the Pregnant Pause

NOTE:  This Trading alert was originally posted at Ritholtz Research & Analytics on Thu 8/9/2006 10:16 PM EDT; An email went out to subscribers alerting them shortly there after.

This is posted here not as investing advice, but
rather as an example of a trading call for potential subscribers. We
expect to post future advisories in a similar manner — after the call,
but in the correct chronological location on the blog.


Yesterday’s Fed pause was anticipated by the markets, and trader’s reaction was to "Sell the News." But what matters to us much more than the day’s trade was the Fed’s thinking — has the Fed finished, and why?

Our answer is one word: Housing. While we are working on a longer market commentary on Housing, I would like to share some data about housing. It is especially important in light of Luxury Home Builder Toll Brothers weak earnings and awful guidance out this morning:

A large part of my Slow-Motion Slow-Down thesis has been based on Real Estate — the prime engine of economic growth the past few years — grinding towards a much weaker posture.

This is notably different from what most economists see, as they are expecting a "soft landing" in the Housing market.

I do not see a Housing Bubble (See this May 1995 discussion); rather, we have a very extended asset class based on historically ultra low rates; as those rates have moved higher, they have taken mortgages from 5.125% to almost 7%. That has brought the biggest housing boom in U.S. history to its logical end; We are now in the early phase of the price and sales volume retracement.

The key question for the economy is "how bad will the aftermath be?" Most economists expect a "soft landing," a gradual decline that won’t derail the 5 year stimulus driven economic expansion.

I disagree.

Here are 7 key data points to consider when contemplating Housing:

1. Inventory is now at 9 year highs, having increased in many areas 75-150% over last year; That inventory issue is why the Home Builder’s Index is down 50% from recent highs;

2. Home affordability index is at 15 year lows, as rates AND price have moved higher during the past 36 months;

3. Real Income gains have been negative or the past 5 quarters, challenging middle income buyers to afford new homes;

4. Home ownership ticked up to record levels after Mortgage Rates dropped to 5.25%; There simply aren’t many new buyers coming into the market;

5. Residential construction accounted for about 6.1% of the economy — close to a 50-year high; When that reverts to the mean (as these things always do), it will take 0.75-1% off of GDP; If (as I suspect) it swings past the mean, as these things tend to do, 1-3% of GDP can get lost;

6. The NAHB Home Builders Index — a sentiment reading of builders — fell to a 15 year low last month;

7. Mortgage Apps for new purchases are down 24% year over year; Refis are off 37% y/y; ARMS are still 42% of dollar volume;

How can Economists expect a "Soft landing" — despite the facts above? At this point, I place the odds of a recession in 2007 well north of 50%.


The Market Call:

If you are a Trader, Cisco’s good numbers and guidance might drive equities higher today — if the markets can develop some momentum, a summer rally is possible.

For investors, however, the writing is on the wall. Over the next 6 months, I expect to see stocks drop appreciably in value — a 15 to 30% correction is very possible. Indeed, any Summer rally sets up that correction possibility.

While that will create a terrific buying opportunity, there is tremendous market risk right here and now. Investors should be making defensive moves, raising cash on rallies, tightening stop losses, rotating into defensive sectors such as Utilities, Health Care, and Consumer Staples.

In the meantime, the economy is slowing, and 3rd Quarter earnings season — in particular, the late September "warning period" — is our likely catalyst down.

That gives Investors about a month to prepare for a major change in markets.

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  1. advsys commented on Aug 16

    Somebody, please give me a definition of a bubble?
    If a soft landing is not going to happen, then how can this not be a bubble?

    Is it a speed issue? I would agree that housing is not going to collapse over night. I don’t see how a collapse over 1 year v. 1 month should change the eventual outcome?

  2. Jim commented on Apr 21

    This is just normal pregnancy related. If you want to see a truly extraordinary pregnancy then go to

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