Good Evening: After a morning decline, the major U.S. stock market averages rallied back to close higher today (this is a recording). Worries about a drop in personal incomes was overcome by a rise in pending home sales, though, as we’ll see, the former should matter more than the latter. The reflation trade (stocks & commodities up; Treasuries & the dollar down) thus survived another test today. Ben Bernanke, the FOMC, and investors are all counting on a continuation of these trends, so the payrolls data on Friday are once again setting up to be important. Unemployed people don’t have healthy incomes, and the 2003-2007 period aside, they usually don’t qualify for mortgages. Housing has received a lot of attention of late, so let’s delve into a few numbers to see how applicable the pending home sales index is to actual home sales. To close, I’ll be asking why senior GE managers won’t be doing the jail time prescribed by Sarbanes-Oxley.
Stocks overseas were on the defensive overnight, and it weighed on our stock index futures heading into Tuesday morning. Futures were further strained when the personal income and spending data came out an hour before the open. While spending came in as expected (+0.4%), incomes fell in both real and nominal terms. Incomes had been flattered by federal stimuli in the months preceding this reading, but to drop 1.3% month over month and 3.4% year over year does not bode well for future spending. Just as automakers can’t forever count on 0% financing or the occasional “cash for clunkers” program to boost sales, U.S. GDP cannot forever count on stimulus packages to pull demand forward (and finance it, to boot!). Credit isn’t (and shouldn’t be) easy to come by these days, so it will fall to income growth to support the consumer spending that comprises some 70% of GDP.
U.S. equities opened 0.5% to 0.75% lower this morning, but the lows were in almost as soon as the NYSE bell stopped vibrating. The move back toward unchanged was then aided when pending home sales were reported to have jumped 3.6% in June. This figure was proof positive to some that housing has now bottomed, but I question the validity of this supposedly forward-looking statistic. Pending sales are just that — pending — and they usually depend upon things like mortgage approval or the sale of a previous residence to become final sales. Comparing January to June pending sales with existing home sales for the same period gives us a hint why realtors post “Contract Pending” on the sign out front in lieu of the “Sold” they would rather place in its stead. Pending home sales have risen for 5 straight months and are up 17.6% since January. Existing home sales are only up just more than half as much (+8.9%, according to Bloomberg) during the same period. If Yogi Berra became a real estate broker, he might say, “it’s not sold until you sell it”.
After climbing back into green territory this morning, the major averages settled into a sideways range for most of the rest of the session. The averages were edging lower when a late rally surfaced in the final minutes to leave all the averages in the plus column. The fractional gain in the Dow Transports wasn’t too far behind today’s leader, the Russell 2000 (+0.9%). Treasurys were once again weaker, though the bears didn’t seem to put their hearts into today’s decline. Yields rose between 2 bps and 6 bps as the yield curve steepened. The dollar also had a sleepy session, with the greenback finishing on the positive side of mixed. Commodities likewise snoozed through Tuesday, though gains in the precious metals did allow the CRB index to finish 0.3% higher.
Friday’s employment data will be given thorough scrutiny, since incomes, spending, and even future home sales all depend, to varying degrees, on job growth. Inventory replenishment and deficit spending can only carry GDP so far before real, final demand has to pick up the slack. If the articles you see below about housing are any indication, then don’t count on high income earners to shoulder the demand burden any time soon. In the first piece, Barry Ritholtz rightly wonders how a firefighter qualified for a mortgage of nearly half a million dollars for a condo in Fort Meyers, FL. The sale closed in 2008, which is just a tad after the point at which unsupportable mortgage applications were supposed to be stamped “DOA” at the lender’s desk. I would further ask just why this family is the sole occupant in a multi-story condominium building (see photos accompanying the article). Hasn’t the rest of Florida read the newspapers? Housing has turned the corner, right?
Not in my hometown of Kenilworth, IL, according to yesterday’s Wall Street Journal (see below). Of the 800 homes in my village, some 65 are officially for sale. Having 8% of the town’s housing stock with “For Sale” signs on the front lawn doesn’t sound like a lot, but it’s approximately four times the normal 2%. Even more homes would be on the market, but they are being rented until prices recover. I’m glad other towns are starting to see “bidding wars”, but the article does not make it clear whether these fights are erupting over fully priced homes or distressed sales (i.e. foreclosures).
This is not some highly localized phenomenon, either. The upper end of the housing market is being squeezed across the nation. As the article points out, the culprits range from a dysfunctional jumbo mortgage market to government housing incentives that essentially read, “affluent need not apply”. High salaries have also been quick to feel the corporate knife during this cycle, and real estate taxes have risen in spite of the lower prices fetched among the homes that do eventually sell. And yet, whining about a problem doesn’t solve it. Perhaps higher marginal income tax rates next year will do the trick!
Finally tonight, I’d like to ask why our supposedly reinvigorated SEC is letting GE off the hook so easily. Some will read that GE is paying a fine of $50 million and think the SEC is back on the beat and handing out tickets. But, as Bill Fleckenstein remarked this afternoon in his always excellent Daily Rap (www.fleckenstein.com), $50 million is little more than a parking ticket for GE. Note please that GE’s accounting sins came in 2002 and 2003, or just after Sarbanes-Oxley was passed. Read the following about what became the law of the land in July of 2002 and see if you also think the SEC should set an example by slapping the bracelets on the GE corporate officers who officially signed off on what can now be described as inaccurate, if not fraudulent, earnings results:
Sarbanes-Oxley Section 302: Internal controls
Under Sarbanes-Oxley, two separate sections came into effect—one civil and the other criminal. 15 U.S.C. § 7241 (Section 302) (civil provision); 18 U.S.C. § 1350 (Section 906) (criminal provision).
Section 302 of the Act mandates a set of internal procedures designed to ensure accurate financial disclosure. The signing officers must certify that they are “responsible for establishing and maintaining internal controls” and “have designed such internal controls to ensure that material information relating to the company and its consolidated subsidiaries is made known to such officers by others within those entities, particularly during the period in which the periodic reports are being prepared.” 15 U.S.C. § 7241(a)(4). The officers must “have evaluated the effectiveness of the company’s internal controls as of a date within 90 days prior to the report” and “have presented in the report their conclusions about the effectiveness of their internal controls based on their evaluation as of that date.” Id.. (source: Wikipedia http://en.wikipedia.org/wiki/Sarbanes-Oxley_Act#Sarbanes-Oxley_Section_802:_Criminal_penalties_for_violation_of_SOX)
Sarbanes-Oxley Section 802: Criminal penalties for violation of SOX
Section 802(a) of the SOX, 18 U.S.C. § 1519 states: “Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both.” (source: Wikipedia op. cit.)
By putting senior executives on the hook — personally — SOX was supposed to scare straight the tricky managers who would otherwise cook the books. “No more Enrons or WorldComs!” thundered Congress at the time the legislation passed. Do you think writing a corporate check out of petty cash will deter others from engaging in illegal accounting practices? You be the judge.
— Jack McHugh P.S.
U.S. Stocks Advance as Home Sales Overshadow Valuation Concern
Treasuries Decline as U.S. Pending Home Sales Surge in June
GE Pays $50 Million to Resolve SEC Accounting Probe
Alone in a 32 Story Condo: How Did This Mortgage Close?
High End Homes Frozen Out of Budding Housing Rebound