Market tidbits

The market had an odd tilt today as the Dow Jones dropped an appreciable .41% while the Nasdaq was up .26%. Still, the Nasdaq only today reached a value equal to half its highest point during the boom -- showing just how long and deep the tech crash has been.

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I would like to make special note that the bloodletting in the mortgage industry continues to grow. More and more small lenders are seeing massive demands that they repurchase questionable loans made at the height of the housing craze. Many of these small lenders, who are required by contract to take back sour loans, will quickly fall into violation of their own loan covenants and wind up in positions of extreme weakness.

In a typical example a small regional bank might be operating on loans from a large national bank which become immediately due if the smaller bank is not profitable for two straight quarters. An astonishing number of smaller loan operations are now coasting into their second quarter of losses and so will soon be technically insolvent, dependent on the forgiveness of the big players like Merril Lynch and HSBC to continue operating.

The result of all this? It's getting hard to get loans and the housing market will be facing yet another force dragging it down.

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(from Worth Civils via WSJ.com)

One of the seven deadly sins, greed, is taking over on Wall Street, pushing aside any fear in the market. That’s according to the Fear & Greed Index, which recently hit an all-time high — suggesting, like many other indicators, that investors are getting a little overexcited.

The F&G index, compiled by Dresdner Kleinwort, is a risk-adjusted price momentum measure comparing global equities (as gauged by the MSCI World Index) to global bonds (represented by J.P. Morgan Chase’s index). The gauge has typically traded between +1 and -2 since its inception in 1986 — but was as low as -3 just four years ago, a sign that “the end of the world is nigh,” and therefore a time to buy stocks and sell bonds. But as the market has turned upward in recent years, the index has shot up above +2 into the “irrational exuberance” area, a sign to sell equities and buy bonds.

James Montier, research analyst at Dresdner Kleinwort in London, explained in a recent report that the F&G Index hitting an all-time high is yet more evidence that ” investors’ euphoria is truly out of control.” Of course, he wryly adds, “this warning is likely to be about as effective as yelling ‘cliff-edge’ to a herd of thundering lemmings.”

Still, he suggests that “the prudent investor should be shipping out beta and junk, and buying quality defensives.” Even better, Mr. Montier says, “holding cash seems like a good idea,” noting that U.S. mutual funds currently have a mere 3% to 4% in cash. To paraphrase Warren Buffett, he says, “holding cash is painful, but not as painful as doing something stupid.”

The budget that wasn't

The president delivered his budget to lawmakers today and it would be silly to say it was anything but doomed as written. I would say not to base any decisions on what is publicized as being in the budget. What sort of things am I basing this on?

• The Bush Budget proposes that people would get AMT relief for just one more year (conveniently into the next election) and then AMT would be left as it is, likely to hammer millions of Americans with higher tax rates and removed exemptions. Nobody really believes the Democratic majority will give Bush such a bit of free electioneering, or that they would let the AMT go unrepaired. As a yearly AMT victim, I wouldn't mind a major fix, but the chances are that any fix won't effect the somewhat more wealthy readers of this column
  
• The budget also keeps the Bush Tax Cuts, sort of Mr. Bush's signature move of his presidency, and funds it by making cuts to lots of government agencies and raising the interest rates on student loans. This one is sort of a dare to the Democrats to raise taxes and make the Republicans look better. We'll see what happens there.
• Finally and most notably much of the savings come from presumed cuts to sacred programs like Medicare and Medicaid, almost all slated to take place after President Bush is out of office. Yeah, right.

Meanwhile some other tidbits of interest:

• Paul Kedrosky comments on the rising vacancy rate for residential real estate, a figure that has increased to its highest level in four decades. “One way to look at it is that, on average, if you wander around your neighborhood and knock on a random sample of 37 homes, one of them is likely to be empty … all the time,” he writes. “Another, and somewhat more serious way of looking at it, is that vacancies create a kind of pressure-cooker, with people increasingly eager to do something, anything to get a sale given that their home is otherwise sitting empty.” [via wsj.com]
• According to Birinyi Associates, two of the most overbought stocks in the S&P 500 are two of the home builders — D.R. Horton and KB Home, and those two haven’t been more overbought in the last 200 days, a potential warning sign. [I say get out now if you are in these.] [via wsj.com]
  
• Morgan Stanley now believes the Federal Reserve will be on hold throughout 2007, and its next move is as likely to be a rate increase as a rate decrease. “Despite our growing confidence in the sustainability of growth, we must acknowledge downside risks: A sizable jump in bond term premiums could make financial conditions more restrictive,” they write. “A significant backup in rates could weaken housing activity and potentially trigger business caution, stifle job growth and further depress housing prices.”
• John Wasik tells readers how to navigate the unsteady waters of the U.S. real estate market. “Determining whether it’s safe to purchase in any given area is a tough call. Local economic conditions combined with mortgage rates and speculative trading make things complex,” he writes in Bloomberg News. “Yet by collecting information to make a matrix on foreclosures, property-loss risk and sales trends, you can get a reasonably good idea of which markets to avoid.”

Invest well,
FW

Some observations

I'm on the road and meeting with people at big companies whose names you would recognize...

• The liquidity in corporate america is very high and board members are feeling a lot of pressure to compete with private buyout results. The recent huge profits generated by private buyouts of fragments of Ford, Vivendi, and several other companies may finally spur managers to start spending some of their huge cash horde. This sort of action, with company spending from cash hordes, could replace some of the potential loss in market strength due to any lessening of debt action.
• The housing market is continuing to get worse! The projections inside housing firms are amazingly bad. Many of them are even starting to mark down the accounting value of unbuilt land on the assumption they won't be able to profitably build houses anytime soon!!
• The last few years we've seen stock declines in January as companies "talk down" projected results followed by better performance later in the year as companies beat those projections. Interesting possibilities and parallels for this year.
• Economic growth rates outside the US are increasing while the US is slowing. That's unusual. Usually US slowdowns prompt slowdowns elsewhere. It could be that the US is decoupling somewhat from its role as the global economic engine, this would actually provide more resilience from financial slowdowns.

This is turning out to be an interesting trip. Some positive things are going on in corporate America. It could be that this year will be okay to "up" in the markets, in which case the Federal Reserve would have achieved a near perfect interest rate performance by preventing inflation without damping the economy.

So, not quite time to run for the hills yet. And if the debt market remains strong and companies start using some of those private equity tricks to extract value, stocks could go up a bit from here.

I'll keep you posted.

FW