Retail Sales Jump, but the Story is in the Details...

Retail sales jumped 0.9% last month on the back of higher gasoline prices and increased automobile purchases. Automobile sales were mostly catalyzed by bigger incentives to clear inventories. But, factoring out these components retail sales would have actually declined for the 4th consecutive month. Therefore, despite what appears to be a significant increment on the surface, the details behind this morning's data do not yet indicate a recovery for the sector. Finally, consumers' purchases were centered around basic necessities such as food and gas versus discretionary goods.

Please click here for his week's full economic calendar with analysis and expectations.

US Economic Week Ahead: The Calm after the Storm

This week’s economic calendar is relatively quiet, especially compared to the hustle and bustle of last week. Monday’s non-manufacturing ISM report starts the week off, followed by Wednesday’s consumer credit report, Thursday’s jobless claims data, and Friday’s US trade statistics and consumer sentiment. The impact of this week’s non-manufacturing ISM report could be somewhat subdued since its release comes after June’s employment report; negating the importance the report’s employment index. But, significant declines or advances in the report’s business activity index could help shift market sentiment. This week’s big headlines, however, will likely be driven by the start of the 2Q09 earnings seasons, with Alcoa set to announce earnings on Wednesday. There is also a G8 summit taking place this week in Italy, which could produce some headlines. Here is this week’s US economic calendar:

Monday July 6^th:

10:00AM: ISM non-manufacturing Index (Risk: Neutral, Market Reaction: Moderate/Marginal): The non-manufacturing ISM index will likely experience its third consecutive monthly rise. The current Bloomberg consensus for the index is 46.7 compared to last month’s reading of 44.0. The market would take any positive surprises to this index as good news echoing better than anticipated data in the manufacturing sector pointing towards a less severe recession. It will also be important to pay attention to non-manuf. ISM’s new order index, which tends to be a forward looking indicator for the primary business activity index. Since June’s employment report has already been released the employment index is essentially a non-factor.

Tuesday July 7^th:

7:45AM: ICSC-Goldman Store Sales (Risk: Downside, Market Reaction: Marginal): This weekly index tracks same store sales at major US retailers, account for roughly 10% of total sales. Given recent data supporting an increasing US saving rates and a worsening employment situation, this index could face some downward pressure. Last week’s number indicated a 1.6% increment in store sales over the previous week.

Wednesday July 8^th:

7:00AM: MBA Purchase Applications (Risk: Neutral, Market Reaction: Marginal): This index, which tracks new mortgage applications tends to be a reasonable forward looking indicator for home sales, but issues including customers filling out numerous applications could skew the index. A recent drop in refinancing activity caused this index to drop 18.9% on a weekly basis last week, while the level of mortgages to purchase new homes dropped by 4.5%.

3:00PM: Consumer Credit (Risk: Downside, Market Reaction: Marginal): Consumer credit has contracted quite severely over the past several months as saving rates rise and banks tighten consumer credit. The current Bloomberg consensus indicates a month over month change of –US$7.5bn compared to –US$15.7bn a month prior—the second biggest drop on record. Given recent deterioration in the employment situation and a drop in consumer confidence we could see this indicator disappoint.

Thursday July 9^th:

Same Store Sales: (Risk: Downside, Market Reaction: Moderate): This monthly release breaks out same store sales data for individual retail chains. Like weekly the ICSC-Goldman Store Sales index, recent data supporting an increasing US savings rate and a worsening employment situation coupled with deep discounts at some stores, will likely place some downward pressure on same store sales.

8:00AM: Federal Reserve Governor Elizabeth Duke: Is speaking at the FDIC's Interagency Minority Depository Institutions National Conference in Chicago. This could create some headlines.

8:30AM: Initial Claims (Risk: Neutral, Market Reaction: Significant): The current Bloomberg consensus forecast for initial claims is 610K versus last week’s number of 614K. It is likely that after Thursday’s disappointing employment data the market will become more sensitive to changes in claims, as it is an excellent forward looking indicator toward payroll data. I anticipate both initial and continuing claims data will improve as the month progresses.

Friday July 10^th:

8:30AM: International Trade (Risk: Neutral, Market Reaction: Marginal/Moderate): The current Bloomberg consensus for the US trade balance is –US$28.8bn versus last month’s reading of –US$29.2bn. Recent increments in oil prices could add to the current deficit, while placing upward pressure on the import price index.

9:55AM: Consumer Sentiment (Risk: Neutral, Market Reaction: Marginal/Moderate): The current consensus on Bloomberg for the Reuters/University of Michigan Consumer Sentiment Index stands at 71.5 versus last month’s result of 70.8. The sentiment index is broken up into two parts, current conditions and future expectations. Investors are likely to focus more on this report after last week’s disappointing consumer confidence number. A positive or negative surprise in this index could impact the day’s trading.

