On Guard for Phase II of the Storm
By Frank Barbera CMT. April 28, 2009
In keeping with our update of 4/07/09 and 4/14/09, “The Eye of the Storm” economic data is now showing clear signs of a bounce typified in today’s headlines which showed both an improvement in Consumer Sentiment and in the Housing Markets. Earlier today, the Conference Board announced that its survey for Consumer Confidence experienced its fourth largest monthly gain on record moving up to a reading of 39.20 in April, up from 26.90 in March. Within the sub-components, the Present Situation Index (which always lags a bit at turns) improved to a reading of 23.70, up from 21.90, while the leading Forward Expectations Gauge soared, gaining 19.30 index points to end at 49.50, up from 30.20. For the Forward Expectations Gauge, the 19 point advance in April was the third largest advance in history and comparable to the kind of sharp bounce seen in March of 1991. Back then, the overall Confidence Index bounced for another month or two and then began to reverse to new lows by early 1992 that ultimately represented the final recessionary lows of the 1990 Gulf War contraction which was a mild recession.
Above: the Headline Consumer Confidence figure (top clip) and the Forward Expectations Gauge (lower clip).
In addition to the improvement in Forward Expectations, the Conference Board also reported that its poll on Business Conditions over the Next Six Months getting WORSE fell to 25.30, down from 37.8, while those expecting Business Conditions over the Next Six Months to get Better improved to 15.60%, up from 9.60% in March. “Jobs Hard to Get” declined to 33.60% from 41.60, while Jobs Plentiful increased to 13.90% from 7.30% leading some economists to explain that perhaps the ‘worst is all behind us.”
In the Housing Sector, the Case Shilling 20 Major Cities Index fell 2.20% in February slowing the pace of decline from its record 2.80% rate in January, and according to S&P economist David Blitzer, showed “some deceleration in the rate of decline.” Indeed, if we look back at the action of the NAHB/Wells Fargo Housing Market Index (HDI), one of its sub-components, “Builder Expectations for the Next Six Months” showed a 10-point surge in April, which was one of the larger gains in that indicator’s 24 year history.
Above: the HDI Component-Builder Expectations for the Next Six Months, surged in April.
Thus, there is no surprise that with the stock market at least temporarily on the mend, that the crowd psychology has begun to improve with some leading economic gauges showing material upticks. Unfortunately, the economic ‘rebound(?)’ of the next few months will very likely plant and water the seeds of its own self-destruction, which in turn could quickly lead the global economy into the next, much deeper level of economic collapse. How could this be so? The answer lies in understanding the pendulum nature of crowd psychology. When crowd psychology reaches a negative extreme, it is the norm for psychology to mean revert. This is “the pause” in the underlying trend. This ‘mean revert’ pause produces the “eye of the storm.” Yet, IF there is no solid foundation for the underlying bounce, then like a shanty house in a hurricane, everything gets blown apart.
In an economic hurricane, just like the real deal, the high winds and waves show no mercy to those unprepared. In this case, we look at the Housing market and we begin with the knowledge that looking ahead at 2010 and 2011 there is still another ‘mountain’ left to climb in the chart showing mortgage resets. That’s right, the schedule ahead begins to rise steadily during the second half of 2009 and beyond. Notice also that the first half of 2009 shows a healthy dip, which is presently aiding and abetting the current reprieve. Yet, the current dip is transitory and much higher waves will follow, as in recent months, there has been another tidal surge in New Loan Defaults. In fact, the tenor of defaults has been spreading ever upward into the ‘high end’ with New Loan Defaults surging past 50,000 in March for the first time. In the world of Real Estate, New Loan Defaults are a reliable leading gauge for forthcoming Foreclosures, which actually lag the market by several months. While the creation of TARP along with last year's GSE Moratorium helped stem temporarily the tidal wave of foreclosures, this only bought us a brief window in time, the window in time which has been unfolding over the last few weeks. Going forward, the odds are very high that banks will once again be facing truly severe conditions during the second half of 2009 and beyond. At that time, those banks whose capital is currently in question, may be stress tested beyond their ability to endure, and an even more dramatic banking crisis may unfold.
Source: the Calculated Risk Blog
In fact, one of the worst side effects of the recent up-tick in economic data, and any continued up-tick in economic data in the months ahead, may be the reversal in the secular down trend in interest rates, especially long-term rates. This is truly a source of major concern and should be a terrifying specter to one and all. The US is now potentially facing a debilitating ‘funding crisis,’ possibly one of epic proportions. In this transition phase into greater crisis, (i.e. the second half of the Hurricane), stronger economic data (perceptually improving economic figures) are at the moment hastening an uptrend in 10 Year Bond Yields. Such transitions in market cycles always take a fair amount of time, but this one seems to be moving along at a relatively rapid pace. Once a trend change has been completed, more rapid movement is possible.
