Construction spending fell -.8% MoM (consensus -.3%) in October, matching the one year low set in July. September's figure was revised slightly lower to +.2% from +.3% originally reported.
Residential construction fell -2% MoM (-15.6% YoY) while non-residential rose +.1% MoM (+16.1% YoY). It appears that non-residential construction is no longer able to offset the weakness in the new home sector. Residential construction is expected to remain weak for the foreseeable future, until the excess inventories are worked off.
Public construction projects grew +.8% MoM, while private expenditures fell -1.4% MoM. Private non-residential spending, on hospitals, hotels, offices, etc, fell -.5% MoM, the largest decline in over a year. Over the past year, public construction spending has risen +14.6% while private spending has declined -4.9%. Within the public category, state and local spending has risen 16% YoY while federal spending has fallen -1.6% YoY. Government spending tends to be focused on things like schools, highways, and office buildings.
Friday, November 30, 2007
Personal Income and Spending Declines as Inflation Rises
Both personal income and spending growth slowed in October to +.2% MoM. Both were also below consensus expectations, with personal income expanding at half the pace of last month, and at the slowest rate in six months. Disposable income actually fell -.1% MoM.
Headline PCE inflation, the broadest measure, rose 2.9% YoY from 2.4% YoY the prior month. Core PCE, viewed as the Fed's favorite inflation indicator, has risen to 1.9% YoY. Core PCE rose +.2% MoM for the second month in a row.
Consumption was virtually unchanged, when adjusted for inflation, for the smallest increase since last March. Inflation adjusted durable good spending fell -.6% MoM, while purchases of non-durables fell a more moderate -.1% MoM. Inflation adjusted spending on services grew a modest +.1% MoM. The savings rate fell to +.5% from +.7%.
Over the past year, personal income has risen 6% and spending has risen 5.4%. Disposable income has risen +2.7% YoY, and inflation adjusted personal spending has risen 2.9% YoY.
The consumer is now facing numerous headwinds as wage and salaries (+.1% MoM) and job growth slow, the housing market deteriorates, and obtaining new credit becomes more difficult. The reality of the rising concern due to these factors appears to be reducing consumer spending. Obviously these are tough data figures for the Fed, as stimulating the economy to improve income and spending growth also has the potential to feed inflation.
Headline PCE inflation, the broadest measure, rose 2.9% YoY from 2.4% YoY the prior month. Core PCE, viewed as the Fed's favorite inflation indicator, has risen to 1.9% YoY. Core PCE rose +.2% MoM for the second month in a row.
Consumption was virtually unchanged, when adjusted for inflation, for the smallest increase since last March. Inflation adjusted durable good spending fell -.6% MoM, while purchases of non-durables fell a more moderate -.1% MoM. Inflation adjusted spending on services grew a modest +.1% MoM. The savings rate fell to +.5% from +.7%.
Over the past year, personal income has risen 6% and spending has risen 5.4%. Disposable income has risen +2.7% YoY, and inflation adjusted personal spending has risen 2.9% YoY.
The consumer is now facing numerous headwinds as wage and salaries (+.1% MoM) and job growth slow, the housing market deteriorates, and obtaining new credit becomes more difficult. The reality of the rising concern due to these factors appears to be reducing consumer spending. Obviously these are tough data figures for the Fed, as stimulating the economy to improve income and spending growth also has the potential to feed inflation.
Thursday, November 29, 2007
HOUSE PRICES WEAKEN FURTHER IN MOST RECENT QUARTER
Contact:
Corinne Russell
(202) 414-6921
Stefanie Mullin
(202) 414-6376
For Immediate Release November 29, 2007
HOUSE PRICES WEAKEN FURTHER IN MOST RECENT QUARTER
First Quarterly Price Decline for U.S. since 1994
Washington , DC – For the first time in nearly thirteen years, U.S. home prices experienced a quarterly decline. The OFHEO House Price Index (HPI), which is based on data from sales and refinance transactions, was 0.4 percent lower in the third quarter than in the second quarter of 2007. This is similar to the quarterly decline of 0.3 percent (seasonally-adjusted) shown in the purchase-only index. The annual price change, comparing the third quarter of 2007 to the same period last year showed an increase of 1.8 percent , the lowest four-quarter increase since 1995. OFHEO’s purchase-only index, which is based solely on purchase price data, indicates the same rate of appreciation over the last year.
The figures were released today by OFHEO Director James B. Lockhart, as part of the quarterly report analyzing housing price appreciation trends.
“While select markets still maintain robust rates of appreciation, our newest data show price weakening in a very significant portion of the country,” said Lockhart. “Indeed, in the third quarter, more than 20 states experienced price declines and, in some cases, those declines are substantial.”
Many of the cities and states experiencing the sharpest declines this quarter were the same cities and states experiencing the sharpest increases just a couple of years ago, suggesting some price corrections in those markets.
Nationally, house prices grew at the same rate over the past year as did prices of non-housing goods and services reflected in the Consumer Price Index. House prices and prices of other goods and services both rose 1.8 percent.
“Rising inventories of for-sale properties are clearly having a material impact on home prices,” said OFHEO Chief Economist Patrick Lawler. “Until those inventories shrink, that will be a great source of resistance to price increases.”
It should be noted that the annual growth rate of 1.8 percent is significantly different from other indexes, which are showing depreciation. The OFHEO index weights sales prices differently than other measures, incorporates data from a wider geographic area, and is focused on homes with conventional, conforming loans. A more thorough discussion of differences can be found in “ A Note on the Differences between the OFHEO and the S&P/Case-Shiller House Price Indexes .”
Significant HPI Findings:
Highest and Lowest Appreciation :
1. Ten states saw price declines over the latest four quarters, the greatest number of declines since the 1996-97 period. Twenty-one states saw price declines in the latest quarter.
2. The states with the greatest rates of appreciation between the third quarter of 2006 and the third quarter of 2007 were: Utah (12.9%), Wyoming (11.8%), Montana (7.7%), New Mexico (7.4%), and Washington (7.0%). The states with the largest depreciation for the same period were: Michigan (-3.7%), California (-3.6%), Nevada (-2.4%), Massachusetts (-2.3%), and Rhode Island (-2.2%).
3. For the third consecutive quarter, Wenatchee, Washington exhibited the highest four-quarter appreciation among the 287 Metropolitan Statistical Areas (MSAs) on OFHEO’s list of “ranked” cities. Annual appreciation in Wenatchee was 15.7 percent.
4. Other MSAs with the greatest appreciation between the third quarter of 2006 and the third quarter of 2007 were: Provo-Orem, Utah (14.4%), Grand Junction, Colorado (14.1%) and Ogden-Clearfield, Utah (14.0%). The MSAs with the largest depreciation for the same period were: Merced, California (-13.0%), Punta Gorda, Florida (-11.8%) and Santa Barbara-Santa Maria-Goleta, CA (-11.6%).
State and MSA appreciation rates can be found on pages 18-19 and 31-52.
Other Notable Results :
1. Of the 287 cities on OFHEO’s list of “ranked” MSAs, 204 had positive four-quarter appreciation and 83 had price declines.
2. Seventeen of the 20 cities having the most depreciation were in Florida and California. The other three were in Michigan.
3. For the fifth consecutive quarter, Utah’s four-quarter appreciation rate exceeded rates in all other states. At 12.9 percent, price appreciation in Utah was more than a percentage point higher than the four-quarter appreciation in Wyoming—the state with the second highest rate.
4. Twenty-four of the 26 California cities on the ranked list experienced price declines between the third quarter of 2006 and the third quarter of 2007. Thirteen of the 24 evidenced price declines of 5 percent or more.
Purchase-Only Index
An index using only purchase price data indicates the same price appreciation for the U.S. over the latest four-quarters as the standard, all-transactions index. Both indexes estimated 1.8 percent price appreciation between the third quarter of 2006 and the third quarter of 2007. The purchase-only index fell 0.3 percent (seasonally-adjusted) between the second quarter of 2007 and the third quarter of 2007, compared with a 0.4 percent price decline for the HPI. The difference between the two price measures may reflect differences in the types of homes refinanced versus those purchased valuations or different proportions of appraisal and sales price data.
For specific Census Divisions and states, the all-transactions and purchase-only indexes sometimes estimate significantly different price changes. This quarter’s purchase-only indexes estimate particularly sharp price declines in states with the weakest housing markets, including California (7.2 percent four-quarter price decline) and Michigan (7.1 percent four-quarter price decline). A short comparison of the purchase-only and all-transactions indexes can be found in the first part of the “Highlights” section on pages 8-10.
Highlights
This period’s HPI release also includes an analysis of the relationship between home prices and foreclosure activity. The article, which can be found on pages 11-17, discusses how the two are related and compares appreciation rates for high and low foreclosure areas.
Background
OFHEO’s House Price Index is published on a quarterly basis and tracks average house price changes in repeat sales or refinancings of the same single-family properties. OFHEO’s index is based on analysis of data obtained from Fannie Mae and Freddie Mac from more than 33 million repeat transactions over the past 32 years. The more limited “purchase-only” index is based on more than five million transactions.
OFHEO analyzes the combined mortgage records of Fannie Mae and Freddie Mac, which form the nation’s largest database of conventional, conforming mortgages. The conforming loan limit for mortgages purchased in 2006 and 2007 is $417,000.
This HPI report contains four tables: 1) A ranking of the 50 States and Washington, D.C. by House Price Appreciation; 2) Percentage Changes in House Price Appreciation by Census Division; 3) A ranking of 287 MSAs and Metropolitan Divisions by House Price Appreciation; and 4) A list of one-year and five-year House Price Appreciation rates for MSAs not ranked.
OFHEO’s full PDF of report is at: www.ofheo.gov/media/pdf/3q07hpi.pdf . Also, be sure to visit www.ofheo.gov to use the OFHEO House Price calculator. Please e-mail ofheoinquiries@ofheo.gov for a printed copy of the report. The next HPI report will be posted February 26, 2008.
###
OFHEO's mission is to promote housing and a strong national housing finance system by ensuring the safety and soundness of Fannie Mae and Freddie Mac.
Corinne Russell
(202) 414-6921
Stefanie Mullin
(202) 414-6376
For Immediate Release November 29, 2007
HOUSE PRICES WEAKEN FURTHER IN MOST RECENT QUARTER
First Quarterly Price Decline for U.S. since 1994
Washington , DC – For the first time in nearly thirteen years, U.S. home prices experienced a quarterly decline. The OFHEO House Price Index (HPI), which is based on data from sales and refinance transactions, was 0.4 percent lower in the third quarter than in the second quarter of 2007. This is similar to the quarterly decline of 0.3 percent (seasonally-adjusted) shown in the purchase-only index. The annual price change, comparing the third quarter of 2007 to the same period last year showed an increase of 1.8 percent , the lowest four-quarter increase since 1995. OFHEO’s purchase-only index, which is based solely on purchase price data, indicates the same rate of appreciation over the last year.
The figures were released today by OFHEO Director James B. Lockhart, as part of the quarterly report analyzing housing price appreciation trends.
“While select markets still maintain robust rates of appreciation, our newest data show price weakening in a very significant portion of the country,” said Lockhart. “Indeed, in the third quarter, more than 20 states experienced price declines and, in some cases, those declines are substantial.”
Many of the cities and states experiencing the sharpest declines this quarter were the same cities and states experiencing the sharpest increases just a couple of years ago, suggesting some price corrections in those markets.
Nationally, house prices grew at the same rate over the past year as did prices of non-housing goods and services reflected in the Consumer Price Index. House prices and prices of other goods and services both rose 1.8 percent.
“Rising inventories of for-sale properties are clearly having a material impact on home prices,” said OFHEO Chief Economist Patrick Lawler. “Until those inventories shrink, that will be a great source of resistance to price increases.”
It should be noted that the annual growth rate of 1.8 percent is significantly different from other indexes, which are showing depreciation. The OFHEO index weights sales prices differently than other measures, incorporates data from a wider geographic area, and is focused on homes with conventional, conforming loans. A more thorough discussion of differences can be found in “ A Note on the Differences between the OFHEO and the S&P/Case-Shiller House Price Indexes .”
Significant HPI Findings:
Highest and Lowest Appreciation :
1. Ten states saw price declines over the latest four quarters, the greatest number of declines since the 1996-97 period. Twenty-one states saw price declines in the latest quarter.
2. The states with the greatest rates of appreciation between the third quarter of 2006 and the third quarter of 2007 were: Utah (12.9%), Wyoming (11.8%), Montana (7.7%), New Mexico (7.4%), and Washington (7.0%). The states with the largest depreciation for the same period were: Michigan (-3.7%), California (-3.6%), Nevada (-2.4%), Massachusetts (-2.3%), and Rhode Island (-2.2%).
3. For the third consecutive quarter, Wenatchee, Washington exhibited the highest four-quarter appreciation among the 287 Metropolitan Statistical Areas (MSAs) on OFHEO’s list of “ranked” cities. Annual appreciation in Wenatchee was 15.7 percent.
4. Other MSAs with the greatest appreciation between the third quarter of 2006 and the third quarter of 2007 were: Provo-Orem, Utah (14.4%), Grand Junction, Colorado (14.1%) and Ogden-Clearfield, Utah (14.0%). The MSAs with the largest depreciation for the same period were: Merced, California (-13.0%), Punta Gorda, Florida (-11.8%) and Santa Barbara-Santa Maria-Goleta, CA (-11.6%).
State and MSA appreciation rates can be found on pages 18-19 and 31-52.
Other Notable Results :
1. Of the 287 cities on OFHEO’s list of “ranked” MSAs, 204 had positive four-quarter appreciation and 83 had price declines.
2. Seventeen of the 20 cities having the most depreciation were in Florida and California. The other three were in Michigan.
3. For the fifth consecutive quarter, Utah’s four-quarter appreciation rate exceeded rates in all other states. At 12.9 percent, price appreciation in Utah was more than a percentage point higher than the four-quarter appreciation in Wyoming—the state with the second highest rate.
4. Twenty-four of the 26 California cities on the ranked list experienced price declines between the third quarter of 2006 and the third quarter of 2007. Thirteen of the 24 evidenced price declines of 5 percent or more.
Purchase-Only Index
An index using only purchase price data indicates the same price appreciation for the U.S. over the latest four-quarters as the standard, all-transactions index. Both indexes estimated 1.8 percent price appreciation between the third quarter of 2006 and the third quarter of 2007. The purchase-only index fell 0.3 percent (seasonally-adjusted) between the second quarter of 2007 and the third quarter of 2007, compared with a 0.4 percent price decline for the HPI. The difference between the two price measures may reflect differences in the types of homes refinanced versus those purchased valuations or different proportions of appraisal and sales price data.
For specific Census Divisions and states, the all-transactions and purchase-only indexes sometimes estimate significantly different price changes. This quarter’s purchase-only indexes estimate particularly sharp price declines in states with the weakest housing markets, including California (7.2 percent four-quarter price decline) and Michigan (7.1 percent four-quarter price decline). A short comparison of the purchase-only and all-transactions indexes can be found in the first part of the “Highlights” section on pages 8-10.
Highlights
This period’s HPI release also includes an analysis of the relationship between home prices and foreclosure activity. The article, which can be found on pages 11-17, discusses how the two are related and compares appreciation rates for high and low foreclosure areas.
Background
OFHEO’s House Price Index is published on a quarterly basis and tracks average house price changes in repeat sales or refinancings of the same single-family properties. OFHEO’s index is based on analysis of data obtained from Fannie Mae and Freddie Mac from more than 33 million repeat transactions over the past 32 years. The more limited “purchase-only” index is based on more than five million transactions.
OFHEO analyzes the combined mortgage records of Fannie Mae and Freddie Mac, which form the nation’s largest database of conventional, conforming mortgages. The conforming loan limit for mortgages purchased in 2006 and 2007 is $417,000.
This HPI report contains four tables: 1) A ranking of the 50 States and Washington, D.C. by House Price Appreciation; 2) Percentage Changes in House Price Appreciation by Census Division; 3) A ranking of 287 MSAs and Metropolitan Divisions by House Price Appreciation; and 4) A list of one-year and five-year House Price Appreciation rates for MSAs not ranked.
OFHEO’s full PDF of report is at: www.ofheo.gov/media/pdf/3q07hpi.pdf . Also, be sure to visit www.ofheo.gov to use the OFHEO House Price calculator. Please e-mail ofheoinquiries@ofheo.gov for a printed copy of the report. The next HPI report will be posted February 26, 2008.
###
OFHEO's mission is to promote housing and a strong national housing finance system by ensuring the safety and soundness of Fannie Mae and Freddie Mac.
Dramatic Drop in New Home Sales as Prices Plummet
September new home sales were revised substantially lower, from 770k to 716k. New home sales in October were expected to decline to 750k, but actually fell to 728k. But because of the dramatic revisions lower in September, the October sales pace actually indicates a rebound of +1.7% MoM versus the original estimate of a decline of -2.6% MoM. Net, new home sales have fallen more dramatically over the past two months than originally forecast. The drop to a 716k annual pace in September represents a 12 year low in sales. New home sales have fallen 24% YoY.
