Stock Market: another 90% up day

It looks as though today was another 90% up-day. That would make three 90% up-days so far in August -- August 17, August 29 and August 31. Pretty impressive, if not spectacular.

A lot of we old-timers watch the Baltic Dry Index which is an index of dry shipping of such items steel, coal, wheat, etc. The graph shows that world commerce is moving along at great speed. No world recession while the Baltic is hitting new highs.

Market is becoming overbought, and it will be interesting to see how much backing-off we see on the next decline.

All the major stock averages are now graded bullish. The bull is pawing the ground and snorting. Make sure you get out of his way. If you have any shorts, get the heck out of them first thing Tuesday morning. This is not a shorters market.

Housing: should be 3 to 4 times your income

Just as stocks break free of fundamental metrics of value in speculative manias, so too do houses. But just as stocks retrace to historical levels of price-earnings ratios, so too will housing retrace to historical levels of income-to-value ratios. Historically, this is about 3-to-1: long-term, houses cost about 3 times household income. Since the median household income in the U.S. is abour $46,000, U.S. incomes would support house values of abour $125,000 - $140,000.

As I have noted before, my parents/step-parents each bought houses in highly desirable locales in the early 70s (Honolulu and Pasadena) at 2:1 (twice annual income) and 4:1 (four times a schoolteacher's annual income to buy in highly desirable Manoa Valley in Honolulu.)

As recently as 1997, friends were purchasing small homes in very desirable S.F. Bay Area communities for $160,000 - $175,000--four times a modest (for this area) household income of $40,000.

In other words, to return to a normal trendline, one that was in place a mere decade ago, even the most desirable areas will command no more than 4 times median income. That would put house prices in Honolulu, the S.F. Bay Area, West L.A., Connecticut, Northern Virgina, etc. at about $180,000 - $200,000 -- not $600,000.

Real estate trends stretch out over much longer time spans, and as a result we can foresee a lengthy, painfully drawn-out decline in housing values over the coming decade.

Could this really happen in the Bay Area?? High paying jobs + Land Use restrictions?

From: www.oftwominds.com

Money Market Funds: infected by mortgage loans

Money market funds were invented 37 years ago to offer investors better returns than bank savings accounts while providing a high degree of safety. Most of the $2.5 trillion sitting in these funds is invested in such assets as U.S. Treasury bills, certificates of deposit and short-term commercial debt.

Unlike bank accounts, money market funds aren't insured by the federal government. They almost never fail. Unbeknownst to most investors, some of the largest money market funds today are putting part of their cash into one of the riskiest debt investments in the world: collateralized debt obligations backed by subprime mortgage loans.

CDO's are packages of bonds and loans, and almost half of all CDO's sold in the U.S. in 2006 contained subprime debt, according to a March report by Moody's Investors Service. U.S. money market funds run by Bank of America Corp., Credit Suisse Group, Fidelity Investments and Morgan Stanley held more than $6 billion of CDO's with subprime debt in June, according to fund managers and filings with the U.S. Securities and Exchange Commission. Money market funds with total assets of $300 billion have invested in subprime debt this year.

$300 billion in money market funds could be infected by CDO's. That's really sweet. No wonder there's a rush to buy T-bills

Fed Bailout: impossible this time around

"Earlier, Alan Greenspan and many others thought that the CDO's and derivatives in general were wonderful because they spread risks broadly. But these debt instruments also encouraged risk-taking, especially among subprime mortgage brokers and lenders whose attitude was, "I originate this garbage, securitize it, I sell it -- and then I forget it. Also, the reality is that risks can be transferred, but never eliminated. Someone ends up holding the bag, and it will probably be well beyond the usual highly-leveraged and unregulated hedge fund suspects. We expect many trustees of conservative pension funds as well as mutual fund investors to be shocked!. Shocked! when they learn about the trash that's in their portfolios.

"Finally, when the risks are spread so widely, it's nearly impossible for regulators to organize bailouts. They could with the S&L collapse in the late 1980s-early-1990s because those lenders were regulated and largely retained their mortgage loans. Similarly, the bailout of Long-Term Capital Management in 1998 was possible because it was a single institution. Not so with today's highly leveraged, opaque and widely distributed derivatives."

