Does anyone know what time it is?

Thursday night I alerted my daily subscribers to a stock market seasonal trend that begins next week and has been profitable each of the last 12 years. Wednesday night I alerted my daily readers to a new jobs report that will be released a few minutes after the regular jobs number (11/02) that will surely influence interest rates. Would you like this up to the minute information delivered every night (Mon-Thurs) between 10-11pm? The cost for this daily e-mail is only $251 and you will receive every update through 12/31/08. Just complete this form and fax or mail to my office.

My last interest rate class for this year (new location – mid-Wilshire) will take place on Wednesday, November 14th at 6pm.This two-hour class is an excellent addition to my newsletter. I will review the current interest rate environment and unveil my 2008 forecast. Each attendee will receive a 50-page book of charts and we have an unlimited question and answer session. This class is excellent for real estate owners, agents, mortgage brokers and investors who need to know the future direction and levels of interest rates. Advance registration is required.

An incredibly busy week ended with US stocks rallying on news that Countrywide lost only $1.2 billion and CEO Angelo Mozilo’s 2 hour conference call which sounded like a college pep rally the night before the big game. Countrywide’s stock rose 4.23 pts. (32.36%) for the day as investors and traders seem to have completely changed their opinion based on today’s news. The Merrill Lynch analyst that forecast a possible bankruptcy for the home lender upgraded his rating from “sell” to neutral.

Merrill Lynch rallied on rumors that their CEO Stan O’Neill would step down this weekend after this week reporting a massive loss from the mortgage mess during the quarter that ended September 20th. The remarkable part about Merrill is that they had (10/5) told analysts the write-offs would be $5 billion less than were reported. Credibility is so important to investors and October 5th was AFTER the quarter ended so what happened in the last two weeks? It is called “I don’t know what my securities are worth?” and “I’m not sure how to value them.” Buried inside the Merrill report was something that should be very disturbing to anyone with any connection to the mortgage market. $6.9 billion of the $8.4 billion write off was from AAA rated collateralized debt obligations. Triple A is supposed to mean gilt edged, unlikely to fail, solid investment, etc. but somehow these can’t miss securities are failing in the area of price and no one seems to know what their price is when they need to have a value. Warren Buffett has a great quote for obtaining the accurate price of a security: “Sell a portion of your position and that is a good start.” The problem is that no one wants to sell a portion because it might lead to a landslide which would hurt everyone. Isn’t that sort of the same thing the home builders are going through now? Isn’t that why home sellers are offering TV’s, boat’s, etc. to buyers as incentives so they don’t have to lower the price which might scare away potential buyers?

When buyers fear that the most recent price is NOT a good indication of present value they retreat and wait until they see prices stabilize or begin to advance. The real estate market has enjoyed a long bull run with an increase in prices for many years. Investors memories are fresh from profitable experiences that buying on every dip was the best method of accumulating wealth so the real estate world is full of investors that are waiting to pounce at the first sign of a price bottom. Unfortunately markets don’t satisfy the majority and after a “dead cat” bounce in the first half of next year these early birds will learn a painful lesson about trying to catching a falling knife in a bear market. Very few catch the handle and the majority catch the blade. Real estate trends go much longer than most other markets because they are not efficient in price discovery like stock, bond and commodity markets.

This bear market is worse than normal because no one has yet found a way to tell what time it is in the mortgage market. Until these securities begin to trade at real prices and not be marked at theoretical prices the market will be worried and spreads to Treasuries will remain wider than we have seen for many years.

Oil and the US consumer

Oil closed today at $91.86 and is in a strong contra-seasonal uptrend that should see $100 a barrel before sellers appear. I use seasonal trends heavily in my forecasts and have warned my daily readers that a seasonal trend that does NOT work is more powerful than a seasonal that performs as expected. The weakest two months of the year for oil are almost always November and December as demand drops and supply increases. Normally the peak each year is shortly after Labor Day but this year oil has continued to rally despite the experts who tell us that supply is no problem and oil “should” trade at $60 or less. Should’s never seem to happen when you are on the wrong side of the market and contra seasonals are always explosive because you have traders who need to exit their losing position and then enter on the opposite side of the market thus giving us twice the normal demand and that is exactly what has occurred in oil. The shorts (betting on lower prices) are constantly covering their positions and then trying to play from the long side which eventually will create a top when they all get long.

