Are Housing and Mortgage Markets at a Bottom?

Friday's 256-point drop in the Dow, precipitated by a surprise earnings miss from General Electric (GE), reminded investors that this remains a volatile, high-risk stock market. GE's stock tumbled 12% on Friday after the company reported a sizable first quarter earnings shortfall ($0.44/share versus expectations of $0.51).

The GE news was significant in several respects. GE is the second largest stock in the U.S. (only ExxonMobil (XOM) is larger) and has long been considered a barometer of the U.S. economy due to the diversity of its business lines. GE has businesses in a multitude of sectors, including industrial equipment, health care, finance, energy, consumer electronics, and media.

Historically, GE has been a model of earnings consistency; the company last missed earnings in the third quarter of 2005, and then it was only by a penny. The size of GE's first quarter earnings miss (7 cents) is notable in and of itself, as is the fact that the weakness was highly concentrated late in the quarter, evidently surprising GE and leaving the company no time to guide down expectations in advance of the earnings report.

GE attributed the earnings shortfall primarily to its financial businesses; the company's CEO stated that "the extraordinary disruption in the capital markets in March affected our ability to complete asset sales and resulted in higher mark-to-market losses and impairment." But there was weakness in other key GE business units (e.g. industrial and medical) that were simply reflective of a weak economy.

The GE earnings miss was not the only data point on Friday signaling a recessionary economy. The University of Michigan reported that its Consumer Sentiment index fell to a new 25-year low, dropping to a level not seen since 1982, which is not surprising given declining household net worth (on account of falling home and stock prices), $111 oil prices, and a weakening employment market.

Markets are likely to remain choppy and volatile over the coming fortnight as the bulk of first quarter earnings reports are released. We expect that, on balance, such reports will contain more negative than positive surprises. It will be instructive, however, to observe how investors react to the coming earnings news.

Given the heavy pessimism that now exists, which suggests that expectations are quite low and that there is a lot of liquidity on the sidelines, it is possible the stock market may hold up reasonably well in the face of bad news and rally on any good news. Psychology could conceivably shift towards the notion that the first quarter will represent the trough in corporate earnings, and that the worst of the housing and credit crisis is behind us. We don't share this view, but it may come to predominate for a period of time.

A catalyst to further the idea that the housing and mortgage markets are at a bottom could come in the form of a government mortgage bailout plan (whereby the government insures hundreds of billions of dollars of troubled mortgages). Bi-partisan momentum is building for such a government mortgage plan, as indicated by John McCain's reversal on this issue last week to support large direct government assistance to troubled homeowners.

Greenspan in Denial

Finally, we feel compelled to note that last week, reminiscent of a bad dream, our former Fed Chairman, Alan Greenspan, inserted himself rather forcefully into our consciousness with very public denials of responsibility for the credit and property bubbles that manifestly inflated on his watch and are now unwinding.

Once lionized as a great central banker, Greenspan's reputation has suffered mightily over the past year, and the "maestro" now feels compelled to defend himself through speeches, editorials in the Financial Times, interviews with CNBC, etc. Frankly, we think he is just doing further damage to his credibility and would be far better off just fading into the background and being grateful that he was able to make tens of millions of dollars from speeches, book royalties, and consulting fees before events caught up with him and the public re-evaluated his record in light of the mess in which we now find ourselves.

For readers interested in an excellent discussion of Greenspan's record as Fed Chairman, which we believe will continue to be downgraded as time passes, we recommend this article by Doug Noland, who writes the invaluable "Credit Bubble Bulletin."

Comments

[rdial54]

I think we are getting close to or at the bottom.

[tradeking13]

These markets will bottom when people give up and stop asking "are we at a bottom?"

[jjason]

The bottom in the Savings and Loan crisis that began in 1990 took about 4 years before home prices started to stabilize. I should know because I was a Real Estate Broker and Certified General Appraiser in CT. Then it took three years (1997) to see single family home prices at 1989 values. Then in 2000 to 2005 home prices went to new highs.

So, four years from 2006 is 2010. This crisis is worse than 1990. But, you can always find someone who will disagree with me.

[billddrummer]

I think it's a function of inventory equilibrium. In my area (northern NV) a balanced market is one with 4-6 months of inventory. Now, while inventory has been rising more slowly than before, sales haven't rebounded, resulting in higher months' supply than historically. Now, there's about 11 months worth of standing inventory available for sale. So until the inventory overhang gets worked off, there will be further price declines.

In short, the bottom is a long way off, at least here.

[nc1]

All I can say is that the media is awash with bad news..but here in the NY metro area...you would never know there is trouble. The malls are filled to brimming every weekend in NJ...people are buying and working and driving enormous vehicles. If this is what a "downturn" or "recession" looks like in the 21st century...I'm not sure there is enough pain to cause any real change in behavior. The downturn won't end until there is enough negative stimulus to cause a real change in business and personal behaviour. From my vantage point, we are not there yet.

[daniela]

I enjoyed the article. I like that author mentions Greenspan, because we always have to remind ourselves what "genius" allowed this to happen. This market is pessimistic, but whenever good news comes out, we all want to believe that things are changing for the better. We should expect somewhat better quarterly earnings going forward. Most of really bad news is out of the bag. We are going through slow healing period.

[iThinkBig]

NC1 makes a great point. NYC & Washington D.C. are the epicenters of U.S. wealth. Considering these men & women run our country and are not much effected by the massive downturn in Main St. (now beginning to reflect in corporate profits) then it may be some time before these two groups running the country wake up. That may be when Wall St. or a key commodity like oil crashes. In other words, the country may well be into deep recession or near depression state for our leadership to take real action and no, I am not just talking about bailouts, I am talking about job creation and innovations in energy which give the global consumer what they want - affordable food and energy. Outside that, the U.S. has only a handful of industries left to offer the globe. What happens in a U.S. downturn? Cut the middlemen and focus on efficiency. What happens when the 80% of the U.S. is the global middle man?