My regular readers are used to me throwing around the concept of uncertainties. I believe the markets trade based on uncertainties. These manic psychological forces operate as both positive and negative driving forces and like clouds in the sky, though they vary in shapes and sizes, are always there.
No sooner do we stop worrying about earnings or war do we start fearing a housing bubble. The largest single uncertainty facing the markets right now has to do with housing. Last week’s new and existing home sales numbers jolted the markets and threw up a red flat so large that until we see stabilization in the housing sector nervous investors are likely to keep the market range bound with little likelihood of a significant lift.
Though this sounds ominous, we should keep in mind the yield on the 10 year has been falling for weeks which will soon start to translate into cheap money for borrowers. We should also note the underlying strength of the economy. Birinyi Associates reported last week that 73% of companies beat earnings last quarter, while only 16% missed. This ratio is one of the best ratios in the past five years, yet companies were rewarded far less for their upside surprises than their downside mistakes indicating that investors are hesitant to commit capital but anxious to take it away.
Economists from Goldman Sachs and Merrill Lynch both agree that the aggregate effect of the real estate sector on GDP growth has been near 2% over the last several years. For an economy that is growing at 3.5% this leaves quiet mark should it evaporate.
Probably the most startling piece I read over the last week was brought to my attention by John Mauldin. He brought up a piece written by David Rosenburg of Merrill Lynch showing the nearly 80% correlation between the NABH Housing Market Index and the S&P 500. It turns out the NABH Housing Market Index tends to be predictive and is undergoing one of the sharpest sell offs in the last ten years. The central worry is that a housing downturn will eventually strain the consumer negating his ability to spend to his potential. By the way, this has been the central worry at each juncture over the last five years.
I would contend that American consumer will not stop spending, and the economy will not fall off a cliff. I see the most likely case scenario being a slowing economy, with rising unemployment, and moderate non-recessionary growth with a stock market that trends down for the next several months before a late fall or winter rally when sentiment finally reaches levels low enough to inflict the maximum amount of suffering to the retail investor who exited the market near the bottom.