Thursday, May 31, 2007

Hovnanian Posts Loss and Issues Grim Guidance

From the

Hovnanian (HOV - Cramer's Take - Stockpickr - Rating) reported a second-quarter loss and painted a bleak picture about the ongoing real estate slowdown, saying the housing market has gotten worse after showing signs of improvement earlier this year.

The Red Bank, N.J., homebuilder withdrew its full-year guidance because of the "increased uncertainty of housing market conditions."

For the quarter ended April 30, Hovnanian recorded a loss of $30.7 million, or 49 cents a share, compared with a year-earlier profit of $101 million, or $1.55 per share. The results were in line with management's previous guidance for a 50-cent loss.

Results were dragged down by $34.4 million of pretax charges related to land impairment and write-offs of predevelopment costs and land deposits. Such writedowns resulted from a continued decline in sales paces and general market conditions in many of the company's communities, Hovnanian said.

Total revenue decreased 29.4% to $1.1 billion in the second quarter. The number of net contracts for new sales, excluding unconsolidated joint ventures, tumbled 21.4% to 3,116 units.

"We are frustrated to report that the housing market has continued to slip further in many locations in terms of both sales pace and sales prices," CEO Ara K. Hovnanian said in a statement. "The housing market weakened in the latter part of the second quarter and the slower conditions have continued into May. Lower prices offered to buyers to close homes during the quarter also led to a further reduction in margins and a net loss for the quarter."

No guidance issued, a big loss for the quarter and a market that "has continued to slip further in many locations in terms of both sales pace and sales prices."

Simply put -- this report indicates housing isn't anywhere near a bottom.

Have We Dodged a Recession?

From MSNBC (and Bonddad's fabulous girlfriend)

After a relatively good showing of 2.5 percent growth in the fourth quarter of last year, the U.S. economy slammed on the brakes in the first three months of 2007. Originally pegged at 1.6 percent growth, the government revised that estimate to just 0.6 percent — barely dodging an outright downturn.

An ongoing slump in the housing market, along with layoffs in construction, real estate, mortgage banking and other related industries, has weighed heavily on the economy. Fearing a further slowdown, businesses cut back sharply on inventories in the first quarter to avoid getting caught with unsold goods. That only made the slowdown worse.

That sums up the current problems nicely. Although consumer spending has been strong, business and residential investment has slowed down, leading some to become very concerned about the coming quarters.

But over the past two months there have been signs that business is picking up again. One of the latest came Thursday from a closely watched index of buying by purchasing managers, which moved higher than expected in May and showed strong growth in manufacturing across a broad range of industries. So the sharp cut in inventories in the first quarter may already be helping the economy get back on its feet again.

Bloomberg has more on this:

A measure of U.S. business activity jumped more than forecast in May, signaling expansion for the third consecutive month and suggesting the economy is accelerating after bottoming in the first quarter.

The National Association of Purchasing Management-Chicago said today its business barometer rose to 61.7 in May from 52.9 the prior month. Readings greater than 50 signal expansion,

Export demand and business investment in new equipment are helping to cushion the drag on the economy from the deepest housing recession in a decade and a half. The report lends support to Federal Reserve Chairman Ben S. Bernanke's forecast that the economy may pick up pace later in the year.

``This is a solid report all around and it represents a clear break from the first two months of the year,'' Scott Anderson, senior economist at Wells Fargo Co. in Minneapolis, who had forecast an index reading of 55. ``It suggests that the inventory correction has run its course.''

Here's a link to the complete report. The overall index is showing an uptrend. It rose in February and March, retreated a bit in April, and rose again this month. The production and employment components have risen for 4 months. New orders spiked up in March, dropped in April and rose again this month. In short, the indicators within the index are looking pretty good right now.

Back to the MSNBC article:

>Businesses also seem to be getting back in a hiring mood. After a string of subpar monthly gains in employment, hiring in May appears to have picked up again. The latest jobs numbers from the government are due out Friday; economists are looking for non-farm payroll gains of about 130,000 in May, up from 88,000 in April, according a poll of economists by Reuters.

We'll have to see how the employment numbers shake out tomorrow.

Today's construction numbers (detailed below) also indicate business spending is increasing.

In summation, business is looking as though it is spending again. While it's not enough to send the economy into the stratosphere, it may be enough to keep up out of recession.

The biggest wild card in this picture is housing. While I originally thought this sector would cause a recession by now, I think the blog Calculated Risk had the correct answer: housing is going to be a drag on growth for some time. Considering builders don't expect a rebound until 2011 (their words, not mine), I think CR is correct.

This is where my concern about consumer spending really comes into play. We're already one year into the housing downturn. There's only so much bad news people can take before they pull in their wings and slow down their spending. I don't know where that level is (in fact, nobody does). But I think we're closer to it now than we were a year ago.

Construction Spending Increases

From CBS.Marketwatch:

Spending on U.S. construction projects rose 0.1% in April as a jump in private nonresidential construction outlays offset a drop in spending on residential projects.

Spending on private residential construction projects fell by 1.0% for the second consecutive month, the Commerce Department reported. Meanwhile, private nonresidential construction spending climbed by 1.5% in April, the government said.

Construction spending in March was revised to rise upward, by 0.6%, from a previously estimated gain of 0.2%

Here's a link (PDF) to the Census Bureau Report.

A few points.

1.) Nonresidential construction is a little under 52% of total construction spending. So long as nonresidential increases at the same pace residential decreases, overall construction spending will be fine.

2.) Nonresidential construction has increased 12.7% since April 2006, while residential has decreased 14.1%. Because these rates are pretty close to offsetting, I have to wonder if the increase in non-residential construction is absorbing the loss in jobs in the residential construction sector. Overall construction employment has barely dropped in the last year. According to the BLS, it has dropped from 7,699,000 to 7,680,000, or a loss of 19,000. The preceding assumes that nonresidential and residential labor is interchangeable and the nonresidential projects are happening in the same place.

3.) Practically every area of nonresidential spending increased, making the gains pretty broad based.

Think Housing Has Bottomed?

Go read this post from the Big Picture. Do it now. There's aren't even any words; it's 4 charts that will scare the bejeebus out of you.

On the Wachovia/AG Edwards Deal

From CBS.Marketwatch:

Pending completion of the deal late this year, the combination will give rise to the No. 2 retail brokerage in the U.S., with $1.1 trillion in client assets and a network of nearly 15,000 financial advisors serving clients nationwide.
The deal moves Wachovia up from the No. 3 spot and behind only Wall Street powerhouse Merrill Lynch & Co. Smith Barney had been the second largest retail brokerage.

The merger would also boost Wachovia's presence in three of the nation's largest states, according to analysts at Lehman Bros., with 25% of A.G. Edwards' assets located in California, Florida and Texas. It will almost double the number of retail offices Wachovia operates and give the bank the opportunity to sell its various banking products directly to A.G. Edwards' customers.

In his book One Up on Wall Street, Fidelity Fund manager Peter Lynch coined a term: "Deworsification." This occurs when a company buys another company that is in a completely different industry. This is the type of transaction to look for as a sign that M&A activity is getting overheated and is probably topping. However, this deal is not an example of this word.

This is a really good example of an intra-industry merger that makes tremendous sense. Wachovia has been using mergers to increase it's market presence in new areas, or to create synergies with existing areas. This is a good example of a company creating synergies. AG Edwards will combine with Wacovia's other assets to make a solid financial services firm. As the article explains:

The merger would also boost Wachovia's presence in three of the nation's largest states, according to analysts at Lehman Bros., with 25% of A.G. Edwards' assets located in California, Florida and Texas. It will almost double the number of retail offices Wachovia operates and give the bank the opportunity to sell its various banking products directly to A.G. Edwards' customers.


"The long-term growth opportunities of the brokerage industry are extremely compelling to Wachovia, and we have long expressed our interest in growing this business both organically and through acquisition," said Ken Thompson, Wachovia's chairman and chief executive, in a statement.

Yesterday, I wrote a piece about when all of the M&A activity would end. One of the conditions of that analysis was deals that went badly. This one probably won't. In fact, it's a really good example of a good deal (in my opinion).

In other words, this is the type of M&A we should be encouraging.

BEA Adjusts GDP Down to .6%

From Bloomberg

The U.S. economy grew last quarter at a 0.6 percent annual rate, the weakest in more than four years, as housing slumped, the trade deficit widened and businesses reduced inventories.

