BEING STREET SMART
by Sy Harding
INVESTORS ARE FEARLESS! July 28, 2006.
This week investors received a few more clues regarding economic conditions going forward.
Prominent among them was evidence that the bursting of the real estate bubble continues apace, with the report on Monday that existing home sales fell 1.3% in June, and are now down 8.9% over the last 12 months, while the number of homes coming on the market is rising sharply. The result is that the inventory of unsold existing homes is 39% higher than a year ago, a more than six month supply (if no more came on the market). The inventory of unsold condos is 63% higher than a year ago.
Clouds are even darker over the sprawling developments of new homes and condos. The Commerce Department reported new home sales fell 3% in June, and are now down 11.9% just over the last six months. The median price of new homes sold in June was 2.3% higher than a year ago, but don’t let that mislead you. That does not mean home prices are still rising on an apples-to-apples comparison. It is only a reflection of the trend of new homes becoming ever larger and more expensive.
So, what does the slowdown in the housing sector mean for the economy going forward? A year ago, the respected London-based financial publication The Economist estimated that consumer spending and residential construction was accounting for more than 90% of U.S. economic growth, while more than 40% of all new private-sector jobs created since 2001 in the U.S. were related to the real estate boom. Obviously a slowdown in the area that has been providing the greatest support for the economy will not be a good thing.
Wall Street and Washington have been telling us not to worry, that while economic growth is slowing some, and an inverted yield curve usually warns a recession is on the way, this time will be different. Yet economists did forecast that the economy, as measured by Gross Domestic Product, probably only grew at a 3.1% pace in the just ended June quarter, considerably less than the 5.6% pace of the first quarter. But even with that forecast they were overly optimistic. On Friday, the Commerce Department reported that GDP rose only 2.5% in the June quarter. With the slowdown continuing, it will be interesting to see how close the current quarter comes to zero growth when it is concluded.
One would think that an economy that is slowing even faster than the experts thought, with the decline in the real estate sector, which was the main fuel for the economy, accelerating, would cast a huge shadow over the prospects for corporate earnings, on which stock prices depend. And already there were too many disappointing 2nd quarter financial reports this week, in which companies either reported lower than expected sales or earnings, or warned that the current quarter will not be as good.
However, investors, or at least short-term traders, seemed to be fearless, keeping the market in rally mode most of the week, taking sustenance from Wall Street’s assurances that the weaker than expected housing and GDP numbers at least mean the Fed should stop raising interest rates.
But even should that happen, would it be a good sign for corporate earnings and the stock market if the Fed becomes so concerned its rate hikes have gone too far and may slow the economy all the way into recession, that it halts its fight against inflation?
It could only be such a concern that would cause the Fed to halt its rate hikes at this point. It certainly couldn’t justify it by claiming it has won the battle against inflation. Accompanying the surprisingly weak housing and GDP numbers, was equally important proof that in spite of 17 rate hikes over the last two years, inflation is rising even faster than previously feared. Within the Commerce Department’s GDP report was the news that core consumer prices rose 2.9% in the June quarter, the fastest pace in 12 years. That confirmed the previous week’s report that the Producer Price Index, measuring inflation at the producer level, and the Consumer Price Index, measuring inflation at the consumer level, both showed even sharper increases than economists expected.
Yet, the stock market reacted to the bad news that the economy is slowing faster than expected, and inflation is rising faster than expected, with yet another of its periodic rally weeks of recent months, apparently based once again only on hopes the Fed will stop raising interest rates, without considering what that would mean regarding the Fed’s concerns about the economy.
In doing so, it also ignored the fact that history shows the stock market most often moves down after the Fed stops raising rates, when investors begin to realize the Fed has slowed the economy too much (and does not begin to move up until the Fed has reversed itself and cut rates several times). The most recent example was in 2000, when the Fed had been raising rates to slow that booming economy and ward off inflation. The Fed made its last rate hike in that series in May, 2000. The stock market had already topped out into the 2000-2002 bear market in March, 2000.
Don’t be surprised if it turns out this time, short-term rallies on rate-hike hopes notwithstanding, that if the Fed made its last rate hike this month, the market had already topped out at its peak in May.
Sy Harding is president of Asset Management Research Corp., DeLand, FL, publisher of The Street Smart Report Online at
www.StreetSmartReport.com and author of 1999’s Riding The Bear – How To Prosper In the Coming Bear Market!