Reducing the Noise: A look at the stories that really matter

A quick perusal of the stories below should result in the immediate understanding of why equity markets are lower this week.  The fairly heady equity gains of Feb. have been mostly neutralized in two days. This should not be a surprise to anyone actually paying attention the the signs. From the geopolitical to the home grown to the simply technical, all signs in the last couple of weeks point to heightened risk and reduced potential for reward. I explained to a reader via private email recently, “When I consider an investment for my own personal assets and our funds(Fortune’s Favor I & Fortune’s Favor Precious Metals) which are one and the same, I always weigh the risk /reward scenario. If I don’t like the results of the test I don’t make the trade.” That quote just about sums up my thoughts for today.

Case Shiller Confirms Housing Double Dip Accelerated, 20-City Composite At Lowest Since June 2009

As of December, so almost three months ago, the housing double dip was getting increasingly worse. This was confirmed by the latest Case Shiller data, according to which the 10- and 20-City Composites posted annual rates of decline of 1.2% and 2.4%, respectively. The 20 City Composite printed at 142.16, the lowest since June 2009 when it was 141.75. Luckily, NAR’s now completely disgraced Larry Yun is nowhere to be found in this release, from which we quote: “Data through December 2010, released today by Standard & Poor’s for its S&P/Case-Shiller1 Home Price Indices, the leading measure of U.S. home prices, show that the U.S. National Home Price Index declined by 3.9% during the fourth quarter of 2010. The National Index is down 4.1% versus the fourth quarter of 2009, which is the lowest annual growth rate since the third quarter of 2009, when prices were falling at an 8.6% annual rate. As of December 2010, 18 of the 20 MSAs covered by S&P/Case-Shiller Home Price Indices and both monthly composites were down compared to December 2009.” Bottom line: the chart says it all.

Italy Exchange Halted for ‘Technical Issues’ After Plunge

Trading on the Italian exchange remained halted because of “technical issues” after the benchmark FTSE MIB Index fell the most in eight months yesterday on concern Libya’s unrest may affect Italian companies.

Borsa Italiana SpA, owned by London Stock Exchange Group Plc, said in a statement on its website that “restoring operations” are under way after stocks failed to open and the futures market was halted at 12:10 p.m. All markets are suspended, the Milan bourse said in a separate statement.

Korean Bank Run Spreading: Eighth Bank Closes Following “Massive Withdrawals”

The quietest bank run that has so far completely evaded mainstream attention, that of Korea, is spreading, and an eighth bank has now shuttered after “Domin Bank, a savings bank with a capital adequacy ratio below 5 percent, voluntarily decided yesterday to suspend its operations temporarily because of massive withdrawals.” As JoongAng reports: “The decision took both depositors and financial regulators by surprise since it was the first time that a local bank shut its doors on its own.” Apparently the courageous decision by the Financial Services Chairman Kim Seok-dong to deposit $17,864 in a troubled bank has not done much if anything to prevent the locals from realizing that their banking system is built on a house of cards.

ECB Emergency Overnight Borrowings Near Record For Third Day In A Row

As was reported on Saturday, the culprits for the surge in borrowing on the Marginal Lending Facility have been supposedly identified, with Ireland once again to blame. The flawed explanation provided was that insolvent Irish banks are paying an extra 75 bps in interest just so they have access to capital on a day’s notice (as opposed to a week) as they unwind their collateral. Needless to say, we are skeptical of that “explanation.” And judging by the fact that today total borrowing on the MLP, while still near record highs, dropped by €2 billion, without any news of collateral unwind to free up asset sales by either Anglo Irish Bank and the Irish Nationwide Building Society, puts the credibility of the FT source at question. What is without doubt, is that borrowings on the MLP will persist for a long time, as was insinuated in the original piece. After all the whole point was to make this latest outlier event “priced in.”

With NYSE Short Interest At The Lowest Level In Years Following A Record Short Collapse… Who Will Be The Bid?

One of the cute side-effects of the Fed’s third mandate has been the successful elimination of all market shorts. A quick update of the NYSE short interest indicates not only the deplorable presence of shorts in the market (those entities who provide a natural bid when the market is plunging), but that the bulk of the market meltup over the past several months has been due exclusively to shorts covering existing positions. Well, with short interest now at a multi-year low of 12.4 billion shares (lowest since 2007), compared to 14.5 billion just after the Flash Crash, a 13.6 billion average over the period, and the lowest amount since the Lehman failure, our only question is when the market plunges, like it is doing today, who will be the natural short covering bid when stocks are in freefall?

