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No Housing Recovery Lurks in Shadow Inventory


But a great many foreclosures do.

Is That Recovery We See?

This week, the market seemed to like financial stocks, and was buoyed on news that Pulte Homes (PHA) would buy Centex (CTX) to create the largest US homebuilder. And with banks having some room to adjust their writedowns as mark-to-market is modified, the market saw significant increases in the financial sector. Everywhere I keep hearing the old saw that the market predicts a recovery about 6 months out, so won't we see a recovery in the fourth quarter of 2009?

If you look at earnings estimates for 2009, that's what's suggested. Bloomberg reports that profits at S&P 500 companies probably fell 38% on average in the first quarter. The stretch of quarterly declines is the longest since at least the Great Depression, data compiled by S&P and Bloomberg show.

Earnings may drop 31% in the second quarter and 18% in the next before gaining 74% in the last 3 months of the year, analysts predict. Banks are projected to account for all of the rebound in the final quarter. Without financial companies, the gain turns into a 5% decline, the data show.

The above estimates are based on operating earnings, not as-reported earnings. Long-time readers know that operating earnings are actually earnings before interest and bad stuff. As-reported earnings are what companies actually report on their tax reports, and as a gauge of profitability, they're much more reliable. Before the mid-'90s, the difference between operating and as-reported earnings was typically quite small. Then, companies found they could play the market if they played games with their operating earnings.

Operating earnings typically don't take into account 1-time, nonrecurring events. The number of items that get classified as "nonrecurring" has mushroomed to the point where projected operating earnings for 2009 are more than double the estimates of as-reported earnings. Operating earnings for 2008 were almost 3 times actual, or as-reported, earnings. We certainly seem to have entered an era of really bad 1-time events - events that just keep coming and coming. As recently as 2006, there was less than a 10% difference between the 2. In some quarters, it was only 5%; a far cry from today's 100%-plus.

Those Wild and Crazy Analysts

Analysts -- who as a group have been egregiously bad at predicting earnings of financial stocks for the last 2 years -- would have us believe they're due for a large rise in the fourth quarter. Let's visit those assumptions for a few minutes.

They contend that much of the bad news in the subprime-loan and housing market has been written off - and one would have to admit that a lot has been. And with the relaxation of mark-to-market, there may indeed be some truth to that suggestion. But there are still some issues that remain for housing. Take a look at the graph below. (Not sure where it's from, as it was sent to me, but I've seen the same data elsewhere.) Notice that monthly mortgage-rate resets declined markedly in 2009 from 2008, but are expected to rise again in 2010 and 2011. There's still some heartburn in the mortgage market.

No positions in stocks mentioned.

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