SubPrime Shakeout Hitting Retail Sales

From Bloomberg:

Atlanta-based Home Depot, the world's largest home- improvement retailer, said last month it expects its first annual profit drop since at least 1990 this year, citing the housing market. The company said profit will decrease this year to as little as $2.55 a share from $2.79, or $5.76 billion, last year.

....

Wal-Mart spokesman John Simley declined to comment. The Bentonville, Arkansas-based company will report March sales on April 12. Wal-Mart in 2006 had the smallest same-store sales gain in at least 27 years. Its shares have increased 1 percent this year.

....

Subprime borrowers' woes also may curb business at casual- dining restaurants targeting low-income consumers, according to a March 19 report by JPMorgan Chase & Co. Applebee's International Inc. has more low-income consumers than its competitors, JPMorgan said.

Same-store sales at Applebee's, a chain with more than 1,940 restaurants, declined in 10 of 12 months through February. Applebee's spokeswomen Carol DiRaimo and Laurie Ellison didn't return messages seeking comment.

Home Depot is a bell weather company for home improvement.

Wal-Mart is a bell weather company for retail.

Market Breadth Turning Neutral

These charts are from Stockcharts. They show a market that is moving away from a bullish sentiment.

Fewer new highs means there is less of an upward pull in trading.





A moderating advance/decline line also means a moving away from bullish sentiment.

Big Inventory Build Out There ....

After yesterday's durable goods report, I looked at overall business inventories from the St. Louis Fed. There's a lot of stuff in the system.



This inventory build may be one reason durable goods orders have dropped 4 of the last 5 months (from the WSJ)

"It's looking like capital expenditures aren't going to be able to offset housing and autos with respect to investment," says Joseph Brusuelas, chief U.S. economist for IDEAglobal, an economic-consulting firm in New York.

Economists monitor new orders for nondefense capital goods excluding aircraft because it gives a clearer picture of how businesses view future economic conditions. In addition to reporting a decline for February, the government also revised January's number to a decline of 7.4% from last month's estimate of a 6.0% decline.

Food for thought...

Markets Looking A Bit Weaker

At the end of last week there was a lot of bullishness to the hourly and daily charts. The market trended up until mid-Wednesday, popped big-time after the FOMC announcement and followed with two days of consolidation.

That trend is reversing itself this week. I added the Fiboinacci fans to get an idea of where the pullbacks stood in relation to Fib analysis. We're at or near the 50% retracement level for all three averages. We're also approaching moving averages. A cross below would add another point to the bearish argument.

Notice a few points about these charts.

1.) The markets have not rallied above resistance.

2.) The SPYs and QQQQs have an increase in volume as prices decline.

3.) A fairly standard bear market pattern has the market making lower lows and lower highs.

Bernanke on Housing

From his Congressional Statement:

The principal source of the slowdown in economic growth that began last spring has been the substantial correction in the housing market. Following an extended boom in housing, the demand for homes began to weaken in mid-2005. By the middle of 2006, sales of both new and existing homes had fallen about 15 percent below their peak levels. Homebuilders responded to the fall in demand by sharply curtailing construction. Even so, the inventory of unsold homes has risen to levels well above recent historical norms. Because of the decline in housing demand, the pace of house-price appreciation has slowed markedly, with some markets experiencing outright price declines.

The near-term prospects for the housing market remain uncertain. Sales of new and existing homes were about flat, on balance, during the second half of last year. So far this year, sales of existing homes have held up, as have other indicators of demand such as mortgage applications for home purchase, and mortgage rates remain relatively low. However, sales of new homes have fallen, and continuing declines in starts have not yet led to meaningful reductions in the inventory of homes for sale. Even if the demand for housing falls no further, weakness in residential construction is likely to remain a drag on economic growth for a time as homebuilders try to reduce their inventories of unsold homes to more normal levels.

Translation:

1.) Housing is the main reason why US GDP growth dropped about 2% points over the last three quarters.

2.) There are a ton of homes on the market.

3.) If demand levels remain at these levels and don't fall any further, it's going to take a long time to clear available inventory.

Therefore:

4.) Housing will remain a drag on the economy for longer than we would like.

And on top of that, inflation isn't behaving. Right now it really sucks being head of the Federal Reserve.

The Markets Today

Here are today's daily charts of the SPY, QQQQ and IWN. These charts have a bearish bias for the following reasons:

1.) The SPY and the QQQQ all sold-off at the end. The SPY's selling volume was higher than previous bars and the QQQQs had a volume spike at the end.

