Underlying economic reality remains much weaker than Fed projections... Business activity remains in continued and deepening trouble, and the Federal Reserve is locked into quantitative easing by persistent problems now well beyond its control. - John Williams, Shadowstats.com
Yesterday featured a parade of three different regional Fed Presidents all suggesting the possibility that the Fed will look at tapering at its December meeting, which begins next Tuesday. Quite frankly, that should not be news to anyone because the FOMC is not thoroughly doing their job if they don't at least look at the possibility of tapering. However, just like the outcome of the four previous FOMC meetings, an examination of the economic data in detail beneath the headline reports shows that the economy may have actually stalled out in November. If the FOMC is looking at the same data I look at, we can expect another meeting in which the outcome yields almost no change in policy from that of the previous meeting. In other words, there will be no Christmas taper in December.
To assess what occurred with the economy, I want to focus on the two primary drivers of the economy's engine since the 2008 financial crisis: consumption and housing. Last week I published an article in which I showed that, looking at the month-to-month numbers, auto sales declined considerably in November from October - significantly more so than the small decline from October to November in 2012. In my view, this big decline in sales reflects a growing weakness in consumption driven by the heavily publicized decline in real disposable income. Given that there's been a small boom in auto sales over the past couple of years, if the consumer slows down purchases, it will take a major driver of strength away from the economy.
To further reinforce my view that the consumer is losing steam, last week we got to see two reports, which measure the degree to which consumers were willing to spend money in preparation for the holidays. First was the release of the ICSC-Goldman Store Sales, which measures comparable store sales at major retail chains. Last week the metric registered -2.8%, which included the Black Friday weekend. As Bloomberg News described it: "Black Friday was a bust...despite extra store hours and heavy promotions" (Bloomberg News).
The same ICSC-Goldman metric reported today for last week showed another 1.6% decline, indicating that the decline at the end of November spilled over into the first week of December. Furthermore, the Redbook, which measures comp store sales at chains, discounters and department stores was released today and it showed what Bloomberg describes as "significant slowing" last week.
In my opinion, both auto and retail sales reflect a significant slowdown in the economy in the last half of November that has spilled into early December. With regard to retail sales, this metric should be showing week-to-week increases right now given that it's the heart of the holiday spending season. In addition to retail sales inclusive of autos, a couple of housing metrics suggest the same slow-down dynamic has occurred in the housing market, which is suggestive of a general slowing in the overall economy.
I published an article last week on new home sales in which I detail the month-to-month sales comparisons going back to July, which show a significant slowdown in new home sales that is not reflected in the year over year comparisons described in the headline reports on new home sales. The trend in new homes sales shows a definitive decline over and above seasonality through October. Although November won't be released until December 24th, we can look at a couple of indicators as a means of measuring home purchase activity.
Mortgage purchase applications have declined in 4 of the last 5 weeks, which covers the mortgage activity for the month of November. In fact, the report released last Wednesday for the last week of November showed a 4% decline in purchase applications. Please note that the data is seasonally adjusted, so theoretically the decline in the index during November would imply that there was a drastic slowdown in home contracts signed during the month even after adjusting for seasonal factors. You can source the data at the Mortgage Bankers Association website.
The second indicator we can look at to measure November housing market activity is residential construction spending (source of chart: Zerohedge), which declined in October and has declined in three of the last four months. This suggests, at least to me, that builders are expecting a lower outlook in the demand for housing because if they thought housing would tick up in November and in the near future they would have invested more money in construction during the last few months, given the reportedly low level of housing inventories. In a sense, the decline in mortgage purchase applications in November reinforces and justifies the residential builder outlook for the market that is reflected in the trend of lower residential construction spending.
Using the recent retail spending and auto sales reports, looking at the new home sales and construction spending activity - both of which reflect a negative trend starting in the summer through October - and examining the mortgage purchase application activity for November it appears to me as if the economy slowed significantly in November, if not completely stalled out altogether. If my analysis is correct, it also means that the FOMC will once again defer on tapering QE at its December meeting, contrary to the general outlook being broadcast in the financial media and from Wall Street.
Based on this, it is my view that the stock market is significantly overvalued relative to the underlying fundamentals. While I have suggested that the market can be shorted successfully in the recent past, I've actually thrown in the towel on that view because of the excessive amount of liquidity that is being thrown into the banking system by the Fed and the apparent willingness of investors to chase the market higher. I will say that I believe that the downside risk that is built into the stock market at these levels far exceeds the reward to be gained from jumping on for the ride.
This being said, I started shorting the housing market in late January and, while my timing wasn't perfect to start, I have a 25% gain on my short position in DR Horton (DHI) and a 3% gain in the KB Home (KBH) short position I established a couple of months ago. This is a remarkable achievement given that the S&P 500 has shot up a little over 20.4% since I first shorted DHI at the end of January. I continue to believe that the homebuilders can be successfully shorted here and recommend using this latest short-term bounce in the homebuilders as an opportunity to sell long positions and/or get short.