The median price of a new home dropped 13%, the largest decline since 1970, to $217k. This level compares with a median price of existing home prices announced yesterday of $207k, which represented a 5.1% YoY decline in value. It is important to point out that these house prices are not directly comparable month to month because the mix of homes and regional sales changes monthly, which makes these data of questionable value versus a more rigourus survey such as the Case-Shiller index which compares repeat sales of the same homes.
The actual inventory of new homes for sale fell 2.3% to 516k homes. This indicates a supply of 8.5 months of homes at the current sales pace, down from 9 months in September. Only the West saw a drop in new home sales in October (-16% MoM), while the Midwest saw an increase of +14% MoM, and the South rose +6.8% MoM and the Northeast lagged at +1.8% MoM. The four month decline in inventories is a positive sign, as it indicates that builders are reducing new supply to reduce the inventory overhange. This is one of the first steps required to get supply and demand back in balance, along with house price declines. Most economists are now look for a total national peak to trough decline in house prices of around 10-15%.
As Fed Vice Chairman Kohn said yesterday, "The housing sector has continued to decline and erode at a very, very rapid rate..." Most economists are looking for further declines in sales and house prices to eliminate the excess inventories. This will become harder to accomplish as the credit crunch continues, and lending standards remain tight. New home sales are considered to be one of the more timely indicators of home buying interest than exisiting home sales, but only account for about 15% of total home purchases. Residential construction has been contracting since early 2006.
The median price of a new home dropped 13%, the largest decline since 1970, to $217k. This level compares with a median price of existing home prices announced yesterday of $207k, which represented a 5.1% YoY decline in value. It is important to point out that these house prices are not directly comparable month to month because the mix of homes and regional sales changes monthly, which makes these data of questionable value versus a more rigourus survey such as the Case-Shiller index which compares repeat sales of the same homes.
The actual inventory of new homes for sale fell 2.3% to 516k homes. This indicates a supply of 8.5 months of homes at the current sales pace, down from 9 months in September. Only the West saw a drop in new home sales in October (-16% MoM), while the Midwest saw an increase of +14% MoM, and the South rose +6.8% MoM and the Northeast lagged at +1.8% MoM. The four month decline in inventories is a positive sign, as it indicates that builders are reducing new supply to reduce the inventory overhange. This is one of the first steps required to get supply and demand back in balance, along with house price declines. Most economists are now look for a total national peak to trough decline in house prices of around 10-15%.
As Fed Vice Chairman Kohn said yesterday, "The housing sector has continued to decline and erode at a very, very rapid rate..." Most economists are looking for further declines in sales and house prices to eliminate the excess inventories. This will become harder to accomplish as the credit crunch continues, and lending standards remain tight. New home sales are considered to be one of the more timely indicators of home buying interest than exisiting home sales, but only account for about 15% of total home purchases. Residential construction has been contracting since early 2006.
3rd Qtr GDP Update Basically As Expected
Third quarter preliminary real GDP was revised up to +4.9% annualized from the original estimate of 3.9% annualized, as better quality data is obtained. This is the fastest quarterly growth in four years. For comparison, real GDP rose +3.8% annualized in the second quarter of 2007. Unfortunately, the fourth quarter is currently looking to see real GDP growth fall to below 1% annualized (a five year low). The real GDP figure represents the total output of goods and services of the US economy after adjusting for rising inflation. Year-over-year real GDP growth is running at 2.4% compared to 3.2% in the same quarter a year ago.
Factors which revised GDP higher were increasing exports (total +19%, goods only +26%) and rising inventories, as well as rising government expenditures at both the federal and state and local levels (defense +10%). Residential fixed investment (-20%) remains a significant detractor. Imports increased, and are recognized as a subtraction from GDP. Real imports rose 4.3% in the third quarter after falling 2.7% in the second quarter.
Though core PCE held steady at 1.8% annualized, the GDP price index rose to +.9% from +.8% previously.
Corporate profits were announced for the first time with this release for the third quarter. In the 3rd quarter profits from current production decreased by $19B after rising $95B in the 2nd quarter. Current production cash flow also went negative in the third quarter, as did taxes paid. Adjusting profits for taxes, capital expenditures and inventories, meant company profits were essentially unchanged for the quarter. Profits for financial companies were hit harder than other sectors, down 20.5% annualized. The 1.2% slide in profits from current production was the first drop since the fourth quarter of 2006. Year-on-year corporate profits growth slowed to 1.9% from 5.7%.
Another notable point was that income gains for the second quarter were revised lower from 5.3% to 3.8%. Labor income is under pressure, and may be just holding constant when adjusted for inflation, which will be a negative for consumer spending. Third quarter consumption was revised down to 2.7% from 3.0%.
Factors which revised GDP higher were increasing exports (total +19%, goods only +26%) and rising inventories, as well as rising government expenditures at both the federal and state and local levels (defense +10%). Residential fixed investment (-20%) remains a significant detractor. Imports increased, and are recognized as a subtraction from GDP. Real imports rose 4.3% in the third quarter after falling 2.7% in the second quarter.
Though core PCE held steady at 1.8% annualized, the GDP price index rose to +.9% from +.8% previously.
Corporate profits were announced for the first time with this release for the third quarter. In the 3rd quarter profits from current production decreased by $19B after rising $95B in the 2nd quarter. Current production cash flow also went negative in the third quarter, as did taxes paid. Adjusting profits for taxes, capital expenditures and inventories, meant company profits were essentially unchanged for the quarter. Profits for financial companies were hit harder than other sectors, down 20.5% annualized. The 1.2% slide in profits from current production was the first drop since the fourth quarter of 2006. Year-on-year corporate profits growth slowed to 1.9% from 5.7%.
Another notable point was that income gains for the second quarter were revised lower from 5.3% to 3.8%. Labor income is under pressure, and may be just holding constant when adjusted for inflation, which will be a negative for consumer spending. Third quarter consumption was revised down to 2.7% from 3.0%.
Initial jobless claims climb 26k last week to second highest level of 2007
Initial jobless claims spiked to 352k, the highest level since the 356k peak in February. The 52 week average is 320k, and the 4 week average has now risen to 335 - both are at six month highs.
Wednesday, November 28, 2007
Today's Tidbits
More on Existing Home Sales and Pricing Data
From JP Morgan: “…single-family home sales are down 31% from their September 2006 peak. By way of comparison, single-family home sales fell 33% peak-to-trough between December 1986 and December 1990, during the last major housing adjustment…The median price of single-family homes sold fell 6.3%oya, a record low of this series, which goes back to the late-1960s.”
From Merrill Lynch: “The steady sales rate of single-family homes was at the expense of lower prices, with the median sales price of single-family homes falling 1.4% on the month. This means prices are now down 6.3% YoY and 10.1% from their nearby peak this summer. We expect that as we approach the peak period for adjustable rate mortgage resets, the capitulation will accelerate and we look for home prices to fall another 10% in 2008.”
From LEHC: “Median sales prices can be dramatically impacted by changes in the “mix” of homes – both by size/amenities and by region. Earlier this year, the median existing home sales price had been inflated following the subprime mortgage market meltdown, which had a disproportionately large negative impact on lower-priced homes. This summer there was a “perturbation” in both the alt-A and the jumbo mortgage markets, which in some areas hit higher-end home sales in a big way, helping the median sales price “catch up” to reflect actual declines in home prices. Median sales prices are still not very reliable in gauging actual trends in home prices – especially in markets where overall sales volumes are extremely low – and economists believe that “repeat-transactions indexes” based on purchase transactions of the same properties over time (such as those produced by S&P/Case-Shiller) are better (though lagged and still imperfect) measures of home-price trends.”
Fed Vice-Chairman Kohn Softens Message – Signals Fed More Open to Easing
From JP Morgan: “Up until this morning, Fed rhetoric and market pricing of the Fed had been on a collision course. A speech by Vice-Chair Kohn in NY today helped to defuse that tension by moving the Fed closer to the market. Kohn's speech dismissed the moral hazard argument, made no real mention of inflation, and dwelled extensively on the growth risks from the increased turbulence in financial markets. Unlike recent speeches from other FOMC members, Kohn did not declare that he is already factoring in weak incoming data, nor did he discuss risks being roughly in balance. The policy debate between easing and not easing at the December 11 FOMC meeting will likely be animated, but Kohn's speech today suggest the crucial center of the committee is moving toward a 25bp ease. Kohn began his talk by discussing the moral hazard argument that monetary policy accommodation in times of financial unrest may encourage excessive risk-taking. Kohn's responded to this argument by noting that "we should not hold the economy hostage to teach a small segment of the population a lesson." If policy felt constrained by the moral hazard argument from promoting the macroeconomic goals of monetary policy, then "innocent bystanders" would pay the cost. Kohn then went on to discuss the much more central issue for policy in the current environment -- the effect of financial markets on the real economy. Here, unlike his colleagues, Kohn expressed a sensitivity to the recent re-intensification of problems in the financial markets. The relevant passage read: "the increased turbulence in recent weeks partly reversed some of the improvement in market functioning over the late part of September and in October. Should the elevated turbulence persist, it would increase the possibility of further tightening in financial conditions for households and businesses. Heightened concerns about larger losses at financial institutions now reflected in various markets have depressed equity prices and could induce intermediaries to adopt a more defensive posture in granting credit, not only for house purchases, but for other uses as well." The last topic Kohn discussed was the stresses in bank funding markets, which he attributed to a variety of factors, including counterparty risk, balance sheet risk, and worries about access to liquidity. Kohn saw year-end issues as being only "partly" to blame, suggesting he may see the problems in inter-bank markets as being a more persistent worry for the central bank. Kohn concluded by summing up his speech as one intended "to highlight some of the issues we will be looking at in financial markets as we weigh the necessity of future actions." Discussing the possibility of "future actions" may not exactly be a promise to ease, but it does re-position the Fed rhetoric to be consistent with that policy choice.”
From Bloomberg: “``The degree of deterioration that has happened over the last couple of weeks is not something that I personally anticipated,'' Kohn said in response to a question following a speech to the Council on Foreign Relations in New York. ``We are going to have to take a look at'' the stress in credit markets ``when we meet in a couple of weeks,'' he said…. Federal funds futures show traders see a 92 percent probability of a quarter-point reduction in the benchmark interest rate to 4.25 percent when the FOMC meets Dec. 11. Odds of a half-point cut rose to 8 percent after Kohn's remarks. ``We need to take account of those market expectations, but not follow them blindly,'' Kohn said in response to a question… Kohn said ``uncertainties'' about the economic outlook are ``unusually high'' now, requiring policy makers to be ``flexible and pragmatic'' in setting policy… He added that a ``broader repricing of risk'' that increases the cost of credit and discourages spending ``would require offsetting policy actions, other things being equal.''… Kohn, 65, is one of the most senior members on the Federal Open Market Committee. He was director of the Monetary Affairs Division and special adviser on monetary policy under former chairman Alan Greenspan… Kohn said labor markets remain strong, which provides an important ``pillar'' for the economy. ``On the other side, the spending data have been maybe a little on the soft side,'' Kohn said. ``There has been a noticeable slowing in the growth of consumption.'' Fed officials forecast prices will rise 1.8 to 2.1 percent next year. Kohn said inflation risks remain a priority for the committee.”
Financial Stocks Rally – Fannie Mae Has Biggest 1-Day Gain Since 1987
From CNN: “U.S. stocks staged the biggest two-day rally in four years, led by financial shares, after Federal Reserve Vice Chairman Donald Kohn reinforced expectations for another interest rate cut. Citigroup Inc., Goldman Sachs Group Inc., Lehman Brothers Holdings Inc. and Morgan Stanley rose more than 6 percent… The S&P 500 Financials Index dropped as much as 16 percent this month on concern that subprime-linked losses will sap profit growth. The gauge on Nov. 26 traded at 10.6 times earnings, the lowest since at least 1995, data compiled by Bloomberg show… Citigroup, the biggest U.S. bank, fell 38 percent from Oct. 12 to Nov. 26 and is the second-worst performer in the KBW Bank Index this quarter after Washington Mutual Inc… Freddie Mac and Fannie Mae, the biggest providers of money for U.S. home loans, were two of the three biggest gainers in the S&P 500 after Freddie Mac after the market closed yesterday said it plans to sell $6 billion in preferred stock and cut its dividend in half to shore up capital depleted by record mortgage defaults and foreclosures. Freddie Mac gained $4.72, or 18 percent, to $30.45. Fannie Mae rose $3.80, or 13 percent, its biggest gain since 1987, to
$33.20 after Morgan Stanley said the stock warrants a ``fresh look'' after falling 51 ercent from its peak.”
From Citi: “Relative banks index under performance [versus the broader S&P 500 index] has proceeded the last two recession in the US [in 1990 and 2001, and the same situation appears to be developing now].”
Fundamentals Support Stock Market Decline
From Fortune: “With the S&P down over 10% from its October record high, TV pundits and Wall Street strategists are blaming the most obvious culprits for the sudden reversal of fortune, chiefly the subprime crisis and the looming threat of a recession. But… The real reason is… Put simply, stocks are extremely expensive relative to the daunting risk in owning them. At current prices, earnings can't possibly grow fast enough to give investors the fat returns they covet. There's just one way for equities to get their lustre back -- their prices have to fall substantially so that investors can harvest attractive returns from the modest profit growth that's in the cards… What we're probably witnessing is a massive, irreversible revaluation of stocks based on fundamentals. The repricing machine is now in motion. The smart money says it won't stop, despite feints and lurches, until stocks are a bargain again, a prospect investors haven't seen in years… subprime was the catalyst, not the cause. It wasn't just a crisis that would pass, as the pundits argued, but a flashing red warning that triggered a durable shift in investor psychology. Before the credit crisis, investors took an incredibly blasé attitude toward risk. Yields on junk bonds, corporate debt, and office buildings were at all-time lows. Then subprime struck. Suddenly, investors recognized that the rates on high-risk mortgages didn't come close to reflecting the high probability that homeowners would default on their mortgages. So the prices of subprime paper plummeted. The downward pull on prices spread to all types of fixed income securities, from all types of junk bonds to LBO loans. Now, the fear of risk is spreading to equities with a vengeance. The problem with equities is that the repricing following the bubble of the late 1990s never fully played out. Stocks roared back from their 2001 lows, reaching record levels this fall. The rub is that they were, and still are, extremely expensive. The best way to measure whether stocks are giving you enough juice for the risk you're taking is examining the equity risk premium. This is the ultimate number in corporate finance, what Dartmouth economist Kenneth French calls "the holy grail" of stock investing. Let's run through some simple math. The best measure for the future return on stocks is the earnings yield, the inverse of the price-to-earnings (PE) ratio. Today, the PE, based on trailing 12 month earnings, is around 16. That's not too far above the historic average of 14. Even by that measure, stocks are far from cheap. But the 16 PE isn't the whole story. Earnings are now near a cyclical peak, having jumped more than 60% since 2001. They're now more than 12% of GDP versus an historic average of around 9%. Over long cycles, earnings grow in tandem with GDP. It's likely that they will grow more slowly than national income over the next few years to restore the normal ratio. That prediction makes sense: Many of the factors that led to the earnings explosion are now shifting. Rates for corporate borrowing have increased substantially, companies are being forced to invest far more capital equipment to remain competitive, and labor is demanding a bigger share of the pie. To get a more accurate read on the PE, it's critical to smooth earnings to take out the spikes in the cycle. Yale economist Robert Shiller has developed a profits-smoothing formula that does just. The Shiller model now puts the PE at around 22 or 23, reflecting today's sumptuous earnings. So where does that put the equity risk premium? With a PE of 22, the earnings yield is just 4.5%. So the return investors can expect from equities is 4.5% plus expected inflation of 2.5%, or around 7%. To get the equity risk premium, subtract that expected return from the 10-year treasury rate of 4%. That's the extra lift investors get for choosing the perils of holding stocks over the comfort of owning government bonds. At 3%, the equity risk premium is low by historical standards. The recent decline has helped make it more attractive. But the drop hasn't gone far enough. Over the past 50 years, the risk premium has averaged around 5%. Maybe investors don't need that big a spread today, given the ease of diversifying portfolios and the Fed's ability to smooth economic cycles. So let's say the number is now 4%. To get there, stocks still need to drop an additional 18%. The most dangerous sector is technology… Google's PE now stands at 52. Say you're expecting a 10% a year return from Google (Charts, Fortune 500). Its market cap would have to double to more than $400 billion by 2014. Even if Google kept a stellar PE of 30, it would need to earn $13 billion by then. Today, it earns about $4 billion. So its profits would need to more than quadruple in seven years. It won't happen. For the bulls, the coup de grace is the math -- earnings growth cannot bail out the market. The reason is that what really counts, earnings per share, don't even grow as fast as GDP. That's because companies regularly issue more shares and dilute their current shareholders -- the explosion in stock options is only the most obvious example. Because of the big dilution, earnings per share grow far more slowly than GDP; the best estimate is around 2%, adjusted for inflation. Investors can't get fat returns from profit growth. But they can get good returns from a combination of far higher dividend yields plus modest profit growth. And for dividend yields to rise, prices have to drop. That's the inexorable math we now see playing out.”
