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Bears, Oil and Housing


Decoding the current market.


Last month I talked about the line in the sand and the positions of the bears and bulls and it's obvious the bears had the best argument. So I'm going to review those bearish points I highlighted in my June letter.


The economy is in the doldrums and the recession will be longer than recent economic corrections.

Financials still have a lot more pain to go and until they come clean the broad economy will flounder and the stock market will remain under pressure.

Consumers are in debt to their eyeballs and with unemployment on the rise many will be forced to stop spending, sell their (oversized) homes and/or stop meeting their obligations.

The housing situation is only going to get worse as supplies mount and would-be sellers still refuse to face facts and lower their asking price.

Inflation is a runaway train and will slam consumers as well as corporate bottom lines. Along the lines of this point is the weak U.S. dollar which is either the main culprit in higher commodities prices or a leading contributor.

Now What?

Going into the summer individual company fundamentals and value have taken a backseat to all the bearish bullet points and a sense of defeat. I want to say it's a sense of fear but the fact of the matter is there isn't that kind of traditional fear in the air, and that actually is one of the biggest arrows in the quiver of the bears: People are still too confident. I personally wouldn't say investors are confident. In fact I don't think we're going to see traditional capitulation because so many would-be weak sisters are already out of the market. In fact these investors began bailing on the market last August when stocks hit a brick wall and experienced daily plunges reflective of pure fear and confusion.

Right now there is the requisite amount of fear in the air; certainly nobody is talking about buying the market outside of the kind of buying that accompanies long term investment strategies. This time around investors in foxholes are just waiting it out and, believe me, they are cowering in fear. The eventual rebound of the economy and stock market will revolve around two things: The death of the current crude oil rally and recovered health of the financials. At the moment investors are expecting the worst, however.

The notion the Main Street investor isn't exhibiting the kind of fear seen in previous meltdowns assumes the average man and woman on the street even care about the stock market. I feel most people see the Dow confirming their worst fears about the economy.

Ironically, the same people that see the current bear market in stocks as an indictment of the economy weren't impressed or enthusiastic when the Dow was at an all-time high last October. Be that as it may, anyone that thinks Main Street is complacent hasn't visited Main Street lately. One of the ironies in the aftermath of the stock market meltdown that wiped out trillions of dollars in assets is investment in equities continued. Even in the shadow of the housing boom household and individual exposure to the stock market continued to increase. The median income of the average equity owner in America is $65,000 a year; these aren't super rich folks just ignoring the goings on.

Crude Oil

Americans have already begun to travel less, eschew gigantic SUVs, and take mass transit en masse. There is no doubt demand in American and Europe have begun to shift but the question is when will hot economies like China and India and even the Middle East start to crack under the strain of higher prices. Interestingly I don't think fundamentals are going to matter right now as crude is the default investment of everyone, including speculators.

These days, of course, anyone that buys crude oil is considered a speculator. Crude is moving in a perfect channel on the upside and is currently perfectly centered. I think the magic number for crude is $150.00 a barrel, but that's simply a number that's gained legendary status and doesn't have to be resistance. (Remember, $1.50 was supposed to be the magic number for the U.S. dollar versus the Euro, and that proved to be the case for a couple of days.)

Technical view of crude oil suggests there is room north of $170.00 a barrel. On the downside there is support at the bottom of the channel at $135.00 but I think oil bears could get an upper hand with a close under $132.00. The key support point is $120.00.

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The Tangible Intangible

The housing situation is still unwinding with enough sellers determined to get their perceived value that they haven't come off their asking prices. If there is a logjam in the American financial sense it's in the housing market where capitulation is slow to happen.

I'm not sure what kind of impact relief from Washington will have other than extending the inevitable. For all the gripping and finger pointing the fact is people that put no money down, and have no verification of income of assets, there's an overwhelming chance of losing their home no matter what. As of May, 25% of subprime loans were delinquent or in foreclosure. It's easy to think the number would be double that figure. Moreover, these kinds of loans only made up 6.8% of loans outstanding. I understand it's a foregone conclusion that the taxes of the folks that own the other 93.2% of mortgage loans outstanding will pay for the mistakes of others with far less skin in the game; It's still a very bitter pill to swallow.

I don't think the housing market needs to rebound in order for the stock market to turn. In fact, the housing market only makes stocks, even in this bear market, look even more attractive. Supply is the key metric when measuring and assuming a turn in the stock market. Homeowners on the whole owe banks more money than the value of their homes.

This is a stat brought up often but it's a trend that has been in place for a couple of decades. In 1982 homeowners owed lenders 30% of the market value of their home and that number climbed to 46% by 1999. The housing market needs to purge itself and a stable economic backdrop to put the brakes on the slide.

The Rest of the Economy

Last week we got the latest on the services part of the economy and the news was ugly. Prices are soaring, employment new orders dying and business is simply rotten. Businesses are caught in the crosshairs, they must absorb runway input cost in the form of outrageous commodites prices but they have no room to pass these costs on.

Non-Manufacturing ISM Report on Business

It was all about the impact of crude oil, which was the culprit for slower growth in virtually every industry. The report temporarily knocked the wind out of the sails of the stock market because the headline of 48.2 was well below the consensus and the prices paid component surged to an all time higher. Prices paid continue to go parabolic, increasing for the 61st consecutive month. Commodities up in price included: aircraft fuel, airfares, appliances, asphalt, bubble wrap, bath tissue, hotels, medical supplies, paper products, plastic resins, shipping surcharges and window envelopes. Cable, copper pipe, electric products and wire cable were the only commodities to see lower prices.

What I found to be very interesting were industries reporting growth, which included, but not limited to:

  • Real Estate
  • Rental & Leasing
  • Mining
  • Construction

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Is there another Bear Stearns out there?
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