Our readers know that we have long warned that the housing bust will be both deeper and longer lasting than most people expect. In fact, we think it is only about one third through its time duration and only a quarter through its price fall. Indeed, we believe that $1 million to $3 million homes may well suffer worse than those of lower value.
We note that while housing starts have recovered somewhat, the NAHB (sentiment) leading index has fallen sharply this year and continues to plunge (see chart below).
When the Fed released the minutes of its FOMC meeting of May 9, it pointed to the fact that, "Housing construction remained under pressure from weak demand and large inventories of unsold homes, and consumer spending appeared to have slowed in recent months. Business fixed investment remained subdued."
Taken alone, we can understand why many investors see lower rates around the corner.
However, the Fed went on in their statement to address their fears of inflation. Their statement said, "The total PCE price index rose substantially in both February and March."
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The Fed went on, "Accelerations in the costs of housing and medical services were major contributors to both CPI and core PCE inflation over the past year.
(By the way, the PCE is the Personal Consumption Expenditures index. It is the main focus index of the Fed, but excludes food and energy — like we "ordinary" people don't eat, drive, use electricity or heat/cool our homes? Talk about hedonistic accounting!)
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From this, we can see clearly how our Congress has hamstrung our Fed with a dual (and often conflicting) mandate.
But if a lead were needed, the subsequent communications of the FOMC and its Chairman tended to give more weight to the Committee's concern about the upside risks to inflation.
The bond market did not miss this and yields on Treasuries have risen, some to levels not seen since Aug. 15 of last year. The 10-year Treasury now yields some 4.88 percent.
However, the U.S. stock markets reacted differently. Anticipating the possibility of a Fed rate cut and apparently ignoring warnings of a slowing economy, they roared ahead.
One could argue that with merger and acquisition activity, Treasury stock purchases by corporations of their own stock and massive private equity buying of stock, all at record levels, the fewer shares available would alone lead to higher prices.
However, the rise in share prices has now outpaced the growth rate of corporate earnings. This has driven the average share yield (earnings/price ratio) on the S&P down to some 5.6 percent.
With cash yielding around 5 percent, many private investors have become increasingly skeptical of the risk/reward opportunity inherent in U.S. equities.
This is especially so as U.S. growth was, according to the IMF, only 2.1 percent in 2006 and now looks to be soft or even faltering.
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Anxious to participate in the gigantic economic "build-out" of the newly freed world economy (according to the IMF, growing at 5.4 percent in 2006), following the end of the Cold War, many investors have moved into relatively higher growth opportunities in overseas investments (growing at 9.4 percent in developing Asia).
Some investors have bought shares in large Dow stocks that derive a large proportion of their earnings from non-U.S. dollar sources abroad.
As CNBC reported, retail buying of mutual funds this year was some $35 billion. However, of that, some $22 billion (62 percent) was placed in funds investing overseas — up from $12 billion in the previous period.
It appears that retail investors are concerned by what they see at home.
Today the GDP numbers showed a growth rate of only 0.6 percent, the lowest for four years.
Low growth, inflationary risks and the prospect of a Democrat President supported by a Democrat Congress is worrying investors. They have decided either to stay in cash or to concentrate their equity exposure to overseas shares.
It appears that there is now a real alternative for U.S. investors, abroad. It is an opportunity that did not really exist before — overseas markets that have mature companies and transparent, high standards of reporting. Indeed some domestic companies are now tempted, by more sensible (less restrictive) regulations and lower costs to list even their IPOs outside the U.S., most notably in London.
We believe that many "bears" have already left the U.S. stock markets, for other perceived "honey pots," in cash or equities abroad. Of those who remain in the U.S. markets, the vast majority are probably "bulls."
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In other words, we feel it is possible therefore, that the domestic U.S. markets are now dominated by "bulls" (buyers) to an extent that has not existed in recent history, when America was overwhelmingly dominant in the economic world and its equity markets were the only relatively safe and liquid place for Americans to invest and for many from abroad.
If this is indeed so, it would go a long way towards explaining why the U.S. stock markets continue to roar, like casinos, in the face of so many adverse political, economic and financial factors here at home.
We believe that American stock markets, increasingly dominated by a residue of "bulls," are becoming more like gambling arenas.
The "bulls" are mainly institutions, playing with other people's money and with access to vast amounts of cheap leverage and liquidity.
In addition, the managers of hedge funds are not only lightly regulated; they are extremely highly rewarded. When the music stops, as we think it will, and their funds are whipped out, they will be rich personally and content to retire, leaving their (relatively rich) accredited clients holding pieces of deeply depreciated paper.
Tomorrow, we will have the latest inflation figures. We await with interest to see how they will be received, in light of possible Fed moves at the next FOMC meeting on July 27.
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