Recession Risks Unequally Priced Into Various Markets
From Merrill Lynch: “Our proprietary Libor/yield curve model is flashing 60% recession odds right now, up from 50% a month ago. Other metrics we look at suggest that the risk could be even higher, but even at 60%, very few asset classes or equity sectors are priced for that risk. Financials, especially the banks and brokers seem to have already discounted this scenario, but not the asset managers. Ditto for consumer discretionary (homebuilders especially), save for hotels etc. This by no means suggests that these groups have bottomed or that they necessarily have much in the way of visibility but based on prior peak-to-trough moves around recessionary phases, it can certainly be said that a whole lot of bad news has been priced into these segments of the market. Industrials, tech, materials, and even energy meanwhile, have more discounting to do - remember, the historical record tells is that in recessions, everything goes down: it's a matter of magnitude and timing, but no stone is left unturned (outside of special situations). They could be next in this domino game, even if the epicenter of the problem is in housing, consumer and finance. As for the traditional defensives, it would seem as though telecom has priced in more recession risk than health care or staples. In the aggregate, the stock market is priced 37% of the way towards a recession outcome. That is about the odds the consensus now applies to a recession scenario, but our models suggest at least 60%, so we would be more comfortable if the market was already discounting such a probability. Small caps, however, are priced 60% of the way there already - in line with our Libor/curve model. By the same token, corporate bond spreads have also priced in a 44% chances of recession so there is prospect for more widening going forward. Treasuries have 42% recession risks priced in, which is why we continue to favor them. Commodities barely have a 10% recession risk being discounted right now (though today they are priced more on global than just US risks).”
From Credit Suisse: “The rates markets are currently assigning a 60% and 40% probability to a "recession" versus "financial crisis" outcome.”
Could Sub-Prime Fall-Out Match Japan’s Losses in Early ‘90’s?
From The Financial Times: “Goldman Sachs analysts now think that total losses on US subprime mortgages issued in 2006 and early 2007 will be as high as 22 cents in the dollar… If that projection is bad, however, there is worse. As defaults rise on subprime mortgages, other types of debt, such as on credit cards and in car loans, also begin to face defaults. “Investors are now starting to worry that the subprime crisis will broaden out into other forms of consumer and real estate lending,” notes Goldman Sachs in a recent research report, which estimates that in a worst-case scenario non-subprime losses could eventually rise as high as $445bn. If so, this would imply America could be heading for a total credit hit of $700bn or so – and that is without taking account of any losses that might occur if risky corporate loans turn sour too. This is a dramatically bigger shock than investors expected back in August and much larger than the losses in America’s last banking shock, the savings and loans crisis of the 1980s. The Goldman team’s worst case is not far from the scale of losses produced by Japan’s 1990s banking crisis, where bad loans were estimated at $800bn-$1,000bn. A blow of this scale could take years to absorb. But aside from its size, there is a second feature of the credit crisis now spooking investors: uncertainty about how the credit pain will affect the financial system as a whole. In previous crises, credit losses were usually relatively well contained: in the S&L debacle, for example, bad loans were held by a limited group of US banks, which were well known to regulators. But the feverish financial innovation seen this decade has enabled banks to turn corporate and consumer loans into securities that have then been sold all over the world. Until recently it was presumed that this innovation had made banks stronger than before, because they had passed credit risk on to others. Consequently, regulators and investors tended to presume that the main threats to stability in the modern financial world came not from banks but risk-loving players such as hedge funds. Recent events have, however, turned these assumptions on their head. Although some hedge funds have run into problems, their losses have generally not posed any wider systemic threat. Instead, share prices of the banking groups have slid as it became clear that banks had offloaded less risk from their books as investors and regulators had presumed. Indeed, the interbank market is gripped by fears that more banks could soon tumble into crisis, as they run out of capital with which to write off loans. Sectors that had been widely ignored in recent years because they seemed utterly safe and dull – such as bond insurers, money market funds and structured investment vehicles – are also beset by a loss of confidence. The revelations are making investors fearful about the potential for unexpected chain reactions to develop as complex interlinkages break down in poorly understood corners of the financial world.”
Fundamentals Support High Oil Prices
From CNN: “The Energy Information Administration, the Energy Department's independent statistical and analysis arm, thinks strong demand and limited supply - otherwise knows as "the fundamentals" - is why oil is so pricey. "Our view is that the market is tighter [than last year]," said Doug MacIntyre, senior oil market analyst at EIA. "We don't have the inventories now." MacIntyre said inventories in developed countries - crude oil stored at refineries, or in tanks at ports, pipeline terminals and other locations - went from 150 million barrels above their five-year average at the start of the year to 10 million barrels below the five-year average now. "That's a big difference," he said. "There's less slack in the system than there was a year ago." EIA attributed the decline to OPEC production cuts of about 1.5 million barrels a day beginning at the start of 2007, when inventories were so high and oil prices briefly dipped below $50 a barrel. The cuts came despite continued strong worldwide economic growth, which EIA said caused oil demand to rise by 1.3 million barrels a day over the last year. The agency projects an increase in demand of 1.5 million barrels a day in 2008. "High oil prices are not rationing demand,"… EIA said other factors contributing to a doubling in oil prices over the last year include moderate growth in new supplies from non-OPEC countries, the inability to immediately produce much more oil in OPEC countries, a lack of refining capacity and ongoing geopolitical threats.”
From CNN: “Oil prices fell another $3 Wednesday after a healthier-than-expected U.S. inventory report and speculation OPEC will boost production… Oil prices, biting at the $100 mark for the better part of two weeks, fell by more than $3 a barrel Tuesday on speculation OPEC will boost production and the Federal Reserve will hold interest rates steady. Ministers from the Organization of Petroleum Exporting Countries meet Dec. 5 in Abu Dhabi… Oil prices have jumped about 16 percent in a little over a month. Retail gasoline prices, at first shielded from rising crude prices due to slack demand, have caught up - although they appear to be leveling off. The nationwide average price for a gallon of regular gas is now $3.09, up from $2.75 a month ago… Crude oil is now at or near all-time highs, even when adjusted for inflation. The last time oil was this high was in the early 1980s, when it rose to an inflation-adjusted $93 to $101 a barrel, depending on the inflation calculation used and the oil contract cited. Crude oil prices have surged nearly five-fold since trading below $20 a barrel in 2002. Analysts say surging global demand combined with limited new supply is the main underlying factor. The surge in prices has also attracted lots of speculative investment money, further driving prices higher. The impact speculative investment has on prices is hotly debated. Some analysts note that only a small percentage of contracts are held by speculators - investment banks, hedge funds and others who are not end users of oil. They point to rising growth in developing economies when asked why oil prices are so high and also note these investors can cause the price to fall just as dramatically and quickly when the market turns lower. Others say there is plenty of supply and these investors are pouring money into oil because the commodity is easier to buy on margin than stocks. Margin buying is a risky technique that involves purchasing contracts with borrowed money. These analysts say fundamentals - such as rising demand from India and China - have been known for some time, yet note that crude has fluctuated from below $50 a barrel to near $100 just this year. Either way, world oil supplies are currently stretched. That tight supply and demand situation magnifies the effect that geopolitical tensions have on prices, as there is less spare supply available globally to cover disruptions from places such as Iran, Nigeria and Venezuela.”
MISC
From JP Morgan: “…single-family home sales are down 31% from their September 2006 peak. By way of comparison, single-family home sales fell 33% peak-to-trough between December 1986 and December 1990, during the last major housing adjustment…The median price of single-family homes sold fell 6.3%oya, a record low of this series, which goes back to the late-1960s.”
From Merrill Lynch: “The steady sales rate of single-family homes was at the expense of lower prices, with the median sales price of single-family homes falling 1.4% on the month. This means prices are now down 6.3% YoY and 10.1% from their nearby peak this summer. We expect that as we approach the peak period for adjustable rate mortgage resets, the capitulation will accelerate and we look for home prices to fall another 10% in 2008.”
From LEHC: “Median sales prices can be dramatically impacted by changes in the “mix” of homes – both by size/amenities and by region. Earlier this year, the median existing home sales price had been inflated following the subprime mortgage market meltdown, which had a disproportionately large negative impact on lower-priced homes. This summer there was a “perturbation” in both the alt-A and the jumbo mortgage markets, which in some areas hit higher-end home sales in a big way, helping the median sales price “catch up” to reflect actual declines in home prices. Median sales prices are still not very reliable in gauging actual trends in home prices – especially in markets where overall sales volumes are extremely low – and economists believe that “repeat-transactions indexes” based on purchase transactions of the same properties over time (such as those produced by S&P/Case-Shiller) are better (though lagged and still imperfect) measures of home-price trends.”
Fed Vice-Chairman Kohn Softens Message – Signals Fed More Open to Easing
From JP Morgan: “Up until this morning, Fed rhetoric and market pricing of the Fed had been on a collision course. A speech by Vice-Chair Kohn in NY today helped to defuse that tension by moving the Fed closer to the market. Kohn's speech dismissed the moral hazard argument, made no real mention of inflation, and dwelled extensively on the growth risks from the increased turbulence in financial markets. Unlike recent speeches from other FOMC members, Kohn did not declare that he is already factoring in weak incoming data, nor did he discuss risks being roughly in balance. The policy debate between easing and not easing at the December 11 FOMC meeting will likely be animated, but Kohn's speech today suggest the crucial center of the committee is moving toward a 25bp ease. Kohn began his talk by discussing the moral hazard argument that monetary policy accommodation in times of financial unrest may encourage excessive risk-taking. Kohn's responded to this argument by noting that "we should not hold the economy hostage to teach a small segment of the population a lesson." If policy felt constrained by the moral hazard argument from promoting the macroeconomic goals of monetary policy, then "innocent bystanders" would pay the cost. Kohn then went on to discuss the much more central issue for policy in the current environment -- the effect of financial markets on the real economy. Here, unlike his colleagues, Kohn expressed a sensitivity to the recent re-intensification of problems in the financial markets. The relevant passage read: "the increased turbulence in recent weeks partly reversed some of the improvement in market functioning over the late part of September and in October. Should the elevated turbulence persist, it would increase the possibility of further tightening in financial conditions for households and businesses. Heightened concerns about larger losses at financial institutions now reflected in various markets have depressed equity prices and could induce intermediaries to adopt a more defensive posture in granting credit, not only for house purchases, but for other uses as well." The last topic Kohn discussed was the stresses in bank funding markets, which he attributed to a variety of factors, including counterparty risk, balance sheet risk, and worries about access to liquidity. Kohn saw year-end issues as being only "partly" to blame, suggesting he may see the problems in inter-bank markets as being a more persistent worry for the central bank. Kohn concluded by summing up his speech as one intended "to highlight some of the issues we will be looking at in financial markets as we weigh the necessity of future actions." Discussing the possibility of "future actions" may not exactly be a promise to ease, but it does re-position the Fed rhetoric to be consistent with that policy choice.”
From Bloomberg: “``The degree of deterioration that has happened over the last couple of weeks is not something that I personally anticipated,'' Kohn said in response to a question following a speech to the Council on Foreign Relations in New York. ``We are going to have to take a look at'' the stress in credit markets ``when we meet in a couple of weeks,'' he said…. Federal funds futures show traders see a 92 percent probability of a quarter-point reduction in the benchmark interest rate to 4.25 percent when the FOMC meets Dec. 11. Odds of a half-point cut rose to 8 percent after Kohn's remarks. ``We need to take account of those market expectations, but not follow them blindly,'' Kohn said in response to a question… Kohn said ``uncertainties'' about the economic outlook are ``unusually high'' now, requiring policy makers to be ``flexible and pragmatic'' in setting policy… He added that a ``broader repricing of risk'' that increases the cost of credit and discourages spending ``would require offsetting policy actions, other things being equal.''… Kohn, 65, is one of the most senior members on the Federal Open Market Committee. He was director of the Monetary Affairs Division and special adviser on monetary policy under former chairman Alan Greenspan… Kohn said labor markets remain strong, which provides an important ``pillar'' for the economy. ``On the other side, the spending data have been maybe a little on the soft side,'' Kohn said. ``There has been a noticeable slowing in the growth of consumption.'' Fed officials forecast prices will rise 1.8 to 2.1 percent next year. Kohn said inflation risks remain a priority for the committee.”
Financial Stocks Rally – Fannie Mae Has Biggest 1-Day Gain Since 1987
From CNN: “U.S. stocks staged the biggest two-day rally in four years, led by financial shares, after Federal Reserve Vice Chairman Donald Kohn reinforced expectations for another interest rate cut. Citigroup Inc., Goldman Sachs Group Inc., Lehman Brothers Holdings Inc. and Morgan Stanley rose more than 6 percent… The S&P 500 Financials Index dropped as much as 16 percent this month on concern that subprime-linked losses will sap profit growth. The gauge on Nov. 26 traded at 10.6 times earnings, the lowest since at least 1995, data compiled by Bloomberg show… Citigroup, the biggest U.S. bank, fell 38 percent from Oct. 12 to Nov. 26 and is the second-worst performer in the KBW Bank Index this quarter after Washington Mutual Inc… Freddie Mac and Fannie Mae, the biggest providers of money for U.S. home loans, were two of the three biggest gainers in the S&P 500 after Freddie Mac after the market closed yesterday said it plans to sell $6 billion in preferred stock and cut its dividend in half to shore up capital depleted by record mortgage defaults and foreclosures. Freddie Mac gained $4.72, or 18 percent, to $30.45. Fannie Mae rose $3.80, or 13 percent, its biggest gain since 1987, to
$33.20 after Morgan Stanley said the stock warrants a ``fresh look'' after falling 51 ercent from its peak.”
From Citi: “Relative banks index under performance [versus the broader S&P 500 index] has proceeded the last two recession in the US [in 1990 and 2001, and the same situation appears to be developing now].”
Fundamentals Support Stock Market Decline
From Fortune: “With the S&P down over 10% from its October record high, TV pundits and Wall Street strategists are blaming the most obvious culprits for the sudden reversal of fortune, chiefly the subprime crisis and the looming threat of a recession. But… The real reason is… Put simply, stocks are extremely expensive relative to the daunting risk in owning them. At current prices, earnings can't possibly grow fast enough to give investors the fat returns they covet. There's just one way for equities to get their lustre back -- their prices have to fall substantially so that investors can harvest attractive returns from the modest profit growth that's in the cards… What we're probably witnessing is a massive, irreversible revaluation of stocks based on fundamentals. The repricing machine is now in motion. The smart money says it won't stop, despite feints and lurches, until stocks are a bargain again, a prospect investors haven't seen in years… subprime was the catalyst, not the cause. It wasn't just a crisis that would pass, as the pundits argued, but a flashing red warning that triggered a durable shift in investor psychology. Before the credit crisis, investors took an incredibly blasé attitude toward risk. Yields on junk bonds, corporate debt, and office buildings were at all-time lows. Then subprime struck. Suddenly, investors recognized that the rates on high-risk mortgages didn't come close to reflecting the high probability that homeowners would default on their mortgages. So the prices of subprime paper plummeted. The downward pull on prices spread to all types of fixed income securities, from all types of junk bonds to LBO loans. Now, the fear of risk is spreading to equities with a vengeance. The problem with equities is that the repricing following the bubble of the late 1990s never fully played out. Stocks roared back from their 2001 lows, reaching record levels this fall. The rub is that they were, and still are, extremely expensive. The best way to measure whether stocks are giving you enough juice for the risk you're taking is examining the equity risk premium. This is the ultimate number in corporate finance, what Dartmouth economist Kenneth French calls "the holy grail" of stock investing. Let's run through some simple math. The best measure for the future return on stocks is the earnings yield, the inverse of the price-to-earnings (PE) ratio. Today, the PE, based on trailing 12 month earnings, is around 16. That's not too far above the historic average of 14. Even by that measure, stocks are far from cheap. But the 16 PE isn't the whole story. Earnings are now near a cyclical peak, having jumped more than 60% since 2001. They're now more than 12% of GDP versus an historic average of around 9%. Over long cycles, earnings grow in tandem with GDP. It's likely that they will grow more slowly than national income over the next few years to restore the normal ratio. That prediction makes sense: Many of the factors that led to the earnings explosion are now shifting. Rates for corporate borrowing have increased substantially, companies are being forced to invest far more capital equipment to remain competitive, and labor is demanding a bigger share of the pie. To get a more accurate read on the PE, it's critical to smooth earnings to take out the spikes in the cycle. Yale economist Robert Shiller has developed a profits-smoothing formula that does just. The Shiller model now puts the PE at around 22 or 23, reflecting today's sumptuous earnings. So where does that put the equity risk premium? With a PE of 22, the earnings yield is just 4.5%. So the return investors can expect from equities is 4.5% plus expected inflation of 2.5%, or around 7%. To get the equity risk premium, subtract that expected return from the 10-year treasury rate of 4%. That's the extra lift investors get for choosing the perils of holding stocks over the comfort of owning government bonds. At 3%, the equity risk premium is low by historical standards. The recent decline has helped make it more attractive. But the drop hasn't gone far enough. Over the past 50 years, the risk premium has averaged around 5%. Maybe investors don't need that big a spread today, given the ease of diversifying portfolios and the Fed's ability to smooth economic cycles. So let's say the number is now 4%. To get there, stocks still need to drop an additional 18%. The most dangerous sector is technology… Google's PE now stands at 52. Say you're expecting a 10% a year return from Google (Charts, Fortune 500). Its market cap would have to double to more than $400 billion by 2014. Even if Google kept a stellar PE of 30, it would need to earn $13 billion by then. Today, it earns about $4 billion. So its profits would need to more than quadruple in seven years. It won't happen. For the bulls, the coup de grace is the math -- earnings growth cannot bail out the market. The reason is that what really counts, earnings per share, don't even grow as fast as GDP. That's because companies regularly issue more shares and dilute their current shareholders -- the explosion in stock options is only the most obvious example. Because of the big dilution, earnings per share grow far more slowly than GDP; the best estimate is around 2%, adjusted for inflation. Investors can't get fat returns from profit growth. But they can get good returns from a combination of far higher dividend yields plus modest profit growth. And for dividend yields to rise, prices have to drop. That's the inexorable math we now see playing out.”