10:00AM: Treasury Secretary Tim Geithner: Is set to testify before the House Financial Services and Agriculture Committees on derivatives regulation. This could create some headlines.

Have a good weekend!

A Blast From the Past... How the Housing Crisis Will End (Revisited)

This piece is simply an updated version to a piece I published back on March 5th 2008 titled 'How will it end'. Despite the fact we are much deeper into this financial crisis; the root of the problem has not changed, and that is the US housing market.

As an interesting exercise consider that in March 2007 the total value of US subprime mortgage market was estimated at USD1.3trn; now lets combine that with the fact that 12% of these mortgages have or are in the process of defaulting. What this implies is that the total value of subprime mortgages effected by these foreclosures equals USD156bn. Now compare that to the cost of write-downs (~USD517bn) and the Fed's bailouts (USD85bn just for AIG)... Of course no one, including the Fed, could have possibly predicted the detrimental wide-spread effect the housing crisis would have on the global economy; my point is solely to demonstrate how a small piece can have a very significant impact on the entire picture in an over simplified manner.

Here it is with updated data and some small changes!

We are continuously being barraged with mixed news concerning the housing crisis. One day we hear signs are pointing towards a bottom; the next housing numbers came in much lower than expectations. So we raise this question: What indicators should we be looking at to truly signal a recovery in housing?

With this question in mind our analysis focused on creating the stages we believe would be necessary to facilitate a recovery. We were able to define 7 chronological stages which need to occur in order for the crisis to end. Additionally, the progress for each of the stages can be measured by several key indicators. The stages we outline below are meant to help to average investor better understand how a recovery will most likely unfold, and includes indicator that anyone with a basic internet connection will be able to easily access.

Our stages and key indicators to watch:

1. The number of defaults from subprime borrowers needs to drop substantially. This will help to stabilize growing inventory levels. Key Indicator(s): RealtyTrac foreclosure data (monthly) & MBA foreclosure data (quarterly)

Subprime ARM mortgage resets continue to be the primary driver behind subprime foreclosures (July 2007-November 2009)

Foreclosures as a percent of total mortgages continue to rise...
Source: Bloomberg

2. Banks need to lower lending standards for home mortgages. This will allow existing and new home sales to increase and prices to stabilize. Key Indicator(s): Fed Senior Loan Officer Survey, mortgage rates, Case Shiller Home price index (monthly), & New and Existing home sale prices

However, lending standards have tightened across all mortgage types according to the Senior Loan Officer Survey

Source: FRB

30Y fixed mortgage rates have fluctuated but remain elevated especially when considering the recent rate cuts ...
Source: Bloomberg

3. Once people are again able to buy homes we will see a reduction in inventory levels. When this occurs demand will rise for new constructions. Key Indicator(s): New home sales data (monthly) & Existing home sales data (monthly)

But for now increased foreclosures and tighter lending standards have caused new home sales to drop

Source: Census

The recent crisis has begun to negatively effect the housing affordability index
Source: Bloomberg

4. The rise in demand for new construction will first show up in building permits. The rise in building permits will lead to our next step... Key Indicator(s): Building permits data (monthly)

But, building permits have shown no signs of a sustained recovery

Source: Census

5. Very soon after the rise in building permits we will see an increase in housing starts. Key Indicator(s): Housing starts data (monthly)

However, with permits still depressed, starts have shown no signs of recovery

Source: Census

6. The increase in starts will lead to an increase in construction spending. Key Indicator(s): Construction Spending (monthly)

As you can see from this chart, this is not yet the case

Source: Census

7. Finally, residential investment begins to rise and the housing crisis is over. Key Indicator(s): Residential Investment via GDP release (quarterly)

Residential investment continues to be a drag on real GDP growth

Source: Bloomberg

Conclusion:

Essentially, this crisis is occurring due to a substantial increase in the supply of houses through subprime foreclosures, and a decrease in demand to buy houses through harder to get mortgages. As more homes enter the market and less people are able to acquire mortgages to by them the price drops. Hence, the first major step in a recovery for the sector will be a slow-down in the number of foreclosures, which has likely been pushed back until second half 2009. Secondly, and equally important banks need to reduce lending standards to allow qualified buyers to purchase new homes. These two actions combined will begin to reduce the inventory of homes on the market and stabilize price. Once the amount of inventory of homes for sale begins to drop, we will see demand for new constructions begin to rise. This will first show up in the building permits index, followed by housing starts, and finally private construction spending. All in all, this will not be a fast process, with the reduction in foreclosures and lowering of lending standards being the hardest hurdle to overcome.