There is one other way to stop prices from rising and Russian President Putin has instituted price controls on food items in his country. This will halt price increases but also create supply shortages which will end in chaos and empty grocery shelves for Russian shoppers.

Bank of America and mortgage brokers

BofA announced earlier this week it was pulling out of the wholesale residential lending business which represents 25% of their total funding of loans. This is not surprising and may be followed by other banks as they attempt to minimize their risk on future loans and increase their profitability by using their retail system with existing bank customers. They also realize that Congress will pass legislation in 2008 that will severely limit the ability of lenders to fund the same kinds of loans they have over the past few years. I expect stated income loans to end along with negative amortization, interest only? and for sure the pay option arms. As usual Congress will go overboard as they always do when they attempt to regulate an area that needs a little help from outside and a lot of help from inside. One proposal floated this week would allow homeowners to remain in their house for up to six years before deciding that they had entered into a “bad” loan and then ask for and receive their past principal and interest payments returned and move on to their next residence. This will never pass both houses but if it remains in a similar form it will push lenders into a position of not wanting to lend to anyone at any interest rate because of the risk of huge losses.

A Congressional study released this week on the mortgage crises did have a few tidbits of info on page 17 that shows us where Congress and banks are probably going in the next year. For 2006, 63.3% of all sub-prime mortgages were originated through mortgage brokers (29.4% of all mortgages). Congress is sure to blame most of the mess on brokers because they can’t find the lenders who bought these loans (overseas investors).

Next week and beyond

The Fed is up to bat on Tuesday and Wednesday with a rate announcement on Wed. at 11:17am. The consensus is for a 25 basis point decrease in the Funds rate to 4.50% but anything is possible as they are as confused as everyone else about the proper solution where rates aren’t the problem. When the Fed cut the Funds rate last month (9-18) the stock market rallied on the belief the Fed had come to the rescue like it has in the past but the lower the Fed drops rates the more likely the markets begin to understand that consumer spending is slowing at the same time gasoline prices are rising due to record oil prices. The Fed is afraid of non-discretionary inflation (gasoline, corn, wheat, etc.) but at the same time is keenly aware that the US economy is being held up by exports (weak dollar) and that won’t last if the mortgage mess spreads to our trading partners (very likely).

Interest rates

Long-term interest rates have declined in the 2nd half of the year 75% of the time over the past 40+ years. The average date of that bottom has been October 24th but in the past 7 down cycles we have seen a bottom 5 times in November or December so I am on the lookout for another move down in rates that should signify the bottom for the year. The big question is: will the rates rise in the first half of 2008 like they do 75% of the time? Too early to tell but I will have a specific forecast at my next interest rate class. Will we see a contra-seasonal fall in rates during the early part of next year or???

The fundamentals have NOT changed and next Friday’s (11/02) jobs number should show an increase in the unemployment rate and job growth of less than 25,000. Last month’s number sent stocks soaring and bonds plummeting but rates recovered quickly and are a few basis points from this year’s lows. I continue to believe that real estate prices have entered a long bear market and the economy led by a tapped out consumer has entered a recession/economic contraction. I’m not sure there is anything the Fed can do to derail this train from its present course but the government could always lower tax rates, give credits for real estate purchases or print money and give banks incentives to lend…doubt this will happen but those buying gold would be happy with their huge profits.

It’s a recession but does anybody care?

On Tuesday evening at 10:30pm I wrote to my daily subscribers the 10-year had dropped to 4.62% and that it was highly unusual to be seeing bond buying in late Asian/early European trading. Something was going on and I’m sure many of my readers hopped on board the lower interest rate train which today arrived at the 4.39% station. Would you like this kind of up to the minute information delivered every night (Mon-Thurs) between 10-11pm? The cost for this daily e-mail is only $251 and you will receive every update through 12/31/08. Just complete this form and fax or mail to my office.