Recession Risks Unequally Priced Into Various Markets
From Merrill Lynch: “Our proprietary Libor/yield curve model is flashing 60% recession odds right now, up from 50% a month ago. Other metrics we look at suggest that the risk could be even higher, but even at 60%, very few asset classes or equity sectors are priced for that risk. Financials, especially the banks and brokers seem to have already discounted this scenario, but not the asset managers. Ditto for consumer discretionary (homebuilders especially), save for hotels etc. This by no means suggests that these groups have bottomed or that they necessarily have much in the way of visibility but based on prior peak-to-trough moves around recessionary phases, it can certainly be said that a whole lot of bad news has been priced into these segments of the market. Industrials, tech, materials, and even energy meanwhile, have more discounting to do - remember, the historical record tells is that in recessions, everything goes down: it's a matter of magnitude and timing, but no stone is left unturned (outside of special situations). They could be next in this domino game, even if the epicenter of the problem is in housing, consumer and finance. As for the traditional defensives, it would seem as though telecom has priced in more recession risk than health care or staples. In the aggregate, the stock market is priced 37% of the way towards a recession outcome. That is about the odds the consensus now applies to a recession scenario, but our models suggest at least 60%, so we would be more comfortable if the market was already discounting such a probability. Small caps, however, are priced 60% of the way there already - in line with our Libor/curve model. By the same token, corporate bond spreads have also priced in a 44% chances of recession so there is prospect for more widening going forward. Treasuries have 42% recession risks priced in, which is why we continue to favor them. Commodities barely have a 10% recession risk being discounted right now (though today they are priced more on global than just US risks).”
From Credit Suisse: “The rates markets are currently assigning a 60% and 40% probability to a "recession" versus "financial crisis" outcome.”
Could Sub-Prime Fall-Out Match Japan’s Losses in Early ‘90’s?
From The Financial Times: “Goldman Sachs analysts now think that total losses on US subprime mortgages issued in 2006 and early 2007 will be as high as 22 cents in the dollar… If that projection is bad, however, there is worse. As defaults rise on subprime mortgages, other types of debt, such as on credit cards and in car loans, also begin to face defaults. “Investors are now starting to worry that the subprime crisis will broaden out into other forms of consumer and real estate lending,” notes Goldman Sachs in a recent research report, which estimates that in a worst-case scenario non-subprime losses could eventually rise as high as $445bn. If so, this would imply America could be heading for a total credit hit of $700bn or so – and that is without taking account of any losses that might occur if risky corporate loans turn sour too. This is a dramatically bigger shock than investors expected back in August and much larger than the losses in America’s last banking shock, the savings and loans crisis of the 1980s. The Goldman team’s worst case is not far from the scale of losses produced by Japan’s 1990s banking crisis, where bad loans were estimated at $800bn-$1,000bn. A blow of this scale could take years to absorb. But aside from its size, there is a second feature of the credit crisis now spooking investors: uncertainty about how the credit pain will affect the financial system as a whole. In previous crises, credit losses were usually relatively well contained: in the S&L debacle, for example, bad loans were held by a limited group of US banks, which were well known to regulators. But the feverish financial innovation seen this decade has enabled banks to turn corporate and consumer loans into securities that have then been sold all over the world. Until recently it was presumed that this innovation had made banks stronger than before, because they had passed credit risk on to others. Consequently, regulators and investors tended to presume that the main threats to stability in the modern financial world came not from banks but risk-loving players such as hedge funds. Recent events have, however, turned these assumptions on their head. Although some hedge funds have run into problems, their losses have generally not posed any wider systemic threat. Instead, share prices of the banking groups have slid as it became clear that banks had offloaded less risk from their books as investors and regulators had presumed. Indeed, the interbank market is gripped by fears that more banks could soon tumble into crisis, as they run out of capital with which to write off loans. Sectors that had been widely ignored in recent years because they seemed utterly safe and dull – such as bond insurers, money market funds and structured investment vehicles – are also beset by a loss of confidence. The revelations are making investors fearful about the potential for unexpected chain reactions to develop as complex interlinkages break down in poorly understood corners of the financial world.”
Fundamentals Support High Oil Prices
From CNN: “The Energy Information Administration, the Energy Department's independent statistical and analysis arm, thinks strong demand and limited supply - otherwise knows as "the fundamentals" - is why oil is so pricey. "Our view is that the market is tighter [than last year]," said Doug MacIntyre, senior oil market analyst at EIA. "We don't have the inventories now." MacIntyre said inventories in developed countries - crude oil stored at refineries, or in tanks at ports, pipeline terminals and other locations - went from 150 million barrels above their five-year average at the start of the year to 10 million barrels below the five-year average now. "That's a big difference," he said. "There's less slack in the system than there was a year ago." EIA attributed the decline to OPEC production cuts of about 1.5 million barrels a day beginning at the start of 2007, when inventories were so high and oil prices briefly dipped below $50 a barrel. The cuts came despite continued strong worldwide economic growth, which EIA said caused oil demand to rise by 1.3 million barrels a day over the last year. The agency projects an increase in demand of 1.5 million barrels a day in 2008. "High oil prices are not rationing demand,"… EIA said other factors contributing to a doubling in oil prices over the last year include moderate growth in new supplies from non-OPEC countries, the inability to immediately produce much more oil in OPEC countries, a lack of refining capacity and ongoing geopolitical threats.”
From CNN: “Oil prices fell another $3 Wednesday after a healthier-than-expected U.S. inventory report and speculation OPEC will boost production… Oil prices, biting at the $100 mark for the better part of two weeks, fell by more than $3 a barrel Tuesday on speculation OPEC will boost production and the Federal Reserve will hold interest rates steady. Ministers from the Organization of Petroleum Exporting Countries meet Dec. 5 in Abu Dhabi… Oil prices have jumped about 16 percent in a little over a month. Retail gasoline prices, at first shielded from rising crude prices due to slack demand, have caught up - although they appear to be leveling off. The nationwide average price for a gallon of regular gas is now $3.09, up from $2.75 a month ago… Crude oil is now at or near all-time highs, even when adjusted for inflation. The last time oil was this high was in the early 1980s, when it rose to an inflation-adjusted $93 to $101 a barrel, depending on the inflation calculation used and the oil contract cited. Crude oil prices have surged nearly five-fold since trading below $20 a barrel in 2002. Analysts say surging global demand combined with limited new supply is the main underlying factor. The surge in prices has also attracted lots of speculative investment money, further driving prices higher. The impact speculative investment has on prices is hotly debated. Some analysts note that only a small percentage of contracts are held by speculators - investment banks, hedge funds and others who are not end users of oil. They point to rising growth in developing economies when asked why oil prices are so high and also note these investors can cause the price to fall just as dramatically and quickly when the market turns lower. Others say there is plenty of supply and these investors are pouring money into oil because the commodity is easier to buy on margin than stocks. Margin buying is a risky technique that involves purchasing contracts with borrowed money. These analysts say fundamentals - such as rising demand from India and China - have been known for some time, yet note that crude has fluctuated from below $50 a barrel to near $100 just this year. Either way, world oil supplies are currently stretched. That tight supply and demand situation magnifies the effect that geopolitical tensions have on prices, as there is less spare supply available globally to cover disruptions from places such as Iran, Nigeria and Venezuela.”
MISC
From The Telegraph: “Forget inflation and the manufacturing figures. Stop looking at the latest existing home sales figures or the data on non-farm payrolls. One of the most accurate indicators of an imminent recession is in and Americans should start tightening their belts. Winnebago, the makers of the famous recreational vehicles so prominent on the highways of the US, is expected to post a decline in sales this year for the first time in six years. Buying a motor home is seen as the ultimate discretionary item, and over the past three decades, declines have always heralded a rapid slowdown in the US economy … Motor home sales have already declined 7.1pc in the first nine months of 2007 year, including a 20pc plunge in September.”
From Business Week: “Some 5,400 Harley-Davidson Inc. workers are out of work this week as the motorcycle maker cuts production because of falling sales… The company cut bike shipments and earnings expectations in September. Shipments were down 10.8 percent to 86,535 units in the most recent three-month period.”
From Handelsbanken: “The Fed’s regional survey of economic activity found that the national economy expanded at a “Reduced Rate”. The glut of available homes on the market was a key factor identified by the report and was credited to a lack of demand as well as to previous over building. Builders remain pessimistic and not expecting a pick up in demand until well into 2008. Mixed reports on manufacturing provided less of an offset to the drag from housing in the latest survey. Consumer spending was reported as generally “downbeat” while an easing in labor markets was identified as dampening wage demands. Prices, outside of those that rely on food and energy, were also seen as stable.”
From Business Week: “Some 5,400 Harley-Davidson Inc. workers are out of work this week as the motorcycle maker cuts production because of falling sales… The company cut bike shipments and earnings expectations in September. Shipments were down 10.8 percent to 86,535 units in the most recent three-month period.”
From Handelsbanken: “The Fed’s regional survey of economic activity found that the national economy expanded at a “Reduced Rate”. The glut of available homes on the market was a key factor identified by the report and was credited to a lack of demand as well as to previous over building. Builders remain pessimistic and not expecting a pick up in demand until well into 2008. Mixed reports on manufacturing provided less of an offset to the drag from housing in the latest survey. Consumer spending was reported as generally “downbeat” while an easing in labor markets was identified as dampening wage demands. Prices, outside of those that rely on food and energy, were also seen as stable.”
End-of-Day Market Update
From JP Morgan: “Financial markets are rallying today. Equities are posting big gains, Treasury prices are weakening, and the dollar is strengthening (as seen in sharp losses in EUR and JPY), as are many fx carry trades. The oil price is down hard for the second day in a row, with nearby WTI trading below $92/bbl.”
From Deutsche Bank: “Having failed to break down through the 5-year uptrend on Tuesday, the S&P500 has taken encouragement and surged 3% at the time of writing. Financial stocks have again led the way, probably continuing to benefit from the Citigroup funding deal announced on Monday night. A sharp decline in the price of crude hasn't hurt the cause. Understandably, the VIX has fallen, credit spreads have narrowed and the carry currencies have caught a further bid.”
From UBS: “Treasuries went into a free fall late this morning, and the 2s30s curve flattened more than 8bps… TIPS took a hit today as energy prices fell, with crude dropping more than $4/barrel intraday. Breakevens narrowed across the board, with January 2009 breakevens in 10bps… Spreads narrowed across the board, particularly in the front end, where 2-year swap spreads were in as much as 10bps intraday. Agencies saw very little flow, but FFCB today announced $2 billion of a new 3-year note. Agencies lagged swaps by 2-3 bps. Mortgages saw solid buying with the Street being caught short, tightening 15 ticks to Treasuries and 12 to swaps at one point.”
From Lehman: “The treasury market got whacked again on Wednesday despite mediocre economic data, as a fairly dovish speech by fed vice-chairman Don Kohn seemed to offer great comfort to risky asset markets, which exploded today. S&P's rallied 45 points on the day, or over 3%, and credit, ABX and mortgages all had great days. Treasuries sold off hard, but tens are only back to where they traded Monday morning before that day's monster rally. As more than a few people pointed out, the ten year performance was not bad given the equity market rally, as one could only imagine what would happen to the bond market on a day that equities fell 3%. Volumes remained high… While that might be counter-intuitive, the front end has generally been pricing a worst-case scenario (just in case you didn't notice the 2.89% 2 year note on Monday) and some relief comes from the knowledge that the fed is sensitive to financial market stress and is on the job.”
Three month T-Bill yield fell 11bp to 3.03%.
Two year T-Note yield rose 10bp to 3.17%
Ten year T-Note yield rose 8bp to 4.03%
Dow rose 331 to 13,289
S&P 500 rose 41 to 1469
Dollar index rose .08 at 75.18
Yen weakened 1.19 to 110.2 per dollar
Euro unchanged at 1.483
Gold fell $7 to $805
Oil fell $2.84 to $91.60
*All prices as of 4:25pm
S&P 500
From JP Morgan: “Financial markets are rallying today. Equities are posting big gains, Treasury prices are weakening, and the dollar is strengthening (as seen in sharp losses in EUR and JPY), as are many fx carry trades. The oil price is down hard for the second day in a row, with nearby WTI trading below $92/bbl.”
From Deutsche Bank: “Having failed to break down through the 5-year uptrend on Tuesday, the S&P500 has taken encouragement and surged 3% at the time of writing. Financial stocks have again led the way, probably continuing to benefit from the Citigroup funding deal announced on Monday night. A sharp decline in the price of crude hasn't hurt the cause. Understandably, the VIX has fallen, credit spreads have narrowed and the carry currencies have caught a further bid.”
From UBS: “Treasuries went into a free fall late this morning, and the 2s30s curve flattened more than 8bps… TIPS took a hit today as energy prices fell, with crude dropping more than $4/barrel intraday. Breakevens narrowed across the board, with January 2009 breakevens in 10bps… Spreads narrowed across the board, particularly in the front end, where 2-year swap spreads were in as much as 10bps intraday. Agencies saw very little flow, but FFCB today announced $2 billion of a new 3-year note. Agencies lagged swaps by 2-3 bps. Mortgages saw solid buying with the Street being caught short, tightening 15 ticks to Treasuries and 12 to swaps at one point.”
From Lehman: “The treasury market got whacked again on Wednesday despite mediocre economic data, as a fairly dovish speech by fed vice-chairman Don Kohn seemed to offer great comfort to risky asset markets, which exploded today. S&P's rallied 45 points on the day, or over 3%, and credit, ABX and mortgages all had great days. Treasuries sold off hard, but tens are only back to where they traded Monday morning before that day's monster rally. As more than a few people pointed out, the ten year performance was not bad given the equity market rally, as one could only imagine what would happen to the bond market on a day that equities fell 3%. Volumes remained high… While that might be counter-intuitive, the front end has generally been pricing a worst-case scenario (just in case you didn't notice the 2.89% 2 year note on Monday) and some relief comes from the knowledge that the fed is sensitive to financial market stress and is on the job.”
Three month T-Bill yield fell 11bp to 3.03%.
Two year T-Note yield rose 10bp to 3.17%
Ten year T-Note yield rose 8bp to 4.03%
Dow rose 331 to 13,289
S&P 500 rose 41 to 1469
Dollar index rose .08 at 75.18
Yen weakened 1.19 to 110.2 per dollar
Euro unchanged at 1.483
Gold fell $7 to $805
Oil fell $2.84 to $91.60
*All prices as of 4:25pm
S&P 500
2 Year Treasury Yield
October Existing Home Sales Fall More than Expected - Inventory at 22 Year High - Record Median Home Price Drop of -5.1% YoY
Existing home sales fell to an eight year low, declining a further -1.2% MoM (consensus -.8%) in October, and a cumulative -20.7% YoY. In October, single-family home sales were unchanged from the prior month while condo sales fell -9.1% MoM. So all of last months decline was in condo/coop sales. Over the last year, both single-family and condos have seen declines of just over 20%. September's existing home sales decline was revised to be slightly larger than originally reported at -8.2% MoM versus the originally reported decrease of -8% MoM.
The supply of existing homes for sale rose to 10.8 months, with single-family at 10.5 months and condos at 13.1 months, based on the current sales pace. The 10.5 months of home supply is the highest since 1985. The actual number of homes for sale rose 1.9% MoM, but remains below the peak level of last July.
The median home price for existing homes declined by the most on record in October to $207k, down -5.1% YoY. This compares with the -4.9% YoY decline in home prices for the Case-Shiller 20-city index released yesterday, with data through September. Average sales prices fell -3.4% YoY based on today's data. For both median and average prices, the declines in value have been solely focused on single-family structures (median price down -6.3% YoY) while condos continue to rise (median price up +4.9% YoY). The previous record decline in median home prices was -4.3% YoY in October 2006, a year ago exactly.
