Chart of the Day

Where do we stand with the US residential real estate?

Whilst the Case-Shiller index has improved over the past few releases, yesterday's single-family home price dropped 2.3% in August.The stock market sold off on the news.

today's chart illustrates the US median price of a single-family home over the past 39 years. Not only did housing prices increase at a rapid rate from 1991 to 2005, the rate at which housing prices increased – increased. That brings us to today's chart which illustrates how housing prices are currently 30% off their 2005 peak. In fact, a home buyer who bought the median priced single-family home at the 1979 peak has seen that home appreciate by a mere 4%. Not an impressive performance considering that three decades have passed. Over the past two months, single-family home prices have resumed their decline and remain (until proven otherwise) in an accelerated downtrend.

Time to short the banking sector?

After being hit hard (and for a reason), the banking sector posted fantastic gains:

	High	Low	Close	H to L	C to L	C to H
S&P 500 Banks	414.75	46.72	131.45	-89%	181%	-68%
	Feb-07	Mar-09	18-Sep-09
FTSE 350 banks	11696.3	1877.1	5308.74	-84%	183%	-55%
	Feb-07	Mar-09	18-Sep-09
DJ Euro Banks	491.78	84.61	231.75	-83%	174%	-53%
	May-07	Mar-09	18-Sep-09
DJ Stoxx Asia Pacific banks	96.93	32.97	56.96	-66%	73%	-41%
	May-06	Mar-09	18-Sep-09
Topix Bank Index	508.18	125.65	150.72	-75%	20%	-70%
	Apr-06	Mar-09	18-Sep-09
Hang Seng Financial	4932.55	1718.91	3573.2	-65%	108%	-28%
	Nov-07	Mar-09	18-Sep-09

Are these sustainable (at least in the developed world)?

• Banks profitability is driven by the endless open check book provided by central banks around the world at 0% or near 0% financing cost whilst investing in US treasuries or equivalent and getting around +/- 3% for 5-10 years maturities. Despite the rhetoric, central banks are more interested in banks increasing their shareholders funds than increasing lending to consumers and companies. The decrease in lending accelerated in July to an annual rate 10.4% (7.4% the previous month) according to data from the FED.

• Whilst having improved, balance sheets are still weak despite deleveraging, capital increases seen for the past 12 months and write-downs. According to today's FT:

  There is mounting concern among industry professionals about how to restructure or refinance the $2,100bn of European commercial property loans, in particular the $200bn in CMBS. [Commercial Mortgage Backed-Securities]

  A report from the UK industry group that met with the Bank highlighted that the UK commercial property sector could be in negative equity until 2017 and undercapitalised by up to £120bn ($195bn) based on current conservative banking refinancing terms.

  Close to £43bn of loans to the commercial property sector are due for repayment this year alone, according to De Montfort University research.

  Half of the outstanding European CMBS market needs to be repaid in 2011 and 2012, and CMBS in default have already proved difficult to restructure.

• In the US, the situation is not much rosier. Since the beginning of the crisis, the FDIC (Federal Deposit Insurance Company - the body that insure deposits) has spent approximately $50 billions and is now underfunded (see graph below). Write-off on US commercial real estate loans could amount up to $400 billion. Add increased delinquency for credit cards and you get the picture.

• Banks are again mulling calls to their shareholders to raise new equity, Royal Bank of Scotland being the last one to queue. With banks showing profits again during H1 2009, investors would have thought that they should not need to come to the markets again so soon. This lead me to be suspicious about the solidity of banks' balance sheets, and I am not convinced by the argument where new equity is needed to get freer from Governments: they need to raise capital because their loan losses are high and rising. The latest release from Institutional Risk Analytics shows that bank stress in Q2 2009 was at the highest level ever.

Conclusion

Between being short or being long, I would choose the former since too many uncertainties are lingering at this juncture of the crisis in the banking industry which benefited from the central bank largess. And I do not expect anything great from the G20 meeting in the US if I refer to the previous meeting in London where tax havens were wrongly targeted and now traders' bonuses seems to be the next scapegoat. I however still scratch my head with leading indicators having improved for 5 months in a row...

Sources:

Financial Times
European property groups face debt time-bomb
http://www.ft.com/cms/s/0/a29bce72-a60e-11de-8c92-00144feabdc0.html

Federal reserve Statistical Release
Consumer Credit
http://www.federalreserve.gov/releases/g19/Current/

John Mauldin
Thoughts from the Frontline Weekly Newsletter
The Hole in FDIC
http://www.frontlinethoughts.com/gateway.asp

Institutional Risk Analytics
Q2 2009 Bank Stress Index Ratings
http://us1.institutionalriskanalytics.com/pub/IRANews.asp

Northern Trust
Loan Delinquency and Charge-Off Rates at Troughs of Business Cycles
http://web-xp2a-pws.ntrs.com/content//media/attachment/data/econ_research/0909/document/dd091809.pdf

W shape recovery?

