Money Game

Have the recent ructions in the Treasury market begun to impact the residential mortgage market in NYC yet?

No. Well, at least not yet. Mortgage rates have only ticked up about 20 basis points in recent days.

Based on conversations we had with a couple of mortgage officers, the real estate market in the city has been hitting its stride, if not quite robust.

But clouds are forming, and yes the Treasury market is a warning sign.

Jeffrey Appel, a loan officer at Bank of America agrees there’s no doubt the outlook on rates is higher, saying that a 100-200 basis point move would “slow things down a lot,” adding that “pricing pressure is something we’re concerned about” right now.

Melissa Cohn at Manhattan Mortgage echoed similar sentiments, saying a 2.5% rise in rates would be particularly harmful: “The greater fear is what’s going to happen April 1.”

Image: www.calculatedriskblog.com

That’s when the mortgage market officially enters a post-Fed period, as Bernanke will not have his finger on the BUY button all day.

How big of a deal is this?

Based on this calculator at Political Calculations (via Calculated Risk), the average normal 30-year mortgage should be aro udn 5.72% based on 10-year yields 3.88%. Right now however, mortgage rates are sub-5.

The upshot is that the 100-250 basis point move that both Appel and Cohn are concerned about is not that far out of the realm of possibility.

Take away the Fed mortgage buying, and take away and add more pain in the Treasury market, and voila, there you go. Higher rates, higher mortgages, slower sales.

And of course, it doesn’t matter why Treasury rates are going up. Cohn observes are Catch-22: “If we get strong economic data, that will drive up rates.”

Beyond the Fed, the other big issue is Fannie Mae, and its insistence on actually following its own rules.

Both pointed to last week’s news that Fannie Mae would no longer finance loans in Battery Park City as a major negative development for NYC housing.

Among the problems: Too many NYC buildings violate Fannie rules, such as having more than 10% of units owned by a single owner, or not having enough money explicitly set aside for repairs or developments.

Basically, the NYC market is not made for a Fannie and Freddie world, and during the boom, when nobody was paying attention to standards this was fine.

Now this is a pain point, and it’s holding back the NYC market.

That being said: our guess is that Fannie will cave in some manner eventually. If rates surge, and the New York housing market is really held back (despite a solidly recovery), expect them to find away.

Courtesy of Karl Denninger at The Market Ticker

Yahoo has jumped the shark with publishing “1,300″ on the S&P by the end of the year, a 17% annual increase:

“The bears have been consistently wrong throughout this whole rally,” Altucher tells Aaron in the accompanying clip. “If you followed the bears’ advice at the bottom you’d be dead broke right now.” For full disclosure, Altucher did not call the market crash in 2008. “Better to be consistently bullish than consistently bearish.”

Well now that’s math: 70% of the time the market is ascending, historically.

The problem is that when it declines it almost always goes down much faster than it goes up, and due to that pesky math again if you lose 50% you must get a clean double to be “back to even.”

Someone better look at the 1930s. We had the same sort of calls then – and there was a ferocious rally fueled in no small part by people who were convinced that 1929 was just a “garden-variety panic.”

They were wrong. When the market rolled over for the second time instead of collapsing in a spectacular crash it instead ground lower for years, and in fact we did not see a secular bull market again until the 1950s – following a World War! Worse, while the market did make its “low” in 1932, it still doled out a 50% loss from 1937 to 1942, as you can see here:

The question, of course, is “where are we now”? From today’s charts you can make a number of arguments but “correlation” is going to be missing in all of them. Indeed, going back through the entire range on this chart I can’t find a pattern that looks like this – so those who claim “we have a good fit” are trying to fit a thesis to a chart, rather than finding the chart fit first and then extrapolating.

I can make a fairly clean argument that this is a head and shoulders pattern in development. A fall below ~6,000 in the DOW would confirm this, although such a fall might not come for as many as five years (if the chart is symmetrical.)

By the way, should that happen the downside target is, effectively, zero (14,000 – 7,000 neckline, approximately = 7,000 points down for the target!)

Is that extreme? Sure is. But the S&P 500 looks an awful lot like a double top, and the target on that, if it is, happens to be a full retrace of the move that led to the double top. Being generous this puts the long-term target at 400, being “aggressive” puts the view more in line with 1988, which is roughly half that. Now you know where my “SPX 210.23″ came from that’s in the header of The Market Ticker.

You could call that sort of view catastrophically bearish, of course.

Or you could call it realistic.