My last interest rate class for this year (new location – mid-Wilshire) will take place on Wednesday November 14th at 6pm.This two-hour class is an excellent addition to my newsletter. I will review the current interest rate environment and unveil my 2008 forecast. Each attendee will receive a 50 page book of charts and we have an unlimited question and answer session. This class is excellent for real estate owners, agents, mortgage brokers and investors who need to know the future direction and levels of interest rates. Advance registration is required.

The most frequent topic of financial commentators the past few weeks is whether the US is going to enter a recession. My question is: Does it matter? If you knew we were entering a recession what would you do differently? What is a recession? Does the President of the United States come on television and address the nation? I will address all of these questions but the answers really don’t have anything to do with your finances.

All year I have written my favorite phrase for 2007: “We only see life through our own experiences” and I want you to write this phrase on your refrigerator door, your bathroom mirror, you car console, etc. Markets are supposed to anticipate economic events and yet this year it has done just the opposite and been the caboose for the economic train that is crashing and will soon resemble a scene from the early 1930’s.

The term recession is used to designate an economic slowdown and is generally, but not always, accompanied by two consecutive quarters of negative real (inflation adjusted) GDP (Gross Domestic Product). The NBER (National Bureau of Economic Research) is the “official” arbiter of this overused description of the economy. Due to massive revisions of government data it is often a couple of years before the term recession is attached to a past economic cycle and is of no use to anyone except historians or those seeking a term to describe their own personal financial pain. If you are in the residential real estate market you realize recession is too soft a term and the word depression is more appropriate. If you are in an export business recession is not in your business model as you dream of finding more workers.

The next time you hear a financial commentator ask his or her guest whether the US is entering a recession feel free to scream at the TV: “Why does it matter and what would you do about it?” You won’t get an answer but it will help you realize that the answer is irrelevant to you and the future course of the US economy.

Markets decline on confusion and rise on certainty

This morning Fed Chairman spoke (via teleconference) to a St. Louis Fed financial conference. The title of his speech tells us everything we need to know about current Fed thinking, “Monetary Policy and Uncertainty.” His remarks were generally about Fed history but he chose the title knowing world financial markets would easily see his current state of mind. Today’s stock market decline of 366 Dow points was caused in part by the realization that the Fed doesn’t know what it will do on October 31st (next FOMC meeting) and is having difficulty forecasting where we are going…..total confusion just like the 1970’s Temptations hit song titled “ball of confusion”.

Monday evening (10/15) Mr. Bernanke told the Economic Club of New York that the Fed was concerned about an unusually high Libor borrowing rate (today at 5.15% for 3 month Libor). The Fed lowered the Funds rate by 50 basis points on September 18th but that only assisted banks as most corporate and real estate variable rate loans are tied to Libor which is normally 10 bp above the funds rate. The Fed was hoping to reduce the market based Libor rate but so far that has not occurred and was noted by Mr. Bernanke with the following quote: “Interbank term funding markets have improved modestly, though spreads there remain unusually wide.” The US economy also has Mr. Bernanke confused as we heard with this comment: “It remains too early to assess the extent to which household and business spending will be affected by the weakness in housing and the tightening in credit conditions.” It is no coincidence that as world financial markets began to realize the most powerful central bank in the world was seeking direction bond prices rose and stocks fell.

Markets always rise when the information flow is clear and understood even if the news is bad but confusion creates fearful sellers and that is why today’s action was so violent. (Dow down 366 and 10-year interest rate down 10bp to 4.39%.

The fight at the Fed

One of the main reasons Fed monetary policy has been behind the curve for most of 2007 comes from the enormous data their staff analyzes on a daily basis. Early in the year they told us the mortgage mess was temporary and would not spill over to the general economy. The stock market’s decline in February was short lived and buyers stepped in with both hands driving the market to new highs. Always have faith in the Fed was a mantra we learned from the Greenspan era (1987-2006) and it always paid off well at the cashiers window. Since we only see life as we experience it stock investors we only too happy to be rewarded from buying on weakness and seeing immediate profits. In the summer we again saw a nasty stock decline that was again met with buyers with hopes that the Fed was always right and if needed would lower short-term rates that would support the economy and stock prices. This again turned out to be prescient as stocks recovered quickly and rose to new highs a couple of weeks ago. Two for two is 100% and this week’s stock decline should again bring out the buyers whose memories are high on success and low on fear.