The gain in gross domestic product was weaker than the median forecast by economists and compares with a 1.3 percent pace initially estimated last month, according to revised figures from the Commerce Department today in Washington.

Last quarter may prove to be the low point for the economy as recent reports showed business spending improved and leaner stockpiles prompted factories to boost production, economists said. Such an outcome would bear out forecasts by Federal Reserve policy makers, who this month reiterated that growth will pickup for the rest of this year and into next.

``We're looking for a gradual firming in growth,'' Michael Feroli, an economist at JPMorgan Chase & Co. in New York, said before the report. ``The inventory situation is a lot more favorable, and the drag from housing will be reduced.''

From the BEA:

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 0.6 percent in the first quarter of 2007, according to preliminary estimates released by the Bureau of Economic Analysis. In the fourth quarter, real GDP increased 2.5 percent.

The GDP estimates released today are based on more complete source data than were available for the advance estimates issued last month. In the advance estimates, the increase in real GDP was 1.3 percent (see "Revisions" on page 3).

The increase in real GDP in the first quarter primarily reflected positive contributions from personal consumption expenditures (PCE) and state and local government spending that were partly offset by negative contributions from private inventory investment, residential fixed investment, and federal government spending. Imports, which are a subtraction in the calculation of GDP, increased.

The deceleration in real GDP growth in the first quarter primarily reflected an upturn in imports, downturns in exports and in federal government spending, and a deceleration in PCE for nondurable goods that were partly offset by an upturn in equipment and software, a smaller decrease in residential fixed investment, accelerations in PCE for durable goods and in PCE for services, and a smaller
decrease in private inventory investment.

Looking at the numbers we have the following.

Personal Consumption Expenditures increased at 4.4% seasonally adjusted annual rate. This is solid growth, and has been the backbone of the current economy.

Gross Private Domestic Investment decreased at a seasonally adjusted annual rate (SAAR) of 9.3%. Residential investment was the primary culprit, declining at a 15.4% SAAR.

Non-residential investment increased at a 2.9% SAAR. This is the weakest growth rate since the 4th quarter of 2003 and 1st quarter of '04.

Net exports decreased at a .6% seasonally adjusted annual rate while imports increased at a 5.7% SAAR.

Government spending increased at a 1% SAAR.

Let's see what the possibility of these trends continuing is.

PCEs had a bad April, with 79% of retailers reported disappointing earnings. However, the latest International Council of Shopping Centers weekly report showed a gain. So, consumers may have simply had a bad month. Tomorrow's income report will be very important.

There is sign business investment may be increasing. Last month's industrial production report showed a solid, across-the-board increase. We'll need a few more months of data before that trend is firmly in place.

Government expenditures come in waves, so expect to see this number rebound in the next few quarters.

Imports will be a drag on growth so long as the US is an oil importer. Exports will be less than imports for the foreseeable future.

So, going forward we need to pay special attention to two areas: consumer spending and business investment.

WSJ Gets The Fed Right

From the WSJ:

On May 9, the Fed left its short-term interest-rate target at 5.25%, where it has stood since last June. It released a statement reiterating that inflation remained its predominant concern and that policy makers considered inflation "elevated." That surprised some observers, given prior data showing inflation had slowed a bit.

The more confident outlook about economic activity would appear to diminish the odds that the Fed will cut interest rates in coming months. "Policy is on hold for as far as the eye can reasonably see," Joshua Shapiro, chief U.S. economist at consulting firm MFR Inc., said in a note to clients.

The Fed's continued focus on inflation, despite risks economic growth will slow, "suggests that the market should not expect a dramatic shift in Fed thinking without a dramatic shift in the economic data," Lehman Brothers economist Drew Matus said in a note to clients.

There's been a lot of talk about the possibility of a rate cut. However, the Fed's own statements have been incredibly consistent. They have consistently stated inflation is their primary concern. Every public statement dealing with the economy has had a paragraph about inflation which has universally had the sentiment, "inflation remains elevated and that makes us really unhappy."

I get a bit perturbed at the entire class of Fed prognosticators who read waaaaayyyyyy too much into the Fed statement. I think some of these people need to go back and take a remedial reading course.

Wednesday, May 30, 2007

An Interesting Rally

I was looking at the sector breakdown of today's rally on Marketgauge. There is something interesting lurking behind the market's performance. Today's volume of all industries except utilities was below average.

Yet, today's volume for the SPY's, QQQQs, IWNs and DIAs was higher than previous days.


FOMC Minutes

Here is a link to the Fed Minutes from May 9, 2007. Let's see how the Fed saw the economy a little under a month ago:

The information reviewed at the May meeting suggested that economic activity had expanded at a below-trend pace in recent months.

We pretty much already knew that.

The average monthly increase in payroll employment through the first four months of this year was well below the relatively strong pace recorded in the fourth quarter of 2006. In April, the construction industry continued to shed jobs, manufacturing employment declined further, and retailers reduced hiring after a large gain in March. The unemployment rate stood at 4.5 percent in April, similar to its average in the first quarter, and the labor force participation rate moved down.

This isn't that good, either. Weak job growth is always bad.

Industrial production increased at a modest annual rate of 1.4 percent in the first quarter, with the monthly pattern reflecting fluctuations in the output of utilities, which was influenced importantly by swings in weather conditions.

The Fed noted the last month was strong across the board, but that was only 1 month.

Real consumer expenditures increased at a brisk pace in the first quarter, although monthly gains in spending slowed over the course of the quarter, in part because of swings in weather-related outlays on energy goods and energy services.

This has been the real story of this slowdown -- the strength in consumer spending. It has remained strong for the last 4 quarters when other areas of the economy were slowing.

Residential construction activity remained soft as builders attempted to work off elevated inventories of unsold new homes.

I've covered this to death.

Real spending on equipment and software rose modestly in the first quarter after having fallen in the fourth quarter of 2006. Spending on high-tech equipment, boosted by a surge in outlays on computers, posted a substantial increase in the first quarter. In addition, purchases of communications equipment--which tend to be volatile quarter to quarter--rebounded strongly after a fourth-quarter dip. By contrast, spending on transportation equipment declined significantly:

One sub-area of business investment declined and one increased, making total growth "moderate".

Real nonfarm inventory investment excluding motor vehicles increased at a slower pace in the first quarter of 2007 than in the previous quarter. The downshift in inventory investment had helped to reduce the apparent overhangs that had emerged in late 2006.

In other words, business is stocking up on less stuff.

Economic activity in advanced foreign economies appeared to have grown at a steady rate in the first part of the year.

This is what may keep the US out of a recession. With a cheap dollar and the rest of the world's growth picking up, the US may be able to export enough to keep growth barely positive for the next quarter or so.

The total PCE price index rose substantially in both February and March. The advance in February was distributed across a broad range of categories, while the March increase was driven largely by a jump in the index for energy. Core PCE prices were unchanged in March after an upswing in February. Smoothing through the high-frequency movements, the twelve-month change in the core PCE price index in March was just a touch higher than the increase over the year-earlier period

OK -- I'll say this one more time. The Fed is not comfortable with inflation's current level. They've said it repeatedly for the last 6 months or so.

So -- where does this leave us?

1.) The economy is slowing, but we're not in a recession. While housing is slowing down, business investment is moderate and the consumer continues to spend at high rates. Job growth is weak. This makes Friday's number really important. Also remember, the 1st GDP revision comes out tomorrow.

2.) Inflation is too high for the Fed.

3.) Rates aren't coming own anytime soon.

Bonddad On the Huffington Post

The Huffington Post has started a business section and they have asked me to contribute. Here is a link to my first post.

I'll be writing longer, hopefully less "eco-geeky" posts there.

Pulte Homes Cuts 16% of Workforce

From CNBC:

Facing a grim housing market, Pulte Homes said Tuesday that it is cutting about 16% of its work force, or about 1,900 jobs, as part of a restructuring.

Pulte Homes Inc. one of the nation's leading homebuilders, said the restructuring will save an estimated $200 million a year before taxes.

"The homebuilding environment remains difficult, and our current overhead levels are structured for a business that is larger than the market presently allows," Richard J. Dugas Jr., president and chief executive, said in a news release.

Notice the public statement from the President and CEO: "The homebuilding environment remains difficult". This is at the same time new home sales spiked 16% last month.

I don't see how the new home sales figures aren't getting revised down with news like this.