Purchases fell -4.4% in the West and -1.7% in the Midwest, and were unchanged in both the South and Northeast in October. In September, sales fell in all four regions, with the Midwest falling the least at -6.3% MoM, and the West and Northeast both declining around -10% MoM.
Goldman Sachs estimates that existing home sales could fall from today's 4.97M annual pace to as low as 4M annually by the end of 2008, as the housing market continues to deteriorate. Remember that the October existing home figures represent pending home sales from August and September, when the credit crunch was tightening. Most dealers are looking for home prices to continue declining through 2008, to reach a cumulative decline of -15% in home price values nationally. The excess inventory of existing homes may remain on the market longer than usual, because of the greater percentage of homes owned by speculators. Owner-occupiers are more likely to remove their homes from inventory when sales soften.
The supply of existing homes for sale rose to 10.8 months, with single-family at 10.5 months and condos at 13.1 months, based on the current sales pace. The 10.5 months of home supply is the highest since 1985. The actual number of homes for sale rose 1.9% MoM, but remains below the peak level of last July.
The median home price for existing homes declined by the most on record in October to $207k, down -5.1% YoY. This compares with the -4.9% YoY decline in home prices for the Case-Shiller 20-city index released yesterday, with data through September. Average sales prices fell -3.4% YoY based on today's data. For both median and average prices, the declines in value have been solely focused on single-family structures (median price down -6.3% YoY) while condos continue to rise (median price up +4.9% YoY). The previous record decline in median home prices was -4.3% YoY in October 2006, a year ago exactly.
Purchases fell -4.4% in the West and -1.7% in the Midwest, and were unchanged in both the South and Northeast in October. In September, sales fell in all four regions, with the Midwest falling the least at -6.3% MoM, and the West and Northeast both declining around -10% MoM.
Goldman Sachs estimates that existing home sales could fall from today's 4.97M annual pace to as low as 4M annually by the end of 2008, as the housing market continues to deteriorate. Remember that the October existing home figures represent pending home sales from August and September, when the credit crunch was tightening. Most dealers are looking for home prices to continue declining through 2008, to reach a cumulative decline of -15% in home price values nationally. The excess inventory of existing homes may remain on the market longer than usual, because of the greater percentage of homes owned by speculators. Owner-occupiers are more likely to remove their homes from inventory when sales soften.
Durable Goods Demand Softening
Durable goods orders fell more than expected in October, falling -.4% MoM (consensus -.1%). But the September decline was reduced to -1.4% from the -1.7% previously reported. Excluding transportation, durable goods orders followed a similar pattern with the October figure coming in much weaker than expected at -.7% MoM versus expectations for an increase of +.3%. In addition ex-transportation orders were revised up to +1.1% in September from an originally reported level of +.3% MoM.
The credit crunch is making it more difficult to find financing, which is combining with slower demand growth to cause businesses to reduce spending. Business appear to be more cautious in making capital expenditures until they see how the economy fairs with the recent credit squeeze and housing downturn. Expectations of a US recession are rising.
New durable goods orders fell for the third straight month, which is the first time that has happened in more than three years. Total capital goods orders fell -1.3% MoM. When looking at non-defense capital goods bookings, excluding the volatile aircraft category, which are viewed as a proxy for future business investment, we see they fell -2.3% MoM in October - the largest decline since February. Shipments of these items are used for computing GDP dropped -1.2% MoM in October. Demand for defense equipment rose 16%, and are likely to continue rising as old weapons systems are replaced. Due to a recent crash, all F-15 fighters in the US and Japan were recently taken off active duty due to concerns about their age and airworthiness. Non-defense new orders for capital goods in October decreased by 3.1% MoM.
Vehicles and parts orders fell -1.4% MoM and non-defense aircraft fell -5.2% MoM. Computer orders declined a substantial -8.4% MoM while machinery fell -1.7%. Areas seeing increasing orders were electrical equipment at+4.1% MoM and metals.
Total shipments rose +.6% MoM the first increase in three months, though capital goods shipments fell -.5% MoM, the first decline in four months. Unfilled orders continue to grow, increasing 1% MoM and 18.1% YoY - a bright spot in the durable goods report and another record high. The backlog is primarily due to unfilled transportation orders (Boeing airliners).
Inventories rose +.2% MoM and are up 2.1% YoY. Inventories have risen for 3 of the past 4 months, and are also at a record high since they began being tracked in 1992. Inventory to shipments slipped to 1.47 from 1.48 the prior month, but remain higher than the 1.42 low reached in July.
Over the past year, new orders have risen +3.1% YoY with capital goods orders up +2.6% YoY. Defense orders have risen 28.2% YoY. Vehicle and non-defense aircraft new orders have risen +2.6% YoY. Total durable goods shipments have risen +2.8% YoY, while capital goods shipments have risen a stronger +4% YoY.
The credit crunch is making it more difficult to find financing, which is combining with slower demand growth to cause businesses to reduce spending. Business appear to be more cautious in making capital expenditures until they see how the economy fairs with the recent credit squeeze and housing downturn. Expectations of a US recession are rising.
New durable goods orders fell for the third straight month, which is the first time that has happened in more than three years. Total capital goods orders fell -1.3% MoM. When looking at non-defense capital goods bookings, excluding the volatile aircraft category, which are viewed as a proxy for future business investment, we see they fell -2.3% MoM in October - the largest decline since February. Shipments of these items are used for computing GDP dropped -1.2% MoM in October. Demand for defense equipment rose 16%, and are likely to continue rising as old weapons systems are replaced. Due to a recent crash, all F-15 fighters in the US and Japan were recently taken off active duty due to concerns about their age and airworthiness. Non-defense new orders for capital goods in October decreased by 3.1% MoM.
Vehicles and parts orders fell -1.4% MoM and non-defense aircraft fell -5.2% MoM. Computer orders declined a substantial -8.4% MoM while machinery fell -1.7%. Areas seeing increasing orders were electrical equipment at+4.1% MoM and metals.
Total shipments rose +.6% MoM the first increase in three months, though capital goods shipments fell -.5% MoM, the first decline in four months. Unfilled orders continue to grow, increasing 1% MoM and 18.1% YoY - a bright spot in the durable goods report and another record high. The backlog is primarily due to unfilled transportation orders (Boeing airliners).
Inventories rose +.2% MoM and are up 2.1% YoY. Inventories have risen for 3 of the past 4 months, and are also at a record high since they began being tracked in 1992. Inventory to shipments slipped to 1.47 from 1.48 the prior month, but remain higher than the 1.42 low reached in July.
Over the past year, new orders have risen +3.1% YoY with capital goods orders up +2.6% YoY. Defense orders have risen 28.2% YoY. Vehicle and non-defense aircraft new orders have risen +2.6% YoY. Total durable goods shipments have risen +2.8% YoY, while capital goods shipments have risen a stronger +4% YoY.
Today's Tidbits
Recession Risks Rising
From Fortune: “After years of living happily beyond their means, Americans are finally facing financial reality. A persistent rise in energy prices will mean bigger heating bills this winter and heftier tabs at the gas pump. Job growth is slowing and wage gains have been anemic. House prices are sliding, diminishing the value of the asset that's the biggest factor in Americans' personal wealth. Even the stock market, which has been resilient for so long in the face of eroding consumer sentiment, has begun pulling back amid signs of deep distress in the financial sector… Rosenberg said the low rates and easy underwriting meant loans were available to just about anyone with a pulse, so recent economic gains were more credit-induced "by a factor of four" than any other U.S. expansion on record. Now many of those loans are going bad, which is why investors are fleeing any debt riskier than U.S. Treasury securities. Making matters worse, the banking system is coming under severe strain. Wall Street has recognized more than $40 billion in losses this year on souring subprime mortgages and a related problem, the toxic debt known as collateralized debt obligations. The losses could constrain the economy by forcing banks and brokerages to sock money away rather than lending it out to businesses and individuals…Northern Trust chief economist Paul Kasriel… says banks are extremely vulnerable to the defaults and foreclosures now sweeping American neighborhoods, with mortgage exposure amounting to 63% of U.S. banks' earning assets … But with banks choking on bad loans, Kasriel doesn't expect to see the return of the easy lending standards that fueled the housing boom. Instead, he expects to see "greater risk aversion" that will slow credit growth and reduce the value of assets like property. He says the median U.S. house price would need to fall 17% to return to its 2001 level, which he notes was hardly at the bottom of the house-price cycle. A decline of that magnitude will further erode home-equity borrowing by Americans and, presumably, deliver one more blow to consumers' wallets. The American consumer seems to grasp the risks. A growing number of Americans expect the economy to tip into recession in the next year -- 40% last week, up from 31% in October, going by a Reuters/Zogby poll released last week. Rosenberg said government statistics show that 500,000 self-employed workers have lost their jobs since July -- a greater loss than was seen in all of 2001. Reported unemployment figures remain low, but Kasriel says those numbers "smell worse than a week-old fish." The combination of an emerging consumer recession and a heavily stressed financial system has some experts suggesting that a financial meltdown looms. "In short, the financial markets are at a critical point," fund manager John Hussman of the Hussman Funds wrote last week in a Web site post devoted to discussing a possible financial crisis. "It's possible that investors will somehow adopt a fresh willingness to speculate, but my impression is that in the weeks ahead, investors will be forced to recognize that the recession risk has tipped."”
Rules for Determining a Recession
From Wachovia: “Although many economic textbooks define a recession as two consecutive quarters of declining real GDP, this is not the true definition of a recession. The most recent downturn did not meet this definition, with three nonconsecutive quarters of declining GDP mixed in with three quarters of increases. A more accurate description of a recession is that it is a pronounced, long-lived, broad based decline in aggregate economic activity. The National Bureau of Economic Research (NBER) is the official arbiter of determining that a recession has begun in the U.S. and their pronouncements usually lag significantly behind the actual start of a downturn. The NBER has a Business Cycle Dating Committee, which provides the generally accepted dates that recessions begin and end. The NBER defines a recession as: A significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades. The NBER follows a whole host of monthly economic indicators to determine whether or not there has been a turn in the business cycle. The four “most important measures” considered by the NBER are nonfarm employment, industrial production, manufacturing and trade sales, and real personal income minus transfer payments. The NBER also noted that there is “no fixed rule” about if and how other economic measures contribute to the business-cycle dating process.
Dealer Estimates of Total Home Price Declines for This Cycle
From Merrill Lynch: “From the Case-Shiller HPI peak in July 2006, the index has corrected 5.28%. We look for that correction to extend to closer to -15.0% by year end 2008, or 1Q-2009.”
From Lehman: “We judge the recent decline in home prices to be the beginning of an extended decline. We look for home prices to fall well into 2009 as excess inventory is slowly cleared and foreclosed homes return to the market at a discounted price. We expect this to translate to a 15% decline in national home prices from peak to trough.”
From JP Morgan: “The national composite index peaked in 2Q06 and has since fallen 5.0%. We estimate that national home prices will fall close to 15% peak-to-trough, with the trough coming around the end of 2008.”
From Goldman Sachs: “No one wants to buy a house. The percent of [consumer confidence] respondents considering buying a house sunk to 2.5%, the lowest since 1994. Before that, you have to go back to 1983 to find this few people looking at buying a home.”
The Country of Abu Dhabi to Buy 4.9% of Citi
From RBSGC: “Abu Dhabi willing to inject $7.5 bn into Citi for what eventually will be a 4.9% stake. This has relieved stocks, raised the specter of further liquidity from such sources coming to the banking system, and hit bonds hard…it comes a bit late to the 45K rumored layoffs at Citi. We don't expect this to be challenged from a legal or national security perspective a la the ports issues a few months ago (minority stake, banking vs. real goods coming into the country), but we do wonder if sovereign wealth funds face some political heat in an election year. It's one thing for a private firm to buy a US firm, but a foreign government buying a private company is NEW.”
From Morgan Stanley: “The Citi capital raising is big news. Worth about 60bp on tier 1, which is more than enough to bring all the SIVs on balance sheet (which would cost about 40bp of tier 1). This crisis morphed from a liquidity crisis to a capital/solvency crisis in October. Capital raising by banks is therefore a big part of the solution. Note, however, that Citi is only the first to raise capital. Many others will need to do so before this is over.”
From Handelsbanken: “CDS spreads came in on financials after Citigroup announced that it received a cash infusion of $7.5billion.”
From Bloomberg: “Citigroup Inc., the biggest U.S. bank, is paying a ``junk bond'' rate to uphold Chairman Robert Rubin's pledge to preserve the dividend and weather this year's mortgage-market decline. The 11 percent interest rate on $7.5 billion of convertible shares that Citigroup sold to the Abu Dhabi Investment Authority is almost double the rate it offers bond investors. Countrywide Financial Corp. paid 7.25 percent to Bank of America Corp., the second-biggest U.S. bank by assets, for bailout financing three months ago. Citigroup's common stock pays a dividend equivalent to a 7.1 percent yield… The average fixed-rate preferred stock yields 7.7 percent, according to Merrill index data. The average high-yield, high-risk bond yields 9.5 percent”
MISC
From Goldman Sachs: “The worsening housing downturn has pushed the risk of a US recession in 2008 to 40%-45%, from around 30% previously.”
From JP Morgan: “Falling house prices, combined with the weakness in the stock market, point to a probable decline in household net worth this quarter, the first since the middle of 2002.”
From HSBC: “Since October 31 (the date of the last FOMC meeting), the SP500 has
declined by roughly 9%. 9%-plus monthly declines are rare events. Before this November, it has only happened twelve times in the past sixty years, or 1.7% of the time. The last time it happened was over five years ago in September 2002. So short of a big rally in stocks in the last few days of November, the stock market performance this month is shaping up to be a true `outlier' event, reflecting financial system concerns and fears of a credit crunch...”
From The Wall Street Journal: “Yesterday, the three-month Libor, or the London interbank offered rate, quoted on dollar loans between European banks was 5.05%, unusually high relative to the Fed's current 4.5% target interest rate for overnight loans between banks, known as the federal-funds rate. It is even more unusually high when compared with the 4.25% that investors expect to prevail in January…In the U.S., the Libor is an especially important interest rate because it is a benchmark for many other kinds of lending, such as floating-rate mortgages and commercial corporate paper. Its rise may be symptomatic of a more generalized reluctance by banks to lend, which could impair consumer and business spending.”
From Barclays: “Bank holdings of MBS declined sharply in Q3 07 after a smaller decrease in Q207. The decline at the top 10 banks was 4.4% over the quarter. Wells Fargo and Citigroup were the biggest sellers of MBS in Q3 07; their portfolios decreased $18.7bn and $12.6bn, respectively. A number of other banks were net buyers of MBS in Q3 07, but their buying was overshadowed by the deleveraging of Citigroup and Wells Fargo. Bank deposits rose 3.5% over Q3 07. In addition, the cost of deposits for banks probably went up in Q3 07, since non-interest bearing deposits fell 3%. At the margin, this could further weaken the bank bid for MBS.”
From HSBC: “…the spread of jumbo mortgage rates over conventional mortgage rates went from about 25bp in July to up to 108bp in August, before improving to 60bp in late October. However, it has re-widened to 81bp now…In the midst of this doom and gloom, it is important to bear in mind that not everything has gone the wrong way as far as financial conditions are concerned. The 30-year conventional mortgage rate has declined from 6.74% in mid-June to 6.20% now, 54bp lower, although it is tougher now for applicants to be approved, given tighter lending standards.”
From Merrill Lynch: “There have been only two times in the past that consumer confidence fell this much at this time of the year - in 2001 and 1991. Both represented recessionary phases in the economy - maybe it will be different this time but we are not convinced. Holiday shopping pundits should note that both years saw fourth quarter ex-auto retail sales stagnating on a y/y basis.”
From JP Morgan: “Chicago Fed President Evans and Philadelphia Fed President Plosser each delivered speeches today which gave little sense that they are looking for an interest rate cut at the next meeting of the FOMC on December 11.”
End-of-Day Market Update
From JP Morgan: “The US stock market is rebounding today, reversing some of yesterday’s loss. Markets were down in Europe and mixed in Asia. US Treasury yields have increased sharply, reversing all of yesterday’s decline. In Fx markets, the dollar has regained a bit of ground against the euro and the yen. Most carry currencies are up marginally too. Oil prices are down almost $3 to near $95/bbl.”
From Lehman: “…if we've learned one thing over the past week, it is that there are few counterparties willing to step in to take the other side of anything.”
From Lehman: “The treasury market made a sharp turnaround after yesterday's stunning rally, but finished well off of the day's lows as equity markets were unable to sustain an early rally. The selloff started on the news that Citigroup would receive a $7.5 bln cash infusion from an outside investor, and we saw heavy selling from both fast and real money in the overnight session, and early NY trading. Ten year yields rose as much as 17 basis points intra-day, and two year note yields over 20 before an afternoon stock swoon, combined with some deal pricing, ripped the market from its lows, pulling ten year yields from 4.01% back down to 3.93%. Volumes were incredibly high… Despite the heavy volumes going through today, the market still feels very illiquid to us, and so big flows are pushing both the overall market and RV relationships all over the map with little resistance…”
From UBS: “The 2s30s curve flattened about 5bps… Swaps saw light flows, and front end spreads came in while spreads further out remained flat on the day. Agencies saw good buying of 2- and 3-year notes, richening slightly to Libor in the front end and trading in line the rest of the way. Mortgages had about $2B in origination and some selling out of Asia. Despite all the selling and the rise in volatility, mortgages hung in quite well, widening only a tick to Treasuries and swaps.”
