It’s still all about the collateral

Good Evening: The U.S. capital markets went on another roller-coaster ride today, and the “fun” doesn’t look to stop anytime soon. The major averages continued to probe the lows they set in October, though a rally late in today’s session managed to give equities a rare up day. Positive news out of Hewlett Packard and Home Depot were the supposed catalysts for today’s up move, but, as I’ve been writing for months, the credit crisis of 2008 is likely to continue as long as the collateral underlying so many poorly underwritten mortgages continues to decline in value.

Before this morning’s historic drop in PPI could be revealed, and before Congress could even start to whine and moan to Secretary Pauslon and Chairman Bernanke, Hewlett Packard and Home Depot posted positive surprises for their shareholders. Both names were up in early trading, but the HPQ news in particular seemed to steady our index futures prior to the open in New York. The firm predicted 2009 would be a better year — no mean feat for a technology company these days. During the boom, this news might have launched fireworks in the equity market, since investors would have extrapolated one company’s success into positive implications for the whole industry. Today HPQ could only help contain an early slide.

Part of the uneasiness affecting investors before the bell took the form of a record drop in PPI. Given the sharp fall in commodity prices since last summer, this reading shouldn’t shock people. What confused them, however, was the substantial and unusual uptick in the core rate. Those who worry about deflation carped about the headline figures (including Merrill — see below), while those who are concerned about what all the Fed’s money printing might bring in the way of inflation down the road were concerned about the peppy core rate. The TIC data, skewed as they are these days by panicky flows of capital around the world, held little interest for me. But, aside from helping explain the dollar’s recent rise, Merrill’s David Rosenberg thinks these inflows washing ashore in the U.S. are on borrowed time (see below). And in the “can you believe it?” department, the housing news flow was simply atrocious. Case Shiller reported that home prices declined in 4 out of every 5 large U.S. cities, while the Housing Market Index plunged to another all time low (see below). Last month’s reading of 9 is more than just a touch below “normal” (i.e. 50).

Somehow balancing all this news, U.S. equities opened just about unchanged. The rallies and dips alternated for the next couple of hours, but the bias was to the upside. Around lunchtime, though, stocks began a steady and persistent slide, one which looked all too familiar to those who’ve lately been burned trying to pick bottoms. But just when it appeared that the October/November lows would give way and usher in a nasty decline, a rally took hold during the final hour. After being down some 3%, the major averages then jumped 4% to finish the day in the green. Well, mostly in the green, since the Russell 2000 (-0.85%) did lag behind, while the HPQ-aided Dow managed a 2% gain. Treasurys continued to stay firm, and yields were down between 5 bps and 12 bps. The dollar tacked on another 0.5%, and commodities dropped by a similar amount. Crude oil fell to another new low, but in a curious twist, energy stocks helped lead today’s comeback in the stock market. The CRB index shed 0.6% during today’s trading.

Longtime readers know I turned too bearish too early on U.S. stock prices a few years ago. Sensing an imminent reversal in what was then a housing bubble, I maintained that it would be the value of the collateral underneath so many shaky mortgage structures that would call the tune for both the economy and the stock market going forward. The economy limped on even after home prices peaked in 2005 because credit was still cheap and was still available to anyone with a pulse. Encompassing more than just housing, the bubble now long since burst was actually a credit bubble of monumental proportions. Our government is fighting to find a solution — literally fighting, if today’s testimony on the Hill is any guide — but these “solutions” will tend to fall short as long as the collateral (home prices) continue to decline in value. It’s really that simple. As we’ve seen with today’s housing statistics, all the programs put in place to date have had little, if any, impact on home values. Unfortunately, there’s not much either Congress, the Treasury Department, or the Fed can do about it. Until homes become more affordable (which can only come with either rising incomes or further drops in price), and until mortgages become cheaper and more available, then the credit and equity markets should continue to struggle. What was true during the up cycle in housing and has been true on the way down since the peak still holds today: It’s all about the collateral.

-Jack McHugh

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U.S. Stocks Rally, Led by Energy, Computer Shares; Exxon Gains
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aiITcOcwDI5Y

Hewlett-Packard Profit Tops Estimates; Shares Advance
http://www.bloomberg.com/apps/news?pid=20601087&sid=acpyNAtXPFrI&

U.S. Economy: Producer Prices Drop Most on Record in October
http://www.bloomberg.com/apps/news?pid=20601087&sid=a2O9fAZckArI&

Home Prices Tumble in 80 Percent of U.S. Cities
http://www.bloomberg.com/apps/news?pid=20601087&sid=ateSmtYTdPWE&

Homebuilder Confidence in U.S. Drops to Record Low
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aKdYsIJg4tUA

Merrill Lynch Reports
TIC-tock: Foreign interest in US securities is likely to wane.pdf

Deflation: you ain’t seen
nothing yetDeflation: you ain’t seen
nothing yet.pdf

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