.     

Successful investing requires the discipline to take only the quality setups and the patience to wait for them. The long-only investor must protect precious capital via a 100% cash position until an obvious opportunity comes along, and there is no specific time period for which the cash position should be held. Cash may be boring and unproductive, but it is safe; and about every ten years an economic storm appears. America had one in 2008 and now there is another brewing in Europe and we are connected by a river of loans, credit default swaps and Fed bailouts. The time to invest is in the eye of the hurricane, because by that time most of the damage has been done---- the eye hasn’t passed over Europe yet, but it will; not to mention what is happening in China, which will take another six months to see eye to eye.    

Finally, here is a video I found on Marketwatch that goes for about 10 minutes on retirement and risk taking. It is different from the mainstream advice that a person should invest in stocks for the long-term for retirement. I have always thought that you should invest according to the risk you can afford to take and skip the idea that stocks will make you rich if you hold them over the long term---maybe they will and maybe they won’t----the “maybe” is what risk is. Therefore, I think your portfolio should be looked at as insurance against running out of money to live the rest of your life in relative comfort; only amounts over the necessary amount (the corpus) can safely be used to speculate in the market. A significant portion of the corpus should only be put at risk if the odds are heavily in your favor, like if the DOW fell to 8 to 10 times earnings as it did in 2009. VIDEO 

-Alan (12/30/2011)

Problems In Europe

From the Financial Times today, I see that the 520 banks in Europe who borrowed 489 billion Euros last week from the ECB, have redeposited 412B of it at the ECB; meaning those banks have no intention of making loans to the private sector, nor are they willing to lend to other banks and get a higher interest rate. The difference of 77B must have been used to pay down interbank bridge loans taken by the 520 to shore up capital. The reality here is that no new loans to “job creators” will been made and the banks are so scared of future write-offs that they are willing to borrow money at the ECB and pay 1%  and only receive a quarter percent on deposits, thereby losing money on the transaction. I am talking about a major liquidity squeeze going on in Europe and the money supply is contracting which is a clear indication of a recession coming. All this is happening as consumer sentiment just took a turn upward. Either consumers don’t get it or I don’t. 

-Alan (12/28/2011)

Market Musings

As you know, American Airlines (AMR) declared bankruptcy a few days ago. The unions caused it. AMR has 18 billion dollars worth of pension liabilities and only 8 billion in assets; so they will get out of their union labor contracts and pension obligations by reorganizing in bankruptcy. The pension will be given to the Pension Benefit Guaranty Corporation (PBGC), the government agency who will pick up the payments to retired workers; but the PBGC only pays out a max of 46k per year and the pilots had a pension that would have paid them $100k with American. So the pilots will get shafted and the PBGC will need a taxpayer bailout to pay all the benefits, all the bankrupt airlines have dumped on it in the last five years. 

As of yesterday, our Federal Reserve Bank will be the lender of last resort to the European Central Bank when the banking system collapses there. So the ECB has chosen the “quantitative easing” route to handle the crisis when it comes. No one can predict when it will come, but it will. However, the stock market loved the financial handshake between us and Europe, and the DOW went over 12,000: It has been in a range of 10,500 to 12,500 for the past year and I don’t expect that to change until the EU breaks apart, caused by a Greek default. Now when Greece does default, the Fed will have some Greek bonds on its balance sheet imbedded in the credit default swaps from the ECB, who will use Fed dollars to try and prop up Greece before it goes down. One thing you can say about the Fed, it doesn’t discriminate when it comes to making a bad loan: Greek bonds are not any worse than the 1.3 trillion dollars of bad real estate loans it has on its balance sheet. In Fed jargon, buying a bad loan is called quantitative easing.

-Alan (12/01/2011)

European Vortex Explained In One Simple Chart

-Charles (11/30/2011)

Retail Sales and Consumer Confidence Disconnect

Historically, retail sales are correlated to the level of confidence of the consumers spending their money on these retail goods and services. Rightly so, if consumers are optimistic about their income and outlook for future employment they are more likely to increase their spending propensities. Moreover, when future earnings and job security are less certain, making significant new purchases is less logical. However, recently a huge disconnect has occurred between the two. Illustrated below is the 15 year plot comparing the Conference Board Consumer Confidence Index (orange) and the Adjusted Retail & Food Services Sales Total (white). Consumer confidence has remained low and plunged to 2008 level lows this month while retail sales have stayed extremely elevated. Either one of the two is being severely manipulated, or a massive psychological swing has happened where the more depressed (broke) consumers are, the more they spend, likely on credit, to feel better from instant gratification. Whatever the reason may be rest assured this divergence is absolutely unsustainable and those calling for an end to the US recession because of a recent short covering rally may want to think again.