Is it really that easy? Maybe not as the Fed is confused and faced with a dilemma that has no easy solution. Normally when interest rates fall we see the economy slowing and inflation falling but this month we have a fight with no clear winner (yet) to drive the Fed in the correct direction. Last night we saw the price of oil reach $90 per barrel in Asian trading as demand from hedge funds, speculators betting on turmoil in the Middle East and those caught on the wrong side of the market propelling this most precious commodity to new daily highs. We have not seen a similar rise in the price of gasoline but if oil holds at these levels for a few weeks it is a certainty that a gallon will surpass $3 and then rapidly ascend to $4. Consumers don’t buy oil they purchase gas for their cars and that is why there has not been an outcry from Congress which always reacts too late to fix the problem. In this case I’m not sure they could create a realistic solution but with next year’s election I’m certain every candidate will try and fix the problem with an impossible solution. Gasoline is a non-discretionary purchase for most consumers and price increases generally don’t move buyers to cut back unless the price levels remain for many months/years. We have virtually the same situation with grain prices as a drought in Australia and strong demand from China and India have sent wheat prices to record highs. These commodities are also non-discretionary and these price rises have many fearful of a rise in inflation. A falling dollar that has our exports rising and trade deficit narrowing has others worried about import price inflation.

But, and its a big but, we now have asset prices declining (stocks, mortgages, etc.) and this is deflationary leading to credit contraction as the mortgage mess has investors worried about the value of securities that were market to model instead of market to market. As a side note the Financial Accounting Standards Board announced this week they will not delay the implementation of FAS 157 which will require companies to value their investments based on market value even if they are going to hold until maturity.

The Fed is caught between two strong forces and is trying to straddle between them but that is causing confusion in world markets. They must make a bold move and acknowledge that the economy is weakening fast and with a declining stock market and an upcoming rise in gasoline prices they will have the cover they need to show the world they are back in the driver’s seat of their Humvee and will make sure passengers will arrive safely at their destination.

Stress in the credit card sector

Capital One today announced a loss for the third quarter of $81.6 million due to closing Greenpoint Mortgage. These results are not surprising but inside the report was a disturbing report that gives us a clue about future consumer spending. They reported an increasing number of delinquencies and defaults in both the credit card and auto finance sectors.

A rising apartment vacancy rate

From Phoenix, Arizona comes the report that third quarter apartment occupancy rates fell to 91.2% from 95.4% a year ago due to a glut of single family homes that aren’t finding buyers so the sellers are attempting to rent at any price. In Shasta, California we see RE developers taking homes off the market and turning them into rentals. It’s called deflation and will soon show up in lower owner’s equivalent rent in the monthly CPI.

Lower house prices = lower state tax revenue

From Sacramento and San Francisco we see stories about pending lower property tax bills for homeowners. From Maryland we have the Governor proposing a legalization of slot machines to cover a $1.7 billion shortfall in the budget. Looking for a solid bet in the next couple of years? Watch gambling companies as states try to out do each other in a race to the casino.

Next Week

The big story will be on Monday as the world watches the US stock market to see if today was a one day drop in prices. For those that are interested in short-term trading (we are NOT an investment newsletter) the last ten years the day after the October option expiration (today) the stock market has risen all ten times. Economic news will be sparse but Treasury Secretary Paulson will be speaking about US-China trade relations and I’m sure that will include rhetoric about the dollar-Yuan relationship. Wednesday at 1:15pm Fed Governor Mishkin will speak on Financial Instability a very timely topic. Thursday at 6am the Fed’s Consumer Advisory Council will discuss mortgage loans and this should receive a lot of attention from Congress and the press. Unfortunately this will again be too little too late as the lenders have already reacted to this year’s meltdown with much tighter underwriting guidelines.

