Do rocket ships ever land safely?

Another week where many major (and minor) markets continued their ride to profit heaven. The Chinese stock market leads the pack with a 55% increase this year and over 200% since 2006. A Reuters article on Wednesday quoted a “private” money lender who charges over 50% interest and has borrowers lined up to borrow funds that are immediately invested in the stock market. Unlike the US where most of the stock trading is done by institutions who theoretically can withstand more risk, 99% of Chinese brokerage accounts are held by individuals. The eventual decline in this market will surely grab worldwide headlines but have little impact on US markets as liquidity and lack of short selling increases volatility on the downside. The consensus is clearly betting that the Chinese government will not allow the stock market to decline until the Olympics end in 2008.

New home sales

The last two days saw reports of soaring new home sales and falling existing home sales in the US. Thursday it was reported that new home sales rose 16.2% in April but the median price of a new home fell 11.1%. On the surface this would make sense as economics 101 tells us that as prices decline demand appears at these lower levels. If prices fall enough many buyers sitting on the sideline will run to their nearest real estate agent asking for listings. Beneath the surface I have serious doubts as to the accuracy of these numbers. On May 24, 2006 it was announced that new home sales rose 4.9% (+56,000) giving everyone a much needed sigh of relief that the impending housing collapse would be avoided. Unfortunately, as so often with these stats, the April 2006 number has been revised and revised and revised to now show what was obvious at the time…..new home sales actually fell in April 2006. A year from now we will find out for sure but I expect that new home sales did NOT soar last month as reported and the median price probably fell less than the stat keepers reported. Be very careful not to jump to conclusions based upon monthly stats that are revised often in the other direction.

Existing home sales

This mornings release of April existing home sales showed a 2.4% decline and most importantly an increase in the number of unsold homes to an 8.4 month supply. Nothing has changed in my forecast for a very long (5-7 years) bear market in residential home prices. This bubble took years to unfold and will take many more years to correct and with so many looking for the bottom (typical behavior after a big bubble) extreme patience will be needed by those who wish to purchase homes in the next 24 months. The best bet is to find a house and then contact the seller with a “rent with an option to buy” offer and thus cut your risk on the downside while retaining some upside potential in the very small chance that the market rebounds (very doubtful).

Additional RE sales

In Tuesday’s Voice of San Diego I found a piece on the city of San Diego offering 17 properties for sale. Faced with a looming budget crisis the city has determined these properties (appraised for $37 million) could raise badly needed cash needed for infrastructure projects. The unusual aspect of these sales is that the city has chosen not to hold a public auction and instead has decided to pay a six percent sales commission to a real estate broker. Could this be the start of a new trend? Competition between builders and existing owners is putting a cap on prices but if cities determine that they wish to sell properties to raise cash it will only add momentum to a market that is clearly moving to the downside. If prices were still rising the city would hold an auction but when buyers are few and sellers are abundant prices usually decline and an auction might prove embarrassing for city officials.

Tis the season for rising interest rates

Seasonal trends are an important part of my interest rate tool box and I have often written about the fact that long term rates rise 75% of the time in the first half of every year. In this months interest rate class I discussed in detail the seasonal tendency for rates to climb from the middle of May until the end of June. In the past 11 years rates have risen an average of 28 basis points from their low in this period to their high at the end of June with not one period showing a decline and the smallest advance occurring in 2002 (11 basis points). We have risen 23 basis points (10 yr.) since May 7th so we are nearing the average. I will discuss seasonal trends for the summer in my next interest rate class on Wednesday June 13th (see above for details). The recent increase in the US 10-year Treasury have the mortgage market worried that a Fed easing will not occur this year and long rates will soar in the summer. This is usual market behavior and very similar to 2006 when world investors were expecting a continuation of Fed tightening and rising long-term interest rates which of course never occurred. The bond market is setting up perfectly for lower rates after June 30th and it is always good news when bond dealers are net short treasury coupons at a near record level.

Inflation worries? Gold lower?

One of the reasons given for the recent increase in long rates has been coming from those worried about an increase in the US inflation rate and rising stock prices. Gold clearly has not received the message about inflationary expectations as it has declined to a recent low of $655 per ounce. Although difficult to verify it appears that the Central Bank of Spain continues to sell large amounts of gold as over 17 tonnes of the metal were sold last week by European central banks according to data released by European Central Bank.

Money supply – up or down?