2.) The indexes tried to rally from the post-Ben sell-off, but couldn't keep the momentum going.

Gas Prices Are Still Rising

From This Week in Petroleum:

Retail Gasoline Prices Up, Diesel Falls Slightly
Gasoline prices were up for the seventh consecutive week, increasing 1.8 cents to 257.7 cents per gallon as of March 19, 2007. Prices are now 7.3 cents per gallon higher than at this time last year. All regions reported price increases. East Coast prices were up 2.0 cents to 255.3 cents per gallon, while Midwest prices rose 0.3 cent to 249.0 cents per gallon. Prices for the Gulf Coast were up 1.6 cents to 241.8 cents per gallon. The largest regional increase was in the Rocky Mountains, where prices increased 9.0 cents to 250.2 cents per gallon. West Coast prices were up 2.6 cents to 294.6 cents per gallon, with the average price for regular grade in California up 1.0 cent to 307.8 cents per gallon, 44.3 cents per gallon above last year’s price.

The rate of increase has slowed. But, prices are still increasing and they are still higher than this time last year. In addition, the price increases are across the nation, indicating a local situation isn't skewing the numbers.

Bernanke's Opening Statement, pt. I Inflation

Here is the link to his complete testimony

Let me now turn to the inflation situation. Overall consumer price inflation has come down since last year, primarily as a result of the deceleration of consumers� energy costs. The consumer price index (CPI) increased 2.4 percent over the twelve months ending in February, down from 3.6 percent a year earlier. Core inflation slowed modestly in the second half of last year, but recent readings have been somewhat elevated and the level of core inflation remains uncomfortably high. For example, core CPI inflation over the twelve months ending in February was 2.7 percent, up from 2.1 percent a year earlier. Another measure of core inflation that we monitor closely, based on the price index for personal consumption expenditures excluding food and energy, shows a similar pattern.

Translation: Inflation came down for awhile. But it's increased over the last few months, and we don't like that too much. It makes our job a whole lot harder.

Core inflation, which is a better measure of the underlying inflation trend than overall inflation, seems likely to moderate gradually over time. Despite recent increases in the price of crude oil, energy prices are below last year�s peak. If energy prices remain near current levels, greater stability in the costs of producing non-energy goods and services will reduce pressure on core inflation over time. Of course, the prices of oil and other commodities are very difficult to predict, and they remain a source of considerable uncertainty in the inflation outlook.

Translation: We've been saying inflation would moderate for awhile and it hasn't.

Also -- Ben might want to take a look at this chart of gas prices, which indicates they're higher now than this time last year.



I also think it's interesting he did not mention anything about agricultural prices, which have been increasing for the last few years and have started to increase over the last 3 months in the PPI and CPI report.

Although core inflation seems likely to moderate gradually over time, the risks to this forecast are to the upside. In particular, upward pressure on inflation could materialize if final demand were to exceed the underlying productive capacity of the economy for a sustained period. The rate of resource utilization is high, as can be seen most clearly in the tightness of the labor market. Indeed, anecdotal reports suggest that businesses are having difficulty recruiting well-qualified workers in a range of occupations. Measures of labor compensation, though still growing at a moderate pace, have shown some signs of acceleration over the past year, likely in part the result of tight labor market conditions.

Translation: We still think inflation is more likely to increase than decrease. So much for my statement at the beginning that "we expect inflation pressures to moderate".

Short version: The Fed is still focused on raising rates if inflation increases.

Durable Goods Orders Disapppoint

From Bloomberg:

U.S. durable-goods orders excluding transportation unexpectedly fell for a second month in February, jeopardizing the Federal Reserve's forecast for a recovery in investment.

The 0.1 percent drop followed a 4.0 percent slide a month earlier, the Commerce Department said in Washington today. None of the 35 economists surveyed by Bloomberg News predicted the decline. Orders for all durable goods -- those made to last several years -- rose 2.5 percent, less than analysts anticipated.

Companies are reluctant to buy new machinery and equipment until inventories are reduced, suggesting the economy may slow further, economists said.

``This raises a major warning flag for the economy,'' said Douglas Porter, deputy chief economist at BMO Capital Markets in Toronto. ``It casts some serious doubt on what had been a leader for the economy in the last year or two.''

First, the Year-over-year percent change in new orders was -.27%. Ex-transportation, the YOY change was +.68%. These numbers are not seasonally adjusted. Here's where the problem lies (also a link to the Census report):

Inventories of manufactured durable goods in February, up twelve consecutive months, increased $0.5 billion or 0.2 percent to $298.0 billion. This followed a 0.4 percent January increase.