To this end, picture this: More resets hitting the housing market in 2010, 2011, against a new backdrop of rising (not falling) long term rates, which in turn ushers in a new period of sequentially less and less affordability. As long-term rates back up, so too will long term mortgage rates. The recent period of low mortgage rates, and a mini REFI boom has thus far, not stimulated final demand one bit. Instead, the lower costs saved by consumer on REFI’s for this ‘go round’ are being used instead to build up cash reserves and savings. This is taking place as part of an all out effort to de-lever personal balance sheets. With credit markets still massively impaired and not lending, there has been no cash-out REFI effect, which in the past put fresh spending power back into consumer pockets. What’s more, on the international flow of funds front, the last two government .tik reports have shown a marked decrease in foreign participation. Net outflows are now a new and serious risk. To fill in this void, the Federal Reserve has stepped in as creditor of last resort using its power to monetize debt as the ‘stop-gap’ bridge to fill in the void left by now receding foreign funding. In the next phases of the uptrend in yields, the lack of foreign funding and a tighter focus on the absence of foreign funding will likely cause upside acceleration in the cost of funds. In my view, long term rates and eventually short term rates will move aggressively back up across their twenty year range and score nominal new all time highs in the years directly ahead. 15% Mortgage rates are on the way and with every step higher, home prices will ratchet lower and lower. For those who expect inflation to produce a Real Estate boom, it will, but not in residential or commercial real estate; instead, the real estate boom will be in undeveloped mineral properties and will benefit those operating in the natural resource industries.
In my view, the spike in rates will be something to behold as the entire maturity spectrum will likely shift up with short-term rates lagging long-term rates well into the cycle as the Fed repeats 2001, and suicidally attempts to hold down short-term rates. In this case, with a slew of future foreclosures and defaults coming from both Residential and now Commercial Real Estate, the upcoming wave of bank and credit market losses will rapidly drown out any profit earning mechanisms the banks may derive from Fed engineered carry-trades with banks trying to re-liquify balance sheets on the Government Carry Trade, spreading short term rates against long term rates.
Above: A move above 3.00% and especially above 3.30% would be a negative turn in interest rate markets, a bull market in yields, and a bear market in bond prices. This could unleash another wave of selling pressure on the already besieged US Housing market where the real bottom may be nowhere in sight.
What’s more, we strongly suspect that the carry trade window for banks in this cycle will be severely limited as the passage of time will undoubtedly reveal a huge funding gap and a chronic withdrawal of foreign capital. Foreigners blame Western Finance for the current tale of woe and are now likely pre-programmed toward efforts ‘for escape.’ For China, this means fighting a fictitious war or words on the subject of Global Monetary Reform while quietly utilizing its high cards as primary creditor to divest and diversify its large pile of dollar reserves. A distribution process akin to a merchandising scheme, China has plenty of forward-looking vision and understands that as the key member of a creditors cartel, it has total control over the timing of a currency crisis. It will happen when China is damn good and ready, and bet on it, not a moment before.
“China calls for reform of global monetary system”
“China called Sunday for reform of the global currency system, dominated by the dollar, which it said is the root cause of the global financial crisis. We should attach great importance to reform of the international monetary system," Chinese Vice Finance Minister Li Yong told the spring IMF/World Bank Development Committee meeting in Washington. A "flawed international monetary system is the institutional root cause of the crisis and a major defect in the current international economic governance structure," Li said, according to a statement. Source: The Australian
“CHINA has revealed it bought 454 tonnes of gold in the past six years as its foreign-exchange reserves surged, bringing its total holding of the precious metal to $US31 billion.”
In China's first update of gold stocks since 2003, Hu Xiaolian, head of the state administration of foreign exchange, said the country's bullion stockpiles had grown from 600 tonnes to 1054 tonnes, giving it the world's sixth-biggest holdings. The news is a positive sign for the prospects of gold, which is forecast to be Australia's third-biggest export earner next year, and confirms expectations China was boosting its stockpiles. Announcement of China's bullion six-year buying spree helped push New York gold futures $US7.70 higher on Friday night, to a three-week high of $US913.60, on speculation purchases would continue. "Central bank buying, not selling that we've been used to, must be considered as an additional stimulus on demand and prices," China has the world's largest foreign exchange reserves, at $US1.95 trillion, with gold now representing 1.6 per cent of that. Chinese Premier Wen Jiabao has expressed concern that a weak US dollar might erode the value of China's $US744 billion of US government bonds. Source: BreitBart.com
That said, none of this precludes a slow ramp up phase measured by two to three years of steadily rising long-term rates for Western Nations, and steadily declining currency values. In the longer range, a rising Yuan will be an invaluable asset for China, holding down price inflation as the value of much of the world's resources appreciates in the decade ahead. For now, while we are mildly impressed at the rebound in China’s stock market, we will be more confident that China see’s steady growth ahead once the Yuan is allowed to move to new highs (outside the current range) something that has NOT taken place over the last few months. For now, strident YTD stock market gains aside, China’s government is still running with ‘shields up’ and ‘in defense’ mode with regard to calling an end to the current economic contraction.
Above: the Chinese Yuan being slowly allowed to appreciate. So far, it remains in the same range for the last several months.
Based on the current set of severe overbought readings in the US Commercial REIT sector, they may be spot on, and the high waves and dark clouds of Phase II may be arriving sooner than most of us would think.
Above: the US Commercial REIT Index with GST Medium Term ARMS Index, low readings are very overbought and can indicate tops, while high readings indicate fear and often accompany important bottoms.
That’s all for now,
© 2009 Frank Barbera