There has been some confusion in the press lately about the direction of the money supply in the US. Without getting too technical, money growth (by the Fed) at a rate faster than economic growth usually creates inflation. My preferred measure is the monetary base and that continues to grow at annual rates of just under 2% as the Fed tries to control its ultimate enemy (inflation). Other money measures (MZM, M2, etc.) have economists worried because it appears that growth rates are soaring but much of this growth can be traced back to an increase in retail and institutional money market funds. With a flat yield curve (short rates = long rates) depositors can earn high rates of interest without having to lock up their money for long periods of time. The Fed is carefully monitoring the money supply and has no reason to expand money growth at a time when everyone is worried about a rise in inflation.

Fed hearing on mortgage credit – June 14th

A May 18th letter from Fed Chairman Bernanke to Senate Banking Chairman Dodd was released today and showed the Fed’s concern over limiting the availability of credit in the mortgage market. Underwriting standards have clearly tightened in the past 90 days and spreads have widened in the mortgage market. I wrote a few months ago that it would not be surprising to see treasury rates fall in the 2nd half of this year but mortgage rates might not follow due to a change in credit standards. The Fed will hold a public hearing on this issue on Thursday, June 14th and it is sure to create headlines in the media.

Jobs are coming, jobs are coming…

After a long holiday weekend (US & UK) the bond market will resume trading on Tuesday with a focus on late week events. Thursday we see the 1st Qtr. GDP growth and price levels with the crowd fearing higher growth and rising prices. Friday the jobs number is released with a consensus guess of an 115,000 increase in jobs but players watching for revisions to the last 2 months data. The key focus for the Fed will be the unemployment rate which currently resides at 4.5%. For those waiting for a Fed ease this rate will need to rise close to 5.0% accompanied by a declining stock market to have any chance to see a change in Fed policy. The other key ingredient in the mix is the rate on the 10-year Treasury (4.85%) and its eventual decline below the key 4.50% level. Two out of three elements raise the probability to 50% but all three will give us a 100% chance of the long awaited decline in the Funds rate.

The song remains the same……

Last week we went to the archives to find Rod Stewart’s old song that a picture tells a story and this week we return with a 1976 hit by Led Zeppelin. The words “everything small has to grow” could be the theme for 2007 investors as each week continues the rocket ship advance in almost every worldwide market. This week saw the yen decline (121+) creating the fuel for another record high for the US stock market (Dow). The events (oil + $2 dollars) of the past few days that would normally put a lid on stock prices now are of little concern to the raging bull. The US bond market is also effected by the rush of capital to equities as long-term interest rates have followed a well worn seasonal path of rising in the May-June period of the last 11 years. Economic fundamentals don’t matter and the short interest (bets on higher rates) are now growing to impressive levels. It is becoming all too easy for investors willing to ride what is normally a roller coaster but has been a one way ride for the past 3 months.

Job growth slows down….

Wednesday, without much fanfare, the BLS (Bureau of Labor Statistics) released its quarterly revisions of employment stats for the 3rd quarter of 2006. (Is it any wonder why the monthly jobs number is revised each month?) Usually the BLS announces they have found jobs that were created but missed in their monthly stats but this week they quietly told us during the period of 3/06-9/06 232,000 jobs were not created as previously reported. How could this occur? Simple, it’s called the seasonal adjustment factor (birth/death model) that is used to guess how many jobs should have been created each month depending on the time of the year. A year later the government tells us what really happened and the summer of 2006 was not nearly as robust as reported in monthly reports. Most of the error can be found in the construction (-112,000) and leisure and hospitality (-170,000) sectors which now confirms what was suspected as the housing market hit the wall in late 2006. The key take away is that in a strong economy we see revisions which add jobs and in a weak economy we see job losses. The revisions for late 2006 and early 2007 are sure to show more jobs that vanished and this will add pressure to the Fed for easing monetary policy.

Pressure on the Chinese government?

Next week Chinese officials will be visiting Washington, DC for meetings with Treasury Secretary Henry Paulson so it was no surprise last night when it was announced that the one year Chinese lending rate was being raised by 0.27% to 6.57%. China also widened the trading band on the Yuan against the dollar to 0.5% per day in an effort to show the US that the Yuan could rise faster thus theoretically setting the stage for a narrowing of our trade gap. Deposit rates were also lifted by 0.27% to 3.06% which somewhat neutralizes the effect of the higher borrowing rate. The reason China continues to accumulate dollars is obvious to world investors as the Yuan remains well below what a true market rate would trade at (6.50?) this year. The Chinese have picked up on the yen carry trade as a record 4.8 million new brokerage accounts were opened last month as only 3 million new accounts were opened in all of 2006. The old NBA marketing phrase is most appropriate for China: “Stock market fever, catch it!”

The Fed is stuck in neutral until ?

