Torpedoed by Sub-Prime -- Again
By Frank Barbera CMT. March 13, 2007
“2007 is going to suck, all 12 months of it,” said CEO of D.R. Horton, the nation's largest homebuilder, Don Tomnitz at the companies March 7th conference call. Criticized for bluntly speaking his mind, the rather extreme verbiage coming from a top drawer CEO underscores the outlook ahead with Tomnitz really telling it like it is. While his wording may offend more sensitive ears, the content of his message is at least honest, and probably on the mark -- a far better outcome than the seemingly endless industry lying, deceit, and cover-ups that has led so many in the falling housing market, proclaiming a bottom, and the “worst is probably” over at virtually every turn. Few industries have a lock on more disingenuous behavior than the homebuilders and realty crowd who “somehow’ manage to consistently find the world's most blindly optimistic economists, (i.e. shills). So much so, even the guys on Wall Street blush. After all, we are now treated to the admission by New Century Financial — the nation's #2 Sub-Prime Lender -- that they made an “inadvertent error” on the magnitude of $500 Million Dollars? -- only 500 Million! -- Hello? Nope, nothing but honesty, and good intentions there…
From CBS MarketWatch Today
“NEW YORK (MarketWatch) -- New Century Financial Corp. shares were delisted Tuesday as the company provided updates on criminal probes and disclosed a $500 million error over debt obligations as it approaches an expected bankruptcy filing. The New York Stock Exchange said New Century's common stock and preferred securities "are no longer suitable for continued listing on the NYSE" just one day after the Big Board halted trading of the stock and Wall Street signaled a looming bankruptcy filing for the lender. The company, whose credit problems have erased nearly $3 billion in market cap in a matter of weeks, said it received a grand-jury subpoena for documents in a previously disclosed investigation by the U.S. Attorney's Office for the Central District of California, as well as formal notice of a preliminary Securities and Exchange Commission probe. New Century also said in a filing to regulators that its obligations to Credit Suisse First Boston Mortgage Capital were $1.4 billion, not $900 million as it previously reported. New Century called it an inadvertent error.”
And of course, we also saw the major headlines coming from Accredited Home (LEND) where a liquidity crisis is taking shape.
From CBS MarketWatch Today
“Accredited Home after said it's seeking more capital and exploring strategic options after paying about $190 million in margin calls since Jan. 1. The mortgage company, which operates in the troubled subprime loan category, said it plans to seek additional capital. Accredited Home is also seeking waivers and extensions of certain financial and operating covenants under its credit facilities. Keefe Bruyette & Woods on Tuesday downgraded Accredited home to underperform from market perform and slashed its price target to $7 a share from $26 previously. "Based on our new significantly lower volume and margin assumptions, we estimate that LEND will lose money for the foreseeable future which will likely trigger a liquidity crisis," KBW said in a note to clients”
Of course, it is this writer's continued view that we are a long, long way from any type of important cyclical economic low, either for the broad economy which is weakening, or for the real estate/housing market which is in a serious recession. Just look at the latest information regarding the number of Homes For Sale that are Vacant. Going back to 1955, the US Vacancy Rate has never seen this type of dramatic surge. One year ago, the number of vacant homes waiting to be sold stood at a total of 1.57 million homes.
Today, the number of vacant homes waiting to be sold has surged by 34% to a total of 2.10 million homes, by far the most rapid increase ever recorded. As a result, the US Vacancy Rate for owned units has jumped to a record 2.70%, up from 2.00% a year earlier, which is now virtually double the long term average of 1.40% for the vacancy rate. From 1955 to 2005, the vacancy rate had never been above 2.00%, highlighting another element of just what kind of boom/bust dynamics are now potentially at work in the present cycle.
In addition, with more than one million housing units of excess supply, there is strong evidence for the case that Housing Starts, already down 18% in the last 12 months, to a seasonally adjusted rate of 1.64 million, will need to fall considerably further before any type of important bottom is seen. In the past, soaring vacancy rates have been a fairly good leading indicator for additional downside pressure on Housing Starts. In the next chart, we plot the 12 month Rate of Change for the US Vacancy Rate using an inverted scale and overlaid against the graph of US Housing Starts. Notice that surging vacancies tend to be a leading directional gauge for more weakness ahead in the Housing sector. In addition, as time passes and inventories continue to build, odds are high that homeowners will soon begin offering these properties for rent, which will put downside pressure on rents as the supply of new rentals hitting the market increases.