Tags: bank run, case-shiller, ECB, flash crash, FTSE, housing, Italy, Korean, NYSE

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G.O.P. takes Massachusetts Senate seat – NY Times

NY Times reports Scott Brown, a little-known Republican state senator, rode to an extraordinary upset Tuesday night when he was elected to fill the Senate seat that was long held by Edward M. Kennedy in the overwhelmingly Democratic state of Massachusetts. By a decisive margin, Mr. Brown defeated Martha Coakley, the state’s attorney general, who had been considered a prohibitive favorite to win just over a month ago after she easily won the Democratic primary. With all precincts counted, Mr. Brown had 52% of the vote to Ms. Coakley’s 47%. “Tonight the independent voice of Massachusetts has spoken,” Mr. Brown told his cheering supporters in a victory speech, standing in front of a backdrop that said “The People’s Seat.” The election left Democrats in Congress scrambling to salvage a bill overhauling the nation’s health care system, which the late Mr. Kennedy had called “the cause of my life.” Mr. Brown has vowed to oppose the bill, and once he takes office the Democrats will no longer control the 60 votes in the Senate needed to overcome filibusters. There were immediate signs that the bill had become imperiled. House members indicated they would not quickly pass the bill the Senate approved last month.

There is hope! Can the American people bring balance back to our capital as well as some much need accountability? Yes, we can! Yes, we can! Yes, we can!

I’m not suggesting Brown is the embodiment of all that is good, but I am saying this is a wakeup call for the political machine that has been grinding the American dream assunder.  A dream that was never built on handouts and entitlements but instead on entrepreneurial spirit, individual freedom and hard work.

Ok, enough of the patriotism. How will this news affect the investment world? I expect the immediate reaction will be a fiscal responsibility trade. The US$ will rally and Treasury bonds will catch a bid as yields go lower. Meanwhile, commodity prices will suffer as will equity prices. However, this trade will not last long. The economic situation is not improving despite all the financial media cheerleading of the last few months. The reaction to Q4 earnings has been disappointing, as we predicted. Companies have been unable to hide the fact that organic growth is nonexistent. Add to this disappointing earnings picture the Brown victory in Massachusetts and you get a recipe for another stimulus package before the November elections.  Hence, the idea of fiscal responsibility is a pipedream.    

If one would care to argue the economic picture is becoming brighter I offer Exhibit A:

Housing Starts Plummet

Housing starts continued their up one month, down the next trend as starts fell 4.0% from 580,000 in November to 557,000 in December. The consensus expected starts to fall only 8,000 to 572,000…The drop in starts was completely attributed to a lack of single-family construction. Single-family home starts fell 6.9% from 490,000 in November to 456,000. It seems builders are well aware of the pitfalls of starting new construction given that the latest increases in existing and new home sales were propped up by government support. Since new homes constructed today would not come onto the market until after the government stimulus expires, it makes sense that builders would hold off on beginning new single-family homes until they are sure demand has stabilized….

The housing starts number is volatile, you say. Things can still get better, you dream. Not without more government stimulus, I reply. And I offer Exhibit B as another nail in the coffin of a housing recovery:

FHA to Lift Mortgage Insurance Fees – WSJ

The Federal Housing Administration will announce more-stringent lending requirements and higher borrower fees on Wednesday to cushion against rising defaults and stave off the need for a taxpayer bailout of the agency.

The FHA, which has taken on a major role in the housing market during the economic downturn, doesn’t lend money to home buyers, but insures lenders against default on loans that meet FHA criteria. In exchange for that backing, borrowers who take out FHA-backed loans must pay an upfront insurance premium, currently set at 1.75% of the total loan amount. The premium can be rolled into the loan.

The FHA is set to raise that fee to 2.25%, the second increase in the past two years, according to people familiar with the matter. The value of the FHA’s reserves to cover losses has fallen to $3.6 billion, about 0.5% of the $685 billion in loans outstanding, down from 3% a year earlier. Congress requires the agency to maintain a 2% capital-reserve ratio. If the larger upfront fee had been in place last year, the FHA would have boosted its reserves by more than $1 billion.

Also to boost the reserve, the FHA will ask Congress to increase a separate insurance fee that borrowers pay annually, people said. If the agency were to run short of cash to cover projected losses, it likely would have to ask Congress for money for the first time ever.

This move by the FHA will have the effect of rising rates for FHA borrowers (those most in need of a loan with the worst credit) resulting in a further reduction of demand. With the end of government incentives and the effective increase in mortgage rates is it any wonder housing starts are plummeting?