Although the three month US Treasury bill has fallen 20 basis points in the last month to 4.80% it is doubtful that investors are making a bet on an imminent Fed easing. The Fed is clearly on hold with a Funds rate of 5.25% and can NOT even think about lowering this rate until the stock market ends its record streak of new highs. Can you imagine the stock market’s reaction to a Fed decrease during a time of stock market highs? It would be similar to a Fed easing to bailout homeowners who need lower interest rates to stay in their homes. Nice thought but not good for public policy to help those that made poor investment or economic decisions. The Fed has always lowered rates after obvious economic weakness or stress or a rising job rate, none of which are present today. Of course there is another side to this argument: What if the market saw the Fed’s easing as sign of economic weakness to come? This would totally catch the markets by surprise and a dramatic fall would be certain but the odds of stopping this bull seem to be very low until the yen turns around and that is a major unknown.

Lock meter dropping fast

The lock meter is updated each afternoon and has dropped to 26.5 and close to the key 20 level which signals a great time NOT to lock a loan for mortgage players. A reading of 80 or more is a signal to lock quickly as interest rates are close to a bottom, My words for this May are very similar to those of May 2006: we are coming to the end of a strong seasonal up pattern for long-term interest rates and the 2nd half of the year should see much lower rates as inflation rates drop and expectations of a slowing economy (especially real estate) increase giving those who have made $$ this year a reason to take their chips off the table.

Every picture tells at least a few stories

With credit to Rod Stewart for his 1971 hit song the US economy shows a clear picture but there seems to be strong disagreements between the Fed and economists as to what action should be taken over the remaining 7+ months in 2007. The background begins with global growth (China, Europe, UK) stronger than the US and central banks raising short rates to combat a fear of inflation (UK). This morning’s US retail sales number of -0.2% shows the American consumer is spending hard earned money on gasoline at the expense of other household items. With gasoline prices soaring and oil prices falling due to a surplus of oil and a scarcity of operating refineries the future for retailers looks bleak. Normally a slowing economy would bring the Fed out of its hibernation and into an easing mode that would surely be welcome by the majority of the real estate industry. But this is not a Greenspan Fed that focused on economic growth but a Bernanke Fed that wants to send the inflation monster into permanent retirement. Wednesday’s FOMC release stated a concern that inflation (2%) fails to moderate as expected. That is not surprising but what happens if inflation slows, the economy slows but the stock market continues to rise? This Fed is inexperienced with only 16 months on the job and is using the market as a judge (TIPS & 10 yr. Treasury) but must remember that the collective wisdom of investors is not always correct. Former Fed Chairman Greenspan had an impressive batting average but was clearly wrong on many occasions but was smart enough to correct his mistakes within a few months. Mr. Bernanke wants to make sure that his first ease will not be reversed quickly due to the negative impact on his building credibility.

Stock market, interest rates, commodities, etc.

We are just 7 weeks away from the second half of the year and our favorite seasonal pattern for long-term interest rates which shows a 75% chance of lower rates based on data back to 1966. The seasonal pattern is the opposite for the first half of each year and 2007 has seen a 28 basis point increase from low to high (4.62 – 4.90) and it occurred in 25 days (1/04-1/29) the lowest rise in my 41 year database (I began watching rates closely in 1966). The second lowest rise occurred in 1976 and was only 53 basis points and was followed by a 120 basis point decrease in the 2nd half of that year. For the first 4+ months of this year the bond market has been the tail to the stock market’s movements. Yesterday’s stock market decline was accompanied by a decline in treasury rates and today’s stock advance was followed by a rise in long rates. It is clear that the bond market is not following economic fundamentals because the negative retail sales news should have created a bond rally that carried through the day. Commodity prices continue to rise and fall at the same rate as an amusement park roller coaster with Corn leading the way today on a better than expected crop forecast. The yen carry trade continues to provide unlimited liquidity to worldwide hedge funds but of course does NOT guarantee profits. The downside of this liquidity is that violent market moves occur frequently and many times randomly, leaving market players confused, dazed (for those on the wrong side) and seeking explanations when none are to be found. Gold falls this week (Spain central bank selling?), oil falls and gasoline rises (refinery outages?), etc. The importance of this to the average consumer? The Fed is seeking certainty before it can move to lower short-term interest rates and the overwhelming evidence from the economic picture has Mr. Bernanke and his crew thoroughly confused so they just sit and sit and sit while waiting for 1) The 10-year US treasury to drop below 4.50% for at least two weeks, 2) the unemployment rate to rise above 5% (12/07?), 3) the stock market to at least not make new highs (9/07). One of the these three requirements will move the Fed to the on deck circle, two of the items will move the Fed into the batters box and three will have the Fed swinging for the fences with a full blown ease. It’s time to take a seat behind home plate, grab a hot dog and cold drink and sit back and watch the game between the Fed and the worldwide markets which could easily go into extra innings.

