Well that's two out of two. At the end of May I predicted the All Ords (XAO) 10 month run of increases would come to an end. Then Last month I said the All Ords (XAO) would do it tough in July.
As it turned out the XAO fell 2.0% for the month of July closing at 6,187.5 down from 6,310.6 at the end of June. The XAO has retreated 4.2% from the closing high of 6,456.7 reached on 20th July.
So what are the odds of the XAO making it 3 months of straight declines? During the last 10 years (which is all I have data for) it has happened exactly 4 times. The last time the XAO fell for 3 straight months was 4 1/2 years ago. From 29 Nov 2002 - 28 Feb 2003 the XAO fell a cumulative 8.2%
The worst ever cumulative 3 months of consecutive falls in the XAO in the last 10 years happened from 29 Jun 2001 - 28 Sep 2001. The XAO shed 13.2% during that time.
What does history say about the month of August? In the last 10 years the month of August has seen rises in the XAO 6 times and declines 4 times. However the last time the XAO declined in the month of August was 6 years ago in Aug 2001.
Aha so what does all this mean? Not much except for the fact that I like to play with numbers. So after all those meaningless statistics my prediction for the month of August is that we will see another decrease in the All Ords index.
There are just too many negatives out there at the moment for my liking and although the markets have started to price some of those in I think they have yet to fully get their head around the current meltdown in credit markets.
Tuesday, 31 July 2007
I'm all but ready to throw in the towel on interest rates. After today more evidence has accumulated to justify the RBA moving on rates in August.
Today the Australian Bureau of Statistics reported that building approvals rose 7.5% to 12,953 units in June, seasonally adjusted, from an upwardly revised 12,048 units in May. Economists had forecast an increase of 2%. in June.
June approvals were driven by a 22.1% increase in the volatile multi-unit dwelling segment. Private sector approvals rose 1.2%.
The consensus is that whilst it is too early to get excited about a housing boom in the face of possible interest rate rises, the housing sector is going through a consolidation phase.
Credit demand surges in June
The RBA's monthly credit report showed overall credit jumped 1.8% in June, driving the annual rate to 15.4%. Economists had expected credit to rise 1.2 per cent in June.
Data showed housing credit rose 1.5% in June, taking the annual rate to 13.2%, personal credit grew 3.6% to an annual rate of 15.3% and business credit jumped 1.9% to an annual rate of 18.7%.Financial markets are betting on a better than 50% chance of a rise in the RBA's official rate on August 7th. Looks like I'll have to concede defeat on this one.
Monday, 30 July 2007
It seems every other day we are hearing of something affected by the meltdown in the US sub-prime mortgage market. The latest comes from Germany:
IKB stock slumps after warning on subprime impact
German bank won't meet its forecast; CEO retires
By Robert Daniel, MarketWatch
Last Update: 6:52 AM ET Jul 30, 2007
TEL AVIV (MarketWatch) -- IKB Deutsche Industriebank AG shares dropped 18% on Monday as the German lender acknowledged losses from its exposure to the U.S. subprime mortgage market, in yet another indication how Americans failing to pay back risky mortgages affects markets worldwide.
IKB's earnings will be "significantly lower" than the 280 million euros ($383.5 million) that it had forecast, the bank said in a statement.
Despite "market discounts affecting the valuation of such assets," IKB said, "to date there have been few loan defaults, and only some rating downgrades affecting portfolio investments.
Nevertheless, towards the end of last week, IKB's creditworthiness was being questioned due to said exposures. There was a risk that this confidence crisis would deteriorate further."
KfW, a German state-backed development bank which holds 38% of IKB, took steps to safeguard IKB's creditworthiness, IKB said, including assuming certain of IKB's financial obligations and protecting IKB against risks resulting from certain portfolio investments.
"These measures will maintain IKB's strong creditworthiness, in particular in its banking business with German medium-sized businesses," IKB said.
IKB said its supervisory board named Günther Bräunig, a member of the bank's board of managing directors, to the post of chief executive. He succeeds Stefan Ortseifen, who retired.
Shares of IKB dropped 18% to 17.69 euros, its lowest level since December 2003.
Reporting season kicks off this week although it will be relatively quiet. The only ASX100 company I know of reporting this week is AWC. Overall for companies reporting full year results earnings growth is expected to be around a very healthy 18%. The Australian economy has performed well in 2007 particularly from a business perspective.
At the moment the US is about half way through 2Q07 earnings season and earnings growth has slowed to around 6%. Clearly Australia is at a different point in the earnings cycle, however given the volatility and uncertainty in the markets at the moment there will be one striking similarity between the US earnings season and our own.
That is that any company that disappoints will be severely punished by the market. That disappointment may not necessarily be on the earnings front. It may be reflected in a more conservative forecast of growth going forward.
Australian investors have gotten used to above average returns and profits over the last few years and any signal that that is about to change could cause investors to reassess their expectations.
Sunday, 29 July 2007
U.S 2Q07 GDP rose at a 3.4% annual rate - the fastest since 1Q06. Having a closer look at the detail:
- consumer spending increased 1.3% in the second quarter after a 3.7% gain in the first. The increase in consumer spending included a 2.2% gain in spending on services, a 1.6% rise in spending on durable goods and a 0.8% decline in spending on nondurable goods, the weakest in 16 years.
- Real disposable income fell 0.8% annualized in the second quarter, after rising 5.9% in the first quarter. The savings rate was 0.6% in the second quarter, down from 1.1% in the first.
Remarkably the University of Michigan said consumer sentiment improved in July over June, although it fell somewhat over the past two weeks. On the inflation front:
- Core inflation (excluding food and energy) slowed to a 1.4% annual rate in 2Q07 from 2.4% in the first, pushing the on-year gain down to 2.0% - the top of the Fed's "comfort zone" for inflation.
- However headline consumer inflation accelerated to a 4.3% annual rate, the fastest pace since 4Q90. That's not a misprint, 1990.