Rosenthal Capital Management runs the Fortune’s Favorite Family of Funds, including Fortune’s Favor I, Fortune’s Favor Precious Metals and Fortune’s Favor Offshore. For more information visit www.rosenthalcapital.com

Tags: commodities, earnings, economy, FHA, G.O.P., housing, housing starts, Investment, Massachusetts, mortgage, Stimulus, treasury bonds, US$

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Welcome to the ‘happy holidays’ edition of the RCM blog.

I thought we should begin with a little year end wisdom:

“Life isn’t about waiting for the storms to pass. It’s about learning to dance in the rain.” – Vivian Green

Managing capital during the last two years required the ownership of solid wading boots and a strong hurricane slicker. For those of you still standing I commend you. In fact, feel free to join us while we dance a jig.

In a nod to the time of year and the tendency for factual stories to be laced with pure fiction, I offer you the following two economic anecdotes.

To begin, let’s review the housing fable released today. Market participants responded to the details with a cheer, an equity market rally and a strong US$ bid. However, as with most fables, one must read between the lines to grasp the true meaning. In the case below, I have boldfaced the important detail and the moral of the story becomes clear. The “good” news about November was in fact fabricated at the expense of future months…

ECONX Existing Home Sales Rise Again
The Existing Home Sales report for November brought good news on a number of fronts. Specifically, sales increased 7.4% from October to a seasonally adjusted annual rate of 6.54 million units (consensus 6.25 mln); median prices rose slightly to $172,600 from $172,200 in October.

Based on the November sales pace, the supply of unsold homes dipped to 6.5 months from 7.0 months. The surge in home sales was driven by a rush of purchasers aiming to capture the benefit of the first-time homebuyer tax credit that they feared might expire at the end of November.

That benefit was ultimately extended, however, so the National Association of Realtors thinks it is quite possible there will be a “measurable decline” in home sales the next few months before another surge starting in spring…

Low financing rates and relatively low prices, though, continue to provide strong support to the housing recovery. If there is a point of consternation for the stock market, it is the idea that uplifting data like this could force the Fed to raise rates sooner than previously expected. That would be tolerable if there was a concomitant pickup in hiring activity, but absent that, higher rates would be a retardant on the housing recovery since it would reduce affordability…

Separately, there is a residual concern that the encouraging signs in the housing market will ultimately unleash a load of shadow inventory being held by banks and current homeowners, who have been waiting for improved conditions to list the homes for sale. The added supply could keep pressure on prices…

…Below, we have the next chapter in the ongoing saga of economic recovery. Rumplestiltskin, a.k.a. the US government, would like to tell the story of economic recovery. Upon the original unrevised GDP release, the US$ rallied due to the “better” than expected number. Today, during a quiet holiday week, the real GPD number reveals a “surprisingly” lower growth rate…

ECONX Q3 GDP- Final +2.2% vs +2.8% consensus, prelim +2.8%

ECONX Q3 Personal Consumption- Final +2.8% vs +2.9% consensus, prelim +2.9%

ECONX A Surprise Revision to Q3 GDP
In surprising fashion, the revision to Q3 GDP was fairly substantial. According to the third estimate from the Bureau of Economic Analysis, GDP grew at a 2.2% annual rate in the third quarter versus 2.8% in the second estimate. A slight downward revision to personal consumption expenditures, which were said to be up 2.8% (versus prior 2.9%) from the preceding period played a part in the downgrade, as PCE contributed just 1.96 percentage points to the change in real GDP versus 2.07 percentage points for the second estimate…

Other gauges that were adjusted to show a lower contribution to the change in real GDP included gross private domestic investment (from 0.91 to 0.54), the change in private inventories (from 0.87 to 0.69), imports (from -2.53 to -2.59), and government spending (from 0.63 to 0.55). Separately, the GDP price index was revised down as well from 0.5% to 0.4%. Core PCE was reported to be up 1.2% quarter-over-quarter versus 1.3% for the second estimate. This inflation gauge won’t alter the Fed’s assured view on near-term inflation pressures.

…So, will the 2010 economic fable resemble a Grimm fairy tale or an uplifting Christmas story? Only time will tell. I will be traveling over the next two weeks, but if duty calls I will post. Until then, enjoy the rest of 2009 and have a happy and healthy.

Tags: GDP, housing, US$

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Early last week, real estate circles were sent abuzz by the release of the Standard and Poor’s/Case Schiller national home price index, which revealed that average home prices in the nation’s 20 largest markets experienced a 3% jump in valuations during the second quarter.  It marked the first quarterly increase in 3 years for the index, leading some prognosticators to suggest that housing has indeed bottomed out.  In fact, CNBC’s Jim Cramer has panned for some time now that housing is bottoming out.  However, Cramerica & friends could not be more wrong.  Despite this hurried optimism, a variety of factors suggest that the darkest days still loom ahead for the US housing sector.

