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Happy Holidays, Existing Home Sales, Revised GDP

Welcome to the 'happy holidays' edition of the RCM blog.

I thought we should begin with a little year end wisdom:

“Life isn't about waiting for the storms to pass. It's about learning to dance in the rain." - Vivian Green

Managing capital during the last two years required the ownership of solid wading boots and a strong hurricane slicker. For those of you still standing I commend you. In fact, feel free to join us while we dance a jig.

In a nod to the time of year and the tendency for factual stories to be laced with pure fiction, I offer you the following two economic anecdotes.

To begin, let's review the housing fable released today. Market participants responded to the details with a cheer, an equity market rally and a strong US$ bid. However, as with most fables, one must read between the lines to grasp the true meaning. In the case below, I have boldfaced the important detail and the moral of the story becomes clear. The "good" news about November was in fact fabricated at the expense of future months...

ECONX Existing Home Sales Rise Again
The Existing Home Sales report for November brought good news on a number of fronts. Specifically, sales increased 7.4% from October to a seasonally adjusted annual rate of 6.54 million units (consensus 6.25 mln); median prices rose slightly to $172,600 from $172,200 in October.

Based on the November sales pace, the supply of unsold homes dipped to 6.5 months from 7.0 months. The surge in home sales was driven by a rush of purchasers aiming to capture the benefit of the first-time homebuyer tax credit that they feared might expire at the end of November.

That benefit was ultimately extended, however, so the National Association of Realtors thinks it is quite possible there will be a "measurable decline" in home sales the next few months before another surge starting in spring...

Low financing rates and relatively low prices, though, continue to provide strong support to the housing recovery. If there is a point of consternation for the stock market, it is the idea that uplifting data like this could force the Fed to raise rates sooner than previously expected. That would be tolerable if there was a concomitant pickup in hiring activity, but absent that, higher rates would be a retardant on the housing recovery since it would reduce affordability...

Separately, there is a residual concern that the encouraging signs in the housing market will ultimately unleash a load of shadow inventory being held by banks and current homeowners, who have been waiting for improved conditions to list the homes for sale. The added supply could keep pressure on prices...

...Below, we have the next chapter in the ongoing saga of economic recovery. Rumplestilskin, a.k.a. the US government, would like to tell the story of economic recovery. Upon the original unrevised GDP release, the US$ rallied due to the "better" than expected number. Today, during a quiet holiday week, the real GPD number reveals a "surprisingly" lower growth rate...

ECONX Q3 GDP- Final +2.2% vs +2.8% consensus, prelim +2.8%

ECONX Q3 Personal Consumption- Final +2.8% vs +2.9% consensus, prelim +2.9%

ECONX A Surprise Revision to Q3 GDP
In surprising fashion, the revision to Q3 GDP was fairly substantial. According to the third estimate from the Bureau of Economic Analysis, GDP grew at a 2.2% annual rate in the third quarter versus 2.8% in the second estimate. A slight downward revision to personal consumption expenditures, which were said to be up 2.8% (versus prior 2.9%) from the preceding period played a part in the downgrade, as PCE contributed just 1.96 percentage points to the change in real GDP versus 2.07 percentage points for the second estimate...

Other gauges that were adjusted to show a lower contribution to the change in real GDP included gross private domestic investment (from 0.91 to 0.54), the change in private inventories (from 0.87 to 0.69), imports (from -2.53 to -2.59), and government spending (from 0.63 to 0.55). Separately, the GDP price index was revised down as well from 0.5% to 0.4%. Core PCE was reported to be up 1.2% quarter-over-quarter versus 1.3% for the second estimate. This inflation gauge won't alter the Fed's assured view on near-term inflation pressures.

...So, will the 2010 economic fable resemble a Grimm fairy tale or an uplifting Christmas story? Only time will tell. I will be traveling over the next two weeks, but if duty calls I will post. Until then, enjoy the rest of 2009 and have a happy and healthy.

The Fed Meeting Fallout, US$ Strength / Smaller than Expected Debt Limit Increase, Shadow Home Inventory on the Rise, State Budget Problems

The Fed chose not to change rates or comments during the Wednesday meeting. While we anticipated this outcome in our Monday post, the market reaction has been anything but expected. In months past the type of Fed commentary exhibited this week led to a lower US$ and inverse strength in commodity and equity markets. This week the results have been anything but ordinary. The US$ gained strength, some commodities have rallied with the US$ (e.g. Oil) but precious metals have suffered. Meanwhile the Treasury markets have rallied and equity markets seem to have stalled.