When Will The M&A End?

From the Financial Times:

Buy-out groups in the US are having their busiest month on record after launching nearly $82bn-worth of bids since the beginning of May.

The frenzy of activity defies predictions of a slowdown in the private equity-driven deal boom but could also signal a desire by buy-out funds to rush into deals before credit markets take a turn for the worse.

So -- when will this end? Cramer of Mad Money Fame offers five signs the boom will end.

1. Interest rates on the long end going to at least 6%-7%. At that point, I believe it will get too risky.

2. The equity market being closed to the IPOs of the companies that need to be flipped. It's wide open right now.

3. Not one, not two, but maybe three or four, or even five deals going bust. Can't we wait for even one to go belly-up before we get too nervous?

4. Valuations ramping up more. With the S&P 500 selling for about 17.5 times next year's earnings, there is plenty of room to keep buying.

5. Private equity funds running out of money. Very unlikely.

Let's take these one at a time.

1.) Credit is still cheap. While I wrote below about increasing interest rates, the 10-year Treasury is still below 5%. That's really cheap credit by historical standards. In addition, corporate credit is also very cheap, especially by historical standards. Until rates move higher, companies can access the credit markets for funds.

2.) I can't speak to the IPO market's liquidity, but there has been a complete black-out of news stating IPOs are getting canceled in a big way.

3.) It takes awhile for mergers to complete -- at least a year and that's assuming everything goes right (which it won't). Easing the assimilation process is the large number of intra-industry mergers. So long as mergers are within the same or complimentary industries it's doubtful we're going to see deals go bad in a big way. And when they do go bad, there's is a more than minimal chance the reason will be company/merger participant specific (say a CEO who just isn't people/culture savvy) as opposed to a bad overall idea.

4.) According to Barron's, the DOW has a PE of 17.89, and the S&P is at 18.18. According too Margetguage, technology is the most expensive are with a PE of 30. We have several industries with a PE in the 20s and 5 with PEs in the teens. In short, the market isn't cheap, but it's not expensive right now either.

5.) There is a ton of liquidity right now. As if the Japan/US carry trade wasn't enough, we have a very clean corporate balance sheets allowing increased debt issuance, $2.5 trillion in foreign government investment funds available and an increasing money supply.

So, there is a great deal of evidence to back-up Cramer's analysis.

10-Year Rates Increasing

The 10-year Treasury Bond has been selling off for the last few weeks, sending yields to the 4.9% level. Here's a daily chart from

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Notice the following.

1.) Prices sold-off starting in early March (remember, price and yield move inversely). They stabilized from late April to early May when they resumed their sell-off. The trading pattern is a standard rally, consolidation, rally pattern and indicates a fairly orderly path to the current price level.

2.) The 10-year yield is approaching a 6-month high.

Here's the weekly chart.

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Prices have been in a trading range since late 2006. If they break from this range we could approach the multi-year highs in yield.

Inflation Expectations Increasing

From the WSJ:

Higher fuel costs, however, have caused consumers to expect a pickup in inflation in the next 12 months -- to 5.5%, compared with the 4.6% they expected in February.

Standard economy theory states that when people have higher inflation expectations they will spend more now while their dollars are more valuable. If this assumption is true, we could have a partial explanation for why consumer spending has been resilient for about the last year.

I should add, I'm not a bit fan of the psychological side of economic theory, but that's just me arguing economics is trying to explain something way beyond its boundaries.

Tuesday, May 29, 2007

Housing Bad News Continues

From Bloomberg:

Home prices in the U.S. dropped last quarter for the first time in almost 16 years, as 13 out of 20 cities reported declines in March.

The value of a house dropped 1.4 percent in the first three months of the year from the same period in 2006, according to a report today by S&P/Case-Shiller. Prices last fell during the third quarter of 1991.

The retreat may deter owners from tapping into home equity for extra cash, economists said. Combined with record gasoline prices, lower home prices raise concern consumer spending, which accounts for more than two-thirds of the economy, will slow.

``We don't see a big rebound in economic growth,'' said Scott Anderson, a senior economist at Wells Fargo & Co. in Minneapolis.

For anyone who is calling a bottom to the housing market, this news essentially blows you out of the water. There is no good news coming from this part of the economy right now. Considering the massive overhang in inventory, I don't expect this trend to stop in the near future.

Compounding the problem is the sentiment of industry insiders who don't see a rebound in homebuilding until 2011:

New home construction in the U.S. may take until 2011 to return to last year's level, said David Seiders, chief economist for the National Association of Home Builders in Washington.

Monthly construction starts would need to jump by 21 percent to reach Seiders's benchmark for full recovery, which is 1.85 million. There were 1.53 million in April, the Commerce Department said. At the height of the five-year housing boom in January 2006, construction began on 2.29 million homes.

``We've fallen way below trend because we soared way above trend during boom times,'' Seiders said in an interview. ``The upswing will be relatively slow, unlike earlier cycles.''

The inventory of unsold homes is the largest since the Chicago-based National Association of Realtors started counting them in 1999 and house prices have suffered the steepest drop since the Great Depression, according to the realtors' group. Defaults and foreclosures also may rise as about $650 billion of loans to subprime borrowers, those with poor or limited credit histories, reset at higher interest rates by 2009.

The article points out a very important point: we're still working our way through the ARMs resets, and will be for the remainder of this year. I would guess the fallout from that part of the market will continue for at least another 6 months, and probably longer.

Is This Really A Goldilocks Economy?

From IBD:

"This points to improving prospects for the economy in the second half," said Lakshman Achuthan, ECRI's managing director. He called the possibility of a recession this year "minuscule."

The index's rise stems from some healing in sickly manufacturing.

"Services were always holding up. But the industrial side is (improving) where it used to be a drag on the economy," he said.

Durable goods orders rose 0.6% in April, the third straight monthly gain. Core capital goods orders, a proxy for business investment, are turning higher again as well.

The ISM manufacturing index and industrial production also signal a factory rebound.

Achuthan characterized the current economy as "Goldilocks with blemishes," or one marked by moderate growth and expectations for moderate inflation.

Business investment has been slow for the last two quarters, coming in at a seasonally adjusted annual rate of -3.1% and 2%. While durable goods orders have increased, they are still at low levels. Here is a durable goods chart from Martin Capital. Notice where orders are in the cycle. It is just as possible for orders to drop from here as go up.

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Later in the article, the author makes the following observations:

Gasoline prices are already at record highs as the summer driving season kicks off.

But wages, a bigger factor for inflation, have risen less than expected for much of the year. Sustained productivity growth has kept anticipated inflationary increases mostly at bay, though efficiency gains are slowing

So far, consumer spending has been very strong. However, decreasing wages and increasing gas prices are a recipe for a slowdown in consumer spending. While we haven't seen a slowdown in consumer spending establish a trend, we saw a really bad April. And there is also the housing slump to contend with.

I am not a fan of the "Goldilocks" description. I think a better description is the "hanging on" economy. There are just enough positive developments to keep us out of recession. The key right now is consumer spending, which represents 70% of GDP growth. As previously mentioned, consumer spending has been solid so far. But with gas prices spiking before summer it's possible the consumer will come under increasing pressure for the next three months. This may be just long enough for the consumer to reign in spending enough to really impact GDP.

NYSE Short Sales Nearing Record

From Bloomberg:

Short sellers are betting against U.S. stocks like never before as the Standard & Poor's 500 Index approaches an all-time high. That's making some of the biggest bulls even more optimistic.

``What the short seller appears to be doing is doubling down,'' said Kenneth Fisher, who oversees about $40 billion as chairman of Fisher Investments in Woodside, California. ``You love to see it, because if you believe there is a basic driver to the bull market, they're going to get run over.''

The amount of shorting -- where traders sell borrowed stocks expecting to buy them back after prices fall -- jumped to 3.1 percent of the total shares listed on the New York Stock Exchange this month. That's the highest since at least 1931, according to Bespoke Investment Group LLC, a research firm in Mamaroneck, New York.

When there are a lot of shorts in a market it actually adds upward price pressure. As markets rise, shorts are forced to cover their positions, which sends shares higher.

I should add that 1931 was a really bad year for the market. I have an old chart of the Axe-Houghton Industrial Stock Price Average from the book Profits in the Stock Market by Gartley. The index dropped from about 180 to 100. However, the US was right at the beginning of the depression then.

