In my previous entry, I wrote about Asian growth as a major bullish factor for the world economy, along with the parallel theme of growing commodity demand and the cross-current of "irrational exuberance" in the Shanghai market. I would now like to turn my attention to a strong bearish influence -- the deflation of the US housing bubble and its consequences.
The decline of the housing market has continued to surprise some by its duration and impact. There were those who saw a bottom last year -- facts have proven them painfully wrong and the general consensus is that it has yet to arrive. The overly optimistic have jumped into the market on several occasions hoping to catch this elusive bottom -- I think we have quite some time, and further down to go, before that happens. Just this week, D. R. Horton reported that its cancellation rate increased to 48% in its fourth fiscal quarter; previously, Beazer Homes USA had announced that its rate reached 68%.
Furthermore, the summer's credit squeeze was a startling wake-up call to the fact that we cannot yet determine the full impact of the growing mortgage crunch on the various holders of credit derivative instruments. Bank of America, for example, had to set aside over $2 billion in this last quarter to cover potential credit losses (up 73% from the prior year). However, we shouldn't be surprised -- when one looks at the amount of money involved, the amount of shakier derivatives created from sub-prime and Alt-A loans, the overhang of potential defaults, and the impact on the housing and mortgage industries, it looks to only get worse over the next twelve to eighteen months. In the meantime, in addition to the pressure on all aspects of the housing industry -- homebuilders, lenders, etc. -- this sad sequence of events will weigh more and more on the consumer.
As the Federal Reserve deals with this crisis through lowering interest rates, this puts additional pressure on the US dollar, reinforcing the trend toward dollar depreciation. While Ben Bernanke works to mitigate the impact of one set of problems, he contributes to another. The dollar looks to have further to fall, a process which will also contribute to the growth of inflationary pressures.
The cross-current to all of this is the ongoing economic growth in the US. Certainly domestic growth is predicted to slow; however, partially due to increased exports (which benefit from dollar weakness), partially due to other factors, the US economy has yet to slip into the recession that some have predicted. With the weakness in housing, things could be much worse, but the economy still seems to be struggling forward. Employers added 110,000 jobs in September. There is room for guarded optimism. Of course, we are not in safe waters yet...
As with the first part of this assessment, this is intended only as a broad overview of major "currents" I see in the present market environment. It goes without saying that there are a multitude of other important factors -- these are simply the ones that figure most prominently in the shaping of my strategy. In my next entry, I will describe that strategy.