Economic numbers have been rosier for a couple of months. Underneath, some fundamentals problems have yet to be solved:

• Rising unemployment (slowing, yes, but still)
• Households continue to deleverage /rebuild their balance sheet and savings
• Whilst conditions in the interbank market is back to normal according to OIS and TED spreads, banks' lending to consumers and companies is muted
• Governments are going to compete with the private sector to finance their needs
• Excess liquidity is finding again it way into financial assets, commodities in particular that are well above what the medium term economy warrants
• Taxes are on the rise in some countries to finance the fiscal gap: US and UK in particular. At a time of high unemployment and low wage growth, there is a risk of withdrawing additional money from households potential spending

I do not believe (as yet) that we will witnessed a double dip recession. However all the noise made by the media and politicians about a better economic outlook, makes me nervous, and the risk of policy mistake is on the rise, fear having disappeared.

Are US consumers going to get the economy rolling at the speed the markets are pricing in?

In a post yesterday, I indicated that unemployment, and therefore consumers, will be key to the recovery: recent numbers are not particularly encouraging with a continued deleveraging in consumer credit that ties up with an increase in the savings rate. These numbers seem to contradict positive noise on consumer sentiment (rebound in the Conference Board Consumer Confidence index in August compared to the bad July number); personally, I prefer hard facts.

Record Plunge in U.S. Consumer Credit Signals Weakened Spending

Sept. 9 (Bloomberg) -- A record $21.6 billion drop in borrowing by Americans added to evidence that consumer spending will be slow to recover as banks and credit-card companies tighten lending standards and households pay down debt.

Consumer credit fell by 10 percent at an annual rate in July to $2.5 trillion, according to a Federal Reserve report released yesterday in Washington. The drop was more than five times larger than economists forecast. Credit fell for a sixth month, the longest series of declines since 1991.

Do not misunderstand me: I do not say that Amaguedon is for tomorrow, but that equity markets went ahead of themselves and will need to adapt to the reality of the economy.

Sources:

Bloomberg
U.S. Consumer Credit Falls by a Record $21.6 Billion (Update2)
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aAYZpSNGocVM
Record Plunge in U.S. Consumer Credit Signals Weakened Spending
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=avvF5aNtrCfc

The Conference Board
Economic indicators
http://www.conference-board.org/economics/indicators.cfm

Goldman Sachs
Where to invest now? Sustainability of rally depends on final demand
http://www.fullermoney.com/content/2009-09-08/WheretoinvestSep09.pdf

Can green shoots be sustainable?

For a couple of months, media ahs been full of greenshoots: the economy is back on track, we are going to see a V shape recovery, GDP upgrades are multiplying, corporate earnings are much better etc.

However without the consumer going back to shops to buy, these greenshots with end up like leaves on trees during the Autumn: brown.

Whilst a lagging indicator, unemployment will be key in this current recession due to its psychological effect on consumers combined with the depth of this recession. Let's review 3 graphs.

Graph 1 shows that the unemployment in the US will be the deepest since WWII. True the pace of employment destruction eased to 216,000 in August vs. 276,000 in July (revised up) and 463,000 in June (revised up). This is however not surprising being nearly 2 years in recession: the pace of 400,000/500,000+ new unemployed a month was not sustainable for very much longer with the stimulus package and money injected. Unemployment rate increased to 9.7%; however including part-time workers who would like to work fulltime and other unemployed that are discouraged to seeking a job, the rate is above 16%!



This recession is however by far the deepest since the early 70s, and will affect the way the baby boomers will consume and reflect on their pensions having lived on debt steroids for 20 years: fear is new; fear of losing their job, fear of losing their home, fear of losing their savings, fear about the social and health coverage, fear about their pension, concern about their children higher education and job, etc.

This results in reconstituting their savings (up to 6.9%) after having been sub zero 3 years ago. However, this steep increase is mainly in the form of debt repayment (and not in liquid savings accounts) and is helped by deflationary pressures. it does not bold well for consumption in the coming months.

The third chart illustrates that the current job market has suffered losses that are more than six times as much as average (20 months after the beginning of a recession). In fact, if this were an average recession/job loss cycle, the number of jobs would have begun to increase five months ago...

Whilst at odd with many commentators, I am still convinced that we are due for not so nice surprises on the economic front by year-end, Q1 2010 at the latest, hence my view of an equity market correction.


Sources:

Bureau of Labor Statistics
http://www.bls.gov/news.release/empsit.nr0.htm

U.S. Department of Commerce
http://www.bea.gov/national/nipaweb/Nipa-Frb.asp?Freq=Qtr

Prof. Michael Hudson
Debt Deflation Arrives:What the Jump in the U.S. Savings Rate Means
http://www.michael-hudson.com/articles/financial/090630ODebtDeflation_SavingsRate.html#_ftn2

The New York Times
http://economix.blogs.nytimes.com/2009/05/08/comparing-this-recession-to-previous-ones-job-losses/