Monday, May 28, 2007

Housing: Oversupply Isn't the Word

This is from the blog Interest Rate Roundup.

* Census data on new home inventory goes back to 1963. Prior to the latest down cycle, the highest inventory level recorded was 432,000 units in August 1973. Throughout the 1980s and 1990s, it was customary to have about 300,000 to 320,000 homes for sale, with peaks (in 1989 and 1995) of around 370,000.

This time around, supply has come down somewhat from the July 2006 peak of 573,000 units. But it's clear that we still have a major inventory glut -- something on the order of 150,000-200,000 units.

* So what about the existing home market? That 4.2 million inventory reading is quite literally off the charts. My data for combined SFH+co-op+condo inventory only goes back to early 1999. Between that year and 2004, inventory typically ran in the 2 million - 2.5 million unit range. In other words, we are potentially oversupplied to the tune of 1.7 million to 2.2 million units.

If you just look at the single-family only data (3.59 million units in April 2007), it's the same story -- a historical inventory glut. This measure typically ranged from around 1.5 million units to 2.3 million units throughout the 1990s and early 2000s.

Corporate Balance Sheets, Merger Mania and the Current Rally

Although the US economy is operating at less than peak performance, the stock market is rallying. M&A is a primary reason for this rally. It seems that every Monday new deals are announced. How long will the pace of these deals continue?

Our U.S. Investment Strategy service noted last week in a Special Report that corporate bond spreads have stayed tight, and the level of bond yields remains low, acting to turbo-charge the stampede to buy/retire equities. The wide gap between equity and corporate bond valuations is being arbitraged and will persist until the valuation gap is closed. If a mania develops like in the late 1990s, then the gap could even move into negative territory. Although such a shift seems a long way off, M&A activity is expediting the re-leveraging, and the financial and investment communities are rushing to take part in this stampede.

They also had a very nice graph accompanying the highlights:

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The graph highlights a few interesting points:

1.) Corporations are issuing more debt than equity.

2.) The total value of M&A activity (as a percentage of GDP) is approaching the pace of the late 1990s, but isn't there yet.

According to the Federal Reserve's Flow of Funds report (PDF) corporations have cleaned up their balance sheets over the last few years. Total liabilities of non-farm non-financial corporate business increased (in billions) from $9,922 at the end of 2002 to $10,493 at the end of the 4th quarter in 2006, or an increase of 5.75%. Over the same period, total assets increased (in billions) from $19,473 to $24,621, or an increase of 26.43%. As a result, total net worth of US business increased (in billions) from $9,551 at the end of 2002 to $14,128 (see page 103 of the FOF).

It's not that corporations have been issuing tons of debt. Non-financial corporate business issued $132.3 billion debt in 2002 and $322.3 billion in the last quarter of 2006 (see page 44 FOF). However, corporations have been buying back tons of stock. Non-financial corporate business issued -41.6 billion of equities in 2002 and -701.2 billion in the 4th quarter of 2006 (page 45 FOF).

What's a bit odd about this is corporate bond yields have been conducive to borrowing. Here is the yield of the AAA and BBB corporate market from the St. Louis Federal Reserve:

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So, let's sum up this picture.

1.) Non-financial, non-farm business is in great financial shape. Debt issuance is low and stock buy-backs are high.

2.) As a result, corporations are in a great place to perform tons of M&A activity. Interest rates are still very low, which encourages this activity.

Let's carry this one step further. A weak economy actually plays into the M&A rally because a weak economy increases speculation the Fed will lower rates, which will add more fuel to the M&A fire.

Sunday, May 27, 2007

Notes of the SPY

I keep a notebook of trading ideas and economic/market observations. Here is what I wrote about the SPYs a few days ago. There is no order of importance to any of the ideas. It's simply a running list/stream-of-consciousness group of observations.

- broke through a month and a half trend line. However, it is still above the 20-day SMA. It is possible the trend line shifted down, but the previous trend line had more support from various price points. OBV has been in a range for all of May at around (roughly) 4.5 billion. CMF (Chaiken Money Flow)went negative, But this indicator has barely gone negative in the last 9 months. P&F (2 points/box and 2 box reversal) chart is still bullish double top breakout. There is so selling pressure on the P&F chart. However, the trend break on the candle chart may be a precursor to the P&F break.

The SPYs increased from (roughly) 137 to 153 afte the China sell-off -- an 11.67% increase. In May the 5 day moving average of volume increased a bit and there have been four big down volume days, although prices have only dropped big on 2 of those days.

The NY advance/decline line was stagnant for most of May, although the new high/new low line continues up.

For those of you who watch the markets, I would strongly suggest doing the same. It really helps to keep your mind focused. Also -- and I have no idea why this is -- writing things down helps me remember things. I got this idea (keeping a notebook) after reading The Money Masters series. This is a book of interviews with various money managers. At the end of the book the author makes some observations about what all the traders have in common. The first thing he mentions is they all keep a notebook.

April Same Store Sales Final Tally: 79% Miss Expectations

From seeking Alpha:

Most retailers announced April same-store sales Thursday. According to Thomson Financial, 79% of them missed expectations. We'll start with the winners:

The article provides a list of the major retailers. It's not pretty.

We have to watch retail sales very closely over the next few months to see about the consumer's overall health.

Saturday, May 26, 2007

Money Supply and the Recent Rally

I've been thinking about the market rally, GDP growth and money supply all morning. Here's my line of thought.

1.) Here's a P&F chart of the SPY rally. Notice it started on 7/31.

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2.) The second quarter ended on 6/31. The BEA releases the GDP information on three dates: the last day of each subsequent month. So, we would have the 2nd quarter releases on the last day of July, August and September. In addition, the third quarter numbers would come out on the last day of October, November and December.

3.) By the end of November 2006 we had the second release of third quarter GDP. By then it was obvious the US economy was slowing down. Here is a chart of the last 4 quarters of the seasonally adjusted annual rate of US GDP growth.

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4.) Here's a chart of the YOY change in money supply. Notice it starts to pick-up in roughly late October/early November. Let's assume the Federal Reserve policy makers have advance knowledge of the GDP numbers.

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This train of thought leads to the following question.

1.) Is the Federal Reserve "priming the pump" -- keeping the market afloat with more actual dollars when the economy is slowing down?

2.) Why is the Federal Reserve Increasing money supply when they are concerned about inflation? Aren't they contributing to their problem?

Now -- why would the Fed do this?

1.) Increasing the money supply would help to ameliorate the slowdown by giving people more money to spend. This could partially explain why consumer spending has been robust throughout the slowdown -- people simply have more physical dollars in their pocket. This is an entirely legitimate exercise of the Fed's authority.

2.) The US has become an asset dependent economy. As the US savings rate has decreased, it's asset base has increased. And as those assets increase in value, people are more likely to spend. By the end of last year it was obvious one major asset class -- namely housing -- was decreasing in value. Therefore, the Federal Reserve has to stabilize the value of other asset classes -- here, equities.

The Rise of Government Wealth Funds and Money Supply

From Barron's (subscription required)

Countries like China and Russia think they have sufficient reserves to meet potential runs on their currencies, and have created sovereign wealth funds in a bid to earn higher returns. Increasingly, these and other nations, including the oil-rich United Arab Emirates and Norway, are expected to funnel new money into wealth funds rather than government securities. Jen estimates sovereign wealth funds could match the size of official government reserves by 2


Russia, which was nearly bankrupt a decade ago, is planning to put a chunk of its $357 billion of official reserves into a Future Generations Fund that will invest beyond government securities. That fund could be staked with about $30 billion. South Korea has formed the Korea Investment Corp. with $20 billion, and Australia has launched a $40 billion Australian Future Fund.

There are several reasons for the rapid growth of sovereign wealth funds. High oil prices are filling the coffers of countries like Russia, the Emirates, Saudi Arabia and Norway. Elsewhere, China's enormous trade surplus is producing rapid growth in its dollar reserves as the country seeks to hold down the value of the Chinese currency by purchasing dollars from Chinese exporters.

Here is a chart from the article that shows where some of these funds are:

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There are several points that come to mind.

1.) Governments are assuming they have sufficient reserves to deal with a currency run. I'm not saying I know they don't. But because governments are looking at increasing wealth through investments, it's possible they are cutting corners to get these investments going.