The Fed's commitment to a lenient stance is not a surprise. The following two stories are just a couple of the driving forces applying pressure to the economy and in turn the Fed...

More homes are poised to hit the market - LA Times
LA Times reports a supply of 1.7 million homes headed for sale because of foreclosure or delinquency looms over the nation's housing market, which could dampen progress toward recovery should the Obama administration fail in its efforts to aid struggling homeowners, researchers said. A variety of measures to keep discounted bank-owned properties off the market -- including moratoriums on foreclosures by major lenders and federal initiatives aimed at keeping people in their homes with mortgage payments they can afford -- has helped increase a backlog of so-called shadow inventory 55% in the year ended Sept. 30, according to a report released Thursday by First American CoreLogic, a Santa Ana-based real estate research firm.

States scramble to close new budget gaps - WSJ
WSJ reports the patches used by states on their ailing budgets just months ago are now failing. Ohio lawmakers were expected late Thursday to vote on a compromise reached with Gov. Ted Strickland to avoid cutting education budgets an average of 10% on Jan. 1. In Arizona, lawmakers met in a special session Thursday -- their fourth on the budget this year -- to grapple with a new deficit. And in New York, Democratic Gov. David Paterson said Sunday he would postpone paying $750 million of state bills to avert a cash crunch. Many states eliminated expected deficits earlier this year with budget cuts, tax increases, short-term borrowing, accounting moves and planned gambling expansions. But despite a slight improvement in the U.S. economy, states are now finding those measures didn't go far enough. Tax collections continue to trail projections in some states, and court rulings and political battles have blocked some gap-filling moves. Plus, some legislatures didn't fully deal with the deficits, leaving the toughest decisions to governors... Only a few states now have cash-flow problems. But if revenues continue to fall below expectations, the list could grow, said Scott Pattison, executive director of the National Association of State Budget Officers.

...the US$'s strength as well as the strength in the Treasury bond market does however, provide some consternation. Apparently, other factors have overshadowed the Fed meeting this week and driven the direction of markets. Many attribute the strength of the US$ to troubles developing in Europe. The fears of a debt default in Greece have led some to believe the viability of the EU is in question. We believe this fear is unfounded and would instead direct your attention to the following story...

House narrowly passes $290 billion increase in debt limit - WSJ
WSJ reports the House approved a short-term $290 billion extension in the nation's debt ceiling, delaying a decision until February about a larger increase in the borrowing cap. The vote comes less than a week after House Majority Leader Steny Hoyer (D., Md.) said he intended to seek a $1.8 trillion increase in the ceiling to support federal government borrowing through 2010. A decision was made to seek the more modest increase after it became clear the larger increase may have failed to win support in the Senate. The Senate must still take up the two-month increase, which it is expected to do next week.

...The decision to delay the "larger increase in the borrowing cap" in our opinion added fuel to a short covering rally already underway in the US$. I will note that the vote has only been delayed and will no doubt be passed in the not to distant future.

In short, year-long trends remain in place although severely tested this week. Seasonality would suggest equity market strength during the last two weeks of the year. Volatility as judged by the VIX index has remained subdued during this week's shenanigans and would add credence to the idea of a resumption in seasonal trends.

Stock Market Investing: Expect Trends to Remain Intact, Investment Strategy: The Fed Meeting Holds the Key,Trader Dan & The Continuous Commodity Index

Trader Dan Comments On This Week’s Action In The Continuous Commodity Index: Courtesy of Jim Sinclaire

...This chart...is significant in telling us the direction that gold prices will take moving forward. For the deflationists to be proven correct, this chart will need to break down technically which would require both a move below the 400 level and a downturn in the rising moving average in which price moves below that average as it trends lower. AS you can clearly see, the moving average is trending higher and prices are above it. This signifies that the inflationists have the upper hand and their assessment is currently the correct one.

Until this chart reverses its positive technicals, those calling for a major top in gold are simply mistaken in their assessment and are attempting to impose their view on the markets rather than reading what the market itself is currently saying. That’s the problem with analysts and even traders who cannot let the market speak to them and get stuck in a losing trade because they refuse to acknowledge that they might be incorrect. In effect, they end up fighting the trend or the tape as we used to say. Continuing Education...