From RBSGC: “People will call it a 'reversal' from Monday's capitulation -- we're referring to the bond market's bearish flattening -- but, in fact, it was an inside day meaning prices/yields held within Monday's extremes. That's true across the curve. While we extract more of a flattening bias, albeit with a switch to somewhat bearish view, in reality the action looks kind of consolidative.”
Three month T-Bill yield rose 4bp to 3.15%.
Two year T-Note yield rose 18bp to 3.07%
Ten year T-Note yield rose 11bp to 3.95%
Dow rose 215 to 12,958
S&P 500 rose 21 to 1428
Dollar index rose.34 at 75.20
Yen weakened 1.49 to 118.9 per dollar
Euro fell .005 to 1.483
Gold fell $11.4 to $813
Oil fell 3.14 to $94.56
*All prices as of 5:20pm
From Fortune: “After years of living happily beyond their means, Americans are finally facing financial reality. A persistent rise in energy prices will mean bigger heating bills this winter and heftier tabs at the gas pump. Job growth is slowing and wage gains have been anemic. House prices are sliding, diminishing the value of the asset that's the biggest factor in Americans' personal wealth. Even the stock market, which has been resilient for so long in the face of eroding consumer sentiment, has begun pulling back amid signs of deep distress in the financial sector… Rosenberg said the low rates and easy underwriting meant loans were available to just about anyone with a pulse, so recent economic gains were more credit-induced "by a factor of four" than any other U.S. expansion on record. Now many of those loans are going bad, which is why investors are fleeing any debt riskier than U.S. Treasury securities. Making matters worse, the banking system is coming under severe strain. Wall Street has recognized more than $40 billion in losses this year on souring subprime mortgages and a related problem, the toxic debt known as collateralized debt obligations. The losses could constrain the economy by forcing banks and brokerages to sock money away rather than lending it out to businesses and individuals…Northern Trust chief economist Paul Kasriel… says banks are extremely vulnerable to the defaults and foreclosures now sweeping American neighborhoods, with mortgage exposure amounting to 63% of U.S. banks' earning assets … But with banks choking on bad loans, Kasriel doesn't expect to see the return of the easy lending standards that fueled the housing boom. Instead, he expects to see "greater risk aversion" that will slow credit growth and reduce the value of assets like property. He says the median U.S. house price would need to fall 17% to return to its 2001 level, which he notes was hardly at the bottom of the house-price cycle. A decline of that magnitude will further erode home-equity borrowing by Americans and, presumably, deliver one more blow to consumers' wallets. The American consumer seems to grasp the risks. A growing number of Americans expect the economy to tip into recession in the next year -- 40% last week, up from 31% in October, going by a Reuters/Zogby poll released last week. Rosenberg said government statistics show that 500,000 self-employed workers have lost their jobs since July -- a greater loss than was seen in all of 2001. Reported unemployment figures remain low, but Kasriel says those numbers "smell worse than a week-old fish." The combination of an emerging consumer recession and a heavily stressed financial system has some experts suggesting that a financial meltdown looms. "In short, the financial markets are at a critical point," fund manager John Hussman of the Hussman Funds wrote last week in a Web site post devoted to discussing a possible financial crisis. "It's possible that investors will somehow adopt a fresh willingness to speculate, but my impression is that in the weeks ahead, investors will be forced to recognize that the recession risk has tipped."”
Rules for Determining a Recession
From Wachovia: “Although many economic textbooks define a recession as two consecutive quarters of declining real GDP, this is not the true definition of a recession. The most recent downturn did not meet this definition, with three nonconsecutive quarters of declining GDP mixed in with three quarters of increases. A more accurate description of a recession is that it is a pronounced, long-lived, broad based decline in aggregate economic activity. The National Bureau of Economic Research (NBER) is the official arbiter of determining that a recession has begun in the U.S. and their pronouncements usually lag significantly behind the actual start of a downturn. The NBER has a Business Cycle Dating Committee, which provides the generally accepted dates that recessions begin and end. The NBER defines a recession as: A significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades. The NBER follows a whole host of monthly economic indicators to determine whether or not there has been a turn in the business cycle. The four “most important measures” considered by the NBER are nonfarm employment, industrial production, manufacturing and trade sales, and real personal income minus transfer payments. The NBER also noted that there is “no fixed rule” about if and how other economic measures contribute to the business-cycle dating process.
Dealer Estimates of Total Home Price Declines for This Cycle
From Merrill Lynch: “From the Case-Shiller HPI peak in July 2006, the index has corrected 5.28%. We look for that correction to extend to closer to -15.0% by year end 2008, or 1Q-2009.”
From Lehman: “We judge the recent decline in home prices to be the beginning of an extended decline. We look for home prices to fall well into 2009 as excess inventory is slowly cleared and foreclosed homes return to the market at a discounted price. We expect this to translate to a 15% decline in national home prices from peak to trough.”
From JP Morgan: “The national composite index peaked in 2Q06 and has since fallen 5.0%. We estimate that national home prices will fall close to 15% peak-to-trough, with the trough coming around the end of 2008.”
From Goldman Sachs: “No one wants to buy a house. The percent of [consumer confidence] respondents considering buying a house sunk to 2.5%, the lowest since 1994. Before that, you have to go back to 1983 to find this few people looking at buying a home.”
The Country of Abu Dhabi to Buy 4.9% of Citi
From RBSGC: “Abu Dhabi willing to inject $7.5 bn into Citi for what eventually will be a 4.9% stake. This has relieved stocks, raised the specter of further liquidity from such sources coming to the banking system, and hit bonds hard…it comes a bit late to the 45K rumored layoffs at Citi. We don't expect this to be challenged from a legal or national security perspective a la the ports issues a few months ago (minority stake, banking vs. real goods coming into the country), but we do wonder if sovereign wealth funds face some political heat in an election year. It's one thing for a private firm to buy a US firm, but a foreign government buying a private company is NEW.”
From Morgan Stanley: “The Citi capital raising is big news. Worth about 60bp on tier 1, which is more than enough to bring all the SIVs on balance sheet (which would cost about 40bp of tier 1). This crisis morphed from a liquidity crisis to a capital/solvency crisis in October. Capital raising by banks is therefore a big part of the solution. Note, however, that Citi is only the first to raise capital. Many others will need to do so before this is over.”
From Handelsbanken: “CDS spreads came in on financials after Citigroup announced that it received a cash infusion of $7.5billion.”
From Bloomberg: “Citigroup Inc., the biggest U.S. bank, is paying a ``junk bond'' rate to uphold Chairman Robert Rubin's pledge to preserve the dividend and weather this year's mortgage-market decline. The 11 percent interest rate on $7.5 billion of convertible shares that Citigroup sold to the Abu Dhabi Investment Authority is almost double the rate it offers bond investors. Countrywide Financial Corp. paid 7.25 percent to Bank of America Corp., the second-biggest U.S. bank by assets, for bailout financing three months ago. Citigroup's common stock pays a dividend equivalent to a 7.1 percent yield… The average fixed-rate preferred stock yields 7.7 percent, according to Merrill index data. The average high-yield, high-risk bond yields 9.5 percent”
MISC
From Goldman Sachs: “The worsening housing downturn has pushed the risk of a US recession in 2008 to 40%-45%, from around 30% previously.”
From JP Morgan: “Falling house prices, combined with the weakness in the stock market, point to a probable decline in household net worth this quarter, the first since the middle of 2002.”
From HSBC: “Since October 31 (the date of the last FOMC meeting), the SP500 has
declined by roughly 9%. 9%-plus monthly declines are rare events. Before this November, it has only happened twelve times in the past sixty years, or 1.7% of the time. The last time it happened was over five years ago in September 2002. So short of a big rally in stocks in the last few days of November, the stock market performance this month is shaping up to be a true `outlier' event, reflecting financial system concerns and fears of a credit crunch...”
From The Wall Street Journal: “Yesterday, the three-month Libor, or the London interbank offered rate, quoted on dollar loans between European banks was 5.05%, unusually high relative to the Fed's current 4.5% target interest rate for overnight loans between banks, known as the federal-funds rate. It is even more unusually high when compared with the 4.25% that investors expect to prevail in January…In the U.S., the Libor is an especially important interest rate because it is a benchmark for many other kinds of lending, such as floating-rate mortgages and commercial corporate paper. Its rise may be symptomatic of a more generalized reluctance by banks to lend, which could impair consumer and business spending.”
From Barclays: “Bank holdings of MBS declined sharply in Q3 07 after a smaller decrease in Q207. The decline at the top 10 banks was 4.4% over the quarter. Wells Fargo and Citigroup were the biggest sellers of MBS in Q3 07; their portfolios decreased $18.7bn and $12.6bn, respectively. A number of other banks were net buyers of MBS in Q3 07, but their buying was overshadowed by the deleveraging of Citigroup and Wells Fargo. Bank deposits rose 3.5% over Q3 07. In addition, the cost of deposits for banks probably went up in Q3 07, since non-interest bearing deposits fell 3%. At the margin, this could further weaken the bank bid for MBS.”
From HSBC: “…the spread of jumbo mortgage rates over conventional mortgage rates went from about 25bp in July to up to 108bp in August, before improving to 60bp in late October. However, it has re-widened to 81bp now…In the midst of this doom and gloom, it is important to bear in mind that not everything has gone the wrong way as far as financial conditions are concerned. The 30-year conventional mortgage rate has declined from 6.74% in mid-June to 6.20% now, 54bp lower, although it is tougher now for applicants to be approved, given tighter lending standards.”
From Merrill Lynch: “There have been only two times in the past that consumer confidence fell this much at this time of the year - in 2001 and 1991. Both represented recessionary phases in the economy - maybe it will be different this time but we are not convinced. Holiday shopping pundits should note that both years saw fourth quarter ex-auto retail sales stagnating on a y/y basis.”
From JP Morgan: “Chicago Fed President Evans and Philadelphia Fed President Plosser each delivered speeches today which gave little sense that they are looking for an interest rate cut at the next meeting of the FOMC on December 11.”
End-of-Day Market Update
From JP Morgan: “The US stock market is rebounding today, reversing some of yesterday’s loss. Markets were down in Europe and mixed in Asia. US Treasury yields have increased sharply, reversing all of yesterday’s decline. In Fx markets, the dollar has regained a bit of ground against the euro and the yen. Most carry currencies are up marginally too. Oil prices are down almost $3 to near $95/bbl.”
From Lehman: “…if we've learned one thing over the past week, it is that there are few counterparties willing to step in to take the other side of anything.”
From Lehman: “The treasury market made a sharp turnaround after yesterday's stunning rally, but finished well off of the day's lows as equity markets were unable to sustain an early rally. The selloff started on the news that Citigroup would receive a $7.5 bln cash infusion from an outside investor, and we saw heavy selling from both fast and real money in the overnight session, and early NY trading. Ten year yields rose as much as 17 basis points intra-day, and two year note yields over 20 before an afternoon stock swoon, combined with some deal pricing, ripped the market from its lows, pulling ten year yields from 4.01% back down to 3.93%. Volumes were incredibly high… Despite the heavy volumes going through today, the market still feels very illiquid to us, and so big flows are pushing both the overall market and RV relationships all over the map with little resistance…”
From UBS: “The 2s30s curve flattened about 5bps… Swaps saw light flows, and front end spreads came in while spreads further out remained flat on the day. Agencies saw good buying of 2- and 3-year notes, richening slightly to Libor in the front end and trading in line the rest of the way. Mortgages had about $2B in origination and some selling out of Asia. Despite all the selling and the rise in volatility, mortgages hung in quite well, widening only a tick to Treasuries and swaps.”
From RBSGC: “People will call it a 'reversal' from Monday's capitulation -- we're referring to the bond market's bearish flattening -- but, in fact, it was an inside day meaning prices/yields held within Monday's extremes. That's true across the curve. While we extract more of a flattening bias, albeit with a switch to somewhat bearish view, in reality the action looks kind of consolidative.”
Three month T-Bill yield rose 4bp to 3.15%.
Two year T-Note yield rose 18bp to 3.07%
Ten year T-Note yield rose 11bp to 3.95%
Dow rose 215 to 12,958
S&P 500 rose 21 to 1428
Dollar index rose.34 at 75.20
Yen weakened 1.49 to 118.9 per dollar
Euro fell .005 to 1.483
Gold fell $11.4 to $813
Oil fell 3.14 to $94.56
*All prices as of 5:20pm
Tuesday, November 27, 2007
Consumer Confidence Sinks More Than Expected in November
The Conference Board's Consumer Confidence Index fell more than expected in November, plummeting to 87.3 (consensus 91) from 95.6 in October. As with other consumer confidence measures, sentiment has fallen to the lowest level since hurricane Katrina in 2005. This index averaged 106 last year. This index puts more weight on the labor market than other consumer sentiment surveys, and suggests consumers are becoming more concerned about their jobs as initial claims rise. All regions saw weakening sentiment except for New England.
Both current conditions and future expectations fell in November. The outlook for the next six months fell off a cliff to the lowest level since early 2003 (when the Iraq War started), from 80 in October to 68.7 in November. On the jobs front the share of people looking for incomes to rise and finding jobs easy to find both dropped, as did the number of people planning to buy a new home or car in the next six months.
This data supports continued slowing of consumer spending going into the holiday season.
Both current conditions and future expectations fell in November. The outlook for the next six months fell off a cliff to the lowest level since early 2003 (when the Iraq War started), from 80 in October to 68.7 in November. On the jobs front the share of people looking for incomes to rise and finding jobs easy to find both dropped, as did the number of people planning to buy a new home or car in the next six months.
This data supports continued slowing of consumer spending going into the holiday season.
Case-Shiller Home Price 20-City Index Falls 4.9% YoY in September as Home Price Declines Accelerate
Home price declines continue to accelerate, rising from a 3.3% drop in the second quarter to a 4.5% decline in the third quarter, which was the largest quarterly decline on record. The index has been tracking home prices since 1988. The monthly YoY decline of 4.95% (consensus -4.8%) for the 20-city index is the largest since the monthly data began being collected in 2001, and follows a 4.3% YoY drop in August. The declines are broad-based with 15 of 20 metro areas showing weakening home prices YoY. When looking at the change from August to September though, all 20 areas saw MoM drops in housing prices (not seasonally adjusted). When looking only at the 10-city composite, which is more focused on bubble areas, house prices have dropped -5.5% YoY.
Annualizing the past three months of data, the 20-city index indicates an annual drop of 7.4% in home prices, while the smaller 10-city index indicates an 8.3% pace of decline. Over the past three months only, the four cities seeing the largest declines in home prices have been Los Angeles(-10.7% annualized), Washington, DC (-8.8% annualized), and New York/San Francisco at -5.7% annualized.
The largest annual decline in home prices happened in Tampa (-11.12%), followed by Miami at -9.96%. Detroit, Las Vegas, and San Diego all have declines of over 9% YoY. Seattle and Charlotte are the two strongest housing markets, both rising around 4.7% YoY.
It is important to remember that even with the recent softening in house prices, over the longer term of three years, only four cities - Boston(-.84%), Detroit(-9.72%), Cleveland(-2%), and San Diego(-3.39%) - have lower house prices. Over these past three years, Phoenix, Seattle, and Portland still have house prices that are over 40% higher than they were three years earlier, on average.
The bottom line is that housing price declines are accelerating and spreading across the country to all regions. Economists are now calling for national house prices to have declined around 7% YoY by the end of 2007.
Annualizing the past three months of data, the 20-city index indicates an annual drop of 7.4% in home prices, while the smaller 10-city index indicates an 8.3% pace of decline. Over the past three months only, the four cities seeing the largest declines in home prices have been Los Angeles(-10.7% annualized), Washington, DC (-8.8% annualized), and New York/San Francisco at -5.7% annualized.
The largest annual decline in home prices happened in Tampa (-11.12%), followed by Miami at -9.96%. Detroit, Las Vegas, and San Diego all have declines of over 9% YoY. Seattle and Charlotte are the two strongest housing markets, both rising around 4.7% YoY.
It is important to remember that even with the recent softening in house prices, over the longer term of three years, only four cities - Boston(-.84%), Detroit(-9.72%), Cleveland(-2%), and San Diego(-3.39%) - have lower house prices. Over these past three years, Phoenix, Seattle, and Portland still have house prices that are over 40% higher than they were three years earlier, on average.
The bottom line is that housing price declines are accelerating and spreading across the country to all regions. Economists are now calling for national house prices to have declined around 7% YoY by the end of 2007.
