Thursday, May 28, 2009

It is simple, just watch two things as indicators of the turn in the economy.

Depending upon to whom you listen, read, or watch, everybody has his or her own idea of the most important thing that we have to watch for in the coming economic recovery. In speaking with a client today who is the CFO of a company, he said that and I quote, “You only need to look at two things and these two will give you a very good indication of the direction of the economy. The two things that I’m watching are jobs and housing”.

He feels that one feeds the other. With jobs still being lost, people will loose their homes unless they can find a new job quickly, and more houses will come on the market increasing supply and in turn depressing prices. If people start going back to work then they will start saving to buy that house. I saw a report this week that the average price of a single family home in Ft. Myers Florida at the end of 2007 was $325,000. This week the report said that the average price was $89,000.

People who have a good secure job and may want to buy a house will be reluctant because they fear that they will be paying too much for the house. If they wait, they might be able to get the house they want at a lower price. In a real sense, we now have the reverse of what was happening in 2007. People were buying houses and condominiums and speculating that the price will go up. Now people are speculating that prices will go down and they are on the sidelines waiting for the opportunity to buy at the bottom of the market.

Getting back to my CFO friend, he said that they have already built their budget for next year and are talking about budgets for 2011 and beyond. I told you many times in the past I do not think we will have a snap back recovery like other recoveries post WWII. I do not think unemployment will drop below 8% by the end of next year and those people who are projecting 6% to 8% GDP for the second quarter 2010 I think are from China.

Let me add a third item to watch. It is in some ways a part of housing and that is interest rates. The 30-year conforming home loan interest rate is based on the 10-year Treasury note yield. Recently we have seen an increase in the yield on the 10-year from 2.47% in April to a yield of 3.62% as of May 28. This backup in interest rates has increased the cost of home loans. The President wants more loans refinanced and the Fed can’t buy enough 10-year notes to bring down mortgage interest rates and keep them down.

It appears to me that we are in a "tug of war "between the Fed and the bond trades for control of the bond markets. There is an old saying in investing, “Don’t fight the Fed.” I think that it is possible that the fed will win and we will see 30-year mortgage rates fall dramatically as the market comes to grips with an economy that will be slower than expected.

Dan Perkins

Tuesday, May 19, 2009

On my terms

During the market and economic collapse of last fall, I warned towards the end of the year that with all the money flowing into the banks, I expected that the interest rates the banks would pay on savings would begin to fall after the first of the year. Here we are in late May and rates are still falling around the world for deposit accounts. If you look at the chart above, you can see how fast the 1-month interest rate investments have fallen. Look at the rates just 6 months ago and compare it to the current short-term interest rate.

LIBOR stands for the London Interbank Offered Rate (LIBOR).The LIBOR rate is the rate of interest banks charge to each other in London, England and it is the benchmark for the rate of interest pricing for institutional depositors and loans around the globe.

As you can see above, the one-month LIBOR interest rate has dropped over 30% in the last month and in the last 6 months it has declined 450%. Part of this decline in LIBOR is based on the Bank of England and the European Central Bank cut in interest rates since the beginning of the year. In addition, the amount of money the central banks have put in circulation has made the bank flush with cash. If they do not need the cash to lend out, they will drop the interest rates they are willing to pay to attract deposits and that is exactly what they are doing.

The impact of these falling interest rates is lower and lower rates on traditional money market funds and of course, US Treasury Money Market Funds. According to Barron’s On Line last weekend the average money market fund yield was 18 basis points, which included the waiver of some of the fees and operating expenses. As more and older assets are replaced with lower and lower returns, the yield on these funds will continue to drop.

Declining gross yields means that more and more managers are paying fund expenses out of their own pockets. Currently, we have about $4 trillion in money market funds in the United States. The US Government Money Market Funds comprise about $1.4 trillion in assets. The investors are making close to zero return and the managers have waived their management fees and are now paying some of the expenses to keep the fund at $1.00 Net Asset Value (NAV). The managers are losing on these funds and if interest rates don't go up soon I believe managers will begin closing funds and returning capital to investors who will have little choices for their money.

Most of the non Treasury Money Fund managers are waiving some or all of the management fees and they are stretching for yield to cover expenses. We have 38 million Americans that own money market funds and are earning very little return. You can earn more on your money at the banks, but that window to get higher yield is quickly closing.

I do not believe that cash investments will see any significant increase in yield for several years to come. You will always have a need for cash investments, but unlike the past you cannot go there and hide and rebuild your capital today. In the wonderful Charles Dickens novel, Oliver, there is a passage when Oliver gets his first meal and he says,” Could I have more please?” . The banks for now do not need your money and their answer is, I will pay you “on my terms”.

Dan Perkins

Thursday, May 7, 2009

Why is the market going up?

A friend, who never asks for advice, recently asked me “Why is the market going up?” The answer to his question was, "The market was not ready yet to go down.” There is too much cash on the sidelines waiting to get into the market and, until the market can attract a big chunk of this cash, it will not have a serious correction. Currently, based on information from the Investment Company Institute, there is about $4 trillion in various money market accounts.

“The bottom is in and everything is fine. It is time to buy stocks right?”. Seven weeks ago the markets were at 12 year lows, now everything is OK and it’s full steam ahead? How did we solve all of our problems in seven weeks? The price of housing has not stabilized as of yet. The #3 automaker just filed for protection under chapter 11 and the #1 US car company is probably going to file for chapter 11 protection in less than 30 days.

I said to you in a previous Blog (March 12) that I thought the Dow Jones would hit 8,500 and the S&P 500 would go to 900 before this rally in a bear market is over. No question we had a great April, we hit my targets on the close of Thursday May 6. By the time you read this Blog we may have already gone through the targets and started down. I would expect to see the markets move a little higher and then I would expect a scary sell off before the next phase of the rally begins.

It is not beyond the realm of possibility that the correction in the S&P 500, when it comes, could take us back to 800 to 810. As for the Dow Jones targets, look for a correction in the average of 7,700 to 7,800 levels. We will hang around these levels for a while then I expect an explosive rally from those levels perhaps to 1,000 or higher on the S&P 500 and perhaps as high as 10,000 on the Dow Jones. Talk about sticking you neck out in making a prediction.

It is this second rally that will bring in a great deal of cash into the market. This second rally may take till summer or fall to develop followed by a hard decline after this significant rally. The pivot point in the correction may be the resolution of the GM problem in late June. Watch the numbers.

Dan Perkins