Where did the growth come from?
- Business investment increased 8.1% in the second quarter, contributing 0.83 percentage points to growth. Investments in structures jumped 22.1%, the fastest pace since 2Q94.
- Imports fell 2.6% in 2Q07, while exports rose 6.4%. The better terms of trade adding 1.2 percentage points to growth.
- Government spending increased 4.2% after falling 0.5% in the first quarter. Defense spending rose 9.5% in 2Q07, and non-defense spending rose 1.3%. Government spending contributed 0.8 percentage points to growth.
- Businesses added $3.6 billion to their inventories after adding only $100 million in the first quarter. The change in inventories added 0.15 percentage points to growth.
- Residential investment fell 9.3% in 2Q07, the smallest decline since 1Q06. Investment in residences subtracted 0.49 percentage points from second quarter growth, compared with 0.93 percentage points from first quarter growth.
Heavy spending on defense drove the government spending number - not encouraging. Of course if the semi-literate chimp that occupies the White House decides to invade Iran then government spending could well continue to contribute strongly to growth.
Businesses replenished their inventories in 2Q07 after the draw-down in 1Q07. There won't be the need to re-stock to such levels in 3Q07.
Longer term, the latest durable goods orders do not bode well for capital spending. Goods orders were down 2.3% in May and up 1.4% in June. After stripping out transportation goods, orders fell 0.5% in June.
Not all doom and gloom but the latest GDP numbers don't instill a lot of confidence. 3Q07 will definitely be weaker but just how weak will it get next quarter and into 2008? Personally I'm leaning towards a recession in the second half of 2008.
Friday, 27 July 2007
Earlier today in London the FTSE100 was up 1% as news filtered through that the funding for the leveraged buyout of U.K. pharmacy chain Boots Alliance was going ahead. However it appears that £5 blillion of senior debt backing the deal remains on hold. At the time of writing the FTSE is down 0.8%.
Also joining the list of deals on hold was Cadbury Schweppes sale of its U.S. division that makes drinks such as Snapple, Dr Pepper and 7-Up because of worries that potential buyers could struggle to secure funding. Analysts estimate the division will be sold for between £7 - £8 billion pounds.
While we're on the subject Tyco International Inc. (TYC) withdrew a $1.5 billion 3-trache offering, citing "unfavorable conditions in the debt markets,"
One more for the road, Russian oil giant Gazprom decided against pricing a 30-year dollar-denomiated eurobond offering, electing to see if it can bring the paper to market at a more favorable time.
Just as news of deal being postponed can rock the markets a couple of high profile deals getting over the line could give investors some confidence to reenter the market. However if and when they do the terms will be much different than those assumed just a few weeks ago as investors quite rightly start re-pricing the risk of such deals.
"Treasury Secretary Henry Paulson, an old Wall Street hand himself, tried to reassure markets with a mid-afternoon televised pep talk. Lenders and borrowers should exercise more "discipline," he said, and he repeated his view that any problems in the subprime market would be "largely contained."
That's the question Joel Naroff, president of Naroff Economic Advisors posed yesterday about the US economy ahead of Friday's release of 2Q07 GDP .
Fed chief Ben Bernanke told Congress last week that the US economy would continue to grow at a moderate pace this year before picking up in 2008.
However in the face of rising prices a consumer that is living off their credit cards and a tanking housing market were is the growth supposed to come from?
I have been flapping on about the current quarter's growth been driven by a restocking of inventory after the draw-down in 1Q07. Now that inventories have been replenished what will drive economic growth from here?
Exports I hear you say, possibly, however is that enough to drive growth considering that 2/3 of US economic activity is driven by a now ailing consumer?
Friday's GDP reading is forecast at a solid 3.2% for 2Q07. However that will probably be the best reading you will see for some time. Expect GDP to reverse gears in the 3rd quarter and come to a screeching halt in 2008.
The Commerce Department reported a 6.6% drop in new home sales in June to a seasonally adjusted annual rate of 834,000, below analysts expectations of 890,000. Sales are down 22.3% compared with June 2006.
Sales in May were revised to a 893,000 annual pace instead of the 915,000 previously reported.
Inventories of unsold homes were unchanged at 537,000. At that pace inventory represents a 7.8-month supply at the June sales pace, up from 7.4 months in May.
The median sales price was $237,900, down 2.2% compared with June 2006.
Some quotes after today's numbers.
"Home building, sales and prices have not hit the ground floor" Stu Hoffman, chief economist for PNC.
"The industry forgot to pack a parachute, and the ground is coming up fast" said Joel Naroff, president of Naroff Economic Advisers.
"2009 is shaping up as an OK year." Richard Moody, chief economist for Mission Residential,
Economist Mark Zandi of Moody's Economy.com said it'll be 2010 before the market turns around.
Notice there is no more talk of being near a bottom in housing. The consensus view is coming around to the reality that there is still a lot of pain to go in the US housing market.
Some truly horrible earnings reports from homebuilders
D.R. Horton Inc. (DHI)reported a huge loss of $823.8 million, compared to a profit of $292.8 million, in the year-ago quarter.
The company cited pretax charges of $835.8 million for inventory impairments and $16.2 million related to write-offs on land options it's abandoning. The company also took a pretax goodwill-impairment charge of $425.6 million.
Also Beazer Homes USA Inc. (BZH) reported a quarterly net loss of $123 million, compared with profit of $102.6 million, a year earlier.
Beazer booked pretax charges of $188.5 million related to inventory impairments, abandonment of land options and goodwill impairments. The company said total revenue dropped to $761 million from $1.2 billion a year earlier.
In case you missed them here are some other recent results from US builder's:
Centex Corp. (CTX) posted a quarterly loss from continuing operations of $131.3 million.
Ryland Group Inc. (RYL) reported a $52.4 million, loss on 38.2% lower revenue.
M.D.C. Holdings Inc. (MDC) printed a loss of $106.1 million as revenue dropped 42%.