Summary

Early in the year we wrote that interest rates would fall after July 1st and the economy would not be able to withstand the fall from the mortgage market. The US 10-year closed today at 4.39% and is headed lower with a final destination around the 3.70% level. The Fed will be forced to ease again as the Libor rate must decline and the Fed’s only weapon is a lower Fed Funds rate. There is not much else they can do and we will really see panic when the world realizes that lower rates are not going to prevent the most serious economic setback since the early 1930’s. No one believed it early this year and no one believes it now because we only see life from our own experiences and 99% of the world wasn’t around during that time period. Fasten your seat belt, the ride is going to be very bumpy over the next couple of years and when you’ve never lived through that experience it can be frightening.

This puzzle has many pieces

Only five more days until my next interest rate class on Wednesday, October 17th at 6pm. (new location – mid-Wilshire) This two-hour class is an excellent addition to my newsletter. I will review my current interest rate forecast and give each attendee a 50 page book of charts. Advance registration is required and we will discuss hedging strategies for those borrowers that want to take advantage of lower rates without having to refinance existing mortgages.

Did you know that I write a daily edition of the EWW packed with breaking news and insight that I have accumulated during the day? My daily subscribers receive all of my views and news updates every evening (Sun-Thurs) around 10pm which gives them a head start on the next business day. The cost for this daily e-mail is only $100 and you will receive every update through 12/31/07. Just complete this form and fax or mail to my office.

When analyzing and forecasting interest rate trends I often find it useful to view the relationship between different points on the yield curve. Bond market rallies are always more impressive when they are led by the long end as that is where the inflation bets are made while the short end is often about expectations about Fed policy and that is NOT a good reason to make a bet on the long end. On Thursday September 20th (two days after the Fed lowered the funds rate by 50 basis points) the yield curve stood at these levels: 2 yr. = 4.11%, 5 yr. = 4.36%, 10 yr. = 4.70%, 30 yr. = 4.97%. The 10-year rose 13 basis points in the two days after the Fed eased as the market was 100% convinced that a Fed easing would easily ignite the US economy (as it has every time before) and that of course would create more inflation. As usual market expectations have changed in the past three weeks and today the yield curve closed at levels that were far different than after the Fed easing with the 2yr. = 4.23%, 5 yr. = 4.41%, 10 yr. = 4.68%, 30 yr. = 4.90%. It’s a lot of numbers but please review because as Rod Stewart told us “every picture tells a story” and the yield curve storybook has many chapters.

Can long rates decline while the stock market rallies?

Since the Fed’s abrupt change in monetary policy the long end (30 yr.) has actually fallen in the past three weeks by 7bp while the 2 yr. has risen by 12bp. I always ask myself each week what is the one thing that would surprise the market the most? What event is the market not prepared for? That event would clearly be for the economy to be much weaker than expected accompanied by more easing by the Fed. The 2nd biggest surprise would be a fall in the inflation rate which would allow long-term rates to reach new cycle lows. Since September 18th the inflationary expectation component of the 10 yr. has risen only two basis points from 2.31% to 2.33%. The biggest reason rates are higher over the last three weeks is that the stock market has been on a rocket ship ride to daily new highs as foreign investors see the US market as a bargain due to the depreciation of the dollar. Within the next 12 months I expect major central banks to jump on board the “let’s depreciate our currency to strengthen our economy” train as they see their own economies soften. I have often written that a weak currency narrows a country’s trade deficit but is almost always a result of weak domestic demand. Would you rather have a weak economy with a narrow trade deficit or a strong economy with a big trade deficit? Hopefully everyone comes to the same answer, low US consumer demand (2008) is not something that can be offset by strong exports. The stock market is about corporate profits and the bond market moves to inflationary expectations, they can and often coexist together.

Retail Sales

This mornings report showed a 0.6% rise (0.4% without auto sales) but most of the gain was from food and gasoline which are both inelastic items(demand does NOT go down when prices rise). When the consumer buys food and gas and their income and assets don’t rise (not everyone owns stocks) the loser is other non-discretionary items. Building materials, clothing and furniture sales were weak which should be expected for the remainder of this year.