12 straight months of inventory builds indicates 1.) there isn't a need for new orders -- and may not be for awhile, and 2.) the sell side of inventories is slowing.

A Look At Homebuilders

After yesterday's announcement of a Federal investigation into Beazer Homes, a look at the homebuilders stocks seems like a good idea.

Here's the yearly chart. Like the rest of the market, this sector rallied starting in September of last year. However, in late February the sector broke the upward trend line and fell below the 10, 20 and 50 day SMA. The index lost about 10%. It is currently consolidating its losses in a bear market wedge pattern.



Here's a look at the 6 month chart, which betters shows the clear upward trend break.



On the three month chart notice a few things.

1.) There are actually two downtrends in place. While recent action has broken the latest, steeper trend, the secondary trend is still firmly in place.

2.) The last 4 bars of downward price action have been on increasing volume. This may indicate selling pressure is increasing.

3.) We're near a low price, meaning a move and close below say $32.75 would be a bearish signal.

Could Be an Interesting Day

1.) We have ongoing tensions between Iran and Britain, which are driving up oil prices.

2.) Bernanke testifies on Capital Hill. To get a better idea of what this testimony is really about Read this article from Barry Ritholtz at the Big Picture

3.) We have durable goods data coming out. Pay particular attention to the year-over-year number. Here are the charts for total orders YOY and total orders ex-transportation YOY.







4.) Federal Authorities announced a probe of Beazer Homes. Watch XHB -- the homebuilders ETF. I'll post a chart later.

2006 Subprime Bonds May be Worst Performing Ever

From Bloomberg:

Subprime mortgage-backed securities from 2006 may be the ``worst-performing in recent history,'' with delinquencies on the underlying debt ``consistently higher'' than in the prior five years, Standard & Poor's said,.

About 13 percent of mortgages made last year to people who have poor or bad credit are delinquent, S&P analysts Michael Stock and Scott Mason said in a report yesterday, with 6.65 percent of the total classified as ``seriously delinquent,'' or more than 90 days late. Losses on bonds backed by the loans will be between 5.25 percent and 7.75 percent, compared with 5.5 percent in 2000, S&P forecasted.

About $540 billion of bonds backed by subprime mortgages made in 2006 are outstanding, making up more than a third of all securities derived from such home loans, according to New York- based Bear Stearns Cos.

This article makes it appear there is a big divergence in performance between 2006 bonds and all other subprime bonds. If that is the case, than we have an isolated year where we have large problems. That doesn't make it any easier to deal with, but it does at lease limit the damage.

Money Managers Say Housing Biggest Risk to Markets This Year

From the WSJ:

Many managers fear that a housing slowdown could crimp consumer spending, a major driver of economic growth, according to Russell Investment Group's quarterly Investment Manager Outlook survey set to be released today. As stocks moved sharply lower in late February and early March, managers became increasingly bearish on market sectors sensitive to an economic downturn, such as basic materials and financial services.

The survey, conducted from Feb. 26 to March 5, overlapped with a stock-market slide. The Standard & Poor's 500-stock index fell 3.5% on Feb. 27 and dropped nearly 6% from Feb. 21 through March 5.

Of those managers responding after the downturn, 20% said a softening real-estate market is the biggest risk to U.S. stocks' performance over the next year, compared with 8% before the selloff. And as stocks dropped, managers became substantially more bullish on U.S. Treasury bonds, a traditional haven in times of market volatility. Of the managers responding after the downturn, 30% were bullish on Treasurys, compared with 10% of those before the downturn.

Managers cited increasing inflation as the greatest risk to U.S. stocks' performance, with many managers concerned that the economy's growth may be too strong.

Consumer spending is responsible for about 70% of US growth. Therefore, anything that effects it is important. This is a graph I put up yesterday, but it seems very pertinent to this story. It shows the year-over-year change in retail sales in red with the scale on the right and the actual sales numbers in black with the scale on the left.

Fed's Investigating Beazer Home on Fraud

From Business Week:

Atlanta-based Beazer, the nation's sixth-largest residential homebuilder, rode high during the heyday of the housing boom—profiting from both selling the homes it constructed and often financing the buyers as well through a wholly owned mortgage arm. It's common in the industry, but Beazer may have pushed the bounds: The North Carolina field offices of the Federal Bureau of Investigation, the Internal Revenue Service, and the Justice Dept. have recently opened a joint investigation into the company over such matters.

The Inspector General of Housing and Urban Development is also part of the group since a large percentage of Beazer's loans were made to low-income borrowers and insured by the federal government through the Government National Mortgage Assn., according to people familiar with the investigation.