Question: Why does the US government like an advancing stock market?
Answer: The Treasury announced that in April the US budget recorded a $177 billion surplus which is the second highest in history. (4/01 was $190 billion)

US jobs are beginning to disappear……

The most often asked question each week from readers is: When will the Fed lower the overnight Funds rate? The answer is: when the Fed is reasonably sure that inflation is contained at 2% or less and the US economy begins to show signs of slowing from its hectic pace of 2005-2006. The inflation number is much easier to quantify than the trend of the economy. One of the components the Fed uses in its decision making process is the monthly jobs number that was released this morning. April payrolls rose 88,000 after a 177,000 increase in March and 90,000 in February. The unemployment rate rose to 4.5% and further increases to the 5% level would place pressure on the Fed to ease short-term rates. The key to today’s job number comes from the seasonal adjustment factor that adds or subtracts jobs each month depending upon the time of the year in an effort by the government to smooth out trends. The April adjustment added 317,000 with 49,000 coming in the construction sector. Take away these seasonal changes and the economy actually lost over 200,000 jobs. Temporary jobs fell again by 6,000 and the last twelve months have shown no growth in an area that would surely be increasing if employers believed the economy was going to pick up steam. The mortgage meltdown is finally having an impact as payrolls at credit intermediaries fell by 14,400. The number of industries gaining jobs in April was only 53.4% (46.6% fell) and 40% of all new jobs in the last 12 months came from the Hispanic sector as many states have created harsh penalties for employers that knowingly hire illegal immigrants. The trend of job growth is clearly slowing down and although a lagging indicator will give the Fed a little bit more room to ease in the 2nd half of 2007 as long as inflation stays low (probable) and the stock market does NOT continue to hit new highs. (?)

Is it time to rent a house instead of a purchase?

The US census bureau reports that 2.8 percent of all US houses for sale were unoccupied in the first quarter of 2007, the highest level since 1956. Recent buyers are concluding that a rent check is better than no check at all as buyers are disappearing when asked to pay 2005-2006 prices for houses that sold within minutes of being listed just a few months ago. The good news for inflation fighters is that a reduction in rents will lower the CPI as this component is a major (30%) part of the calculation. Assuming other prices (oil, etc.) stay the same (maybe) a lower overall rent level would easily drive the CPI below 2% before the end of 2007.

Homeowners struggling to create liquidity

Freddie Mac announced this week that 82 percent of its loans refinanced in the first quarter of 2007 were for “cash out” of $70.5 billion. This is not a surprise and with loan underwriting standards becoming tighter I expect homeowners to tap into their credit cards later this year in an effort to pay bills and/or stave off bankruptcy. Unless home prices rise quickly to 2005-2006 levels (very doubtful) consumer spending (except for the very wealthy) will begin to fall thus creating layoffs in the retail industry and driving the unemployment rate to 5.0% or higher.

Mr. Bernanke, are you listening?

Bank of England Governor Mervyn King announced this week that he will be giving much clearer guidance concerning the circumstances that would trigger a change in UK lending rates. He admitted that the BOE has failed to explain properly to markets how it was likely to respond to economic data thus creating too much uncertainty in financial markets. The best quote from Mr. King was clearly aimed at the US Federal Reserve when he said ” the BOE will not do monetary policy by code word” which is something Fed Chairman Greenspan perfected when head of the Fed from 1987-2006.

Next week’s calendar

The key event takes place on Wednesday (5/09) with the Federal Open Market Committee Meeting (FOMC) and its announcement at 11:17am. I am expecting no change in the Fed Funds rate and a statement that emphasizes a Fed that is predicting the economy to show contained growth and inflation but is ready to act if circumstances dictate a change up or down. This is very different from the old Greenspan Fed which used those “code” words to alert everyone as to an upcoming change in monetary policy. The US Treasury will hold three auctions next week (3 yrs. 10 yrs and 30 yrs.) totaling $32 billion in bonds and should be absorbed quite well despite a dollar that continues to fall (except against the yen) with no opposition from anyone in the US government. The last piece of big news occurs Friday morning with the release of April retail sales. When the consumer finally slows down spending we will see it first in these numbers although April is expected to show a high number (0.6%? )

Summary

Nothing changed for the stock market this week as it rose to new highs after the yen fell again (120+) thus fueling asset markets all over the world. The yen is the key that unlocks greater profits to investors and if it continues to fall there is no reason to believe that sellers will appear in markets that have seen hedge funds place leveraged bets in 2007. It is often said that the “trend is your friend” and that friendly trend in 2007 has been a falling yen and until it changes direction the non-stop express to wealth for many will continue.