To call it catastrophically bearish (that is, ridiculous) you have to make the argument that a burst credit bubble can be re-inflated via some means. I would like to see someone show me where this has been successfully accomplished in the modern world. Certainly Japan has tried, yet with 20 years of effort they remain nearly 75% off their stock market’s all-time high.

Japan couldn’t make it happen – why do you believe we can?

Dave Rosenberg makes the same set of essential points in a piece that Zerohedge linked up today. And certainly, this rally has been good to you if you bought the bottom – instead of being paralyzed in fear. Many people (myself included) did, but sold out far too soon – we did not believe that the balance-sheet fraud among banks could carry us this far. We were wrong. That’s ok – nobody ever goes broke taking a profit, even if you leave half of it on the table.

Mr. Rosenberg makes the argument that the rally has been essentially fueled by the prop desks selling back and forth to each other and acting like geniuses. Maybe. What we do know is that institutional mutual funds are back to 3-1/2% cash positions – where they were in October of 2007. We do, of course, know what came next.

What we do know is that there are simply no sellers. Absent sellers prices tend to drift upward. That’s ok, for how ever long it lasts. It is the “how ever long it lasts” problem, however, that eventually comes home to roost, as those prop desks can short just as quickly as they can buy.

More troubling as Dave has picked up on is the fact that ex-government handouts personal income is contracting and now has for two months in a row. NBER uses this indication (as do I) for a real read on whether we are in an economic contraction or expansion. It is, in my view, much more accurate than the so-called GDP, which is influenced by trade imbalance and inventory cycles – neither of which have a thing to do with organic final demand.

This Friday we will be treated to the Non-Farm Payroll report where the only people trading it will be the Globex (electronic) futures players. That promises to be a wild ride, and one that I will sit out on purpose. Surprises either side of consensus are likely to be poorly received – a “hot” (good) number will probably spike yields higher, which is what produced the two late-day sell-offs last week. A “cold” (poor) number likely hammers yields, but at the same time hammers stocks, as it leads to questions about whether the so-called “recovery” we’ve been promised is in fact real. So like Goldilocks, we need a “just right” figure (in the eyes of the market, not necessarily the so-called “consensus”) for the market to treat this release with benign neglect.

Key to this release will be the “ex-Census” figures, since Census jobs are both part-time, of limited duration and relatively-low-paying. As such everyone doing analysis on the number (myself included) will be backing that out to the best of our ability; one hopes that we get a clean delineation from the BLS so our efforts are not “a guess.”

The risks in the back half of the year are quite a bit more serious. To begin with those census jobs will be finished, and those employees will get pink slips. This will impact the NFP number in the back half of the year. Housing appears to have sputtered despite all the tax credits and distortions and at the same time The Fed is finishing their purchases of MBS (which have artificially suppressed rates); this portends more softness in housing, perhaps a lot of it.

The bottom line on housing, which is underlying this entire mess, is that it is still too damn expensive.

Like many Chicago-area residents who’ve lost their homes to foreclosure, Alondra Navarette had nowhere to turn when forced to leave her spacious house earlier this year.

The struggling maid could no longer afford her ballooning mortgage payments when house-cleaning jobs dried up. So she moved into the already cramped basement apartment occupied by her daughter and a roommate on Chicago’s Northwest Side.

Government hacks always prattle on about “affordable housing”, but none want to talk about why houses are so damn expensive – it is the deliberate actions of government, which have protected banks who lent far more than these homes are realistically worth, that prevents homes from being affordable!

Is there any hope for this to change? Not so far. The banksters are more important than those of modest means, and the consequences become increasingly severe the longer these outrageous and destructive policies are maintained.

Then you have small business – the engine of job creation and economic advancement in this country. There’s no joy to be found there:

After some upward trends for most of last summer and into the fall, Discover’s monthly check on the pulse of small business owners measured 75.7 in March, down 9.2 points from February and back to the levels of a year ago.

“We’ve seen bigger month-to-month drops, but there is clearly a pattern here: Small business owners don’t like what they’re seeing – both at home and in the larger economy – and they’re responding by pulling back, rather than just holding the line,” said Ryan Scully, director of Discover’s business credit card, who commissions the monthly survey. “Tax season could be having an effect on the overall mood, especially because they’re still not seeing any relief from the government.”

So much for “recovery” among the engine of job growth.

We have a radical divergence between the stock market and opinions in the real world. Who’s right? In the end, the real world always wins, but timing is a problem – manias always go further than you think they possibly can, and this one has been and will be no exception to that rule.