Investigators, however, are not limiting their probe to possible mortgage fraud. "There's all sorts of potential fraud issues here," FBI spokesman Ken Lucas told BusinessWeek. "We're looking at all types of [potential] fraud associated with Beazer—corporate, mortgage, investments." Beazer did not comment by press time.

This is the worst possible news for the new home industry at this time. Yesterday, the Census Bureau reported a 3.9% drop in new home sales. Subprime mortgage lenders are already tightening their credit standards, and over 40 have with gone out of business, declared bankruptcy or sold their assets.

Now we learn the FBI, Justice Department and the IRS are investigating the 6th largest homebuilder in the country for "all types of potential fraud." This has the potential to cast a shadow over all homebuilders and mortgage lenders at a time when they least need negative publicity.

The Markets Today

All of the markets have a downward bias today. They all opened lower and zig-zagged a bit. However, pay particular attention to the SPYs and QQQQs end of the day action. They both sold-off on heavy volume. This is never a good sign because it indicates traders saw something that led them to want to get out of the market. The QQQQs ended the day at their low point.





Looking at the daily chart, notice none of the averages has closed above the drawn resistance lines from the sell-off a few weeks ago. Something is keeping the markets from advancing above these points. However, the price action for the last few days could be considered a standard pull-back during a rally. In other words, the fact the markets haven't sold-off is also important. This qualifies as a "we'll have to wait and see" how it all shakes out.

How Confident Are Consumers?

Here is a chart of the Year-over-year change in retail sales. The figures aren't adjusted for inflation, but are adjusted for seasonal factors.

How Confident is Business?

Business is ordering less and less new "stuff". Here is a chart of new orders, seasonally adjusted. The black line is total orders. The red line is the percentage change from year ago levels.



Transportation orders can really skew these numbers, so let's take them out of the graph. The same color scheme applies:

Oil Refineries Are Breaking Down With More Frequency

From the LA Times:

Refineries across the country are breaking down with unusual frequency this year, boosting prices at the pump and endangering workers and communities.

The rash of oil plant problems may not be a coincidence. The breakdowns stem from the hard use of aging equipment, a shortage of trained workers, corporate cost-cutting and ownership changes, refinery experts say.

In the first six weeks of 2007, there were 43 incidents involving pipeline leaks, chemical releases, plant breakdowns and fires, more than has been typical, Kim Nibarger, a safety expert for the United Steelworkers Union, told Congress during a hearing last week on refinery safety.

If it continues, this will only add upward pressures on gas prices.

Lennar Earnings Drop

From Bloomberg:

Lennar Corp., the largest U.S. homebuilder by revenue, said earnings plummeted 73 percent in the fiscal first-quarter as demand waned in the worst housing slump in more than a decade.

Net income for the three months ended Feb. 28 declined to $68.6 million, or 43 cents a share, from $258.1 million, or $1.58, a year earlier, the Miami-based company said today in a statement. Lennar said it will likely miss its 2007 profit forecast as the normally stronger spring selling season had not materialized.

``Given the state of the market, we do not expect to achieve our previously stated 2007 profit goal,'' Chief Executive Officer Stuart Miller said in the statement. ``We are not comfortable providing a new earnings goal at this time.''

Pay particular attention to what the CEO said:

``The housing market continues to demonstrate overall weakness,'' Miller said in today's statement. ``While some markets are performing better than others, the typically stronger spring selling season has not yet materialized. These soft market conditions have been exacerbated by the well-publicized problems in the subprime lending market.''

When industry insiders stop spinning and start using words like "weakness" and "the typical stronger spring selling season has not materialized", you know two things.

1.) It's an accurate statement. CEOs as paid to make positive public statements to support the company and the industry.

2.) Things are pretty damn bad to force that level of straight talk.

Gasoline Futures Hit 7-Month High

From IBD:

April gasoline rose 6.94 cents to $2.0677 a gallon, its highest since Aug. A BP refinery in Indiana is running below pace after a small fire there, reports say. That's the latest in a slew of refinery woes. Crude rose 63 cents to $62.91, a 3-month high amid rising tensions with Iran, OPEC's No. 2 producer. Retail gas prices are up 42 cents in the last 7 weeks to $2.655 a gallon.

Here's a daily chart of gasoline prices.



While that chart looks like prices are out of control, notice in the chart below the seasonality of gas prices. Gas prices this year (denoted as #2) are more or less following the same pattern as last year (denoted as #1). Gas prices typically spike in the summer.