Gary and his organization do extensive research, and as usual Gary's latest mailing is loaded with great charts. One chart in particular caught my attention. It's the ratio of the coincident to the lagging indicators. The ratio has an outstanding record of predicting recessions. This ratio hit a high in 2005 and it has been declining ever since. The latest reading (June, 2007) shows the ratio at new lows, in the area where many previous recessions have started. The ratio of coincident to lagging indicators appears to be hinting that a recession lies ahead. The intensity of the stock market decline may be saying the same thing. From: Gary Schiling

Prime Loans: getting harder to get

U.S. home-mortgage market is starting to pinch even buyers of high-end homes with good credit records, in the latest sign of rising anxiety among lenders and investors.

This surge in rates on so-called jumbo loans is particularly notable because rates on 10-year Treasury bonds have been falling. Normally, mortgage rates move in tandem with Treasurys, but market jitters have caused investors to ditch mortgage securities.

Lenders -- having already slashed lending to subprime borrowers, as those with weak credit records are known -- now are jacking up rates on jumbo mortgages for prime borrowers. These mortgages exceed the $417,000 limit for loans eligible for purchase and guarantee by Fannie and Freddie. They account for about 16% of the total mortgage market

Lenders were charging an average 7.34% for prime 30-year fixed-rate jumbo loans yesterday. That is up from an average of about 7.1% last week and 6.5% in mid-May.

Losses on most types of prime mortgages have remained very low. Even so, lenders have raised rates on prime jumbo loans defensively because they are unsure what rattled investors may be willing to pay for them.

Investors who buy loans and securities backed by mortgages have fled the market for almost any loan that isn't guaranteed by Fannie Mae or Freddie Mac ($417k limit)

What does this do to the high end Bay Area Market? Anyone seeing an effect?

WSJ

Mortgage resets: the worst is yet to come

It will take longer than you might think for that negative influence of mortgage resets to decrease.

Let's take a look at the following table. This shows the amount of adjustable rate mortgages that reset each month for the first half of this year and will reset for the next 18 months.

Note that these reset numbers are a driving factor in the increasing rise in foreclosures. Pay attention to the numbers I highlight in red for January through June of 2008. The largest portion of mortgage resets is not until next year.

"We have just seen $197 billion of mortgage resets so far this year. That is less than we will see in two months (February and March) of next year.

The first six months of next year will see more than the total for 2007 or $521 billion. This suggests to me that the number of foreclosures is due to rise dramatically from the already high current levels, putting more homes into a weak housing environment."
The statistics are out, the bad news and ominous possibilities are openly discussed. The stock market is now in the process of measuring and discounting the entire housing and subprime process, and this could drive the market lower. In fact, it would not surprise me to see the stock market decline irregularly into the October period (that's just a guess, not a prediction). From: DowTheory

Mortgage: implosion

Starting in the spring of 2005, these adjustable rate mortgages began to get a lot more popular, largely because regular mortgages no longer allowed many buyers to afford the house they wanted.

They turned instead to a mortgage that had an artificially low interest rate for an initial period, before resetting to a higher rate. When the higher rate kicks in, the monthly mortgage bill typically jumps by hundreds of dollars. The initial period often lasted two years, and two plus 2005 equals right about now.

The peak month for the resetting of mortgages will come this October, according to Credit Suisse, when more than $50 billion in mortgages will switch to a new rate for the first time. The level will remain above $30 billion a month through September 2008. In all, the interest rates on about $1 trillion worth of mortgages, or 12 percent of the nation’s total, will reset for the first time this year or next. A couple of years ago, by comparison, only a marginal amount of mortgage debt — a few billion dollars — was resetting each month.

So all the carnage in the mortgage market thus far has come even before the bulk of mortgages have reset. “The worst is not over in the subprime mortgage market,” analysts at JPMorgan recently wrote to the firm’s clients. “The reason for our pessimism is that loans originated in late 2005 and all of 2006, the period that saw peak origination volumes and sharply decreased underwriting quality, are only now starting to reset in large numbers.”

The flood of those homes onto the market will further depress house prices. So will the newfound conservatism of mortgage lenders, which will make it harder for tomorrow’s buyers to get a mortgage. (Thank goodness.) The S.& P./Case-Shiller index of home prices covering 10 major cities has fallen about 3 percent since its peak last summer. Two or three years from now, JPMorgan predicts, the index will have fallen 15 to 20 percent. Adjusting for inflation, the decline will be worse.

There has never been a real estate bubble like the one of the last decade. So it’s impossible to know what the bust will bring, especially when there are still so many mortgages that are about to get a lot more expensive.

From: patrict.net via NY Times Aug. 3rd