Monday, November 26, 2007
Today's Tidbits
Impact of Tighter Credit Conditions on Consumers
From USA Today: “Each week brings fresh evidence of how the credit crisis is causing damage. Last week, for example, the stock market fell after Goldman Sachs downgraded the nation's largest bank, Citigroup, to a sell. Goldman said the bank would likely have to write down $15 billion over the next two quarters, mainly because of its exposure to risky mortgage securities. And darker days probably lie ahead: Mortgage-related losses industry wide are likely to mount through 2009 and further bruise financial institutions, says Mark Zandi, chief economist at Moody's Economy.com. Such losses eat away at banks' capital reserves. That means they can't lend as much money. Goldman Sachs analysts predict that, overall, banks' exposure to risky mortgages could reduce the credit available to consumers and businesses by a staggering $2 trillion… Gary Perlin, Capital One's chief financial officer, said at an analysts' conference this month that the company has become more selective about granting credit cards and auto loans. And JPMorgan Chase says it's being more careful about issuing home-equity credit lines and auto loans, mainly for consumers with poor credit. "When there's less credit extended," says Jack Malvey, chief global fixed-income strategist at Lehman Bros., "it reduces world economic growth and puts the U.S. at risk of recession. The real damage of that could be measured in hundreds of billions of dollars and, depending on what happens to the world economy, it could be $1 trillion."… Credit bureau TransUnion's TrueCredit.com division has begun recommending that consumers maintain a credit score of at least 680 to qualify for prime rates. For years, TransUnion had recommended a score of only 650 or above.
Its rival Equifax has introduced a service to analyze a lender's portfolio to figure out the probability that existing customers or new applicants have adjustable-rate mortgages. Based partly on this factor, lenders could decide to withhold, or to increase, credit to certain consumers….In recent years, consumers have borrowed record-high amounts from credit cards. Revolving balances on credit cards are at an all-time peak, with U.S. households owing a monthly average of $6,960 in the year that ended in September 2007, up 41% from four years ago, according to Synovate, a research firm in New York… By the time the housing slump bottoms out, $1.7 trillion in housing wealth will have been lost, economic consulting firm Global Insight estimates. For each dollar that a home falls in value, consumer spending falls by 4 cents to 9 cents, Fed Chairman Ben Bernanke recently told Congress. That could lead to a drop in consumer spending of as much as $153 billion over several years. While that's no pittance, it's only a fraction of the $9.2 trillion that consumers spent in 2006. Consumers, in turn, are likely to have difficulty gaining access to money. Peters, the Morgan Stanley credit strategist, says the "virtuous cycle of packaging and selling credit has turned vicious." "The impact on the economy and consumers has yet to fully play out," he says. "We're still in the early stages.’”
From Merrill Lynch: “…since the last round of rate relief in late October, the Dow is down nearly 1000 points (was that supposed to happen?). Not only is the stock market down but 9 out of the 10 sectors are in the red, including those allegedly 'recession-proof' groups such as the materials, tech and industrials, which are down more than 8% on average (the only sector up is consumer staples - +0.5% - which is where you want to be in a recessionary backdrop). The VIX has surged 31.3% to a four-year high (but isn't Fed easing supposed to awaken investor "animal spirits"?); Libor and jumbo mortgage rates have actually risen (oh, great - so the Fed rate cut has reduced borrowing costs for Uncle Sam and that's it); and credit spreads have widened sharply (what happened to that great "liquidity" story?). The commercial paper market continues to shrink at a rate that boggles the mind - by $20.8 bln in the November 21 week and by more than $30 bln since the last Fed rate cut. And what this means is that the "shadow banking system" is contracting and more unanticipated assets are showing up on bank balance sheets at the same time. This bulge in the banking sector balance sheet then ties up regulatory capital and in turn ends up curtailing lending growth - this is how credit crunches get started… Since the last FOMC meeting, the futures market has gone from pricing in a December 11 rate cut from 30% odds to practically 100% today; and one must wonder whether the Fed will end up going 50 bps.”
Dow Theory Indicates Stocks Entering Bear Market
From UBS (last Wednesday morning): “Both the Dow Industrials and the S&P 500 are nearing critical support levels that could come into play today if things turn ugly. .. there is a very well-defined, 4.5 year Bull trend in the S&P 500 that comes in today at roughly 1,409. There is well-defined Bearish Divergence seen in the Weekly chart (higher highs in price July to October and lower highs in momentum over the same time) and momentum points South…Dow Theory. Dow Theory holds that Transports and the broader Dow should move in the same direction and when there is divergence, a change in trend is likely for the stock market. The theory goes that the Industrials can’t bask in the glow of higher prices when the shippers who move the goods are struggling. Both the Dow Industrials and the Dow Transports hit intermediate lows on August 16th, 2007—the day before the Fed surprised the market with a Discount Rate cut. What’s worrisome is that the Transports have taken out and closed below their August 16th low—a troubling divergence between the Transports and the Dow Industrials…the August 16th lows in the DJIA (12,518) are a huge support for the broader stock market—a close below this level would bring technical confirmation that a bear market us upon us. There’s also Bearish Divergence in the two charts as well: note how the Dow Industrials made higher highs in the July to October period (like S&P’s) while the Transports made ever-lower highs. Troubling to say the least.”
From MarketWatch: “With the Dow Jones Industrial Average's finish on Wednesday below its August lows, the three Dow Theory newsletters I track are solidly in the bearish camp… Why should you care about the Dow Theory? One reason is that many investors pay close attention to it. I suspect that was one of the reasons that the DJIA seesawed all day Wednesday above and below its August closing low of 12,846. In fact, it wasn't until the final few minutes of trading that it became clear that it would close below that level, and thereby trigger a Dow Theory sell signal. The Dow Theory's popularity should trigger additional selling when investors currently on vacation return from their Thanksgiving holidays, either on Friday, or more likely this coming Monday. Another reason to pay attention to the Dow Theory: Its long-term track record is good. Confirmation comes from none other than the Ivory Tower, which traditionally has pooh-poohed the notion that the stock market could be timed. Consider a study conducted in the mid-1990s by three finance professors -- Stephen J. Brown of New York University, William Goetzmann of Yale University and Alok Kumar of the University of Texas at Austin. They fed Hamilton's market-timing editorials from the early decades of the last century into neural networks, a type of artificial intelligence software that can be "trained" to detect patterns. Upon testing this neural network version of the Dow Theory over the nearly 70-year period from 1930 to the end of 1997, they found that it beat a buy-and-hold by an annual average of 4.4 percentage points per year.”
Fed To Help Ease Year-End Funding Pressures
From the Fed: "In response to heightened pressures in money markets for funding
through the year-end, the Federal Reserve Bank of New York's Open Market Trading Desk plans to conduct a series of term repurchase agreements that will extend into the new year. The first such operation will be arranged and settle on Wednesday, November 28, and mature on January 10, 2008, for an amount of about $8 billion. The timing and amounts of subsequent term operations spanning the year-end will be influenced by market and reserve developments. In addition, the Desk plans to provide sufficient reserves to resist upward pressures on the federal funds rate above the FOMC's target rate around year-end."
From Barclays: “…the Fed Funds vs. LIBOR basis swap…spread has moved much wider from its August level. The second more subtle observation is that the forwards have continued to creep higher over time. My interpretation of this is that the market is finally starting to see that the denouement of the current credit problems will not lead back to the excess liquidity of the 2005/2006 cycle. More simply, even after we move beyond a period of extreme tight liquidity, we will rest at a level of Fed Funds at around 20 bps. This is consistent with banks actually serving their traditional roles as lenders of capitals with true funding needs – in stark contrast to 2005-2006 when banks were mainly financial intermediaries.”
From Morgan Stanley: “The repo desk thinks that the rates accepted at Wednesday's operation could give a clear, and to many people surprising, indication of the sort of balance sheet pressures being faced over year end. Today's daily operation yielded average rates of 4.20% for Treasuries, 4.65% for agencies, and 4.70% for mortgages. Based on where repo rates are currently trading over the year end turn, he thinks at Wednesday's term operation Treasuries will have a 3-handle, agencies will be in the high 4's, and mortgages will have a 5-handle. This would be a stark illustration in particular of the balance sheet issues seen funding mortgages over year end. He thinks if the Fed does enough of these operations it could help the LIBOR situation, but the looming near-term at least psychological negative in the LIBOR market is expected to be a 35 bp surge in the 1-month rate (which was 4.80% today) on Thursday when it moves to start encompassing the year end turn.”
From JP Morgan: “Following this morning's announcement of longer-term repo operations to supply year-end liquidity, the NY Fed also announced temporary changes to the securities lending program of the System Open Market Account (SOMA). The securities lending program makes the SOMA's $775 billion portfolio of Treasury securities available for borrowing by primary dealers (collateralized by other Treasury securities) in order to promote clearing and liquidity in the Treasury market. Previously, the SOMA would lend 65% of its holding of any given Treasury security -- that limit has been raised to 90%. Moreover, each primary dealer was limited to 20% with a maximum $500 million per issue (of the 65% available for borrowing) -- those limits have been raised to 25% with a maximum $750 million per issue (of the 90% available for borrowing). Finally, the minimum maturity of securities lent was 13 days, that has been shortened to 6 days. Today's two successive actions by the NY Fed appear aimed at encouraging confidence that the Fed is prepared to act to stem the stresses associated with year-end funding needs.”
Contagion Spreading to Asia as Short-Term Interest Rates Plummet
From the Telegraph: “The global credit crisis has hit Asia with a vengeance for the first time, triggering a massive flight to safety as investors across the region pull out of risky assets. Yields on three-month deposits in China and Korea have plummeted to near 1pc in a spectacular fall over recent days, caused by panic withdrawls from money market funds and credit derivatives… Korean and Chinese three-month yields have fallen from 4pc to 1pc in a matter of days in a eerie replay of events on Wall Street in late August when flight from banks and the US commercial paper markets caused yields on three-month Treasuries to falls at the fastest rate ever recorded. Asian investors appear to be opting for deposit accounts with government guarantees. It is unclear what prompted this latest "heart attack" in the credit system, though rumours abound that Asian banks have yet to own up to their share of the expected $400bn to $500bn losses from the US mortgage debacle… In a rare move, the European Covered Bond Council said it was suspending trading of mortgage-linked bonds in the inter-bank-market owing to the "undue over-acceleration in the widening of spreads"… Charles Dumas, chief strategist for Lombard Street Research, said credit woes had led to an alarming spike in the 'Ted spread' between commercial Libor and US Treasury bills, now near 150 basis points. "Libor is at a premium to T-bills not matched the great crash in 1987," he said.”
Rating Agency Reviews of Monoline Insurers Expected Soon
From Dow Jones: “As soon as this week, markets may get a clearer picture of the vulnerabilities of bond insurers to the broadening subprime mortgage contagion. The sector has been pummeled by uncertainty in the past weeks, with share prices tumbling and credit protection costs jumping higher. Investors fear that if the bond insurers, linchpins of the asset-backed, structured finance and municipal bond markets, lose their triple-A ratings, the ramifications for the broader fixed-income markets could be dire.
As the worries have mounted, investors are shunning insured deals, bringing parts of the asset-backed market to a standstill. Bond insurers live off their stellar creditworthiness. Other, less-well-rated issuers tap the insurers to guarantee, or in industry parlance, wrap their bonds to give them a better rating. That makes it cheaper for the issuers to raise funds. But as the subprime mortgage market woes have spread, setting off a broader credit crunch, the ratings firms are taking a closer look at the bond insurers. In particular, they’re looking at their business of selling credit default swaps to insure structured securities such as collateralized debt obligations, or CDOs, many of which are backed by subprime mortgages. Moody’s Investors Service is expected this week or the next to issue a report evaluating the the capital cushion needed to maintain the firms’ Triple-A ratings. Fitch Ratings’ update may be released in early December. Standard & Poor’s Ratings Service plans to complete its review within the next two or three weeks. “Results will be worse and put some of the monolines in a position where they’ll have to raise more capital,” Seth Glasser, director of U.S. credit research at Barclays Capital, recently predicted in a conference call about the stress tests. Downgrades would follow if the insurers have insufficient capital.”
Misc
From Merrill Lynch: “We believe we are going to see a recession in '08”
From UBS: “On Wednesday the Treasury 2yr versus Fed Funds spread re-tested -150bp for only the third time in the last 20+ years. In the last two times that this spread has reached such stretched/stressed levels, a recession has followed.”
From Barclays: “…the slowdown in Home Price Appreciation (HPA) will lead to much slower prepayments which, in turn, will cause mortgages to lengthen in duration. In the vol sector, this ripple effect will lead to much greater demand for vol from mortgage hedgers, particularly in longer dated options.”
From RBSGC: “MBS holdings by US banks increased $7 bn with pass-through and CMO holdings higher by $5 bn and $2 bn, respectively. MBS holdings were down $43 bn since the start of this year. Deposits increased $74 bn over the past week. Since the start of this year, deposits increased $518 bn. Commercial and industrial loans increased $6 bn for all banks over the week. Since the start of the year, C&I loans increased $209 bn. Whole loan holdings decreased $25 bn over the week. Since the beginning of the year, whole loan holdings increased by $186 bn.”
From Bank of America: “Given huge liquidity premiums in the market both because of flight to quality and balance sheet issues affecting 4 large dealers with Nov 30 y/e, we expect a lot of volatility in the rolls this time around and a fairly wide band of uncertainty around the opening levels. We expect the 2yr and 5yr [Treasury] auction sizes to be unchanged at $20bn and $13bn respectively. This would raise $13.8bn of new cash for the Treasury.”
From the Wall Street Journal: “In recent weeks, regulators have quietly ordered China’s commercial banks to freeze lending through the end of the year, according to bankers in several cities. The bankers say that to comply, they are canceling loans and credit lines with businesses and individuals. A China Banking Regulatory Commission official here confirmed that local and Chinese subsidiaries of foreign banks have been asked to ensure that loans at the end of the year don’t exceed the total outstanding on Oct. 31. The official described the request as “guidance aimed at supporting the macro-control measures being implemented."”
From Merrill Lynch: “Chicago Fed National Activity Index is one of the most reliable real-time indictors of economic activity…This index slid 0.73 points in October from a -0.25 average in 3Q - it is now down three months in a row and in five of the past six. We haven't seen a number that low since April 2003 when the corporate sector froze up between the onset of Sarbanes-Oxley and the Iraq war and the Fed was fretting over deflation risks and the jobless recovery.”
From RBSGC: “…the Defined Benefit pension world has closed a massive asset/liability gap that may have been as much as $400 mn 5 years ago. That's due almost entirely to gains on their equity assets. But over the course of these 5 yrs the asset allocation has swung to heavily overweighted equities -- equities as a % of the total have increased by 10-12%. Point being, with FASB in force next year there is a good reason to find pension funds reallocating to a less volatile mix, i.e. more fixed income and fewer stocks.”
End-of-Day Market Update
From UBS: “Treasuries enjoyed a parabolic ascent today as yields on notes and bonds fell by 14-17 bps on the day. Although the curve has tended to steepen during rallies such as this, we actually saw the 2s10s curve more than 2bps flatter at 3pm. Impressively, the curve was back steeper by late in the session as stocks fell by more than 200pts… Swaps saw receiving in the long end on both rates and spread, and spreads narrowed across the board; particularly in the back end. Agencies had only light flows, and although they richened to swaps in the front end, 10-year agencies cheapened to between Libor flat and L+1 by 3pm. Mortgages also had a fairly quiet day, with FNMA 5.5's going 3 ticks tighter to Treasuries and 1.5 wider to swaps, and 6's widening a plus to Treasuries and 3 ticks to swaps.”
From RBSGC: “Stocks reverse gains with Dec S&P closing at a new low under 1425 for an outside day down. The bond market got a strong FLATTENING bid on Monday for some obvious and not so obvious reasons. That reversed later in the day as stocks caved in, but was the dominant theme. In the first instance, stocks gave up the limited gain of Friday and with no key fundamental news tended to capture attention. We note that both Fannie and Freddie were down nearly 10% at one point. News? Nothing specific though some analyst did cut buy recommendations -- with the stock down nearly 64% YTD we wonder why that type of recommendation would be deemed new information. The new element we've NOT seen until today was convexity related buying as swap yields in the 10yr sector came through 4.75% and MBS outperformerd Treasuries. This forced some duration buying… And our long expectation that weaker stocks and the calendar will drive pension funds to reallocate could be at least partial explanation for the very long end's outperformance. Flows were below average today…”
From Deutsche Bank: “10-yr bond yields decline to new lows, carry currencies soften, TED spread widens, LIBOR basis spread also wider in the US…”
Three month T-Bill yield fell 11bp to 3.10%.