Meritage Homes Corp. (MTH) recorded a loss of $56.6 million as revenue fell 38%.
Truly ugly stuff. As a sign of things to come Wells Fargo & Co. (WFC) Home Mortgage division announced that they will close their nonprime wholesale lending business, which processes and funds subprime loans for third-party mortgage brokers.
Strap yourselves in folks, we're just getting started.
Thursday, 26 July 2007
A timely reminder that Australia is not immune from the financial excesses that receive so much attention in the US. Last week Australian Hedge Fund manager Basis Capital conceded that they have exposure to the US sub-prime market.
The company's Basis Yield fund fell 14% in June, and said it was likely to stop withdrawals to prevent forced sales of assets. The Financial Times reported that the group is currently in talks with creditors after banks seized and began to sell some of its investments.
Creditors said the $1 billion manager missed margin calls on Monday for its Basis Yield Fund, and has appointed accountants Grant Thornton as restructuring advisors.
Absolute Capital Hedge Fund Suspends Withdrawals
Today, another Australian Hedge Fund Absolute Capital, that invests in CDO's suspended withdrawals from two of its funds after forecasting losses due to a fallout in the subprime market. The company's Chief Investment Officer Bill Entwistle commented that:
"Because of the contagion from subprime, all of the credit sectors are re-pricing,'' Sydney-based Entwistle said." "There are lots of sellers and no buyers, the market has to settle down before we can get some clarity."
Funny stuff, well Bill I'd say the market has has gotten a dose of clarity for the first time in a long while. Who would actually want to buy this crap? I also liked the following quote:
Absolute Capital said it won't process any requests for withdrawals until Oct. 25, estimating it may take three months for enough buyers to return to the CDO market.
It may take three months, it may take only two or they may not return at all. This thing is going to get a lot worse before it gets better and even when buyers do return it will be at fire-sale prices.
A more balanced opinion was that expressed by Kim Ivey, chairman of the Australian Alternative Investment Management Association, which represents 80 of the nation's hedge fund managers. Commenting on the exposure of local hedge funds to the subprime market he said:
"I expect that it will be contained to just a handful.'' "More of a concern is what will happen once the fallout moves from the subprime sector to more senior debt, when many more managers have exposure.''
Absolutely Kim and as we have seen this week firstly from Countrywide and yesterday from Citigroup Inc. it is definitely spreading.
The Bloomberg article referenced in the last post is worth fleshing out a little more.
As mentioned in the article sales of securities used for CDO's fell 80% this month from $42 billion in June to $9.1 billion. Amongst others Maxim Capital Management in New York and Paris-based Axa Investment Managers have delayed or scrapped planned CDO sales this month.
So who is going to be affected by the drop-off in CDO sales?
Kravis' Kohlberg Kravis Roberts & Co. and Blackstone Group LP, need to borrow at least $300 billion in coming months to finance acquisitions, according to Baring Asset Management in London.
That's a fair chunk of change to have to borrow as investor start to demand significantly higher yields to compensate for the risk of losses. That's not to say that some of these deals will fall over, they might well all go through as planned. However the private equity binge was built on the assumption of a never ending gravy train of cheap credit. That is now coming to a quick end.
CDOs also financed growth in lending to home owners with poor credit or high debt, known as subprime mortgages. About $50 billion of home loan debt rated BBB and BBB- went into CDOs in 2006, almost the same as the total sales of mortgage backed securities with identical ratings, Citigroup Inc. analysts estimated in a report in April.
We know now and can see the effect on home owners and potential home owners. Stricter lending practices and higher interest rates. These factors are showing up in home sales data.
Merrill Lynch is the biggest underwriter of CDOs, selling $55 billion last year. Banks collected a total of $8.6 billion underwriting CDOs last year. If July is any indication the majority of these fees will evaporate. In addition firms such as Citibank are raising their loan loss provisions. Both a drop-off in fees and increases in loan losses (and remember we haven't hit the top of the mortgage reset cycle yet) are going to take a chunk out of earnings which I suspect will start to become ore apparent in the coming quarters.
If you read on in the article you will see that some deals are still going ahead and dealers are saying that this month is just a lull and consequently a good time to get back into the market:
We don't know when it will come back, but it should,'' said Dagmar Kent Kershaw, who helps manage 6.5 billion euros of CDOs at M&G. ``We believe now is a good time to get into the market, as some of these assets are cheaper than they have been for a while and offer excess value to the savvy investor.''
I wanted to quote that line because I'm quite certain I'll be able to come back sometime in the near future and have a good laugh at it.
- Defaults on some so-called Alt A mortgages packaged into bonds last year are now outpacing those from subprime loans, according to Citigroup Inc. Bloomberg Article
- Between June 1 and July 17, typical spreads on BBB rated Alt A securities widened by 125 basis points to 475 basis points, while spreads for similar subprime securities rose 200 basis points to 450 basis points, according to Citigroup.
- Sales of CDO's plummeted to $9.1 billion in the U.S. this month from $42 billion in all of June, according JPMorgan Chase & Co. in New York.
The last part of Mish's article is worth repeating here for the "it's different this time" crowd.
The Ghost of Drexel Burnham Lambert
Kevin Depew on Minyanville gave everyone a history lesson in point one of Tuesday's Five Things.
1. Ghost in the Machine Slowly Grinding to a HaltThey say that history does not repeat but it does rhyme. In this case they have it wrong. CDO History is indeed repeating. What will also repeat is how the Fed will react to the problem. That way of course will be the same way the Fed reacts to every problem (by cutting rates). Regardless of whether or not that tactic works the next time (I doubt it), the attempt itself should be good for gold as the yield curve steepens.
The market for collateralized debt obligations is slowly grinding to a halt, according to Bloomberg, threatening one of Wall Street's sacred cash cows - (read: $8.6 bln in annual underwriting fees) - and reducing the availability of credit for everyone from major Wall Street buyout firms to homeowners themselves.
What's behind the declining appetite for CDOs?