Stock Market Investing: The equity markets have consolidated over the last few weeks in a tight trading range. Meanwhile, the US$ has caught a bid sending Oil and Gold lower. Once again the financial media would like you to believe a major crossroads has been reached. We at RCM would beg to differ. Perhaps a review of reality would help:

1) Over the last several months, the US$ experienced strength during the week or so before the Fed meeting. Said strength rapidly dissolves as Fed comments from the meeting reiterate the need and desire for easy credit. If the US$ strengthens after this week's meeting then perhaps a "crossroads" has been reached. Until then, recent US$ strength appears nothing more than the financial equivalent of a hiccup.

2) Please review the chart and comments above from Trader Dan. Clearly, the commodity markets as a whole have not responded to the "US$ strength" of the last two weeks. One would need to see the up trend in commodity prices challenged before a "crossroads" could be reached.

3) During previous US$ rallies in '09 the equity markets have suffered. Often a sell off of 5 - 10% would occur in the equity markets if the US$ rallied 2 - 3%. This time however, equities have used the US$ rally to consolidate gains in a tight sideways movement. Equity players may be signaling disbelief of US$ strength, the exact opposite of a "crossroad".

Investment Strategy: The Fed meeting this week will be key. Should the Fed choose to change language and appear inclined to reduce liquidity then a crossroads of some kind will in fact be reached. However, until the Fed stance changes expect year long trends to remain intact.

As I have explained above, commodity and equity markets are not foreshadowing a change in Fed stance.

On the other hand, the last two weeks have been replete with Government statistics suggesting economic "strength". The retail sales data "surprised" on the upside and University of Michigan Consumer Sentiment Index rose more than expected. Both announcements led to spirited US$ rallies.

What will the Fed decide? We won't know until the stories hit the wire.

However, we do know rates need to remain low for this country to handle an enormous Federal debt burden. We know the economy, whether recovered or not, is precariously perched and needs liquidity. We know consumer confidence does not equate to consumer spending; income is required for consumption. And we know income will continue to be constrained as debt defaults continue to mount...

The Coming Wave Of Debt Defaults -Sam Rovit and David Sweig - Forbes

The worst is not yet past. Be prepared.

The trouble in the commercial real estate markets is getting ugly, as the precarious situation of Dubai World has made all too clear.
Expect many more unpleasant situations like that one. Speculative-grade debt issuers are bracing for the default rate to hit 12% to 14% by the end of 2009, according to our projections at Bain & Company. The last time the U.S. economy experienced default rates of that magnitude was 28 years ago. Continuing Education...

My parting question: Knowing all that we know, should this week's Fed comments really be a mystery? What possible good could result from the Fed changing its stance at year end? A stance change now would simply not be logical and perhaps that is where the risk lies. Logic and government are often at odds.

Precious Metals: A Minuscule Market, BLS Jobs Report Worthless, Obama Continues to Increase Spending, U.S. Treasury Zero-Rate Auction

The volatility of precious metals prices will continue to astound. For those requiring a courage boost, I offer the following information as succor...

The Precious Metals market is minuscule - Matterhorn Asset Management
The graph below shows how small the gold and silver industries and markets are in relation to major US corporations and to total world financial assets. The market capitalisation of the silver industry is only $ 9 billion and of the gold industry $ 200 B whilst Microsoft is valued at $250 B and Exxon 350 B.

Both the silver and gold industries as well as the physical markets are so small that any increase in demand is likely to drive prices very substantially higher.

Zerohedge further exposes the BLS Friday jobs report as worthless...

Even as the BLS and the administration are trying to cover up the real state of unemployment affairs using assorted semantic gimmicks of just what it means to be unemployed, and as companies provide adjusted EPS numbers, while actual earnings continue to collapse, the true barometer of spending, provided by the Financial Management Service, tax withholdings (net of refunds), continues to paint the truest picture of just what is really happening with both America's consumer and the corporate world....

...On a rolling 12 month basis, individual tax withheld has dropped by nearly 8% YoY, from $1.42 trillion to $1.31 trillion, while company witholdings are down a whalloping 64%, from $274 billion to just under $100 billion! Read More...

Of course, the Obama administration is aware of the true nature of the unemployment problem...