Two year T-Note yield fell 21bp to 2.87%
Ten year T-Note yield fell 17bp to 3.83%
Dow fell 237 to 12,743
S&P 500 fell 33.5 to 1407
Dollar index fell .29 to 74.76, another new record low
Yen fell .94 to 107.37 per dollar
Euro rose .003 to 1.487, a new record high close
Gold unchanged at $824
Oil fell $1.15 to $97.03
*All prices as of 4:45pm
From USA Today: “Each week brings fresh evidence of how the credit crisis is causing damage. Last week, for example, the stock market fell after Goldman Sachs downgraded the nation's largest bank, Citigroup, to a sell. Goldman said the bank would likely have to write down $15 billion over the next two quarters, mainly because of its exposure to risky mortgage securities. And darker days probably lie ahead: Mortgage-related losses industry wide are likely to mount through 2009 and further bruise financial institutions, says Mark Zandi, chief economist at Moody's Economy.com. Such losses eat away at banks' capital reserves. That means they can't lend as much money. Goldman Sachs analysts predict that, overall, banks' exposure to risky mortgages could reduce the credit available to consumers and businesses by a staggering $2 trillion… Gary Perlin, Capital One's chief financial officer, said at an analysts' conference this month that the company has become more selective about granting credit cards and auto loans. And JPMorgan Chase says it's being more careful about issuing home-equity credit lines and auto loans, mainly for consumers with poor credit. "When there's less credit extended," says Jack Malvey, chief global fixed-income strategist at Lehman Bros., "it reduces world economic growth and puts the U.S. at risk of recession. The real damage of that could be measured in hundreds of billions of dollars and, depending on what happens to the world economy, it could be $1 trillion."… Credit bureau TransUnion's TrueCredit.com division has begun recommending that consumers maintain a credit score of at least 680 to qualify for prime rates. For years, TransUnion had recommended a score of only 650 or above.
Its rival Equifax has introduced a service to analyze a lender's portfolio to figure out the probability that existing customers or new applicants have adjustable-rate mortgages. Based partly on this factor, lenders could decide to withhold, or to increase, credit to certain consumers….In recent years, consumers have borrowed record-high amounts from credit cards. Revolving balances on credit cards are at an all-time peak, with U.S. households owing a monthly average of $6,960 in the year that ended in September 2007, up 41% from four years ago, according to Synovate, a research firm in New York… By the time the housing slump bottoms out, $1.7 trillion in housing wealth will have been lost, economic consulting firm Global Insight estimates. For each dollar that a home falls in value, consumer spending falls by 4 cents to 9 cents, Fed Chairman Ben Bernanke recently told Congress. That could lead to a drop in consumer spending of as much as $153 billion over several years. While that's no pittance, it's only a fraction of the $9.2 trillion that consumers spent in 2006. Consumers, in turn, are likely to have difficulty gaining access to money. Peters, the Morgan Stanley credit strategist, says the "virtuous cycle of packaging and selling credit has turned vicious." "The impact on the economy and consumers has yet to fully play out," he says. "We're still in the early stages.’”
From Merrill Lynch: “…since the last round of rate relief in late October, the Dow is down nearly 1000 points (was that supposed to happen?). Not only is the stock market down but 9 out of the 10 sectors are in the red, including those allegedly 'recession-proof' groups such as the materials, tech and industrials, which are down more than 8% on average (the only sector up is consumer staples - +0.5% - which is where you want to be in a recessionary backdrop). The VIX has surged 31.3% to a four-year high (but isn't Fed easing supposed to awaken investor "animal spirits"?); Libor and jumbo mortgage rates have actually risen (oh, great - so the Fed rate cut has reduced borrowing costs for Uncle Sam and that's it); and credit spreads have widened sharply (what happened to that great "liquidity" story?). The commercial paper market continues to shrink at a rate that boggles the mind - by $20.8 bln in the November 21 week and by more than $30 bln since the last Fed rate cut. And what this means is that the "shadow banking system" is contracting and more unanticipated assets are showing up on bank balance sheets at the same time. This bulge in the banking sector balance sheet then ties up regulatory capital and in turn ends up curtailing lending growth - this is how credit crunches get started… Since the last FOMC meeting, the futures market has gone from pricing in a December 11 rate cut from 30% odds to practically 100% today; and one must wonder whether the Fed will end up going 50 bps.”
Dow Theory Indicates Stocks Entering Bear Market
From UBS (last Wednesday morning): “Both the Dow Industrials and the S&P 500 are nearing critical support levels that could come into play today if things turn ugly. .. there is a very well-defined, 4.5 year Bull trend in the S&P 500 that comes in today at roughly 1,409. There is well-defined Bearish Divergence seen in the Weekly chart (higher highs in price July to October and lower highs in momentum over the same time) and momentum points South…Dow Theory. Dow Theory holds that Transports and the broader Dow should move in the same direction and when there is divergence, a change in trend is likely for the stock market. The theory goes that the Industrials can’t bask in the glow of higher prices when the shippers who move the goods are struggling. Both the Dow Industrials and the Dow Transports hit intermediate lows on August 16th, 2007—the day before the Fed surprised the market with a Discount Rate cut. What’s worrisome is that the Transports have taken out and closed below their August 16th low—a troubling divergence between the Transports and the Dow Industrials…the August 16th lows in the DJIA (12,518) are a huge support for the broader stock market—a close below this level would bring technical confirmation that a bear market us upon us. There’s also Bearish Divergence in the two charts as well: note how the Dow Industrials made higher highs in the July to October period (like S&P’s) while the Transports made ever-lower highs. Troubling to say the least.”
From MarketWatch: “With the Dow Jones Industrial Average's finish on Wednesday below its August lows, the three Dow Theory newsletters I track are solidly in the bearish camp… Why should you care about the Dow Theory? One reason is that many investors pay close attention to it. I suspect that was one of the reasons that the DJIA seesawed all day Wednesday above and below its August closing low of 12,846. In fact, it wasn't until the final few minutes of trading that it became clear that it would close below that level, and thereby trigger a Dow Theory sell signal. The Dow Theory's popularity should trigger additional selling when investors currently on vacation return from their Thanksgiving holidays, either on Friday, or more likely this coming Monday. Another reason to pay attention to the Dow Theory: Its long-term track record is good. Confirmation comes from none other than the Ivory Tower, which traditionally has pooh-poohed the notion that the stock market could be timed. Consider a study conducted in the mid-1990s by three finance professors -- Stephen J. Brown of New York University, William Goetzmann of Yale University and Alok Kumar of the University of Texas at Austin. They fed Hamilton's market-timing editorials from the early decades of the last century into neural networks, a type of artificial intelligence software that can be "trained" to detect patterns. Upon testing this neural network version of the Dow Theory over the nearly 70-year period from 1930 to the end of 1997, they found that it beat a buy-and-hold by an annual average of 4.4 percentage points per year.”
Fed To Help Ease Year-End Funding Pressures
From the Fed: "In response to heightened pressures in money markets for funding
through the year-end, the Federal Reserve Bank of New York's Open Market Trading Desk plans to conduct a series of term repurchase agreements that will extend into the new year. The first such operation will be arranged and settle on Wednesday, November 28, and mature on January 10, 2008, for an amount of about $8 billion. The timing and amounts of subsequent term operations spanning the year-end will be influenced by market and reserve developments. In addition, the Desk plans to provide sufficient reserves to resist upward pressures on the federal funds rate above the FOMC's target rate around year-end."
From Barclays: “…the Fed Funds vs. LIBOR basis swap…spread has moved much wider from its August level. The second more subtle observation is that the forwards have continued to creep higher over time. My interpretation of this is that the market is finally starting to see that the denouement of the current credit problems will not lead back to the excess liquidity of the 2005/2006 cycle. More simply, even after we move beyond a period of extreme tight liquidity, we will rest at a level of Fed Funds at around 20 bps. This is consistent with banks actually serving their traditional roles as lenders of capitals with true funding needs – in stark contrast to 2005-2006 when banks were mainly financial intermediaries.”
From Morgan Stanley: “The repo desk thinks that the rates accepted at Wednesday's operation could give a clear, and to many people surprising, indication of the sort of balance sheet pressures being faced over year end. Today's daily operation yielded average rates of 4.20% for Treasuries, 4.65% for agencies, and 4.70% for mortgages. Based on where repo rates are currently trading over the year end turn, he thinks at Wednesday's term operation Treasuries will have a 3-handle, agencies will be in the high 4's, and mortgages will have a 5-handle. This would be a stark illustration in particular of the balance sheet issues seen funding mortgages over year end. He thinks if the Fed does enough of these operations it could help the LIBOR situation, but the looming near-term at least psychological negative in the LIBOR market is expected to be a 35 bp surge in the 1-month rate (which was 4.80% today) on Thursday when it moves to start encompassing the year end turn.”
From JP Morgan: “Following this morning's announcement of longer-term repo operations to supply year-end liquidity, the NY Fed also announced temporary changes to the securities lending program of the System Open Market Account (SOMA). The securities lending program makes the SOMA's $775 billion portfolio of Treasury securities available for borrowing by primary dealers (collateralized by other Treasury securities) in order to promote clearing and liquidity in the Treasury market. Previously, the SOMA would lend 65% of its holding of any given Treasury security -- that limit has been raised to 90%. Moreover, each primary dealer was limited to 20% with a maximum $500 million per issue (of the 65% available for borrowing) -- those limits have been raised to 25% with a maximum $750 million per issue (of the 90% available for borrowing). Finally, the minimum maturity of securities lent was 13 days, that has been shortened to 6 days. Today's two successive actions by the NY Fed appear aimed at encouraging confidence that the Fed is prepared to act to stem the stresses associated with year-end funding needs.”
Contagion Spreading to Asia as Short-Term Interest Rates Plummet
From the Telegraph: “The global credit crisis has hit Asia with a vengeance for the first time, triggering a massive flight to safety as investors across the region pull out of risky assets. Yields on three-month deposits in China and Korea have plummeted to near 1pc in a spectacular fall over recent days, caused by panic withdrawls from money market funds and credit derivatives… Korean and Chinese three-month yields have fallen from 4pc to 1pc in a matter of days in a eerie replay of events on Wall Street in late August when flight from banks and the US commercial paper markets caused yields on three-month Treasuries to falls at the fastest rate ever recorded. Asian investors appear to be opting for deposit accounts with government guarantees. It is unclear what prompted this latest "heart attack" in the credit system, though rumours abound that Asian banks have yet to own up to their share of the expected $400bn to $500bn losses from the US mortgage debacle… In a rare move, the European Covered Bond Council said it was suspending trading of mortgage-linked bonds in the inter-bank-market owing to the "undue over-acceleration in the widening of spreads"… Charles Dumas, chief strategist for Lombard Street Research, said credit woes had led to an alarming spike in the 'Ted spread' between commercial Libor and US Treasury bills, now near 150 basis points. "Libor is at a premium to T-bills not matched the great crash in 1987," he said.”
Rating Agency Reviews of Monoline Insurers Expected Soon
From Dow Jones: “As soon as this week, markets may get a clearer picture of the vulnerabilities of bond insurers to the broadening subprime mortgage contagion. The sector has been pummeled by uncertainty in the past weeks, with share prices tumbling and credit protection costs jumping higher. Investors fear that if the bond insurers, linchpins of the asset-backed, structured finance and municipal bond markets, lose their triple-A ratings, the ramifications for the broader fixed-income markets could be dire.
As the worries have mounted, investors are shunning insured deals, bringing parts of the asset-backed market to a standstill. Bond insurers live off their stellar creditworthiness. Other, less-well-rated issuers tap the insurers to guarantee, or in industry parlance, wrap their bonds to give them a better rating. That makes it cheaper for the issuers to raise funds. But as the subprime mortgage market woes have spread, setting off a broader credit crunch, the ratings firms are taking a closer look at the bond insurers. In particular, they’re looking at their business of selling credit default swaps to insure structured securities such as collateralized debt obligations, or CDOs, many of which are backed by subprime mortgages. Moody’s Investors Service is expected this week or the next to issue a report evaluating the the capital cushion needed to maintain the firms’ Triple-A ratings. Fitch Ratings’ update may be released in early December. Standard & Poor’s Ratings Service plans to complete its review within the next two or three weeks. “Results will be worse and put some of the monolines in a position where they’ll have to raise more capital,” Seth Glasser, director of U.S. credit research at Barclays Capital, recently predicted in a conference call about the stress tests. Downgrades would follow if the insurers have insufficient capital.”
Misc
From Merrill Lynch: “We believe we are going to see a recession in '08”
From UBS: “On Wednesday the Treasury 2yr versus Fed Funds spread re-tested -150bp for only the third time in the last 20+ years. In the last two times that this spread has reached such stretched/stressed levels, a recession has followed.”
From Barclays: “…the slowdown in Home Price Appreciation (HPA) will lead to much slower prepayments which, in turn, will cause mortgages to lengthen in duration. In the vol sector, this ripple effect will lead to much greater demand for vol from mortgage hedgers, particularly in longer dated options.”
From RBSGC: “MBS holdings by US banks increased $7 bn with pass-through and CMO holdings higher by $5 bn and $2 bn, respectively. MBS holdings were down $43 bn since the start of this year. Deposits increased $74 bn over the past week. Since the start of this year, deposits increased $518 bn. Commercial and industrial loans increased $6 bn for all banks over the week. Since the start of the year, C&I loans increased $209 bn. Whole loan holdings decreased $25 bn over the week. Since the beginning of the year, whole loan holdings increased by $186 bn.”
From Bank of America: “Given huge liquidity premiums in the market both because of flight to quality and balance sheet issues affecting 4 large dealers with Nov 30 y/e, we expect a lot of volatility in the rolls this time around and a fairly wide band of uncertainty around the opening levels. We expect the 2yr and 5yr [Treasury] auction sizes to be unchanged at $20bn and $13bn respectively. This would raise $13.8bn of new cash for the Treasury.”
From the Wall Street Journal: “In recent weeks, regulators have quietly ordered China’s commercial banks to freeze lending through the end of the year, according to bankers in several cities. The bankers say that to comply, they are canceling loans and credit lines with businesses and individuals. A China Banking Regulatory Commission official here confirmed that local and Chinese subsidiaries of foreign banks have been asked to ensure that loans at the end of the year don’t exceed the total outstanding on Oct. 31. The official described the request as “guidance aimed at supporting the macro-control measures being implemented."”
From Merrill Lynch: “Chicago Fed National Activity Index is one of the most reliable real-time indictors of economic activity…This index slid 0.73 points in October from a -0.25 average in 3Q - it is now down three months in a row and in five of the past six. We haven't seen a number that low since April 2003 when the corporate sector froze up between the onset of Sarbanes-Oxley and the Iraq war and the Fed was fretting over deflation risks and the jobless recovery.”
From RBSGC: “…the Defined Benefit pension world has closed a massive asset/liability gap that may have been as much as $400 mn 5 years ago. That's due almost entirely to gains on their equity assets. But over the course of these 5 yrs the asset allocation has swung to heavily overweighted equities -- equities as a % of the total have increased by 10-12%. Point being, with FASB in force next year there is a good reason to find pension funds reallocating to a less volatile mix, i.e. more fixed income and fewer stocks.”
End-of-Day Market Update
From UBS: “Treasuries enjoyed a parabolic ascent today as yields on notes and bonds fell by 14-17 bps on the day. Although the curve has tended to steepen during rallies such as this, we actually saw the 2s10s curve more than 2bps flatter at 3pm. Impressively, the curve was back steeper by late in the session as stocks fell by more than 200pts… Swaps saw receiving in the long end on both rates and spread, and spreads narrowed across the board; particularly in the back end. Agencies had only light flows, and although they richened to swaps in the front end, 10-year agencies cheapened to between Libor flat and L+1 by 3pm. Mortgages also had a fairly quiet day, with FNMA 5.5's going 3 ticks tighter to Treasuries and 1.5 wider to swaps, and 6's widening a plus to Treasuries and 3 ticks to swaps.”
From RBSGC: “Stocks reverse gains with Dec S&P closing at a new low under 1425 for an outside day down. The bond market got a strong FLATTENING bid on Monday for some obvious and not so obvious reasons. That reversed later in the day as stocks caved in, but was the dominant theme. In the first instance, stocks gave up the limited gain of Friday and with no key fundamental news tended to capture attention. We note that both Fannie and Freddie were down nearly 10% at one point. News? Nothing specific though some analyst did cut buy recommendations -- with the stock down nearly 64% YTD we wonder why that type of recommendation would be deemed new information. The new element we've NOT seen until today was convexity related buying as swap yields in the 10yr sector came through 4.75% and MBS outperformerd Treasuries. This forced some duration buying… And our long expectation that weaker stocks and the calendar will drive pension funds to reallocate could be at least partial explanation for the very long end's outperformance. Flows were below average today…”
From Deutsche Bank: “10-yr bond yields decline to new lows, carry currencies soften, TED spread widens, LIBOR basis spread also wider in the US…”
Three month T-Bill yield fell 11bp to 3.10%.
Two year T-Note yield fell 21bp to 2.87%
Ten year T-Note yield fell 17bp to 3.83%
Dow fell 237 to 12,743
S&P 500 fell 33.5 to 1407
Dollar index fell .29 to 74.76, another new record low
Yen fell .94 to 107.37 per dollar
Euro rose .003 to 1.487, a new record high close
Gold unchanged at $824
Oil fell $1.15 to $97.03
*All prices as of 4:45pm
Two Year Treasury Yield
Ten Year Treasury Yield
Dow Jones Industrial Average
Dow Jones Transportation Index
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