Stock Prices To Emulate Drops In Housing Values Post Bernanke Put

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Includes: DIA, REZ, SPY
by: TrimTabs

By Charles Biderman

The stock market went up yesterday when Ben Bernanke said what I have been saying, which is that U.S. economic growth is not only weak, but appears to be weakening further. Why do stocks go up when the economy weakens? The answer is the Bernanke Put. Each of the last three times when economic growth was slumping, the Fed eased and stock prices soared. Although Bernanke didn’t say it, investors were betting yesterday that the Fed will take action again. The problem is that the Fed easing is becoming less and less effective. It is the law of diminishing returns.

I have been saying whenever the Fed does announce the next easing, I do expect a pop in stock prices. Maybe as much as 10%, but no more than that. Why? Because interest rates are already so low, how much lower can they go? Even mortgage interest rates are already down to 3.5%. What difference to the overall economy would a 2.5% mortgage interest rate make compared with 3.5%, particularly when most homeowners cannot get a new mortgage? I say not much. That is why I think the next Fed easing will be the last hurrah for this stock market.

Monday’s video compared the collapse in home prices at the same time as the stock market has come roaring back. From some of the responses, I think an amplification might be useful. Each Fed easing since 2008 has lowered interest rates. The 30-year Treasury yielded 4.5% when the financial mess began in 2008 and today that yield has been cut almost in half to 2.5%. Logic says the lower the interest rate cost of money goes, the higher the price of a constant stream of business cash flow. That is why bond prices go up as interest rates drop.

Also helping stocks is that corporate America has a record amount of cash on its balance sheet earning nothing. Therefore, corporate America has been using some of that money to buy back shares. And that is what has been supporting stock prices over the past year. But the economy is growing weaker. So the real question is will corporate America keep using balance sheet cash to shrink the float if corporate cash flow starts to shrink? I do not think so.

The relationship between home prices and stock prices shows what happens when liquidity leaves one market and pours into another one. Prior to the bubble bursting, a house could be bought for nothing down with a mortgage payment below rent. And as we know, almost anyone who applied, qualified for a mortgage. Today home prices are down 50%. Why?

Besides overbuilding and job layoffs, you now need a 20% cash down payment compared with zero during the bubble, What is more unless you have near-perfect credit and do not have an underwater mortgage of your own, you cannot get a new mortgage. Except of course from a motivated seller, such as the lender via short sale, bankruptcy court or the builder.

At the top of the bubble households had $13 trillion in home equity and $14 trillion in stocks. Now home equity have been cut in half to $6.5 trillion; yet stocks are just a trillion less then at the peak. To repeat, homes remain in the crapper due to extremely tight credit conditions. Stocks are in the penthouse because the Fed has been giving zero cost money to Wall Street and the banks.

When the prospect of another Fed easing no longer runs up stock prices, the stock market will have no place to go but down, and down big time.