- Sales of collateralized debt obligations (CDOs), which are used to pool bonds, loans and their derivatives into new debt, fell to $9.1 billion in July, down from $42 billion in June, analysts at JPMorgan Chase (JPM) said, according to Bloomberg.
OK, so what are we really talking about here with these so-called CDOs?
- The near collapse of two Bear Stearns (BSC) hedge funds, for one. The downgrade of 75 CDOs by the ratings agency S&P, for two. And concern about growing losses due to rising homeowner mortgage defaults, for three. Those are just for starters.
Wait a minute.
- CDOs were created in 1987 by bankers at Drexel Burnham Lambert.
Did you say Drexel Burnham Lambert?
Isn't that the same firm that was driven into bankruptcy in 1990 due to illegal trading in junk bonds driven by Drexel employee Michael Milken?
And did you say they were created in 1987?
The same year the market crashed?
And wasn't the 1980s known as the "Decade of Greed"?
So let's see if we got this right. Today, in 2007, the market for securities that were created in the "Decade of Greed" by a firm that was only a short time later forced into bankruptcy due to illegal trading in high-risk bonds is grinding to a halt?
- Yes, yes, yes, yes and yes.
US existing home sales continued to slide reaching a five year annual low of 5.75 million units in June.
Sales of single-family homes plunged at a 30% annual rate in the 2Q07, the steepest decline in 28 years, the National Association of Realtors said Wednesday. Sales of single-family homes were down 12% in June compared with a year earlier.
Inventories of unsold homes on the market fell by 180,000, or 4.2%, to 4.20 million, representing an 8.8-month supply at the June sales rate. Despite the drop in inventories, supply remains at 15-year highs.
Optimists may have gained some encouragement from the first year-over-year increase in the median sales price which inched 0.3% higher compared with a year ago. However one month does not make a trend. Expect house prices to resume their downward slide in coming months.
For the full NAR report click here.
The Commerce Department will report data on new-home sales for June on today.
Wednesday, 25 July 2007
The high growth low inflation period of late 2006 and early 2007 appears to be over as consumer prices surged 1.2% in the June quarter on the back of higher transport, food and health costs.
Treasurer Peter Costello was patting himself on the back as the annual inflation rate dropped to 2.1%, however the annual rate is misleading as it omits the sharp price rise in the 2Q06 which now drops out of the calculations. The important point is that the latest quarter shows that inflationary pressure are back.
The RBA's underlying measures of annual inflation rose 0.9 % pushing the annual rate into the top half of its 2-3% target prompting some economists to predict a interest rate rise in August as all but inevitable. Financial markets were quick to factor in the higher risk of a rate rise, placing the chance of an August rate rise at 68%.
Another interest rate rise would not be popular with home buyers facing a 30 year low in affordability and will do little for the government's re-election campaign. However the RBA can't sit on their hands forever in the face of rising prices.
A few days ago I wrote that I believed the RBA would not hike rates again this year. I may have to revisit that call very soon but probably not in August. It is my belief that the RBA will wait for a little more evidence before hiking again.
It's not over yet, M&A deals are still flourishing however financing is becoming tighter. The latest deal to run into difficulty is the leveraged buyout of General Motors' Allison Transmission business. The sale of $3.1 billion in leveraged loans for the deal has been delayed.
The delay comes on the heels of the significant reduction on Monday of a buyback plan by online travel Expedia Inc. (EXPE) The company was unable to borrow necessary funds at acceptable terms. These two are just the latest in a series of setbacks for corporate debt offerings.
More than $16 billion worth of leveraged-loan and high-yield bond deals have been canceled or postponed so far this summer, according to Fitch Ratings' estimates.
What would bring the leveraged buyout frenzy that has driven a lot of the equity market gains this year to an end? Could it be the unraveling of a mega deal?
The Cerberus Capital Management LP's $12 billion buyout of DaimlerChrysler AG's (DCX) U.S. unit may not be the biggest deal but it could be in danger of toppling over as Cerebus scrambles to find takers for the debt.
PIMCO bond manager Bill Gross noted that the Financing for Chrysler will be an important indicator of the health of the leveraged loan and high-yield markets, Gross also noted. That deal has already been put back a week and bankers are considering increasing the pricing to attract more investors. Read here for more on the state of the leveraged buyout market.
The past few days has seen a mixed bag of earnings results. Tuesday was no exception with Amazon announcing a 250% rise in 2Q07 profit after the bell whilst Dow component Dupont disappointed with flat profit growth.
However the highlight of the day and possibly of this earnings season came from the largest US mortgage lender Countrywide Financial Corp. (CFC).
Countrywide reported 2Q07 profit dropped 33% almost double the 17% decline expected by analysts. The company cut it's full year earnings forecast to a range of $2.70 to $3.30 a share, down from $3.50 to $4.30 a share previously.
The company said payments were at least 30 days late at the end of 2Q07 on 4.56% of prime home-equity loans serviced by the company, up from 1.77% a year earlier.
That's PRIME loans, you know, the good ones, the ones given to people with the highest credit ratings. What's that I hear you say about containment Mr Bernanke?
Payments were late on 23.71% of subprime mortgage loans, up from 15.33% at the end of the same period in 2006.
Whilst the results were below expectations it was the commentary that really got the market's attention. On a conference call with analysts chief executive Angelo Mozilo this to say amongst other things:
"During the quarter, softening home prices continued to affect many areas of the country, and delinquencies and defaults continued to rise across all mortgage product categories as a result."
"based upon what I have seen in the past and the size of this market -- is that it's going to take 2007, the balance of this year, to get this thing to look like it is slowing down; 2008 to get it to slow down and stop; and 2009 to head in the other direction."
"I say 2009 because my experience is that it just takes a long time to change, to turn a battleship around,"
That's 2009 folks as opposed to mid 2008 for a turnaround, however the CEO also refused to rule out price declines in 2009.
"definition of prime may not be as high as some people think."
