Housing, Banks and Global Credit: The Next Leg Down Awaits

by: Ophir Chador

The next leg down for riskier assets is now upon us and investors should prepare themselves for further, significant declines going forward. Global equities markets will continue to descend toward their 2009 lows, as the global economy almost certainly faces a severe contraction in the coming months.

The latest culprit in the ongoing selloff of riskier assets was the truly horrific jobs report issued Friday morning. The addition of 41,000 private sector jobs was well off the 180,000 jobs “analysts” had been expecting. Of course, a disappointing jobs report was easy to anticipate:

(May 21, 2010) This shortened week of trading is being capped off with the Jobs Report this Friday. This is not necessarily a report I want to head into long risk. The estimate of 508K jobs added is extremely optimistic, leaving very little room for an upside surprise and a lot of room for disappointment.

For the week, the Dow and S&P 500 were off 2% and 2.3%, respectively, and both indexes managed to breach key technical levels heading into the weekly close. The S&P 500 is last priced at 1064.88, which is beneath the May 6 intraday crash lows.

The Dow, on the other hand, closed the week below the psychologically imperative 10,000 mark, last priced at 9,931.97. As warned on May 23, the Dow is positioned to trade in sub-10,000 territory for an “extended period.” (More timely, however, were the warnings I issued while the Dow was trading near and above 11,000, including this May 5 warning: “Significant Correction, Reversal Looming.”)

Looking ahead, riskier assets face severe declines, where a sub-10,000 Dow quickly reaches sub-9,000 levels. Worrisome trends in credit and housing, which show no signs of abating, will continue to drag on the economy while bettering the prospects of a realized global double-dip scenario.

Securities of Interest

Long: US Dollar, Safe Havens

Short: Banks, Homebuilders


Safe haven securities such as the US dollar, Japanese yen and Treasuries will continue to outperform their riskier counterparts. Particularly weak, meanwhile, will be the banking and housing sectors, which will suffer declines similar to those seen in late-2008 through March 2009.

Ongoing strains in the credit markets, where interbank and bank-to-consumer lending is running dry globally, will add significant pressure to bank shares going forward. In fact, the utter lack of demand for corporate paper threatens companies beyond the banking space and will doubtless lead to creative policies out of the Federal Reserve in the weeks ahead.

As warned on May 16, “a second – and therefore doubly repugnant – bailout of US banks” will be required due to continued over-exposure to European assets, mortgage-related debt and insufficient capitalization to weather a second financial crisis.

Homebuilders, too, are positioned for a second collapse in as many years, as demand for housing will decline significantly from present levels. As noted last Wednesday, the April 30 expiration of the homebuyer tax credit will expose the true weakness in housing, which has rebounded slightly, if at all, in recent months:

(June 2, 2010) Absent government incentive, the primary drivers for the housing market going forward will be economic growth, employment and wages, all of which remain sluggish heading into the second half of 2010. Add to that the anticipated rise in mortgage defaults ... and the next leg down for homebuilders may be upon us.

While some “analysts” would argue that the government need only reintroduce the homebuyer tax credit to fuel housing demand, such is not the case. Indeed, it was the temporary nature of the tax credit that fueled what little demand we enjoyed. To continuously extend the deadline would, in effect, render the tax credit a permanent one, which would reduce the sense of urgency that surrounded the incentive in previous months.

In the weeks to months ahead, investors should maintain a “fade-the-rally” bias toward riskier assets, as advised in recent weeks. Any remaining exposure to the banking and housing sectors should be eliminated altogether – or, better yet, flipped to short positioning.

Forex traders should continue to bet on the US dollar, which will strengthen significantly against the euro and the British pound from present levels. The Japanese yen, while generally a great play in a risk averse environment, should be handled cautiously following the resignation of Prime Minister Yukio Hatoyama. Mr. Hatoyama’s replacement, Naoto Kan, prefers a weak yen and may force policies targeting yen devaluation.

Disclosure: Author is Short KBH, EEM, EUR/USD, GBP/USD