Wednesday, May 21, 2008

PPI Shows massive inflation

Here is what the PPI numbers show
http://www.bls.gov/news.release/ppi.t01.htm

I've highlighted in red the areas where adjusting shoves inflation down quite a bit.
As with CPI, energy is dramatically reduced.

What is especially noteworthy is that annual inflation is running much hotter than is being reported. Consumer goods, for example, is almost at 10%.

I don't know the rationalization behind the adjustments, but clearly things are running hot

Moodys Busted for Manipulating CDO Ratings

http://www.bloomberg.com/apps/news?pid=20601087&sid=atxKM4_PXZVM&refer=home

Nearly $500B has been wiped out so far by the housing market debacle and the associated CDOs, the financial paper that sold the worthless mortgages. The entire sales process depended on a validation performed by neutral ratings firms like Moodys.

As recently as 2007, Moodys was giving high quality ratings to issues that Joe Sixpack knew were bad. Either the Wall Street analysts were severely out of touch with reality or something else was going on. That 'something else' was fraud. Turns out, the fix was most definitely in.

"The firm adjusted some assumptions to avoid having to assign lower grades..."

Deliberately fudging the data to drive a higher review is fraud. Sadly, this fraud - if wider in scope - has led to billions of dollars in losses and worse.
I'm really not surprised. A few weeks back I noted the peculiar timing of the latest round of ratings reviews by Moodys and the S&P. The timing of their release was a bit too coincidental for me: they waited until after the end of the quarter, when banks had closed their books. Had they released days sooner, all hell would have broken loose because the lenders would have had to scramble to cover the suddenly lower value CDOs.

In the meantime, expect more reviews to lead to suddenly lowered ratings on other bonds. A lot more turmoil ahead for the financial sector.

Tuesday, May 20, 2008

Bay Area Housing Woes Continue - But The Spin Machine Works Overtime

http://www.dqnews.com/News/California/Bay-Area/RRBay080520.aspx
For the Bay Area, April housing sales are down 15% over April 2007.
Here's how that compares:
Return to normalcy
It looks like the normal April sales rate is ~7K homes per month. Even during the furious dotcom craze, April home sales peaked at 7.8K. And after the dotcom bubble burst and population decline rose to over 100K, home sales drifted back down to 7K per month.

Arguably, we might head even lower for a while. A lot of people who would have waited to buy were able to get easy credit and bought sooner than they would have. The market in 2005 pulled in folks who would have normally been buying in 2008, for example.

Speculators stuck
If 7K was the home sales rate for residents, it is plain that the 2002-2006 rates reflect speculation. My ballpark guesstimate would be 150,000 homes are owned by speculators and investors. That's a lot of excess inventory waiting to get released into the market

The media is spinning hard
The media wants a happy ending to this story. So they are pointing out that home sales are up 28% since March. Some 1,400 more homes were sold in April 2008 than in March. Does this mean that the good times are back?

I wouldn't break out the champagne yet.

First of all, 26% of the April Bay Area sales were foreclosures. A lot of wannabe investors pounce on foreclosures. Take out the foreclosures, and home sales are closer to 4.7K homes, about the number sold in March.

Now consider that all things considered, this was the worst April since 1995.

Most likely, we are witnessing the first wave of knife-catchers, the folks who jump in too soon. We want to see knifecatchers because it reassures us that this bubble is behaving like all other bubbles. Every bearish bubble enjoys a wave of knifecatching before falling again. Because there aren't a lot of these investors. The sooner that they are pulled out, the sooner the real price drops can start.

Meanwhile, weakness is finally hitting Silicon Valley: Santa Clara county sales are down 28% year-over-year and San Mateo are down 16% yoy. The Silicon Valley home sales are incredibly dependent on stock market options - and those haven't been performing well. Imagine what happens when layoffs start hitting the area.

No remedy in sight
A major headwind is interest rates. The 4% ARM rates are gone. Anyone facing a re-setting loan rate is looking at a significant hit. A $700K mortgage now costs ~$14K more per year. And the rules are much more stringent - downpayments are required and no more liar loans.

Will rates fall? With Congressional meddling on mortgages, it's difficult to say. But they won't fall to the pre-2005 levels.

And inventory is rising. Some 1.5K foreclosed homes sold in April but that's against a rate of 2.3K homes getting foreclosed on each month since January.
http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/04/23/MNK0109TLP.DTL
The backlog is big and growing.

Finally, think about the impact on HELOCs. Median home prices in the Bay Area dropped ~$100K in one year. Banks will not be giving credit lines. A lot of spending is going to dry up. The California consumer is the biggest market in the US, and they have no money to draw on.

Monday, May 19, 2008

I can sense the crash coming

Something is up. I can feel it.
The mood has shifted and it's palpable. Folks are starting to go bearish. Most are doing it to lock in profit after the heavy run-up. Others see the fundamentals and are asking questions.

These things tend to have a life of their own.

Meanwhile, it's time to do those ETFC calls.