Oh, so prime borrowers aren't all that prime after all. Seems as though the mortgage industry has been adopting the same Humpty Dumpty use of language as Bear Stearns and the Ratings Agencies.
...and for the grand finale how about this humdinger:
"Company is seeing home price depreciation at levels not seen since the Great Depression"
The company also said they expect to hear mergers and people going out of business in the near future. No surprises there, people have already been going out of business. As the Mortgage Lender Implode-O-Meter suggests more than 100 major U.S. lenders have imploded.
Tuesday, 24 July 2007
As I noted last Friday Bank of America (BAC) raised their loan loss provisions almost 50% as non-performing loans rose 18% in 2Q07.
After hours Monday, American Express Co. (AXP) reported a healthy 12% increase in 2Q07 profit, although growth was restrained somewhat by an 85% jump in loss provisions. Granted provisions are coming off a low base from the same time last year, however expect them to keep rising as the credit cycle worsens.
No doubt the large banks are big enough to absorb higher delinquency rates but both higher loss rates and higher provisions are obviously starting to effect earnings growth. With delinquency rates set to increase expect provisions and loan losses to further dampen earnings growth in the remaining quarters of this year and into the first half of 2008.
Monday, 23 July 2007
Australian producer prices (PPI) increased by 1.0% in 2Q07, exceeding forecasts of a 0.8% rise driven by higher petrol and construction costs. However, growth for the year slowed to 2.3%, significantly lower than the peak of 4.5% in 2Q06 and is the slowest pace since mid-2004.
Attention now turns to the more important Consumer Prices (CPI) to be released on Wednesday. Traditionally the PPI does not have a close correlation to the CPI however over recent quarters they have been more closely corrrelated.
Economists are forecasting a 1.0% rise in 2Q07 CPI, driven by the higher cost of petrol, food, rents and health care. Still, that would see annual inflation slowing to just 1.9% from 2.4% in 1Q07. The RBA focuses on underlying inflation, which is expected to rise 0.7% in 2Q07 which would lower annual underlying inflation to 2.5%, from 2.7% in 1Q07 - bang in the middle of the RBA's 2 to 3% target range.
For the RBA to move on rates in August Wednesday's CPI reading would have to significantly exceed forecasts. I maintain the view that we are unlikely to see another interest rate rise from the RBA this year.
- Whilst GDP improved in 2Q07, driven mainly by restocking of inventories, the underlying fundamentals of the economy deteriorated.
- Personal consumption has been flat for the past 4 months signaling that a softening labor market and lower income growth coupled with falling home prices and tighter lending standards are starting to take their toll on consumers.
- The employment picture is not as rosy as the offical figures suggest. Non-farm household employment, an alternative jobs measure that historically has been more accurate at cyclical turning points, expanded 45,000 per month this year compared to a 235,000 average monthly gain in 2006, an 80% decline.
- Equity extraction from homes between 2002 and 2006 that accounted for 45% of the rise in total personal consumption expenditure has largely dried up since home prices are no longer rising, and credit standards have been tightened.
- By now you know all the stats on housing. Home prices are deflating in 3/4 of the US's individual markets. In the past year, home prices decreased 2.7%, the steepest decline in 16 years, NAHB index at 16 year lows. Delinquincies at the highest level since 2001.
- Strong global growth is not enough to offset a downturn in domestic consumer spending. As the graph below illustrates, U.S. domestic demand leads domestic demand in the world's largest economies by 6 to 9 months.
- Our view is that faltering consumer spending and a continuing housing recession will lead to recessionary conditions in the quarters ahead. This will negatively impact global economic conditions and decrease the U.S. inflation rate from its already modest 1.9%, thereby lowering inflationary expectations, and subsequently long bond yields.
Saturday, 21 July 2007
Sorry I'm still catching up with the news over the last few days. Couldn't let the US housing data slip by without some comment.
New homes starts rose by 2.3%, to a seasonally adjusted annual rate of 1.467 million in June, 19.4% below where they were at the same time last year.
Meanwhile, building permits fell by 7.5% in June, to a pace of 1.406 million annualized - 25.2% below June 2006 levels.
Remember that these numbers are volatile and subject to large sampling and other statistical errors. In most months, the government can't be sure whether starts increased or decreased. Large revisions are common. Permits are generally considered a better indicator of building fundamentals than starts, which can be heavily influenced by weather conditions. The sampling error on permits is also lower.
Not a pretty picture if we take the more reliable permits data as a proxy for the state of the housing market. Add to that the latest reading from the NAHB's builder confidence index and US housing is still looking pretty sick.
Home builders' confidence plunges again in July
Housing starts could begin gradual recovery next year, builders say
WASHINGTON (MarketWatch) - With interest rates moving higher, a glut of homes sitting unsold, and the problems in the subprime mortgage market worsening, U.S. home builders' confidence in the housing market plunged further in July, according to a monthly survey released by the National Association of Home Builders.
Friday, 20 July 2007
I go away for a few days and everything falls apart. Well not really, things have been falling apart for some time now.
First the boring stuff. US producer prices declined a surprising 0.2% in June whilst consumer prices rose a moderate 0.2%. Nothing earth-shattering there, expect the short term pullback in energy prices in June to be short-lived as oil punched through US$75 a barrel this month. Consumers will continue to feel the pinch of rising food and energy costs.
Now for the fun stuff.
Bear Stearns hedge Funds worthless
The Bear Stearns hedge funds are now officially worthless. The net value of assets in the High-Grade Structured Credit Strategies Enhanced Leverage Fund are zero, according to the Wall Street Journal and the net value of assets in its other, larger, less-leveraged fund lost about 91%. Bear Stearns has only had to use about $200m of the 1.6bn that it committed to shore up the assets of the less leveraged of the funds. Not such a bad outcome for (BSC), however quite a different outcome for investors.