I still need to see real improvement in the leading indicators I follow, and so far, it simply isn’t there. I don’t use “stock prices” as part of my data set for business conditions either – if I had, I would have been catastrophically wrong in 1999, 2007 and 2009! Rather I focus on consumer and small business confidence, sales tax numbers from the states and internals from the household survey in the employment report. Of those only one – the internals of the NFP report – and only for one month, last month – has show encouragement, and one month does not a trend make.

Small business and consumer confidence have not put in the sort of forward expectation numbers that tell us people believe they will both hire and be hired, and thus be able to spend freely. Leverage in the consumer space is still too high, as measured by the HOPE DTI numbers – instead of forcing those who are in fact bankrupt to recognize it and clear their debts (which would also bankrupt the banks that imprudently loaned these people money) we have chosen instead to paper over insolvency with fraudulent accounting.

This, however, doesn’t change the overburdened consumer’s mood nor does it help their long term spending power. It can (and has) provided a temporary, short-term support to spending, as the government has come in with direct and indirect subsidy. But this cannot last forever, and without actual economic activity in the private sector the odds rise precipitously of a ruinously bad “double dip”, destroying those people who jumped back in “chasing” this market higher – especially if you were late to the party, as most individual investors were and are.

Be careful.

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Submitted by Tyler Durden

The BEA released its February Personal Income and Outlays data: continuing the trend of PI outpacing or same as Expenditures, the sequential change in February Personal Income came in at 0.0%, lower than the 0.1% consensus. On the other side, expenditures increased by 0.3%. Previous revisions indicated that January PI has been an increase of 0.3%, while PCE was greater by 0.4%. Most troubling, this implies that the Personal Savings Rate declined by 0.3% from 3.4% to 3.1%, the lowest this metric has been in over a year. Keep in mind, the primary reason why Goldman sees that 10 Year at 3.25% (as opposed to Morgan Stanley’s 5.5% call) is because of the “increased” savings by US consumers. Now that these same consumers have decided to put their money in iMaxiPad pre-orders, maybe Goldman will consider reevaluating their Treasury forecast.

TOP STORIES
Greece tests the waters with bond sale – MarketWatch
The Maestro and the Hundred-Year Flood – Anecdotal Economics
Ford reaches agreement to sell Volvo to Geely for $1.8 billion – AutoWeek
Paulson’s $32 Billion Funds Prompt Too-Big-to-Succeed Concerns – Bloomberg
Germany and China’s policies have become a source of global concern – Telegraph
Greenspan Calls Treasury Yields ‘Canary in the Mine’ – Bloomberg
What is the Bond Market Telling Us? – Five Thirty Eight
Interest rates spike up – EconBrowser

Zero Hedge

The maestro managed to run away from the old folks’ bent on monetary destruction home just long enough to carry this amusing interview with Bloomberg TV’s Al Hunt. Tomes (will) have been written about Greenspan’s dementia, just as books will be available on the Kindle one day analyzing his successor’s massive mistakes which are slowly but surely leading to an American day of reckoning, so we won’t comment much, suffice to point out some of the key highlights in Greenspan’s presentation. Most amusingly, note the escalating battle between Greenie and the Fed’s new vice-chairman Janet Yellen, who blatantly contradicted Greenspan’s that higher interest rates would have prevented a housing bubble. For all it’s worth, Alan’s response is actually quite interesting: “We tried to do that in 2004. We ran into a conundrum. For decades, every time the Fed raised its short-term rates, the 10-year note, which is really the proxy for mortgage rates, the yield went up with it. This time, it did not. And the reason it did not, is you cannot have the 10-year note determined both by arbitraged global finance and individual central banks. As a consequence of that…starting in the period where the sensitivity of the early stages of the bubble were building up, it was very clear that what was determining the rise in prices was movements in long-term mortgage rates going down, not the federal funds rate.” In English, this is quite intriguing: China, which at about this time started running up massive trade balances, essentially became indifferent about US monetary policy, as it gobbled up everything east of 5 Years, with a preference on the 10 Year. The reason for this is the US consumer became the one driving force behind the massive Chinese economic expansion. With the consumer out, and with China set to report its first trade deficit in 6 years, and the Fed pulling out its support of mortgages, and the Chinese National Bank pulling liquidity, the move in 10 Year over the next few weeks is now more critical than ever, which is why the 10 Year – 30 Year MBS spread is paradoxically pressured at an all time tight spread, as all the early MBS shorts are covered, forcing pundits to say MBS are cheap as fighting momentum in this market is professional suicide. To be sure, this technical push down will soon end. And when this last coiled spring blows out, watch out below, first in housing, then in rates, in corporates, and last, in equities.