2.) There's an amusingly socialist/communist angle to this situation. Governments are using capitalist financing to acquire business. So long as the governments remain on the sidelines I don't see any problems. However, if governments start to direct internal business decisions, we'll have the possibility of government run business.

3.) There's a ton of liquidity right now -- I mean a literal flood of currency.

Here's a chart of M2 from the St. Louis Federal Reserve:

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Notice that starting in about 1995, the year-over year change in M2 was about 5%. Notice how there was a flood of liquidity during the recession. Also notice the recent increase in the year-over-year figures that corresponds to the latest stock market rally. Here's a chart of the last few years of growth to give you a better idea.

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Here is a chart of M3 from the website Shadow Stats. I can't vouch for their methodology, but I present this graph because it's the only source I know of for M3 right now.

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So, let's sum up.

1.) Governments are taking some of their excess currency reserves and building investment pools.

2.) Actual money growth is helping to create these pools.

3.) M3 growth -- if the Stadowstats numbers are accurate -- is really helping to build these funds.

This leads to the following questions.

1.) Is the Federal Reserve increasing money supply with the intention of spreading US dollars around the world?

2.) Is the Federal Reserve trying to quietly build these government investment pools with the intention these pools buoy US asset prices? This is especially important as the US economy has become more and more dependent on asset values.

3.) At a time when the Federal Reserve is concerned about inflation, why are they increasing money supply?

Friday, May 25, 2007

Weekend Humor

I've been laughing about this all day..

Existing Home Sales Drop

From Bloomberg:

- Sales of previously owned homes in the U.S. unexpectedly fell in April to the lowest level in almost four years, dimming prospects for a quick recovery in the housing industry.

Purchases fell 2.6 percent to an annual rate of 5.99 million last month from 6.15 million in March, the National Association of Realtors said today in Washington. A measure of the supply of homes for sale rose to the highest since August 1992.

The decline comes a day after a government report showed sales of new homes surged as buyers took advantage of a slide in prices. Today's figures suggest that owners of existing homes may have to cut prices further during the prime spring selling season. The drop also reflects the impact of banks making it tougher to get subprime loans, a response to rising defaults.

``The housing market correction won't be resolved quickly,'' said Kevin Logan, senior market economist at Dresdner Kleinwort in New York. ``Downward pressure on prices will persist and sales will be sluggish for some time.''

Here's a link to the NAR report.

There are several interesting points in this report, especially compared to yesterday's report.

1.) This report is consistent with all of the earnings releases from the major homebuilders. As I noted yesterday, no homebuilder has issued a positive report. In fact most have refused to give future guidance. Considering the housing market has been dropping for about a year now, you'd think homebuilders would be shouting "reversal" from the rooftops.

2.)According to yesterday's new home sales report, the South saw a jump of 27.8% and the West saw a jump of 8.5%. Yet in today's existing home sales numbers, the south dropped 1.2% and the west dropped 1.7%. The existing home sales market in the west is 5.4 times the size of the new home sales market, while the existing home sales market in the south is 4.24 the new home market.

A Map of Gas Prices

Here is a map from the WSJ that shows gas prices around the country. I resized the image to fit on the page. I'm still learning about the whole image thing on he web so the image may be small for some people. So --

1.) Only New Jersey has prices below $3.00/gallon.

2.) The darkest color on the map means prices are over $3.40/gallon.

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OPEC Won't Increase Production

From the WSJ:

Two years ago when gasoline prices in the U.S. surged to the then-lofty level of $2 a gallon, the Organization of Petroleum Exporting Countries sprang into action, seeking to provide relief by pledging to boost oil production.

Now, with gasoline topping an average of $3.20 a gallon nationwide, OPEC officials say they see no reason to open the oil spigot wider.

OPEC's new attitude reflects a tug of war in the global oil patch over how the profits from a barrel of oil are divvied up between the world's producers -- which develop oil deposits and pump oil -- and its refiners -- which process it into fuels like gasoline.

In recent years, the balance in the world's oil-supply system has shifted, giving the refining industry more power and more profit.

This time, OPEC says, the world has ample oil supplies. The cartel's members contend gasoline prices have climbed particularly fast in the U.S. because refining capacity is tight, imports from Europe are down, and U.S. inventories have tumbled.

This article highlights an interesting economic situation. The oil market (raw material) and the production market (refining) have "decoupled."

Let's review the US situation.

Gas prices have spiked over $3.00/gallon before the beginning of the summer driving season. Prices usually increase during the summer because of increased demand. However, this year we have high prices before the summer begins.

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Supplies are down

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Demand is up:

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This is a very bullish fundamental scenario. In addition, a few weeks ago we had a very strong technical picture in the oil market. Prices were in a three month long up-trend and prices had formed an ascending triangle formation -- a formation of higher lows indicating upward pressure building on prices.

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Yet oil prices dropped a few weeks ago and have again approached $67/barrel only to meet price resistance again.

The raw material of gasoline -- oil -- had two very strong reasons to rally higher yet didn't. Now -- it's possible oil will go higher. That is always a possibility. And prices have not crashed either. However, this statement appears to be very true now.

The cartel's members contend gasoline prices have climbed particularly fast in the U.S. because refining capacity is tight, imports from Europe are down, and U.S. inventories have tumbled.

Thursday, May 24, 2007

Was Today's Market Action A Reversal Day?

A reversal day occurs when, well, the trend reverses. Key signs are a break of a trend line and high volume. We have both today. The SPYs and the QQQQs broke through their upward trend line on high volume.

The common theme to the market analysis was today's housing and durable goods news implies the Fed may hike rates. I think the markets were simply looking for a reason to sell and found it today.

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New Home Sales Increase 16%

From Bloomberg:

Purchases of new homes in the U.S. unexpectedly jumped in April by the most in 14 years, a sign low lending rates and incentives may be reviving demand.

Purchases rose 16 percent to an annual pace of 981,000 last month from an 844,000 rate the prior month that was lower than previously reported, the Commerce Department said in Washington. The supply of unsold homes at the current sales pace dropped.

Lower prices and incentives offered by builders such as Centex Corp. are stirring demand for new homes after two years of falling sales. Still, a glut of unsold properties suggests homebuilding is likely to remain a drag on growth throughout this year and into 2008.

Let's add a very important piece of information from the AP:

However, the median price of a new home sold last month fell to $229,100, a record 11.1 percent decline from the previous month. The big price decline indicated that builders are slashing prices in an effort to move a huge overhang of unsold homes.

First -- color me really surprised.

However, let's look a bit deeper at some of the housing news.

Toll brothers reports decline (posted yesterday):

Second-quarter revenue fell 19 percent to $1.17 billion.

Net contracts were down 25 percent to $1.17 billion. Net of cancellations, contracts totaled 1,647 units, down 24 percent.

The second-quarter cancellation rate was 18.9 percent, down from the prior quarter's rate of 29.8 percent, but still higher than the company's historical average of about 7 percent, Toll said.

"Given the uncertainty surrounding sales paces, and market direction and, thus, the potential for and size of future impairments, we are not comfortable giving full earnings guidance," Chief Financial Officer Joel Rassman said in a statement.

Pulte and Beazer report lower earnings (May 14, 2007):

It became more of the same this week when two more large builders -- Pulte Homes (NYSE: PHM) and Beazer Homes (NYSE: BZH) -- reported first-quarter losses and refused to issue earnings guidance for the current year.

For the quarter, Pulte recorded a net loss of $85.7 million, or $0.33 per share, compared with earnings of $262.6 million, or $1.01 a share, a year ago. With the nation's depressed housing circumstances worsening steadily, the company's revenues declined 37%. All of Pulte's seven regions experienced declining revenues, and all but the Southwest saw net new orders decline.

For its part, Atlanta-based Beazer reported a loss of $1.12 a share, versus $2.35 a share a year ago. The company's closings fell 36% for the quarter to 2,743 units, while its revenues slid 35% to $826.3 million.

"Overall, the homebuilding environment remained challenging during the first quarter of 2007, as elevated inventory levels, combined with weak consumer confidence for housing, continue to place pressure on results," said Richard J. Dugas Jr., Pulte's president and CEO, when he released his company's results.

"Challenging" -- that's a word that builders have been invoking more frequently than Aaron Burr and Alexander Hamilton ever thought to do before their famous duel. Beazer CEO Ian McCarthy took his turn when he described the climate for his company: "We continued to experience extremely challenging operating conditions during our second quarter of fiscal 2007. Most housing markets across the country continue to experience lower levels of demand, coupled with higher levels of inventory, resulting in increased competition and continued significant discounting."