Sunday, May 18, 2008

The CPI And the Market Built on Sand

Facts are simple and facts are straight

Facts are lazy and facts are late
Facts all come with points of view
Facts don’t do what I want them to
Facts just twist the truth around
Talking Heads

The CPI report was released last week and showed mild inflation of 0.2%. This was less than the expected 0.3% and the market ended the week up almost 2%.

The CPI is a bundle of differently weighted products that consumers buy. Consider the actual data:

Now, if the unadjusted data were to be used, April inflation would have clocked in at a runaway 0.8%. That’s an annualized 10% inflation rate. That’s about what we would expect considering that food and fuel prices have surged.
* Food index: unadjusted April inflation is 0.8%
* Household utilities (which is basically gas and electricity) index: unadjusted April inflation is 2%
* Gasoline index: unadjusted April inflation is a whopping 5.6%. That’s an annualized 67%, which is about how much the price of oil has risen.

So why does the gasoline index suddenly change from a 5.6% rise to a -1.9% drop? Especially when household electricity isn’t similarly massaged.
The answer: government statisticians at work. March and April are traditionally heavy driving months so the CPI formulas neutralize any jumps in fuel prices. Although oil prices jumped 20% March-April, the CPI will erase them.

But, come May, the story will be bleak. Even a partial reversal, say from -1.9% to +2%, will drive CPI back up to 0.4%. That's double the Fed's target.

Take another look at that chart. Divide it into things people want and things people need.
Need (61% of total): Food, Housing, Home utilities, Fuel, Education
Want (21% of total): Furnishings, Apparel, recreation, communication, Other
Grey Area (18% of total): Transportation excluding fuel, Medical

The Need CPI is rising fast and it represents most of people’s disposable income
The Want CPI is mainly negative, with offsetting rises in Apparel and communications
The Grey Index is mild. One could argue that transportation belongs in the Want category, but not everyone can postpone buying a car or avoid public transportation. Similarly, Medical could be both a need (necessary care) or a want (deferred elective surgery or insurance) .

My conclusions are:
1. Good news today is very bad news tomorrow. Officially reported CPI will spike up starting next with the May numbers. This is entirely due to oil prices and the manner in which they are reported.
2. No more Fed interest rate adjustments for a while. The Fed reads these numbers the way I do. They know that inflation is running hot, just as they know that they are exporting inflation around the world. The Fed believes that a softening economy will lead to soft demand and therefore lower CPI. In fact, they seem quite willing to trade-off high inflation if it leads to an economic turnaround. But I would guess that there is a limit – separate comments last week by Bernanke and Yellen alluded to concerns about inflation. Perhaps the Fed expected some inflation and has been surprised at the huge jump
3. Consumer belt tightening will accelerate. Avoid any consumer durable company. Expect massive use of the credit card to manage finances. This spells recession.
4. Lower corporate margins as vendors get squeezed. Inventories will remain lean and vendors will layoff employees. Factory spending will similarly drop and so will equipment orders (machinery, forklifts, etc). More earnings and sales negativity

Go back to my 2nd point above: inflation is going global. The Fed's gamble is that the economy will turnaround just in time before inflation does any real damage or the counter actions become too severe.


Certainly a lot is being thrown at the situation
* Loose lending: rates at 2% and ~$700B in loans to banks
* Consumers getting $117B in stimulus checks
* Massive central banker coordination

Several things are working against the Fed's Plan:
1. Consumers aren’t spending or planning to spend

  • Consumer Confidence is at a 28 year low http://www.bloomberg.com/apps/news?pid=20601087&sid=aqqGY5BrKuoA&refer=home
    Fell to 59.5 from 62.5, the lowest since June 1980
  • Consumer Spending is flat: retail in inflation adjusted dollars is flat. And when gasoline is subtracted, spending on non-gas items has plummeted. Kohls and JC Penny have reported the pullback is already cutting deeply into their profits
  • Future spending will drop. The index of consumer expectations for six months from now (monitors the direction of consumer spending) dropped to 51.7 from 53.3.

    Look at the chart below. this is the University of Michigan's consumer confidence chart
    Consumer confidence has collapsed from 95 to the 50s in 1 year. A collapse of that magnitude usually presages a recession and stock market collapse. Because in a consumer driven economy, a sudden wave of belt-tightening forces everyone into a slowdown.



2. Manufacturing is weak (http://www.bloomberg.com/apps/news?pid=20601103&sid=aLvQshBDjL8w&refer=us)

The bulls are grasping for lifelines. Manufacturing may be weak, but it isn't getting significantly worse. There is always exports

3. Rest of world is starting to stagger

4. Inflation will not follow historical trends of following growth down

This is conjecture, but much of the inflation is caused by shifts in long-term demand for food, energy, and infrastructure. US inflation won't drop if Chinese demands doesn't slacken. And oil supply/demand equilibrium is too close.

But this need not be horrible. Even inflation of 5% is low from a historical standpoint. It certainly isn't the Reagan or Carter era level.

So the signs are there - the economy is weak and getting much, much weaker. It will show up in the stock market eventually. The issue is whether the Fed's monetray policies (the easy money) are going to keep the market up as proof of recession emerges and becomes incontrovertible.