Sub-prime contagion spreads to Alt-A
Residential mortgage lender "Alliance Bancorp announced that they will go into liquidation since:
“We have exhausted our resources and do not have the means to move forward. Therefore, it is with great sadness that I announce that we have ceased operations as of today, July 13th.”
Click here for the full story.
Once again the containment scenario is being exposed as farcical. Alliance Bancorp was not a sub-prime lender, rather they specialized in lending to so-called Alt-A borrowers: mortgage borrowers with credit between those of prime and subprime borrowers. These mortgages are loans where borrowers lack some of the documentation required by traditional mortgages. No doubt there are loads of RMBS's packed with Alt-A loans to keep the ratings agencies busy for a while yet.
Moody's setting the standards for the industry WTF?
Speaking of scum, I mean ratings agencies, it seems Moody's are trying to make themselves out to be the island of propriety in a sea of corruption as they valiantly refuse to attach high ratings to low grade crap. Baseless self-aggrandizement at its best. Click here for the full story from MGETA.
Credit cycle catches up the Bank of America.
I've been mentioning for some time now that financial companies have yet to substantially raise their bad loan provisions in the face of a worsening credit cycle. On Thursday Banc of America (BAC) had to finally face reality by raising credit loss provisions by almost 50% as non-performing loans rose 18% for 2Q07 from a year ago. Strong capital market gains offset the rising tide of non-performing loans helping the company to a 5% profit rise. Not encouraging results. When the music stops in the capital markets expect BAC to start bleeding red ink.
Tuesday, 17 July 2007
The last thing the investment banks want is a real market price for the toxic waste they've been flooding the asset backed securities markets with. That may force them to revisit the imaginary values in their books and take some decent sized write downs.
Yesterday THE BIG PICTURE picked up on a sharp downward movement in the value of the ABX.HE indices as measured by markit. What exactly are the ABX.HE indices I hear you ask? This from Deutsche Bank:
On 19 January 2006, ABX.HE, a new group of credit default swap (“CDS”) indices linked to subprime RMBS securities, began trading. Collectively, the ABX.HE indices form a subgroup of the ABX index family, which is expected to eventually extend to other asset classes in the ABS market. The index has transparent rules and relies on dealers for pricing. ABX.HE is owned and administered by CDS IndexCo and Markit, the same entities that manage the well-established CDX family of indices for corporates. In the first week of its launch, trading on the indices was extremely active, with some sources estimating traded volume as high as $10 billion.
The main point here is that in bold. The dealers price them. However it seems someone or a number of investors are trying to reduce their exposure and are willing to take sharply lower prices to exit. BBB and BB rated indicies began to tank a few months back. Now the contagion seems to have spread to the AAA and AA tranches.
Remember AAA rated securities are supposed to be top quality yet as the mentioned in the article 8% of these AAA securities are sub-prime toxic sludge with about 12% in the AA catergory. Click here for the full article. Click here for the ABX.HE prices, note that all tranches regardless of quality are all at their historical lows.
Last week's rally in the US market took just about everyone by surprise. No one could really put a finger on what was driving it. Climbing the wall of worry seems to be the cliched phrase thrown about at the moment, the theory being that stocks can still rally despite market jitters. Skeptics sit on their cash and as their fears are alleviated, they pile into stocks, pushing the market higher. As long as their worries are held in check the market continues to rally.
Overly simplistic but plausible enough. More interesting to me is where all this money is coming from. We know the markets have been awash with liquidity in recent years. The current M&A frenzy is testament to that. Michael Shedlock has postulated another reason that is fueling the current market rally on his blog Mish's Global Economic Trend Analysis.
Margin Debt Drives The Market
The WSJ is reporting 'Margin Debt' Hits Record $353 Billion on NYSE
Investors are borrowing record sums of money to finance trades on the New York Stock Exchange, according to data due out from the Big Board today.Idea that the market is rising because of rising retail sales (or anything else) is fatally flawed. The market is rising because speculation has not stopped regardless of what economic activity is (or will) report. The market (in spite of what anyone thinks) is simply not any sort of leading indicator. Proof of that is easy to find. Please read Leading Economic Indicators for further discussion of this idea.
NYSE officials attribute the trend to recent regulatory changes effectively allowing both small and big investors to take on more leverage, or borrowed money, from their brokers. So-called margin debt, a broad measure of leverage, jumped 11% to $353 billion at NYSE in May, up from nearly $318 billion in April.
Wall Street has had a love affair with leverage in recent years, typified by hedge funds and private-equity firms that make use of it to buy companies and stocks and bonds.
Such financing can also amplify losses if investors' bets go the wrong way. But regulators say that doesn't necessarily translate into more risk. "I wouldn't necessarily say that leverage equates to risk," said Grace Vogel, executive vice president for member regulation at NYSE. "We feel that the amount of margin being collected by the firms is appropriate, given the strategies in [their customers'] portfolios."
Under the financial industry's old rules, investors who wanted both to buy shares in a company and use so-called options contracts on that stock to guard against an unexpected drop in the value of those shares would have to put up separate collateral for both the stock and the option. If the shares dropped in value, the customer might get a margin call, or request for additional collateral, from a broker to cover the price of the shares, even if the value of the option had increased.
Under a pilot program that the NYSE launched with eight brokerage firms in April, brokers can assess the portfolio as a whole. So if one part of the portfolio goes down but the other part goes up, the investor won't necessarily get a margin call.
The upshot for investors is they don't have to tie up as much money on one particularly investment, allowing them to borrow more to make other investments if they want to. ...
Leverage may kill but while things are hot no one cares. In the aftermath there are government investigations, Congressional inquiries, lawsuits galore, absurd regulations, and eventually government bailouts at taxpayer expense.
I am for Ron Paul because he alone will stop bailouts at taxpayer expense.
On Tuesday July 10th and on the record in Quotes of the Day / Top Call I made a top call.
Sorry folks, I was wrong.
It is not the first time, nor will it be the last time I am wrong but I do not make top calls lightly. I was laughed at when I made a top call on housing in summer 2005. But who is laughing now about that call?
