While the market mindlessly climbs as it feeds on its own momentum, let’s take a look at the facts.
1) Global short rates have been rising for some time, and, according to ISI, there is a 62% correlation between that and a weak economy.
2) The yield curve has been inverted for the last few months. This condition has almost always been followed by recessions.
3) Year-over-year housing starts and permits are down by percentages always associated with recessions
4) The Conference Board Index of Leading Indicators is down 0.8% year-over-year. With one exception such negative readings on this indicator have consistantly been followed by recessions
5) Non-farm payroll employment is up only 1.4% over a year earlier. Over the last 50 years whenever this has happened, the reading has always dropped to negative territory, and has been followed by recession
6) The NAHB seasonally adjusted housing index dropped to its lowest level ever for the month of April—and all three components of the index were similarly at their all-time April lows. Significantly, this index is compiled by the home builders.
7) March new home sales were down 23% year-over-year, and the first quarter was down an annualized 45%. The absolute level of sales was the lowest since the 2nd quarter of 2002. Available inventories are equal to an uncomfortable 7.8 months, and even this is understated since order cancellations are not reflected. The median number of months for newly completed houses on the market is 5.6 compared to 3.6-to-3.9 for much of last year.
8) Existing home sales were down 8% in March, the slowest since 2003, with single family homes down 9.5%, the largest decline since January 1989.
9) The Case-Shiller home price index dropped 1.5% year-over-year, the lowest since October 1993. The firm stated that "the declines in home prices are showing no signs of a turnaround."
10) Countrywide financial said that tighter banking regulation may push more homeowners into foreclosure by making it harder to finance sub-prime mortgages. Moody’s stated that losses on subprime home loans will be more than they expected. Mortgage delinquency and default rates are soaring.
11) Contrary to consensus views, the housing woes are already spreading, as the following items will indicate. Mortgage Equity Withdrawals (MEW) has declined 54%. A recent study by Greenspan and James Kennedy, issued by the Federal Reserve Board, estimated that home equity financed almost 4% of consumer expenditures from 2001 through 2005. That impetus is no longer there, while the household savings rate has been negative for almost two years.
12) General Motors said the mortgage meltdown would be worse than previously forecast and would have a serious impact on auto sales. Ward’s is forecasting a sharp decline in April light vehicle sales.
13) The four-week average of new unemployment claims is trending higher, and has been doing so since early 2006. Continuing claims are at the highest level since early 2006 with the exception of one reading in February. Surveys show that the jobs harder to get number is rising while the jobs plentiful figure is declining.
14) UPS said the softening economy hurt its package delivery volume in the first quarter.
15) Non-defense durable goods orders ex-transportation, a good indicator of capital goods expenditures, was down an annualized 15% in the 1st quarter, after a drop of 4% in the 4th quarter.
16) Industrial production has been flat since last August.
17) Year-over-year retail sales growth is less than half of what it was this time last year, and yearly growth of core retail sales is the lowest since May 2003.
The above-mentioned indicators of a weakening economy occurred before the newly issued tighter mortgage regulations were put into effect. The new rules will eliminate most of the non-traditional mortgages including no documentation, no interest, no down payment and waver of payments. This will drive housing demand down even more and spread to the rest of the economy. Even in more normal times, the housing industry was the main conduit through which credit tightening or easing was transmitted to the economy at large. Following this historic boom, the impact of housing is likely to be even greater than usual. In our view the probability of a hard landing is extremely high.
The current upward momentum in the stock market reminds us a lot about the situation near the market peak in March 2000 when we also bucked the consensus. At that time we had just started writing these commentaries, and began with a series of articles with titles such as "Bad Ending Likely"; "Stretched to the Breaking Point"; "A Game the Market Cannot Win"; Traditional Rules Still Apply"; and "Rally Not Soundly Based". Perhaps this time we’ll be wrong, but as we see it, the probabilities strongly favor a hard landing.
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