Emerging Markets Still Look Strong, U.S. Housing Weak

Economic indicators in October constituted one of my decision points in determining the way ahead for my investment strategy. After the tumult of the summer, the Fed's rate cut (now plural!), and the first wave of the credit crisis, I hoped that what emerged in October would provide some hint of future market direction.

The October equity markets didn't send any clear signals. The Dow Industrials were basically flat for the month, starting at 13,895 and finishing at 13,930, before starting November's slump. Similarly, the S&P went from 1,527 to 1,549, before turning south in the past two weeks.

In my estimation, the month's results pointed to a continuation of the two major trends which I am tracking -- (1) Asian/emerging market economic growth and (2) the continuing decline of housing and its impact on the credit markets. The first days of November only seem to confirm this assessment.

Beginning with the second of the two trends, the news, especially in the past several weeks, has been gloomy. Housing and credit worries have returned with a vengeance. The misplaced optimism that the worst is behind us in this area has been deflated (yet again).

Simply stated, housing continues to be weak. Though new home sales for September showed a 4.8% increase, this is a volatile measure and other metrics were less encouraging. September's housing starts were down 10.2% from August; housing permits fell 7.3%. Standard & Poor's reported that August prices for single family homes were down 4.4% from the previous year.

The credit crisis, too, continues to take its toll. I do not need to review the long list of credit-related write-down, starting with Merrill Lynch and Citigroup, among others. More importantly, despite billions in losses, great uncertainty remains about the assets still on the banks' books. Similarly, the capital adequacy of bond insurers is now being called into question.

On the other hand, the economy in the third quarter continued to perform well. It grew at an annualized rate of 3.9%, despite the fact that housing may have subtracted up to 1% from growth. Non-farm payrolls in October increased by 166,000, with the unemployment rate holding steady at 4.7%, while the September CPI came in at +2.8% year-on-year. Though it will undoubtedly slow, the US economy has so far resisted all predictions of a recession.

Turning now to the first of the two trends mentioned earlier, the prospects for growth in emerging markets, especially Asia, remain good. Of course, these economies will not be insulated from any slowdown in the US; however, they are no longer as dependent upon this market. While the expectations are for a slowdown in the US, Asian economies are forecast to continue their robust growth next year. According to The Economist, China's GDP is expected to grow at 11.5% this year and 10.0% the next. The numbers for India are 8.0% and 7.9%, respectively; for South Korea they are 5.0% and 4.7%. While the Shanghai market is clearly in bubble territory, that does not necessarily threaten future Chinese economic growth.

Consequently, as I reviewed my strategy at the end of October, I decided to continue to play these two trends by investing in Asia (though not much in Mainland Chinese equities) and other emerging markets while maintaining/increasing my puts on home builders, mortgage lenders, and bond insurers in the domestic market.