-Charles

The Truth Behind Bank Earnings Reports

JP Morgan reported $1.03 in earnings last week, but 29 cents of it came from a book entry; the other four biggest banks did the same in an attempt to not show a decline in earnings. The book entry was this: because Morgan’s debt has been downgraded by Moody’s, it is selling for less than the face value in the market place and Morgan has it recorded on their books as a liability at face value. Since they could go in the market and buy their own debt back at less than they issued it for, modern accounting allows them to reduce the liability on their books and take the difference into income.  Phantom income because they don’t have the cash to actually buy the debt back from investors. Almost half the earnings the big five reported in the third quarter were derived this way. When a bank has income, it is added to capital------ and bank capital isn’t what it used to be.

However, being a CPA, I can appreciate this ingenious interpretation of the mark-to-market rule which was supposed to make them write down assets (loans) and decrease earnings accordingly. Of course the Fed took over their bad loans in 2008 so they didn’t have to do that, and they will have to do it again if Greece defaults and contagion results.

-Alan

September Retail Sales

Highlights:

• Biggest monthly increase since February
• Sales helped by lower gas prices
• Core sales surprisingly strong
• Dealers reported a big jump in unit sales
• Building material sales decline following boost from hurricane prep
• Electronics sales third straight month of healthy increases
• Department sales increased by 1.1%
• Strong apparel sales of seasonal styles
• Food and drinking sales increase belies lower reading on consumer confidence

September Retail sales increased the most since February by 1.1%, helped in part by strong vehicle sales. Motor vehicles and parts rose by 3.6%, following a 0.8% decline in August. However, sales growth was also firm outside of autos. Non-auto retail sales rose by 0.6%, and "core" retail sales (ex-autos, gas and building materials) rose by 0.5%, the most since March. Apparel, furniture and department store sales accelerated. Earlier months sales were also significantly revised higher. Incorporating the new data gives an upside risk to most sell side Q3 GDP calls.

Europe Is "Saved"

The Europeans have a deal, which is why the stock market has rallied over the past week. The 440B Euro stability fund will be used to leverage guarantees for up to 2.9 Trillion in sovereign bonds that must be financed over the next few years. Theoretically, no actual cash will be ponied-up, except for the rubber stamp needed to make the bonds salable to institutions and investors. Below is a chart of who is guaranteeing what and I calculated percentages for a few; as you can see, Germany is on the hook for the most. The irony is Greece and Spain together are guaranteeing 15% of the guarantees they need to get to support their debt. They will actually end up having to default twice, once on the debt and again on the guarantees. Let me explain this plan in simple terms: The 440B fund contains no cash, just commitments from distressed borrowers; and it will be used like capital in a bank to leverage loan guarantees amounting to 6 times the non-funded capital base---so it is nothing on top of nothing. 

If you ever wondered how a Ponzi scheme works, this is it: those sovereign bond holders will actually be paid interest out of deficits which will be financed by more bond debt, requiring more and more guarantees until the 2.9T limit is hit. None of this will ever make Greece, Spain, Portugal and Ireland solvent; it just kicks the can down the road to Germany.  

-Alan

The Unemployment Situation

Despite the cheers after this Friday's release of the Employment Situation the two charts below show just how scary the environment is for people looking for work. 

-Charles

Number of Months Until Job Situation Recovers For Past and Current Recessions 

Average Duration of Unemployment (Weeks) 

"Shock Market" by John Slavic

One of the characteristics of today’s society is that what we are right this minute is the most important in all of recorded history. In some sense, we all at the same time are participants in and victims of a narcissistic culture. That also carries over to our investing tendencies. The uncertainty of the future can be paralyzing as one looks to invest. This long-term chart illustrates that the long-term march of the market through good times and bad has been progressively upward. The chart shows real rates of return for large company, small company stocks, bonds and inflation.

Real world events like world wars, the Cold War (where I had to “duck-and-cover”) and the terrorist attacks of the last few decades have kept us uncertain and on the defensive. Investing at its very core is placing confidence on someone or some entity in the future. The question is how do we systematically go about doing this? Here are some basics:

1. Diversification. Know what risk you are exposed to. Proper diversification really does spread the risk into different asset classes. If you are young, you should take some risk; if you are older, don’t be desperate for return and take-on too much risk. 
2. Systematically invest. Most people cannot pick the best time to buy or sell. Even if you are very objective in your analysis, the factors that can influence the market are very complex and unpredictable. Periodic investments, like a 401k deferral approach, spread risk over time like diversification spreads risk over asset classes.
3.  Emotional stamina. It is important to realize that CNN, Fox, CNBC, Bloomberg or any other news outlet makes money when people are watching their broadcast. They are all selling in the “shock market.” Emotion is often brewed-up in their stories, which can cause panic or greed, the two worst enemies of successful investing. Stay informed, but discern fact from hype.

This chart is valuable as a reminder in turbulent times that the free markets are very powerful despite short-term tensions. It is a stock market, not a shock market!

-John

Developed Country Debt Exposure to European PIIGS Part Two

Here, instead of showing simply which developed country is exposed to the most of PIIGS member debt, we expand and show each developed country's dollar value (in millions) holdings of debt for each PIIGS member. 

-Charles