As for this call, I am sticking with it. The signs of speculation, of margin, of bullish sentiment, etc. in spite of deteriorating fundamentals are all around us. I see no reason to change that call.
By the way, it is not really margin debt that is driving the market. It is sentiment. Sentiment is driving margin debt. In spite of everything that has happened, speculators are still bullish on this market just as greater fools were bullish on housing in the summer of 2005. The longer this goes on, the greater the eventual collapse.
Saturday, 14 July 2007
Interesting article from Michael Shedlock that exposes the sham the rating agencies have been running for some time now.
Bloomberg is reporting S&P will implement a "stress test" of subprime mortgages.
Standard & Poor's said it may cut the credit ratings on $12 billion of bonds backed by subprime mortgages, prompting investors to dump the securities. S&P is preparing to lower the ratings on 2.1 percent of the $565.3 billion of subprime bonds issued from late 2005 through 2006 because the housing slump is worse than the company anticipated. The announcement sent U.S. government bonds higher, the dollar lower and caused shares of financial companies to drop.
[Mish Comment: $12 Billion? 2.1%? Is this a joke? Hell, they ought to downgrade it all. The excuse might be that most of it was rated properly in the first place but realistically speaking we all know that to be another blatant lie.]
"S&P's actions are going to force a lot more people to come to Jesus," said Christopher Whalen, an analyst at Institutional Risk Analytics in Hawthorne, California. "When a ratings agency puts a whole class on watch, it will force all the credit officers to get off their butts and reevaluate everything. This could be one of the triggers we've been waiting for."
Almost 65 percent of the bonds in indexes that track subprime mortgage debt don't meet the S&P ratings criteria that were in place when they were sold, according to data compiled by Bloomberg.
[Mish comment: I stand corrected. They should only downgrade 65% of it. The rest should be put on credit watch. Seriously what's with this pathetic downgrade of a mere 2.1% of the debt?]
S&P's review covers ratings on 612 pieces of bonds backed by subprime mortgages. S&P will implement a "stress test,"of hypothetical scenarios to see how a bond will react.
[Mish comment: Excuse me but don't we already know? What else would you call it when there are no takers on the ask at 11 cents on the dollar for Bear Stearns' High-Grade Structured Credit Strategies Enhanced Leveraged Fund. The offer was a mere 5 cents. That's not stress?!]
Critics of the ratings companies include Bill Gross, chief investment officer at Pacific Investment Management Co. Gross, who runs the world's biggest bond fund, said last month that Moody's and S&P gave mortgage bonds investment-grade ratings because they were fooled by the "six-inch hooker heels" of the collateral backing them.
[Mish comment: Gee no mention of Mish. Then again I was not as colorful as to describe the ratings companies as hookers like Gross did. Then again I think that Moody's and the S&P knew full well what they were doing. If they didn't then I think were incompetent. So what is it? Incompetent Hookers?]
"I'd like to know: Why now?" Steven Eisman, a portfolio manager at Frontpoint Partners in New York said on a conference call hosted by S&P to discuss the possible ratings changes. "The news has been out on subprime now for many, many months. The delinquencies have been a disaster for many, many months. The ratings have been called into question for many, many months. I'd like to know why you're making this move today instead of many months ago."
[Mish comment: "Why now?" is very easy to answer. The blowup at Bear Stearns forced the issue. The ratings companies as well as Bear Stearns was hoping that this would blow over. Obviously it didn't in spite of a multitude of fools yapping on CNBC how contained this mess is. Guess what? It's still not contained and it is going to spread all the way to ridiculously rated grade A rated paper.]
Tom Warrack, an S&P managing director, said it takes time for performance to show through.
"We have been surveilling these deals actively on a regular basis beginning in 2005 and 2006," Warrack said on the call. "We believe that the performance that we've been able to observe now warrants action."
[Mish comment: That is one of the most ridiculous understatements of the year. Your heels have to be colored brightly to make such a straight faced statement. Yes, "action is now warranted", but it was also warranted last month, in April, In March, in February, and in January. And action is warranted on far more than a measly 2-3% of the issues."
Fran Laserson, a spokeswoman for Moody's, and James Jockle, a spokesman for Fitch, said they had no immediate comment.
Mish comment: This is all part of the strategy. If you can't say anything good, then simply hide under a rock]
Figures released by the department of commerce on Friday showed a 0.9% fall in retail sales for the month of June - the worst reading since August 2005. Analysts had been expecting a fall of 0.3%. Sales ex autos fell 0.4% the worst since last September. Analysts had forecast a rise of 0.2% ex autos.
It seems investors are willing to look past weak retail numbers and sub-prime jitters and pin their hopes on better than expected earnings for 2Q07. General Electric gave comfort to the market on Friday announcing that they would divest their sub-prime business and deploy more capital in buybacks and reiterated their full-year earnings forecasts.
Large companies with international operations exposed to strong global growth are the place to be as they can insulate themselves from a slowing domestic economy, reap the benefits of a weak dollar and prop up earnings with share buybacks. They can't do it indefinitely but can they do it long enough to ride out the current slowdown?
Consumer sentiment rebounds in July
University of Michigan/Reuters gauge increases to 92.4
By Greg Robb, MarketWatch
Last Update: 4:17 PM ET Jul 13, 2007
WASHINGTON (MarketWatch) -- U.S. consumer sentiment rebounded in early July, as rising stock prices and falling gasoline prices brightened the outlook.
The consumer sentiment index rose to 92.4 in July from 85.3 in June, according to a monthly survey released Friday by Reuters and the University of Michigan.
This is the highest level since January. The level in June was the lowest since last August.
Economists were expecting an improved reading of around 86.5, according to a survey conducted by MarketWatch.
The current conditions index rose to 105.7 from 101.9, the highest level since February. The expectations index jumped to 83.9 from 74.7, the highest level since January.
Economists attributed the improvement to the strength of the stock market and the recent drop in gasoline prices.