Hovnanian reports loss (May 7, 2007):

On Friday, Hovnanian Enterprises (NYSE: HOV) joined several of its peers in painting a bleak picture of its markets. The homebuilder expects a total loss for the second quarter in the range of $0.45 to $0.50 per share. Of that amount, about $0.30 is expected to occur before land charges, with the remainder related to land impairments and write-offs of predevelopment costs and land deposits.

The company's net contracts for the quarter dipped about 21% to 3,116, but without the especially hard-hit Fort Myers-Cape Coral market, net contract additions would have declined just 17%.

Hovnanian's prerelease follows recent reports from other major builders, including Beazer (NYSE: BZH), Centex (NYSE: CTX), and Pulte (NYSE: PHM), all of which have declined to provide guidance on the rest of the year's results, given the climate for continued soft housing conditions. On Friday, however, Hovnanian said that when it formally releases second-quarter results, "the company expects to update its 2007 guidance to reflect the charges and operating results for the first half of the year and its expectations for the remaining quarters of the year."

Builders have lower contracts, they call the environment challenging and they refuse to give guidance. There is no mention in any of these reports of a "rebound", or "the worst is over" or similar statements.

In short, today's numbers do not jibe with the latest reports from the industry. In fact, today's report is diametrically opposed to the news we have been hearing from the housing industry

While I am not saying today's report is total bullshit, it does not jibe in any way with the reports the housing companies have consistently reported this earnings season.

Durable Goods Orders Surprise On the Upside

From CBS Marketwatch:

New orders for U.S.-made durable goods increased 0.6% in April, boosted by strong demand for metals, the Commerce Department reported Thursday.

Orders in March rose a revised 5%, a six-month high, compared with a 4.3% estimate previously.

Demand in April was held back by a 10.7% drop in orders for civilian airplanes, where new orders had doubled in the previous two months. Excluding the extremely volatile transportation category, orders were up 1.5% in April, identical to the increase in March.

Orders for core capital equipment goods - the best monthly gauge of business investment - rose 1.2% after a 4.4% gain in March.

Here's a link to the actual report.

There are some really interesting points in the report that should be highlighted.

First, the Census Bureau has a spreadsheet download that has unadjusted totals for 2006 and 2007. This means the Bureau has a "year to date" running total on all the different categories.

Year to date, total new orders including transportation are up .4%, but excluding transportation are down .4%.

Here's where things start to get really interesting. Let's use total new orders of $844,523 million as the denominator in the following calculations.

Primary metals are up 6.8% than the same time last year and they make up 9.67% of all new orders.

Electronic equipment and appliances are up 8.6% from the same time last year and they make 5.26% of total new orders.

Fabricated metal parts are up 1% from their total at this time last year and they comprise 12.40% of total new orders.

Transportation is up 2.2%, but that's because non-defense aircraft and parts are up 26.9%. Auto new orders are down 6.1%.

Computer and electronics parts are down 3% compared to the same totals last year and they make up 11.97% of all new orders.

So what does all of this mean? It's largely a commodities driven durable goods market. My guess is foreign demand is responsible for more than a small share of all these orders -- especially orders from China/India and any other country that is manufacturing goods.

Problems With the Employment Numbers?

From the WSJ:

• The News: Recent signs indicate the job market may be weaker than monthly data show, particularly in construction.

• The Background: The economy has slowed, but job growth has remained robust.

• The Upshot: The cause of the statistical disparity remains something of a puzzle.

Let me caution here: the primary reason for the disparity is based on statistical sampling which is not my strong suit. I'm good at explaining final numbers, not generating the numbers used in analysis. Now that we have that caveat out of the way:

Those signs are particularly stark in the home-building industry, which has been hurt by the slump in the housing market. Housing starts in April fell 33% from their recent peak in January 2006. Yet, the number of residential-construction jobs has dropped by only about 3% over the same period.

Economists cite several possible explanations for the disparity. One is that layoffs have lagged behind the housing slump and will weaken further.

In addition, some economists say the monthly figures from the Labor Department's Bureau of Labor Statistics may be overestimating employment, perhaps by misclassifying construction workers or by failing to count large numbers of laid-off illegal immigrants.

The bureau releases two monthly employment figures: the unemployment rate, which is based on a household survey, and a tally of nonfarm payrolls, based on a survey of employers. Both are conducted through sampling and depend on voluntary responses.

A lesser-known employment snapshot, based on a quarterly census of state unemployment insurance records, shows the economy created about 19,000 private-sector jobs in the third quarter of 2006, the most recent data available. That contrasts with the 500,000 indicated in the monthly figures for that period. It also shows the number of construction jobs dropped by 77,000, in contrast with the increase of 19,000 jobs shown in the monthly surveys.

The data suggest that "maybe the labor market behaved a little more like we thought it should in times of a slowing economy," said Michael Feroli, an economist at J.P. Morgan Chase & Co.

There has been a lot of discussion about the employment reports this economic cycle. The discussions have centered on a few problems:

1.) The birth/death model. The BLS uses a model (called the birth/death model) that attempts to account for new businesses that aren't in their employment sample and businesses that go out of business whose closing is not reflected in the final employment numbers. I can't speak for the veracity of this analysis, but it has come under fire from several commentators.

2.) The continual revisions of the jobs numbers. The BLS has continually recalculated the monthly figures, making the initial release an almost moot points. In addition, the BLS magically found about 800,000 jobs in an annual revision last year. The point is there appears to be a pretty big problem with the way BLS is conducting business. There is always a certain amount of lee-way with economic numbers and analysis. However, the size of the revisions have led some people (myself included) to question the way BLS does business.

There have been several articles lately which noted the divergence between the overall growth rate (1.3%) and the continued low unemployment rate. These two numbers just don't add up from an analysis perspective. Usually every economic cycle creates analytical problems because (surprise) reality does not add up like economic models say they should. This cycles are not more pronounced than other cycles. But the divergence between theory and reality has emerged again.

Toll Brother's Net Drops

From the WSJ:

The luxury-home builder's earnings fell to $36.7 million, or 22 cents a share, from $174.9 million, or $1.06 a share, a year earlier. Analysts polled by Thomson Financial expected, on average, earnings of 25 cents a share.

The company said earlier this month it expected a second-quarter profit, but said it wouldn't meet its prior outlook of 43 cents to 57 cents a share. Write-downs lowered earnings by 44 cents a share, compared with just four cents a share a year earlier.

Revenue for the quarter ended April 30 fell 23% to $1.17 billion from $1.44 billion a year earlier. Analysts were looking for $1.12 billion.

Fiscal second-quarter net signed contracts fell 25% to $1.17 billion from $1.56 billion a year earlier.
The company signed 2,031 contracts before cancellations in the period, down 14%. Toll Brothers reported earlier in May that second-quarter net orders fell 24% to 1,647.

Some of this loss is accounting -- lowering the value of assets on the balance sheet. My guess is Toll brothers is reporting as much bad news as possible to "get it out of the way."

However, the drop in revenue and contracts signed indicates one glaring fact: the housing market is still very weak.

Wednesday, May 23, 2007

Gas Prices Up Nearly 50% Since January

From CBS Marketwatch:

Average retail gas prices jumped by 12 cents to a record $3.26 a gallon last week, the Energy Department reported Monday. Gas prices are up nearly 50% since late January, one of the largest sustained increases ever recorded by the government.

Here is a chart from the same article. Notice that prices usually spike mid-year. However, this year year prices are spiking significantly earlier.

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This Week in Petroleum also noticed this trend in the latest report:

:For the fourth consecutive week, gasoline prices were up, increasing 11.5 cents to 321.8 cents per gallon as of May 21, 2007. Prices are 32.6 cents per gallon higher than this time last year and have now reached an all-time nominal high for the second week in a row. All regions, except for the West Coast, reported price increases. East Coast prices were up 11.6 cents to 309.7 cents per gallon. In the Midwest, prices jumped 15.4 cents to 332.6 cents per gallon, while prices for the Gulf Coast rose 17.7 cents to 309.2 cents per gallon. The Rocky Mountains saw prices increase 7.2 cents to 326.5 cents per gallon. West Coast prices were down 0.6 cent to 337.2 cents per gallon. The average price for regular grade in California was down 1.4 cents to 343.6 cents per gallon, but remains 11.3 cents per gallon above last year's price.