In a separate report out today, the Mortgage Bankers Association noted that late mortgage payments shot up to a 3 ½ year high in the final quarter of last year, with new foreclosures surging to a record high as borrowers with tarnished credit histories have had trouble keeping up their monthly payments. According to the MBA, “Home loan delinquency rates showed an increase for a fourth straight quarter as sub-prime defaults rippled through the real estate market. Past-due payments on 43 million loans tracked by the survey have climbed with about 4.6 percent of mortgage holders now at least 30 days late. “This includes about 2.4 percent of prime borrowers and 12.6 percent of subprime customers with poor or limited credit histories” noted Nicolas Retsinas, director of Housing Studies at Harvard University at Cambridge, Massachussetts. "The delinquencies and defaults have started to soar -- a lot of these lenders started to make loans and lost track of some of the fundamentals.'' Separately, Grant Bailey, analyst at Fitch Ratings noted that "with delinquencies going up, the rate of the increase doesn't appear to have slowed down,'' and that delinquencies on subprime loans have doubled in the past 12 months. According to Bailey, “If you graph that, it's a pretty steep line”.
On the positive side of the ledger, the weakness in Housing and in the Sub-Prime Mortgage sector in particular, will very likely force cyclical pressures on the inflation front to peak in the months ahead -- if they have not peaked already. This in turn could pave the way for the Federal Reserve to begin lowering short term rates. In a report out earlier today, the Commerce Department announced that February Retail Sales rose just .1% in February, with many would-be shoppers held back from the country's shopping malls by poor weather. Yet, even allowing for the fact that February was a very cold month, the trend for Retail Sales over the last few months has been unmistakably down, with today’s report showing some stand out weakness in home furnishing down 1.70%, the most since August 2004, and a 1.2% drop in sales at bars and restaurants, the largest decline there since September 2003. Clothing store sales were also quite weak, down 1.80% with sales at sporting goods, hobby, book and music stores down .8%. Over the balance of the last 18 months, the smoothed, annualized rate of change for Retail Sales has been in a marked downtrend, which as Chris Puplava pointed out in his 2/28/07 article entitled “Transportation & Other Economic Data Point Towards Continued Economic Weakness Ahead” could be pointing the way toward the beginning of a Fed Easing Cycle. This dovetails very closely with the message from the Fed Yield Curve Indicator which has been inverted now for a number of months. In the past, an Inverted Yield Curve has had an excellent long-term track record at foreshadowing recessions/economic slow downs leading both Retail Sales and GDP lower, usually, by several months.
In addition to the softness in Retail Sales, I would also point out that the recent trends in hiring have also had a distinct downside bias. Yes, the government numbers have been weakening, but the reliability of these figures seems to be increasingly at odds with more pronounced trends seen in the data from private sector sources such as ADP. In their most recent report, from Wednesday, March 7th, ADP noted only a modest gain in the number of new jobs created, at 57,000 in February down from 121,000 new jobs in January. In its 2007 Economic Survey, the Cleveland Fed noted that ADP’s meager February job gains of just 57,000 represented the smallest increase in ADP’s total non-farm private employment survey seen since July 2003. What’s more, both goods producing and manufacturing sectors shed jobs losing 43,000 and 29,000 respectively, Remember that these are from actual adjustments that companies make to their real world payrolls as phoned in to ADP. There is no ARIMA ‘Birth-Death Model’ (i.e. guesswork-extrapolation contrivance) under-pinning this data, and for my money, this reinforces the trend toward a soft/recessionary economy seen in the Retail Sales data.
So what’s the Bottom Line for the economy and the markets? In my view, the economy is most likely facing a serious slowdown as 2007 continues to unfold, with weakness in the Housing sector likely weighting on consumer spending and consumer psychology. This cycle could very well be different from prior cycles as in the past, a reversal in Fed policy could carry the day, and put an effective floor underneath an economic decline. Unfortunately, in today’s reality, with a huge current account deficit, any economic slowdown in the US will likely trigger radical alterations in the path of capital flows within this now globalized economy. More specifically, it is the current ‘positive carry’ found in the absolute value of high US short-term rates that is presently putting an effective floor underneath the US Dollar.