Currently, the primary driver for subprime foreclosures are interest rate resets. When these borrowers we first given their mortgages they were given low teaser rates which would eventually reset into higher adjustable rates. Meaning some mortgage holders who were paying USD1,200 a month for their mortgage in November could be paying USD3,200 a month in December. For a lot of these borrowers it has been nearly impossible to pay the new amount and they have been forced to default. On a positive note, based on available market information we should see the number of resets for adjustable rate subprime mortgages peak sometime in late spring/early summer. However, it is tough to estimate the lag time between mortgage resets and actual foreclosures, which prolong this situation. The deteriorating employment situation in the US will add additional downward pressure to this indicator. All in all there is no quick easy fix on the housing front, and we will likely have to deal with these conditions for quite some time.

Investment Idea:
Once a the market starts showing signs of a sustained recovery we feel that US home builders could significantly benefit. US homebuilder stocks have been pounded since the housing crisis first began, and will be poised to make a recovery as demand for new homes eventually rises. However, as we said this could take some time, but it will happen. I currently hold a long position in ITB, a US home builder ETF.

The Week Ahead: Fed Cuts and Bank Failures

Despite the news from Bear Stearns and a weak retail sales report, the Dow actually ended the week up 0.48%. Nonetheless, there isn’t much else to boast about; the NASDAQ ended unchanged while the S&P500 lost 0.40%. However, the CPI release surprised the market by coming in well below expectations and showing no increase for either the core or headline indices. This development was mostly sidelined by the problems at Bear.

But looking forward; this week it’s all about the Fed. Despite the encouraging CPI report the Fed will not view one month’s data as the beginning of a trend; they will remain very vigilant over inflation. However, the news from Bear Stearns and growing trouble in the financial sector will cause the Fed to cut rates by 75bps. We do not believe the Fed will move a total of 100bps given their current concerns over inflation. If the Fed was to move a total of 50bps verses 75bps and the market reacted adversely it would potentially open the window for an additional inter-meeting rate cut, which the Fed would like to avoid. As we have said before we feel one of the best indicators for the Fed’s move is what the market is currently pricing in. The Fed typically does not disappoint the market. (For a more detailed analysis on Fed cuts and inflation please look at our posts from March 11^th titled “Inflation, Inflation, Inflation” & February 27^th titled “Fed Cuts & Inflation”)

Effective Fed Funds rate pre-March 2008, implied Fed Funds rate post, as of March 14th.

Monday March 17th:
8:30AM: Empire State Manufacturing Survey (Risk: Neutral) The Bloomberg consensus survey indicates the market is currently expecting a reading of -6.3, this would be an improvement from last’s month unexpected drop to -11.7, but still in negative territory. This survey is one of the first indicators monthly indicators released covering the manufacturing sector and thus it is used as a tool to help forecast the overall ISM number. A negative reading of this survey combined with negative readings from the Philly Fed and the Chicago-NAPM can indicate a slowdown in the ISM.

9:15AM: Industrial Production (Risk: Downside) The Bloomberg consensus survey indicates the market is currently expecting a reading of -0.1% on production and a 81.3% capacity utilization rate, compared to 0.1% and 81.5% on production and capacity utilization, respectively. The recent slowdown observed in manufacturing could adversely impact production.

Tuesday March 18th: Fed Day!
8:30AM: Housing Starts (Risk: Downside)- According to Bloomberg.com the market is currently expecting housing starts to total 0.99mn. Permits continue to decline, inventories continue rising, we just don’t see much upside potential for this indicator. (For more information please read our post on the Housing Crisis from March 5^th titled ‘How will it end?’)

8:30AM: Producer Price Index (Risk: Neutral/Slight Upside)- According to Bloomberg.com the market is currently expecting PPI and Core PPI to increase 0.4% and 0.2%, respectively.

2:15PM: Fed Announcement (Risk: Neutral/Slight Upside)- We expect the Fed will cut rates by 75bps and continue to hold a negative bias. We expect the Fed will indicate that they will continue monitoring inflation, and that downside risks to growth still exist and will continue to affect employment. They may also mention in more detail their concerns about the financial sector after the Bear Stearns bailout and surprise rate cut on Sunday.

Wednesday March 19th:
None

Thursday March 20th:
8:30AM: Jobless Claims (Risk: Neutral)- According to the consensus survey Jobless Claims are expected to come in at 360K, still above our 350K threshold.

10:00AM: Leading Indicators (Risk: Neutral)- Bloomberg.com currently states a market consensus of +0.3% M/M change for the leading indicators.

10:00AM: Philly Fed Survey (Risk: Neutral)- Bloomberg.com indicates the market is expecting a reading -20.0 verse -24.0 last month. As with the Empire Survey being released earlier in the week, the Philly Fed will be the second release to address the health of the US manufacturing sector.

Friday March 21st:
Market Closed (Good Friday)

Investment Idea:

Please look at the posting from March 9^th. Also, we have begun looking at long dated Citigroup calls as a possible investment idea. At the same time, we are very concerned about Lehman Brothers and expect to see its shares catch a strong bid.