The main reason for increased prices is a drop in inventories:

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Coupled with increased demand:

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Notice that demand this year is higher than last year.

The good news is gas production has increased over the last few weeks.

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However, the days of supply are lower than last years.

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Putting all of these factors together -- decreased supply + increased demand -- and you get higher prices.

Now the question becomes will production increase sufficiently to lower prices?

More Retail News

From Yesterday's retail sector market brief at CBS Marketwatch:

Elsewhere, shares of American Eagle Outfitters (fell 4.3% to $28.06. American Eagle offered a second-quarter forecast that fell short of Wall Street's expectations, sending the shares lower. The teen-wear retailer is looking at second-quarter per-share profit of 34 cents to 36 cents, compared with the 37 cents per share average estimate reached by analysts reporting to Thomson Financial.

Shares of Pacific Sunwear of California also fell, closing at $19.60, off 2.2%. Late Monday, the retailer reported a first-quarter loss and said its second quarter should produce a profit in a range of 18 cents per share to 20 cents per share.

Here's a three year chart of the Retail Holders Trust -- the retail ETF. It's trading at the top of its three year range, indicating traders are still bullish on the retail sector.

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American Eagle Outfitter is trading off its highs, but is still doing well.

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Pacific Sunwear has bounced off its recent lows.

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Short version: the general retail sector still looks strong from a market perspective, although traders are willing to sell stocks they think will under perform in the sector.

Would a Yuan Devaluation Really Help the Trade Deficit?

From IBD:

But most economists say a big yuan revaluation wouldn't have a major impact on trade.

As long as Americans spend more than they save and the Chinese continue to save at high rates, the trade deficit will endure.

"To achieve any meaningful change in trade flows, you need a reduction in (spending) by countries that spend more than their income and expenditure increases in countries that spend less than their income," said Nouriel Roubini of Roubini Global Economics. "Changes in relative prices are not by themselves sufficient."

America's trade gap with China hit $235 billion last year.

I've seen various opinions on this matter, but I tend to agree with the above statement. The real issue is the US consumes more than it produces. That is what the trade deficit really represents. I wrote an article dealing with outsourcing that came to the same conclusion: so long as the US buys cheap stuff, we're going to outsource manufacturing to places where it's cheaper to make stuff.

However, I think it's important to realize where this might lead. To quote Paul Volcker from an article he wrote two years ago (and which is still very relevant):

The difficulty is that this seemingly comfortable pattern can't go on indefinitely. I don't know of any country that has managed to consume and invest 6 percent more than it produces for long. The United States is absorbing about 80 percent of the net flow of international capital. And at some point, both central banks and private institutions will have their fill of dollars.

Tuesday, May 22, 2007

Gas Hits A New Record

From CNN

Gasoline prices broke a record Tuesday for the 10th day in a row as every state except for New Jersey now has an average price above the $3 a gallon mark in AAA's daily survey.

The latest reading from the motorist group Tuesday showed the nationwide average for a gallon of regular unleaded hit $3.209 a gallon, up from $3.196 on Monday. The group's survey of 85,000 gas stations, by far the broadest sampling of gas prices, has been showing a series of record high prices starting May 13.

Need I say anything more?

Fed's Lacker Is Concerned About Inflation

From CNBC:

However, Lacker, one of the Fed's toughest inflation hawks, said he'd like to see the inflation rate come down a bit more. Although he is not a voting member of the Fed this year, Lacker dissented four times last year from the majority at the Fed who wanted to keep interest rates unchanged instead of raising them.

“I don’t think the moderation we’ve seen is statistically significant,” he said. “The core inflation has been fluctuating between 2% and 2.5% for two years now and before that from 1996 through 2003, core inflation was between 1% and 2%. We need to get back to containing core inflation between 1% and 2%.”

I have to admit, the following statement made me laugh.

Still, the Fed official believes the economy and consumers can handle higher gasoline prices. He said his major concern is that the public has become “conditioned” to the idea that higher oil and gasoline prices equal higher inflation.

“That does not have to be true," he said. "It is a matter of relative price changes that go on all the time in a healthy economy. Lacker said he was worried that rising gasoline prices will prompt an uptick in inflation expectations.

Obviously, Lacker wasn't aware that Wal-Mart had a big sales decline recently, which they attributed in part to higher gas prices.

In addition, the average consumer probably isn't thinking relative prices when they fill up at the pump. What they are thinking about is "this is getting pretty expensive."

Any questions? I've been adamant in my stance that the Fed won't lower interest rates anytime soon. While the economy is growing below it's full potential, the inflation rate is still higher than the Fed wants it to be. As a result, don't expect a rate cut anytime soon.

Retail Snapshot

With gas prices hitting a record and the housing market still in a slump, it's important to keep an eye on some of the areas that may be negatively impacted such as retail. Wal-Mart is the largest retailer in the US by a wide margin, so keeping as eye on the daily news is very important. But there are other retailers to watch as well.

Lowe's reports lower earnings.

Lowe's Cos. reported a 12% fall in first-quarter profit Monday as the housing slump and tough comparisons sawed into the home-improvement retailer's bottom line.

Multiple factors, including a difficult housing market in many areas, tough comparisons to hurricane rebuilding efforts and significant lumber and plywood-price deflation continued to create a challenging sales environment in the first quarter," said Robert Niblock, Lowe's chief executive, in the earnings report. "Those anticipated factors were compounded by mixed weather during the quarter."

The central issue here is housing. The other points are pure noise and deflection. Home Depot had the same market and the same set of problems.

Target sales drop

Target's same-store sales fell 6.1% in April. The average estimate of analysts polled by Thomson Financial called for a decrease of 6.2% for the month. Net retail sales fell 1.8% in the period to $3.9 billion from $3.97 billion a year earlier.

The Minneapolis-based general-merchandise retailer cited a sales shortfall in the first two weeks of April for the lackluster results. It forecast May same-store-sales growth in a range of 5% to 7%. In the May period a year earlier, Target's same-store sales increased 5.7%.

Target has been successful at taking customers away from Wal-Mart. However, Target's performance this month is not that impressive and falls in line with Wal-Mart's results.

JC Penney surprises on the upside.

The moderate-priced department-store chain has been on a tear in recent months, introducing new private-label and designer lines found only at Penney stores. It has brought out Ambrielle lingerie, the largest private-brand launch in its history, as well as Liz & Co. and Concepts by Claiborne. It is on track to launch the American Living collection of apparel and home goods by Polo Ralph Lauren and is stepping up its rollout of Sephora cosmetics counters on its sales floors.
All that helped boost Penney's (profit to $238 million, or $1.04 a share, compared with last year's income of $210 million or 89 cents a share.

JC Penney has completely turned themselves around and are doing a great overall job. Now -- can they keep it up in the current environment? We'll have to see.

Credit Is Still Cheap

From CNBC:

As of mid-May, total M&A activity world-wide totaled about $2.19 trillion, compared with the record $3.87 trillion for all of 2006, according to Dealogic. In the U.S. M&A activity totaled $717.37 billion through May 16, on pace with last year’s $1.49 trillion. Both are shy of 1999 and 2000, when activity topped $1.5 trillion in each year.

Private-equity buyouts have totaled $218.7 billion so far this year, compared with $421.56 billion last year and $53.9 billion in 2000.

So far this year, buyouts represent 30% of the the total value of all U.S. deals, slightly ahead of last year's pace, and about 14% of all mergers.

So this year's pace is on track to tie a record year in buyouts -- which occurred at the end of a stock market bubble.

“It will end,” Steve Rattner, managing principal of Quadrangle Group, told CNBC’s “Power Lunch” recently. “We are in a credit bubble. Credit is an over-valued commodity at the moment. The lenders are not getting compensated relative to the risks they are taking and at some point that will change. Right now, the default rates are at historic lows and that will also change. When it all changes, we’ll get back to some kind of norm."

Right now credit is cheap. Below are charts of AAA and Baa credit from the St. Louis Federal Reserve. Notice that interest rates are still low by historical standards.

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Fed's Moscow Wants Lower Inflation

From Reuters:

Moskow noted that core inflation is still running above the 1 percent to 2 percent range that some policy-makers, including himself, see as an informal comfort zone.

"I'd like to see inflation rates running lower at this point and more toward the center of that zone," he said.