WASHINGTON – President Barack Obama called for a major new burst of federal spending Tuesday, perhaps $150 billion or more, aiming to jolt the wobbly economy into a stronger recovery and reduce painfully persistent double-digit unemployment. Read More...

Geithner said to be seeking TARP extension until next October -

Bloomberg.com reports Treasury Secretary Timothy Geithner plans to tell Congress that the Obama administration will extend the $700 billion financial-rescue program until next October, according to people familiar with the matter. While the Troubled Asset Relief Program expires on Dec. 31, Geithner can extend it by notifying Congress. A letter notifying Congress of the extension could come as soon as today, said the people, who declined to be identified. Andrew Williams, a Treasury Department spokesman, declined to comment. The TARP, passed in October 2008 to prevent a collapse of the financial system, has drawn criticism from Congressional opponents of taxpayer-funded bailouts of banks including Citigroup Inc. The Obama administration, preparing the ground for an extension, has emphasized that the program may also be used to aid homeowners and small companies.

Both actions above are US$ bearish, precious metals bullish. Add to the mix the recent zero-rate U.S. Treasury auction and you can see why our Gold and Silver investment thesis remains intact...

U.S. Treasury zero-rate auction matches record low
WASHINGTON, Dec 8 (Reuters) - The 0.000 percent high yield on the U.S. Treasury's four-week bill auction on Tuesday matches the lowest on record for the security, the Treasury's Bureau of the Public Debt said.

The Treasury's auction of $29 billion in four-week bills at a strong 5.33 bid-to-cover ratio marks only the fourth time that the security was sold at a zero rate. The other three zero-rate auctions occurred in December 2008, near the height of the financial crisis.

Stock Market Investing: Fallout From Employment Data

Stock Market Investing: Market action continues to revolve around the fallout from Friday's employment data. Equity markets consolidate and precious metals take a breather. Yes, I wrote 'take a breather'. Allow me to state unequivocally, we believe a dubious government supplied employment number lacks the power to end a Gold and Silver generational bull market. If you feel otherwise, please do us all a favor and sell your precious metals holdings. In fact, if you would like to borrow and sell short that would be even better.

All healthy bull markets experience shakeouts. Often, these shakeouts can be violent, but they tend to be short lived. These shakeouts result in the expelling of weak holders and suckering in of short sellers. These same players will again be buyers at higher prices.

Investment Strategy: Maintain previous positions and look to add on weakness where appropriate.

TrimTab's explains Friday's employment numbers:

TrimTabs employment analysis, which uses real-time daily income tax deposits from all U.S. taxpayers to compute employment growth, estimated that the U.S. economy shed 255,000 jobs in November. This past month’s results were an improvement of only 10.2% from the 284,000 jobs lost in October.

Meanwhile, the Bureau of Labor Statistics (BLS) reported that the U.S. economy lost an astonishingly better than expected 11,000 jobs in November. In addition, the BLS revised their September and October results down a whopping 203,000 jobs, resulting in a 45% improvement over their preliminary results.

Something is not right in Kansas! Either the BLS results are wrong, our results are in error, or the truth lies somewhere in the middle.

We believe the BLS is grossly underestimating current job losses due to their flawed survey methodology. Those flaws include rigid seasonal adjustments, a mysterious birth/death adjustment, and the fact that only 40% to 60% of the BLS survey is complete by the time of the first release and subject to revision.

Seasonal adjustments are particularly problematic around the holiday season due to the large number of temporary holiday-related jobs added to payrolls in October and November which then disappear in January. In the past two months, the BLS seasonal adjustments subtracted 2.4 million jobs from the results. In January, when the seasonal adjustments are the largest of the year, the BLS will add anywhere from 2.0 to 2.3 million jobs. In our opinion, trying to glean monthly job losses numbering in the tens of thousands or even in the hundreds of thousands are lost in the enormous size of the seasonal adjustments.

In November, the BLS revised their September and October job losses down a surprising 44.5%, or 203,000 jobs. In the twelve months ending in October, the BLS revised their job loss estimates up or down by a staggering 679,000 jobs, or 13.0%. Until this past month, these revisions brought the BLS’ revised estimates to within a couple percent of TrimTabs’ original estimates. The large divergence between the two results begs the question of what is causing the difference. While we don’t have an answer today, we will be poring over the data in an attempt to answer that question.