Key highlights from the interview.

On the outlook for the economy:

“Ordinarily, we think of the economy affecting stock prices. I think we miss a very crucial connection here in that this whole recovery, as best as I can judge, is to a very large extent, the consequence of the market’s bottoming last March and coming all the way back. You can see the whole blossoming of finance. Remember, it is the market value of equity in a financial institution that determines the ratings of its debt. It’s not the book value. As the stock prices have gone up, debt became far more valuable and you can see this huge issuance especially of junk bonds. It is affecting the whole structure of the economy, as well as creating the usual wealth effect impact.”

On the jobless rate at the end of 2010:

“I think the jobless rate will be ending up not far from where it is, because even though the economy is going to continue to rise, provided I might add that the stock market moves ahead of it, but if that happens, you’re going to get a significant rise in employment as we move into the year, but we will also get a rise in the labor force.”

“The rate will come down a bit. Those who are looking for sharp declines will be disappointed.”

On rising yields for treasury auctions:

“It is a canary in the mine at this stage. The way I would look at it, if the markets are working well, the short term outlook is one of increasing momentum. You can see it developing. But if the 10-year note and say the 30-year bond yields begin to move up, in other words, the10-year note begins to move aggressively above 4%, that is a signal that we are in some difficulty. There is basically this huge overhang of federal debt which we have never seen before. It is going to have a marked impact eventually unless it is contained, on long-term rates. That will make a housing recovery very difficult to implement and put a dampening on capital investment as well.”

“I am very concerned about the fiscal situation, not so much about the numbers, but the climate. One of the unfortunate fallouts from these huge amounts of money that we’re putting in the budget and the Fed is that $1 billion is not what it used to be. You cannot turn someone’s debt down who is requesting $20 million or $400 million when we are talking about trillions. That adds up. It’s the culture. We cannot cut expenditures. We could not even cut the C-17.”

On whether a consumption tax would work:

“I think it would be a short- term fix. It will work in the short run. The problem is very much of the type of issue that Greece has got. Unless the underlying system contracts – the deficit contracts – it’s just delaying in the problem. I am not convinced by any means that we can succeed in stabilizing this long-term outlook strictly from a value-added tax. Because unless we come to grips with the fundamental issue, which is the fact that we have promised in the ways of benefits for Medicare and social security, physically more than we have the assets to deliver with. The economy can only grow so far. Right now, the claims on the real economy – forget finance –are getting larger and larger. Social security, I might add, is money. You can always print money. Medicare is not a defined benefit program. It is one based on the physical needs of the population.”

On whether the current financial regulation bill would leave the Fed weaker or stronger:

“Weaker. [Al Hunt: Does that concern you?] It does indeed.

“My basic problem is that people don’t understand how important it is for the Federal Reserve banks in the districts, how important they are to the functioning of monetary policy supervision and regulation and all the aspects of the central bank. I am concerned that if the Fed loses that aspect of its structure, we are going to find that what was originally the notion that instead of centering the central bank in wall street, which was the argument leading up to 1913, it was decided to go geographically and spread it around. What is in the bills right now, in my judgment, reverses that.”

On whether there is a bubble waiting to burst in China:

“I think so. To be sure, there are significant bubbles in Shanghai and along the coastal provinces. Some of that is going back into the hinterlands as well. Remember, the bursting of a bubble by itself is not a big catastrophe. We had a dotcom bubble, it burst and the economy barely moved. It is hard to tell when that bubble bursts, what the consequences are, because we do not have enough data on China.”

On the outlook for the Euro and the dollar:

“The unfortunate issue is that the dollar and the euro are both going down, if I may put it that way. Since the exchange rate is a ratio, it is very hard to tell what the actual dollar-euro ratio will be. It went up this morning with the temporary agreement. Both sides have a problem. We have a long-term deficit problem. The Europeans have the obvious problem in that they are dealing with Greece and the other peripheral states.”

On whether we could have seen the crisis coming:

“I look back at our monetary policies and I see it could have gone wrong, it didn’t. The problem, as best I can judge on the fairly detailed analysis of the evidence, is that the roots of that crisis are very broad and geopolitical going back to the end of the Cold War and the massive changes in flows of finances that brought long-term, real interest rates down. And the consequences of that created a major expansion in capitalized values for real estate, especially residential real estate, across the globe. Certain aspects of monetary policy probably had some effect.”