A solution to the mortgage problem?

Amity Shlaes from Bloomberg wrote a good article today with a couple of interesting ideas. First she brings up the possibility that short-term rates might decline which would allow adjustable rate mortgage holders to pay less than their new reset rates. The problem is that underwriting guidelines are much tighter than when the original loans were made so many of these borrowers probably can’t qualify at any interest rate. There is also the problem of declining home prices so the loan to value ratio might be too high. She also invites Washington to consider limiting the deductibility of adjustable interest while increasing the deductible fixed rate interest. Changing public policy to deal with this problem is a sure bet but changing the tax code doesn’t stand a great chance of being the preferred choice of most legislators. The easiest solution is always throwing government money at the problem but this time I’m not sure that would help unless they want to embrace my idea of having lenders take over the houses and rent back to current owners.

Real auctions clear supply but….

We are witnessing a record amount of home auctions by builders overwhelmed with costly inventory and lenders who have foreclosed on delinquent borrowers. Normally auctions are a great way to reduce supply and allow the market to find its true price levels. An article today from the Sacramento Bee shows us why current auctions may not be the answer to the housing market supply problem. In an auction last week the seller rejected all bids because they were below the minimum price set by the lender. The lenders have not caught up with reality and are unwilling to lower selling prices to the point at which it will attract buyers. Reading my 27 daily newspapers I am amazed at how many builders and lenders are cancelling “once in a lifetime” sales and auctions due to a lack of buyer interest at listed prices. Home prices are a very inefficient market and prices will take much longer to adjust than other markets that trade daily (stocks, bonds, commodities, etc.). Best quotes of the week come from this morning’s Boston Globe in an article about the housing problems. “The housing bust is like a leaking ship. You may still be to stay afloat, depending upon where and how bad the holes are. Markets glutted with housing may sink further. Like too much water in a ship, excess inventory doesn’t contribute to buoyancy.”

A very busy week

Markets may be very volatile next week as we have CPI and housing starts on Wednesday (10/17) and Fed Chairman Bernanke will speak to the Economic Club of New York on Monday at 4pm. Usually the speaker at this event accepts questions from the audience so watch the markets on Monday evening for any reaction. Friday at 7am the Fed head gives a speech at the St. Louis Fed Economic Conference. This has a better chance of being a non-event as the host St. Louis Fed President Poole may want the headlines. Pay close attention the how the long end of the bond market reacts to these events and that should give us an indication for the direction of rates until the next FOMC meeting on October 30-31.

Would you pay $182.50 for….

Countrywide’s “protect our house” bracelet? They are offered on E-bay at this price and I’m sure there is an unlimited supply at its current price. If these actually sell someone with a lot more time than me will soon be producing these at far lower prices.

Supply goes up, prices must fall

Palm Beach County, Florida now has 33,708 houses and condos for sale which represents a 40 month supply. Unless they find oil or gold in Palm Beach the only way to reduce the supply is for prices to decline and that is going to happen in 2008. I’m sure most of these owners have mortgages and not fully paid for so the pressure to sell will increase each month and it also tells us foreclosures are coming sooner than later to this Florida county. The problem is that these new owners will not want to hold this new inventory. Home prices are going to accelerate their decline and the next 75 days are going to be the worst for sellers since the 1930’s. From San Pablo, California comes the story of an angry homeowner (probably with a mortgage) that paid $585,000 from a developer that is now stuck with unsold homes and accepting $295,000 bids for the same house at an upcoming auction. It is unfortunate but the markets believe the worst is over for the housing market and that these problems will not spread to other parts of the economy. The dollar could go to zero and it wouldn’t create enough demand for our exports to offset the coming depression in consumer spending.

Summary

Nothing has changed and the markets are focused on future inflation so long rates have risen for the past few weeks. There is almost a zero probability of the housing mess ending anytime soon. Interest rates are headed lower as the consumer does the unexpected and cuts back on spending. Those that have been predicting the demise of the consumer for the past 20 years will finally be right but sadly timing is everything and most of these experts have moved on to other ventures.