1.  First, we have that pesky figure called “unemployment.” According to the US Department of Labor, 247,000 people lost their jobs in July.   While that figure may be beginning to taper down when compared to previous months, any realistic hope for positive job growth will likely wait until 2010, at best.  Meanwhile, an extra 200,000 people gave up looking for jobs, most likely as a result of frustration and a lack of hope.  While not an earth-shattering figure, bear in mind that millions of Americans, gainfully employed or otherwise, are still receiving mortgage statements in the mail every month. If the recession lingers on, we are likely to see more and more out-of-work homeowners falling behind on or simply walking away from their mortgages.

2.  The federal housing credit is due to expire. First-time home buyers are currently eligible for up to $8,000 in credits from the federal government to use towards the purchase of a new home.  However, the program ends abruptly on December 1.   Roughly 1/3 of all new home purchasers currently take advantage of the credit; thus, when this government subsidy expires, the housing market may find itself in a pickle. Consumers might ride the wave of buyer momentum and continue to scoop up houses, or, more likely, a considerable pool of price-conscious home buyers will decide to delay or abandon entry into the housing market.

3.  The effects of ARM resets have yet to be fully realized. As this schedule of adjustable rate mortgage resets illustrates, the US should still see a sizeable chunk of recently-originated ARM mortgages reset in the coming two years (Credit Suisse predicts the total amount could reach $1 trillion).  As more and more homeowners see their mortgage payments reset from initial, artificially low teaser rates, the serious threat of foreclosure will remain.  Ben Bernanke & Co. has pledged to do its best to keep interest rates low, which should help to mitigate the extent of upward rate resets.  Nonetheless, the threat of foreclosure could grow considerably for millions of additional ARM holders as their monthly housing payments rise.

4.  Housing inventory data is misleading. Estimates suggest that the US currently has a 6-8 month inventory of homes available for sale, which equates to how long it takes for the average home sitting on the market to sell.  In actuality, that figure is much higher.  Millions of Americans who in rosier times would sell their homes have taken them temporarily off the market, either continuing to live in them or renting them out.  This has created a “shadow” surplus inventory, equating to a surplus backlog of condos and homes. When prices finally do begin to inch back upward, homeowners could very well look to unload their homes en masse, threatening to push prices further south.

5.  Pending budget deficits are forcing local governments to raise taxes. As Californians have been made well aware of, the recent recession has forced state, county, and local governments to reign in on spending as tax revenues have evaporated.  With continued government bailouts less likely, several states and municipalities are considering measures to recoup such losses, including raising taxes on everything from personal income to water usage and public transportation.  This increase in taxation, in the wake of our worst economic struggle since the Great Depression, could easily push even more homeowners beyond their means and out of their homes.

6.  Last, access to consumer credit has tightened considerably. Long gone are the days in which just about any John, Jane, or Alberto could lock in a mortgage with little or no down payment and attractive terms.  In fact, even if interest rates mimic the artificially low rates encouraged by Alan Greenspan earlier in the decade, home buyers must still navigate a much less-forgiving lending environment.  A majority of banks have both reigned in on lending practices and upped their underwriting standards.  These efforts, done in an attempt to both deleverage and build up capital reserves, have been passed directly on to the consumer.  As a result, home buyers are being forced to shell out larger down payments, undergo more stringent proof-of-income terms, and, in contrast to several years ago, convince the banks that they represent a healthy credit risk.  Oh, how  times have changed!

Although home prices have recently flirted with the notion of heading north, a multitude of risks still remain.  Unemployment, the expiration of home buyer subsidies, ARM resets, a bloated housing inventory, a heightened tax environment, and tightened lending standards should place continued downward pressure on the housing market.  While these trends admittedly will not affect all regions of the country equally, they cut to-the-core several of the major themes affecting municipalities across the US.  While the recent upswing in prices represents a welcoming change for homeowners, such a price movement is unsustainable.  Furthermore, the price weighted Case Schiller Index is disproportionately responsive to changes in prices amongst the most expensive homes in each market.  Hence, it is an unreliable indicator of broad market changes in home prices.  Lacking any fundamental changes in the consumer landscape, the media pundits and housing bulls will nonetheless pounce at any opportunity to grab the headlines with their ‘bold’ claims of a turnaround in the greater economy and housing.  However, taking a quick look around the housing landscape, it’s safe to assume that we aren’t out of the woods quite yet.

Tags: adjustable rate mortgage, federal housing credit, foreclosures, Great Depression, housing, mortgage crisis, Real estate, US Department of Labor

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