This was brought to you by the guy who has been saying for the last 6-9 months the Fed isn't going to lower rates anytime soon.

Monday, May 21, 2007

Gas Hits A New Record

From the Atlanta Journal Constitution

The average price of self-serve regular gasoline hit a record high of $3.18, rising more than 11 cents over the past two weeks, according to a nationwide survey released Sunday.

The latest figure topped the record of $3.07 set two weeks ago, which had been the highest price since the average cost of a gallon of gas hit $3.03 on Aug. 11, 2006, according to the Lundberg Survey of 7,000 gas stations across the country.

How long until this starts to impact consumer spending? I don't have a clear answer, but when gas prices hit records in May the picture isn't that good.

As a rough rule, every penny increase in gas prices lowers consumer spending by $1.3 billion.

When Will the Buy-Out Splurge End?

There was an article in the print version of Barron's this week. I can't find it online, but wanted to give credit where it is due. The author was discussing when the buy-out mania currently gripping the markets would end. He made the following points.

1.) When the sheer size of the deals becomes astronomical. So far the size of the deals has been pretty contained, especially considering the strength of corporate balance sheets. There are two recent deals that do raise flags. The first was Newscorp's bid for Dow Jones. The thinking here is Newscorp was making a bid so large it would fend off all possible competition. However, the bid was way over the asking price as expressed by the share price of Dow Jones. The second was the recent Microsoft deal when they bid an 80%+ premium for an online ad company. Microsoft is a cash rich company, so they have the money to throw around. But, they could have bid a 50% premium at most and probably gotten the deal. My guess is they were using the same logic as New Corp was in the Dow Jones deal -- putting a bid in play that was so large it would fend of rivals. In addition, several competitors successfully purchased other online ad companies, so Microsoft may have simply wanted to get in while the getting was good. However, the premium does raise a bit of a flag.

2.) When diversification starts to really stretch the imagination. So far the announced deals pretty much make sense. For example, the web companies are clearly moving into the ad area, aluminum companies are buying other aluminum companies etc... When we start to see mergers that strain business sense -- an aluminum company with a newspaper -- then we'll start to think the merger boom has gone too far.

Will Business Investment Pull the US From the Brink of Recession?

An article in today's Wall Street Journal makes this case, based on the following points.

As the economy cooled last year, many companies found themselves with excess stock, particularly home builders, car makers and the suppliers that depend on them. The result was a sharp pullback in inventory accumulation that now appears to be over, a development that portends production increases. Business inventories declined in March. Although still 4.8% above year-earlier levels, they were 7.7% above year-earlier levels in August. Inventories in the languishing auto industry are running 2.7% below year-earlier levels, the U.S. Commerce Department says.

As the economy has become more technologically sophisticated the inventory to sales ratio has become less important. In other words, companies don't have to have as much product on hand to be successful. That means low inventory levels are the norm. While the inventory draw-down is good, I don't think it has the same predictive power as before.

However, the recent industrial production figures showed a marked increase from the previous month's levels giving this point more credence.

But so far this year, profit growth hasn't sagged quite as much as some anticipated, leaving many businesses with hoards of cash they can steer to capital purchases if the mood strikes. Noting plans by cable companies and telecommunications firms to increase capital spending, Federal Reserve governor Frederic Mishkin last month predicted a rebound in business investment this year. "Business balance sheets are strong, and although profits have slowed, profit margins remain elevated," Mr. Mishkin said. "The continuation of a moderate economic expansion is likely over time to restore confidence and lead to a firming in business investment."

The problem with this point is business was cash rich through the last two quarters. According to the Flow of Funds report corporations are the only economic sector that has contributed to national savings over the last 5 years. In other words, business already had the money to invest and didn't.

Strong global growth together with the recent weakness of the dollar have created what should be an excellent climate for U.S. exporters. Most economists chalk up the decline in exports in the first quarter to a statistical fluke that will soon be undone.

This is the strongest point in the article. A look at the earnings reports from the latest quarter show that companies with strong international exposure did well. The continued projected weakness of the dollar will most likely continue this scenario for the foreseeable future.

As with all matters economic, we'll have to wait and see how this plays out. However, the author does make some good points that provide excellent food for thought.

An Ugly Chart

Here is a long-term dollar chart from the Wall Street Journal. The article dealt with a different topic. I simply wanted to put up this chart to show what the dollar chart looks like right now. It's not a pretty picture.

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Sunday, May 20, 2007

The Markets Through a P&F Lense

For those of you who are unfamiliar with P&F charts, I would highly recommend you start to get acquainted. These charts allow you to filter out a great deal of extraneous market noise and focus solely on the big price movement. This helps to get a solid picture of the market's general trend.

All three of these charts say the same thing: the market is in a bull phase. Also notice the cumulative volume on the up moves (market with the green x's) is higher than the volume of the price declines.

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However, the NY and NASDAQ advance/decline lines aren't looking that strong right now.

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Despite the new highs on the Dow for what seems like forever, the Advance decline line is in a range for most of May. The NASDAQ advance decline line is declining. Both of these charts indicate the market's recent advance is on shaky ground and a pullback should be surprising.

Bonddad's Back

I'm back from a wonderful three days in San Diego. I would like to thank the Britt Scripps Inn for their wonderful accommodations, the San Diego Zoo, the Museum of Photographic Arts, Old Town San Diego and the Sicilian Festival for a wonderful time.

Bonddad's amazing girlfriend found the Britt Scripps Inn, and she gets many kudos and much praise for the find.

I feel rested and rejuvenated and ready to tackle the market and my law practice. It's amazing what a few days can do.

Saturday, May 19, 2007

For those looking for a fix of Crude Oil News:

... you can find Crude Oil news at The Oil Drum ... mixed in with a wide range of Peak Oil and New Energy Technology news, some of it at a very high level of technical sophistication ... and also that special post-apocalyptic Mad Max spice that sometimes enters into the discussion threads.

This week's This Week In Petroleum, in particular, has a very cogent discussion on understanding what is going on with gasoline prices ... and how the decline of gasoline prices last fall is one of the principle driving forces for the rise in gasoline prices that we are going to be experiencing over the next few weeks to months.

Thursday, May 17, 2007

Bonddad On Mini-Vacation

I am signing off until Monday. Bonddad and Bonddad's girlfriend are going to San Diego for some R&R. I am not taking a computer, I am not answering my cell phone (save for my niece and Dad), I am not reading a newspaper, nor am I watching the news.

I will see y'all on Monday morning, bright and early.

Have a safe weekend.

Leading Indicator Drops

From the Conference Board:

* The leading index decreased in April, and the small March increase was revised up as actual data for manufacturing new orders for nondefense capital goods became available. The leading index declined or remained the same in three of the last six months. As a result, from October to April, the leading index fell 0.2 percent (a -0.4 percent annual rate). In April, housing permits made the largest negative contribution, but the weaknesses among the leading indicators have been somewhat more widespread than the strengths over the past few months.

* The coincident index increased again in April, the third consecutive gain. From October to April, the coincident index rose by 0.7 percent (a 1.3 percent annual rate). In April, all four coincident indicators contributed to the gain and the largest contribution came from industrial production followed by personal income. The coincident index grew at an average annual rate of about 2.5 percent in 2006, but its growth has moderated to about a 1.5 to 2.0 percent average annual rate in the first four months of the year.

* The leading index is 0.7 percent below its April 2006 level. In the second half of 2006, the leading index was essentially flat from July through November, followed by a small pick up in December, and it is now slightly below its October level. At the same time, real GDP grew only at a 1.3 percent annual rate (advance estimates) in the first quarter of 2007, following a 2.5 percent rate in the fourth quarter of 2006. The recent behavior of the composite indexes suggests that economic growth is likely to continue to be slow in the near term.


The leading index now stands at 137.3 (1996=100). Based on revised data, this index increased 0.6 percent in March and decreased 0.6 percent in February. During the six-month span through April, the leading index decreased 0.2 percent, with three out of ten components advancing (diffusion index, six-month span equals thirty percent.)

I made it a habit of not looking at leading/sentiment indicators because I didn't think they were very good at predicting. However, some research from Merrill Lynch (I'm a client) proved me wrong. The LEI index is actually pretty good at forecasting the next 3-6 months.

Here's a chart from Martin Capital that shows the Leading, Coincident and Lagging indicators from the Conference Board:

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