Wanted: More US government workers to count jobs

My next interest rate class will be held on Wednesday, October 17th at 6pm at our new location (mid-Wilshire). This two-hour class is an excellent addition to my newsletter. I will review my current interest rate forecast and give each attendee a 50 page book of charts. Advance registration is required and we will discuss hedging strategies for those borrowers that want to take advantage of lower rates without having to refinance existing mortgages.

Did you know that I write a daily edition of the EWW packed with breaking news and insight that I have accumulated during the day? My daily subscribers receive all of my views and news updates every evening (Sun-Thurs) around 10pm which gives them a head start on the next business day. The cost for this daily e-mail is only $100 and you will receive every update through 12/31/07. Just complete this form and fax or mail to my office.

Early this morning the BLS (Bureau of Labor Statistics) announced that the US had created 110,000 new jobs in September (100,000 was expected) but revised August to +89,000 from -4,000 and July to +93,000 from +68,000. They also quietly told us that job growth for the 12-month period ending March 2007 was revised down 297,000. The stock market roared to new highs as all news is good news in equity land but bonds fell hard with the 10-year rising 12 basis points to end the day at 4.64%.

As usual there is a lot more to the story than just the headlines which confirm that the government has no idea of how to count those working during the preceding month. The BLS uses a birth/death model which is similar to the seasonal adjustment we see with most economic indicators but the monthly revisions are often greater than the initial estimates. The government should delay the release at least a month or stop counting and begin throwing darts as they would find more success. People invest billions of dollars based on a number that always changes as time goes on and many times in a different direction. The birth/death model has accounted for over 68% of all job growth in the past year so I’m not sure why investors are so excited but it never pays to fight the tape.

Analyzing the report, I find it very curious that temporary help payrolls fell 20,000 in September and a total of 74,000 over the past 12 months. If the economy was booming and firms hiring wouldn’t they be hiring temps before taking on permanent workers?

One of the other important parts of the jobs report is the diffusion index. This is the percentage of industries showing job growth and in a strong growing economy will frequently be above 60%. Today’s report saw a 2007 low of 52.5% which means that 47.5% of industries saw no job growth last month.

Finally the unemployment report rose to 4.70% a high for 2007. The low was 4.40% in March of this year and this is one the most important reference tools for the Fed and usually a .5% increase from the low is followed by a recession. I am confident will see a 5.0% rate in the next few months.

The Fed

A couple of questions must be answered after today’s jobs report. The first is upcoming Fed policy and whether the Fed is done easing for this cycle. Let’s start with an important point that it is very doubtful the Fed knows where it is going at this point other than the next FOMC meeting will take place on October 30th & 31st. A speech given this morning by Fed Vice Chairman Donald Kohn sounded very much like it could have been written by Chairman Bernanke. A couple of quotes confirm my observation and since the Fed was caught flat-footed this summer by economic events they seemed to miss they will be keenly observing the economy and financial markets before considering any action at their upcoming meeting.

The first quote is: “Pending further evidence, a 50 basis point easing (9/18) was not an unreasonable FIRST approximation of what might be required to keep the economy on a sustainable growth path.” Those waiting for more easing will hang on that quote until they see another Fed cut. The second quote is for the bears that believe the Fed is done for this cycle. “With the news on inflation relatively favorable of late and with inflation expectations seemingly well anchored, I believed that we would be able to offset the cut in the federal funds rate- if it turned out to be LARGER than needed – in time to preserve price stability.

Next week’s important data point will be Friday with the release of retail sales which should show little, if any, growth. The following week CPI will show a steady 2.0% inflation rate and for those that believe the actual inflation rate would be higher if the government included more items please read yesterday’s speech by Dallas Fed Pres. Fisher. His research department created an inflation indicator called the “trimmed mean” which includes everything except the one item that rose the most last month and the one item that declined the most last month. It is also growing at a 2% annual rate.

