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Five Things You Need to Know: Pending Home Sales; M1 and M2; The End of Containment?; Inside CVS; The Compact


What you need to know (and what it means)!


Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Pending Home Sales

First the economic news of the day. The National Association of Realtors' index of pending previously-owned home sales fell more than expected in November, down 2.6% to 87.6. Economists had expected a decline of 0.7%.

  • Year-over-year the pending home sales index is down 19%.
  • But wait, there's a silver lining!
  • October's pending home sales were revised upward from a 0.6% gain to 3.7%.
  • According to NAR Chief Economist Larry Yun, the October revision suggests the market may be stabilizing.
  • "On the one hand, we have a pent-up demand from the four million jobs added to our economy over the past two years of sales decline," he said.
  • Uh, is this because the first thing anyone does when they get a job is buy a house?
  • Well, there are plenty of houses to choose from.
  • There was a 10.3 months' supply of previously owned homes on the market in November at the current sales pace, compared with an average 6.5 months in 2006.
  • If only that supply was in birth/death model homes, as opposed to "actual" homes.

2. M1 and M2

A number of Minyans have written in asking for clarification on the deflation theme. Their question usually accompanies a chart of M2. Like this:

Click to enlarge.

The chart shows M2 rising a 6.2% clip year-over-year. How can that possibly be deflationary? And certainly the long-term chart of M2 dating back to 1958 speaks for itself, right?

Click to enlarge.

The answer is best found in this chart of M1:

Click to enlarge.

Why is this important? First, it shows M1 declining at a .5% rate year-over-year. More important, however, is understanding the differences between the two M's. The essential difference is that M2 adds M1 (demand account cash, including checking accounts) and most savings accounts.

So what do we make of the fact they are each telling a conflicting story? Simple, cash in current accounts is declining while cash in savings accounts is rising. Or, put another way, risk aversion is growing.

Interestingly, the last time we saw this divergence between M1 and M2 was in the deflation scare of 2002, and the dotcom bubble unwind in late 2000.

Click to enlarge.

Incidentally, these charts, and even more economic data, is available at the St. Louis Fed's Website.

3. The End of Containment?

Yesterday in a speech before the New York Society of securities Analysts, Treasury Secretary Henry Paulson suggested for the first time that the mortgage industry consider expanding the plan to ease loan terms for troubled homeowners to include prime borrowers. Guess that marks the end of "Containment." If we're talking about housing problems isolated to "ill-gotten" subprime loans, why do we need to expand the program to prime borrowers?

In his speech, Paulson wasted no time trying to rewrite history. The prevaricating began in the third sentence. "As I have said for some time, the housing and credit disruptions have slowed our economic growth, and the housing downturn remains the greatest risk to our economy." As he has said "for some time?" Really? For some time?

To be fair, that last one he said in Beijing. Area Codes Rule!* Area Codes Rule! So that doesn't really count.


4. Inside CVS

Yesterday I spent some time listening to the CVS (CVS) presentation at the JP Morgan Healthcare Conference since that was one of my stock selections in Five Themes You Need to Know for 2008.

The company, like many other retailers, noted seeing "some slight evidence of a cautious consumer." The headlines on Bloomberg this morning were fairly negative; talk of a weak consumer, weak flu season and CVS SAYS WE ARE NOT TOTALLY RECESSION RESISTANT, an actual headline. As usual, a closer look reveals some interesting things that didn't quite make it into the news headlines.

First of all, although the CVS CEO DID say the company is not "totally recession resistant," that's completely taken out of a much more positive context. And after all, why should CVS be recession resistant in the first place? Much of that has to do with the reformulation of the company following the merger. Prior to Caremark, CVS garnered nearly a third of its operating profit from front-end sales, anything purchased that was not from the pharmacy. Post merger that's been cut in half, so only 15% of its operating profit comes from front-end sales.

That's significant when you consider that some items in those front-end sales are the first to go in a consumer recession. For example, the company noted this morning that while people (hopefully) don't use less toothpaste and deodorant in a recession, they do buy fewer Christmas lights. As Chairman and CEO Thomas Ryan put it, "[I]n a perverse way, the economy actually helps our private label sales. People who haven't used CVS private label will actually try that because of the cost difference."

CVS estimates that if, say, 20% of its front-end sales are discretionary, losing 25% of those sales translates into less than a penny a share for the company. Even if discretionary sales cutbacks are more severe, that's a fairly reasonable margin for error.

5. The Compact

Minyan Hal forwarded us an interesting article from the Minneapolis Star Tribune. What if someone threw a sale but nobody showed up?

The Compact, a San Francisco-based group (Wait. Did you just, "Naturally!"? You did, didn't you! Let us finish.) a San Francisco-based group is a movement that practices the art of purchasing nothing new. The group has grown from a small dinner party of 10 friends to more than 8,700 members. That's probably just the tip of the iceberg, but more on that in a moment. What does this have to do with Minneapolis?

According to the Star Tribune, in 2006 Karen Heimdahl found herself counseling a growing number of Minnesotans having trouble paying their mortgage and credit card debt when she read about The Compact in the news.

"For a while I had been feeling fed up about the consumer nature of our society," said the 31-year-old financial counselor for Lutheran Social Service. "I think part of it is what I do for my job too, seeing a lot of people have debt ... and not having anything to account for it."

So Heimdahl took the plunge and has spent the past nine months avoiding big box stores and refraining from purchasing anything new, save food, medicine, underwear and cleaning products.

Now a walk by the dollar bins repulses her. "There's all this stuff and so much is unnecessary and disposable."

Tip of the iceberg? Possibly. The change is rooted in too much debt, the inability to access more, and how we respond to that situation psychologically. Rather than moping around bemoaning how they can't afford taking on more debt to buy stuff, people will instead vilify consumption to make it acceptable to themselves that they cannot choose that path. Rejection doesn't engender longing, it engenders revulsion. As increasing numbers of people face "rejection" from consumables they no longer can afford, expect revulsion to set in.

No positions in stocks mentioned.

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