Tuesday, June 16, 2009

Today The Markets Ignored Good Housing News

Today’s housing data was clearly good news. A 17.2% increase in housing starts is a hugely positive data point. This was led by a massive 62% gain in construction of residential apartments. And there was even a 7.5% rise in single family homes. And building permits, which are a reliable leading indicator of activity, were up significantly – and for the third straight month. Of course, the naysayers can always think of some excuse to pooh pooh this data. However, it is my view that under current circumstances, homebuilders are very unlikely to be building and applying for permits unless they are pretty certain about the final demand.

Many people will have trouble believing these numbers – perhaps because many live in areas where there is no such normalization occurring in the housing market. And clearly there are many areas that are still in decline – especially in the bubble regions and the regions (like the rust belt area) that are in a longer term secular decline. There are no shortage of anecdotes that bears can cite in support of the view that things are getting worse, not better. However, anecdotes are anecdotes. People can cite anecdotes of contraction in various regions when the economy is growing at a vibrant rate. That is irrelevant. The problem is that housing markets are local. And in many localities things are normalizing. Indeed, across wide swaths of the country, there was never a housing bubble to begin with, so there is no need to recover from a crash.

National statistics are national statistics. You can accept them or you can choose to join the conspiracy theorists that believe that the government is cooking the books to hide the fact that the economy is still in freefall. Believe what you will!

For those that believe that statistics are worth analyzing, it may be of interest to note that for housing construction to have a positive impact of GDP, all that has to happen is for it to grow at about 0.1%. Indeed, I estimate that basically zero growth in housing over the next 12 months would translate into a 1% increase in GDP, which is huge. That occurs because the contraction of housing construction ceases to be a drag to growth. Today’s numbers indicate that an even more optimistic outlook is possible.

Many commentators are talking about mortgage rates at 6% as being terrible for the economy. Yes, they exaggerate. Sure, 6% is not as good as 4.7%. But it is very good in historical terms. And, with respect to the housing construction industry, if people’s personal economies are stabilizing, as it appears that they are, 6.00% to buy homes or apartments that have declined sharply in value looks pretty good. Rumors of the demise of the American dream are premature, in my opinion – indeed, you can’t kill it precisely because it is a dream. The anecdote driven speculation about a permanent change in psychology in the American populous is, for the most part, fantasy. Life goes on. Young people that have a job, and feel relatively secure, are looking to buy. They don’t care if mortgage rates are at 6% or if they are at 8%. They want their own place. Period. (I know I did way back then..)

Now, let’s get back to financial markets. It matters not that the news be great. What matters is the reaction. And clearly, the market is tired of reacting bullishly to good news. It is now reacting poorly to so-so or bad news and it is acting indifferently to good news. Yesterday’s reaction to marginally negative news was indicative of a market that is a bit “exhausted” after repeated failures to clear the 950 area. And today’s reaction to good news confirms this view.

A market that is transitioning technically from a positive to a neutral bias implies that it will take considerable amounts of positive fundamental news flow for the market to firm up and renew its bullish uptrend. I am expecting an important flow of positive preannouncements in the next couple of weeks as well as a continued flow of positive economic data in the US and abroad. Will it be enough turn the tide?

I think this very much depends on the technical floor that is established in this “neutral” phase, and how quickly it occurs. Will the market find a new base at around the 900-910 level or will it go to 870-880? I certainly don't know; I am agnostic.

I believe that activity in foreign markets will be a major wild card factor in the next 3-4 sessions. Trading overseas can set the early tone in the mornings. They are also pretty good indicators of risk aversion, the movement of marginal money and the tenor of the “animal spirits.” If Asian and European markets are able to bounce in the next few sessions, this will be extremely important for US markets in my opinion. The converse is just as true. If foreign markets keep plunging, it is unlikely that the US market in its current technical state can buck the trend.

I maintain my 100% core long positions. However, I will not hesitate to use leverage to play defense. The short-term outlook is complicated, as usual.

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