The problem facing the Fed remains the level of the three month Libor rate which stubbornly holds at 5.24%. This is 49 basis points above the current Funds rate and very close to the level it traded at before the Fed lowered the Funds rate to 4.75%. Most of the variable rate loans in the residential mortgage market are tied to the Libor rate and the Fed told us they eased to help the lack of liquidity in the mortgage market. They are worried about the Libor rate but also must be wondering what would occur if they eased again; Would the Libor rate fall? Would long term rates rise? Uncertainty is never good for any market and the Fed is clearly confused as to its next move and this is causing greater than normal volatility in global money markets.

Long-term rates

The 10-year reached its low (4.32%) for the year on September 10th, eight days before the Fed lowered the Funds rate to 4.75%. At 4.64% (today) we have risen 32 basis points or 33.3% of the move down from 5.26% reached on June 12th. The rally in rates has come from an increase in inflation expectations of 19 bp and 13bp from the real rate of interest. This is a lot of numbers but nothing more than a normal reaction to a 96 bp move down in rates that took three months.

I do not believe inflation is a worry for the market even though the recent price rise in gold and decline in the dollar have many concerned about an increase in import prices. The US economy is in the early stages of a consumer led recession due to a contraction in the availability of borrowing outlets.

Seasonal trends are a very important part of my work and we remain in a very favorable time for lower interest rates. During the first half of this year I repeated almost weekly (despite higher rates) that we would see much lower rates after July 1st and that is exactly what occurred. With long rates rocketing higher today and a fear of inflation looming it is only natural to wonder if the low for the year has been seen in the 10 year. Reviewing my 40+ years of daily interest rate movements I found that 29 out of the last 32 moves down in rates in the 2nd half of the year did not reach bottom until October, November or December. The exceptions were 1999, 1988 and 1978. 2007 could be #4 with its September 10th low but my feeling is that we have another move down in long rates as the market realizes the summer mortgage problems have not gone away.

This week we saw many brokerage firms take huge write-offs from their mortgage and structured product departments and their stocks soared as investors are convinced that the good old days are back again. I don’t agree and the fact that the commercial mortgage backed securities (CMBS) market remains in a chill with larger than normal spreads does not send a message that storm clouds have gone away.

The green flag remains at the top of the EWW and a yellow flag will only be added if we see the 10-year rise above 4.70% on a closing basis. A move above 4.80% will bring down the green flag but until then we must go with the seasonal trends and play for much lower long rates before the end of the year.

Congress and the housing mess = big problems

Thursday the House subcommittee on Commercial and Administrative Law created bill HR 3609 which would allow bankruptcy judges to modify the terms of a mortgage in Chapter 13. It would allow judges to make changes to the maturity, interest rate, amortization, etc. of a mortgage. If this ever passes Congress with current language the mortgage lending business would come to a quick halt as the risk to the lender would skyrocket as they would never know what could happen in the future. When Congress gets involved with something the end result is frequently not what anyone would desire.

This bill might have a better chance than many believe as it appears that very few sub-prime mortgages are being renegotiated. According to Moody’s just one percent of these loans have seen terms eased by lenders and I’m sure Congress will use that as ammunition for this bill.

Declining rental rates?

If you want to rent a house or condo why not go where there is a glut of unsold homes. How about Desoto County, Florida where owners are having trouble finding renters at any amount.

Rapidly declining house prices?

If you want to buy a house at a bargain price why not go where the supply far exceeds the demand? Flagler County, Florida has one of every five homes for sale but the city of Celebration has 50% of their homes for sale. You might even be able to buy the entire city for a reasonable price as the other 50% not for sale are probably wishing they could move.

Can anyone help Michigan?

If it wasn’t so sad it would be funny, but this week the legislature in Michigan voted to raise the income and sales taxes in a futile attempt to balance it’s budget. Michigan has used this solution before and yet they still have not learned that a weak economy (car manufacturing) and high tax rate rates are not a good reason for businesses to move to your state. For those with an appetite for undervalued real estate and a lot of patience you will be rewarded when this state hits bottom (they all do, remember New York’s problems in the 80’s).