Ian Shepherdson, chief U.S. economist at High Frequency Economics, noted that gasoline prices are rising again, so he said it was doubtful the jump in sentiment "represents the start of a sustainable trend."
Earlier on Friday, the Commerce Department reported retail sales fell 0.9%, the biggest decline since August 2005.
The economic team at Action Economics said the various measures of consumer confidence are at solid levels, supporting the notion that retail sales will recover from their June weakness.
Earlier today, the government also said oil prices boosted import prices by 1% in June. In addition, the government reported business inventories rose 0.5% in May.
Friday, 13 July 2007
The Dow surged 284 points on Thursday or more than 2% driven by Rio Tinto's (RIO) bid for Alcan (AL)and retail chain stores recording better sales than expected. Not that sales could be described as good but they were good enough to beat lowered expectations.
The International Council of Shopping Centers (ICSC) initially forecast overall sales growth for June of 2% - 2.5% but had trimmed that range to 1.5% - 2% by earlier this week. With 45 retailers reporting, the ICSC was showing a 2.4% gain in same-store sales. That was enough to give the bulls something to roar about.
According to same-store sales estimates compiled by Thomson Financial, 53% of retailers reporting results had missed forecasts while 44% beat them. Only 2% were right on target.
Leading the positive surprises was Wal-mart (WMT) with same store sales growth of 2.4% analysts had been expecting a tepid 0.8%. Other major companies to report results were:
Macy's (M), same-stores sales fell 2.7% compared with an expectations of a 0.8% decline. And the department-store chain is looking at July sales that will be flat to down 3%. Macy's warned that 2Q07 earnings would be in a range of 20 cents to 30 cents a share, not the 35 cents to 45 cents that it had been expecting.
Kohl's (KSS) disappointed with same-store sales slipping 4.9%, deeper than the minus-2.4% projected.
Dillard Department Stores (DDS) same-store sales slipped 1%, slightly narrower than the 1.4% retreat expected.
Saks Inc. (SKS)same-stores sales fell 5.6%, lower than estimates of a 4.1% decline.
J.C. Penney (JCP) said same-store sales fell 1.5%, but that turned out good compared with the 3.6% drop analysts were bracing for. Penney reiterated its quarterly forecast, indicating that though sales fell, the department-store chain was able to keep costs under control to protect margins.
Gap Inc. (GPS) total chain sales fell 5% compared with the 4.5% decline expected.
Ann Taylor (ANN) same-store sales stumbled 8.4% amid slow traffic into its stores and particular weakness at the Loft chain. Analysts were looking for sales to fall 4.8%.
Costco Wholesale (COST) were only slightly off expectations with a 6% gain instead of the 6.1% gain forecast by analysts.
Limited Brands (LTD) did slightly better with a 3% increase rather than the 2.9% expected.
American Eagle Outfitters (AEO) same-store sales results jumped 8% almost double expectations of a 4.4% increase. The company raised it's earnings projection by a cent.
Pacific Sunwear (PSUN) produced same-store sales growth of 4.5% beating expectations of 3.2%.
As you can see from the sample above results were a mixed bag prompting Michael Niemira chief economist for the ICSC to comment that overall, the results were "moderate," he added that:
"The results were better than we feared," and noted that Wal-Mart accounted for much of that unforeseen strength. "Beyond that, the themes were as expected" - weakness in home-related merchandise and apparel sales driven by late-month discounting and promotions.
Government to report weak retail sales for June
Whilst the large chain stores beat very low expectations in June, total retail sales are expected to be anemic when the Commerce Department reports its figures on Friday.
Economists are expecting 0.3% decline in total retail sales for the month of June after the strong 1.4% increase in May, however economists also expect May figures to be revised downwards.
Except for the quarter that followed the Katrina disaster, it would be the weakest consumer spending in more than four years.
The economic fundamentals of a depressed and weakening housing market, credit re-ratings and lower consumer spending are still firmly in place. As stocks tick higher on the back of M&A deals the bigger the disconnect grows between stock prices and economic reality.
If retail sales for June come in positive rather than the negative figure expected the market may well continue to tick higher. However the further the market rallies in the face of the deteriorating economic picture the more it is looking like a last gasp.
This webcast from marketwatch.com featuring Joe Battipaglia of Ryan, Beck & Co. sums up well the macro environment and why Thursday's retail figures are not as bullish as the market's reaction indicated.
Thursday, 12 July 2007
Yesterday's forecast from The National Association of Realtors for July was more pessimistic in nearly every aspect than June. The main points were:
- Housing starts are expected to drop 20.6% in 2007 and rise 0.6% in 2008. Starts for single-family homes are expected to fall 23.3% this year and 1.3% next year. A month ago, the Realtors were expecting single-family starts to rise 1.6% in 2008.
- Sales of existing homes are expected to fall 5.6% this year and rise 4.2% next year. Sales of new homes are expected to fall 17.7% this year and rise 1.4% next year.
- Total spending on residential construction is expected to fall 14.2% this year and rise 1% next year.
- The median sales price of an existing home is expected to fall 1.4% this year and rise 1.8% next year. The median sales price of a new home is expected to fall 2.6% this year and rise 2.2% next year.
The furious pace of jobs growth set in previous months slowed in June and the unemployment rate ticked up from 33 year lows.
Employment rose 2,500 in June after an upwardly revised 43,200 in May. The unemployment rate rose to 4.3% from the 33 year low of 4.2% registered in May easing pressure for a rise in interest rates.
In recent weeks there has been data suggesting that the economy whilst still powering on is taking a bit of a breather. Yesterday business confidence while still at historic highs came back 1 point on the NAB monthly business survey. Also yesterday total lending rose a modest 0.9% rebounding from the 10.6% slump in April.
Add to that the latest soft retail sales and housing numbers, lower consumer sentiment with the prospect of higher petrol prices and you have more reason for the RBA to remain on the sidelines for the rest of year.