Were the Fed forced to cut short term rates aggressively in order to stabilize housing, the equal and opposite affect would most likely be the resumption of the US Dollar Currency Bear, and a bullish outcome for Precious Metals, especially Gold. Thus, we reside on a global ‘teeter-totter,’ one with the most ‘epic’ proportions, where the Fed can save Housing or save the Dollar, but for all intents and purposes, they cannot save both. In the months ahead, the Fed is very likely to choose, or quickly become irrelevant, and that is a frightening proposition for all to contemplate.
In the near term, markets do not move in a straight line, and the path ahead, even if it is destined to lead into the renewal of a larger secular bear market, will be punctuated with many sharp rallies. In the current time frame, the stock market remains significantly oversold and while very scary, today’s decline packed less punch than its immediate successors seen in prior weeks. The overall configuration for the S&P and its key sub-sectors including Finance and Brokerage, show this setback unfolding against the larger backdrop of a rising 20 week moving average and rising lower 20 week (100 day trading bands). Against this backdrop, a medium term low of some degree should form with prices rising in coming days to establish a “failing” right shoulder high. The momentary relief of a stock market rally says nothing about larger problems, and is the reflex action of crowd psychology gone a few steps ‘too far’ right out of the gate. In the case of the S&P 500, the 20 week or 100 day lower band closed today at a reading of 1360.50, and that area should be major support if tested tomorrow. On the momentum side, the 14 day RSI is NOT making new lows, and most likely will not make new lows in the near term given that prices are already fiercely oversold.
While the market's larger inability to find a solid low over the last week or two hints at the most likely manner of things to come, at present, less than 5% of the stocks on the NYSE are above their 10 day moving average. Historically, whenever the market has been this oversold, prices have rebounded in short order with a typical rebound usually approximating 50% to 61.80% retracements of the prior decline. For the S&P, assuming an important low within the next day or so in the 1360 zone, a 50% retracement would see prices recover back toward the 1411 area, while a more normal 61.80% retracement would lift prices back toward the 1430 zone.
In the case of the Philly Bank Index, one of the prime drivers behind today’s vicious stock market decline, the index has now come in contact with its 100 day lower band and is also deeply oversold, with the 14 day RSI finishing today at a close of +26.23, making this cluster of readings highly consistent with the bottoming patterns seen in March 2005 and May 2004. For the Bank Index which ended today at 110.76, down 3.73 index points or 3.26%, there is support tomorrow near 109 to 109.50. Any subsequent rally could recover the bulk of recent declines with a price gap “open” above the market as high up at 118.93, the February 26th close.
For the AMEX Broker-Dealer Index, the XBD, there should be good support below the market between 219-220 with prices once again bouncing off a deeply oversold condition over the course of the days just ahead. For the XBD, a typical retracement rally would lift the index back up toward the 245 to 248 zone, the area of what had been key support which I wrote about only four weeks ago ( link). In the weeks ahead, it is now highly likely that any recovery rally in this sector will “fail” at the underside of that former support which should now reverse roles and become strong resistance.
Obviously, while we can know that the markets are heavily oversold, no one has a crystal ball, including myself. Yet, if the past is a reasonable forecaster, some type of strong, but erratic rally should soon materialize with today’s climactic sell-off in the Sub-Primes -- Accredited Home (LEND) and New Century (NEW) most likely defining a mini-panic bottom in this time period where Round One is most likely near its end. Mind you, where very short term timing is concerned, there is always an element of educated guess work, but the message from the markets now seems to be that this would be the wrong time to sell already depressed equity positions. Perhaps, instead of “Panic Now,” the correct mantra should be “Panic Later” or better yet, lighten up on strength in coming weeks and don’t panic at all.
At the close, the DJIA was down 242.66 index points to end at a reading of 12,075.96 for a loss of 1.97%, with the S&P 500 down 28.65 index points to close at 1377.95 for a loss of 2.04%. Among various sectors, the Amex Oil and Gas Index held up well, down just 1.28% to close at 1136.27, with the Philly Oil Service Index (OSX) also holding well, down just 1.23% to close at 200.85. As noted earlier, Banks and Brokers were especially hard hit, with the BKX down 3.73 to finish at 110.76, down 3.26%, and the XBD ending down 10.40 index points or 4.42% to finish at 224.70. In the near term, expect continued high volatility and hopefully, a decent sized recovery rally.
That’s all for now,
© 2007 Frank Barbera