On Fed President Janet Yellen’s remarks that higher-short-term interest rates probably would have restrained the demand for housing by raising home mortgage rates:

“I think [that is wrong]. We tried to do that in 2004. We ran into a conundrum. For decades, every time the Fed raised its short-term rates, the 10-year note, which is really the proxy for mortgage rates, the yield went up with it. This time, it did not. And the reason it did not, is you cannot have the 10-year note determined both by arbitraged global finance and individual central banks. As a consequence of that…starting in the period where the sensitivity of the early stages of the bubble were building up, it was very clear that what was determining the rise in prices was movements in long-term mortgage rates going down, not the federal funds rate. And indeed, when the federal funds rate was purposely put down in 2003, long-term rates did not come down. As far as I can say, the general notion is just not supporting. The general notion that the Fed was the propagator of the bubble by monetary policy, does not hold up to the evidence.”

Response to critics who say that a proposed systemic risk regulator (which Greenspan does not want) could hardly have done a worse job than the current system did:

“They wouldn’t. But the problem is, that is not the answer to this issue. It is very evident to me that the underlying crisis was caused by what is clearly a once-in-a- century event. We have had almost no instances of short-term credit being withdrawn on a global basis the way it happened right after the Lehman bankruptcy. All of the individual evidence here is that this is a very rare occasion.”

Courtesy of The Pragmatic Capitalist

Another earnings season is around the bend and it’s shaping up to be another good one.   As we’ve repeatedly mentioned over the last 6 quarters the environment is and remains particularly ripe for profit outperformance.  The trends that have been in place for the last 6 quarters remains largely intact.  Analysts remain woefully behind in terms of raising their estimates (see here) and corporate profits remain a margin story.

Figure 1 shows the corporate profit margin over the last 40 years.   Most important in the last few years is the turnaround in margins since Q4 2008 when enormous cost cutting campaigns kicked in.   The one remarkably positive sign during this recession has been the ability of corporations to remain lean and mean.  They have done a superb job in cutting costs and maintaining a fairly robust bottom line.  As you can see, profit margins are surging in recent quarters and should continue to trend higher as unit labor costs remain low (see figure 2) and revenues begin a slow rebound (the extent of this revenue rebound will be the key driver of any future market performance).  This trend has continued this quarter and should help power another quarter of “better than expected earnings”.

Figure 1

Figure 2

While revenues have certainly bottomed it remains the key missing ingredient in the recovery.  In order for stocks to continue their record breaking trajectory we must begin to see revenue growth.  According to recent jobs data it looks like the labor market is beginning to firm.  This is a clear sign that companies are beginning to see more stability in their top-line growth.  This also means companies are beginning to incur extra costs and the margin story will cease to be the primary driver of earnings without equal or greater revenue expansion.  One bright sign here is that revenues significantly lagged the equity market rebound during the 2003 recovery.  As you can see in Figure 3 revenues didn’t substantially recover until 2004.  We’re seeing the same thing occur with this recovery although the extent of the rebound in revenues remains questionable as consumer balance sheets remain underwater and the global economy continues to drag itself out of recession.

Figure 3

Perhaps most important in all of this, however, is expectations.  As we mentioned earlier, analysts have been woefully behind the earnings recovery.  This is best reflected in our expectations ratio which had been trending higher since just before the market bottomed last year and only recently began to roll over.  This shows that analysts estimates are becoming increasingly in-line with actual earnings and could create an environment that is not quite so friendly to the usual “beat and raise” environment we have all become accustomed to.  If a strong revenue rebound fails to materialize in the back half of the year analysts estimates will prove too high and stocks will respond negatively.

Figure 4

Based on my analysis, I believe we are in for one more quarter (Q1 2010) of easy analyst comparisons and then the heavier lifting begins as estimates ratchet up in Q2 2010 and even higher in the back half of the year where analysts estimates are very optimistic.  If we don’t see a stronger rebound in revenues in the next two quarters companies will not match these optimistic outlooks.

Currently, the market appears to be front-running the current earnings season and is pricing in another very strong earnings season.  Don’t be shocked to see another quarter of very high percentage earnings beats and tepid revenue performance.  Whether that is enough for an already optimistic market remains to be seen.  My guess is we will see another “sell the news” earnings season.  Companies are running out of tricks to pull from the cost cutting bag and revenues haven’t quite stabilized to the extent that would make most executives highly confident in their full year earnings.  If we don’t start seeing a pick-up in top-line growth this market is not going to be celebrating for long and the recent optimism in stocks will be proven wrong.

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