There was a little Monday combebacker mentality in pre-market trading yesterday that flowed into the official session, but as touched on above traders hesitated a bit with such a huge week ahead – 136 S&P 500 members reporting, a slew of big economic releases and the State of the Union address.
Japanese policy makers may have also helped out a bit. Not that Japan monetary policy matters much these days, but they did state a possible increase in their quantitative easing (QE) program is on the horizon if the economy slips again – which means they will step up their QE program.
Last week’s performance certainly suggested the market is not going to react well when copious and aggressive varieties of stimuli are removed – and soon enough at least some of this unprecedented level of coordinated global accommodation will have to be removed. There is little evidence to this point that the global economy will be able to foster much growth on its own – without the benefit of either time or a more permanent incentives-based growth policy in the U.S..
Along these lines, we see the Chinese are sticking their path of reining in some of their very aggressive stimulus measures. I was beginning to think statement from the Chinese were nothing but a trial balloon -- see how the market responds. Well, they appear to be serious as they’ve instructed the Bank of China Ltd. and China Construction Bank (huge lenders that are major sources of infrastructure-based lending) to restrict new loans and build reserves. This has the international bourses down this morning – obviously, Asian markets are leading the declines. U.S. stock-index futures are under pressure as a result.
Market Activity for January 25, 2010
Earnings, Data Releases and SOTUThe battle between economic headwinds and improved bottom-line corporate results continues and this week should enlighten us as to which side will prevail in determining the market’s direction. We’re into the heart of earnings season now and it will also be a huge week on the economic data front.
As of this morning, about 20% of S&P 500 members are in and operating profits are up 374% -- up 22% excluding financials. As that comment illustrates, total results are being fueled by the banking sector (the big names in this sector are always early reporters) as they set aside lower levels of loan-loss provisions and results are compared to the as-bad-as-it-gets quarter of a year ago. But banks will still have to deal with future headwinds and I expect they’ll be setting aside more provisions over the next couple of quarters. So, we focus on ex-financial results to help smooth out results and one hopes we can hold onto this 20% increase. Oh, and we’ll be watching the top line as well; the market will want to see some increase in sales. Lets’ hope we can manage a mild increase as these results are against the revenue collapse of the year-ago period.
What we do know is we’ve seen the trough in earnings, it occurred in the third quarter. For Q3 2009, S&P 500 operating earnings per share (EPS) totaled about $40 on a trailing twelve-month basis (TTM), down 56% from the peak of $91 hit in Q2 2007. If we assume the expected $17 in S&P 500 fourth-quarter earnings comes to fruition, we’ll end 2009 at about $57. Most seem to expect total 2010 S&P 500 EPS to come in around $77; we’ll see if that happens.
When it comes to building a valuation analysis I find it appropriate to assume $65 as the basis to evaluate the market – I see the payroll reduction-driven profit story as short lived and so it makes sense to use a more normalized number. So assuming $65 on total S&P 500 earnings, the market currently trades at roughly 17 times. This is a reasonable valuation, but it is slightly above the long-term average of 15-16 times. Considering the headwinds we face (the macroeconomic, populist and geopolitical challenges), it is difficult to afford the market a multiple that is even in line with the LT average much less above it. Sales will have a rough time mustering steady improvement due to a 10% unemployment rate and heightened business caution; this increases doubts that the profit bounce will be lasting. Margins will continue to look good thanks to the super-aggressive cost cutting. But it cuts both ways as the slashing of payrolls will hurt final demand.
The week’s economic data may prove quite challenging, particularly from the standard point of additional housing data, consumer confidence and jobless claims. In addition, the Chicago manufacturing reading – a big market-moving release – may struggle to print a number in line with expectations after December’s robust print of 60.
The big positive reading (not necessarily on an expectations basis but just because we haven’t seen a good GDP print in eight quarters) will come on Friday via the Q4 GDP reading. The first look (there will be two additional primary revisions) at GDP is going to be good, something around 4.5%. But if it disappoints by coming in shy of expectations, worries about a pace of recovery that’s necessary to move the jobless rate lower may ensue – we’ll need at least four-quarters of 4.5%-5.0% growth to get us down to 9.0% by year end and I think there is little chance of this happening.
I’m having a hard seeing how the market responds well to any GDP print below say 6.0%. (Why do I pick 6%? It certainly isn’t an arbitrary number. This level is the low-end of the averages growth performance coming out of the worst recessions in the postwar era – a level that would indicate the economy may be able to withstand some very mild tightening.) If GDP disappoints, it will offset the improvement in corporate profits. But even if the number surprises to the upside, one can see renewed concerns that policymakers will remove stimulus sooner than currently expected. (There is zero chance even slight policy accommodation will be taken away before the market expects, which is currently sometime between June-September, but with the easy-money/fiscal stimulus “sugar high” the government has engendered the market is intensely sensitive to any signs of reversal.)
And then we have the SOTU address tomorrow night, which brings yet another factor the market must consider this week. If the President’s tenor resembles the rhetoric expressed in his speech on Friday, things will get even more interesting.
Existing Home Sales
The National Association of Realtors illustrated what the pending homes sales have suggested earlier in the month: the extension of the home-borrowers tax credit will not have the same affect as it did initially, at least not until spring arrives.
Previously-owned home sales got whacked by 16.7% (-16.8% for single-family only) in December, falling back to 5.45 million at a seasonally-adjusted annual rate (SAAR). This the largest monthly decline since records began in 1968. The expectation was for a decline of 9.7%. For all of 2009 though, existing home sales rose 4.9%; the first annual gain since 2005.
Foreclosures and other distressed properties continue to make up about a third of total sales. For December, that percentage was 32%, according to the National Association of Realtors (NAR).
Above I referreed to the pending sales data because existing home sales are not counted until the contract is closed. Since contracts take 4-6 weeks to close, the 16% slide in signings via the November pending sales data signaled what was about to occur. (For clarity, new home sales are not counted this way, they are official sales at signing.) Those buyers in November knew what was going on with the tax credit as the extension was announced on November 4, so one cannot blame the decline on buyers’ uncertainty as to the extension of that credit.
I want to concentrate on the single-family numbers, which make up nearly 90% of all previously-owned home sales. The 16.8% decline in single-family units marks the first monthly drop in three months and only the second in nine. There is indeed more than just a hangover that’s following the antecedent three-month surge in sales – fostered by buyers rushing to get in before what was perceived to be the expiration of the tax credit, which was originally slated to expire November 30. The December results were a complete purging as the decline erased the sales increases of November and October. From here, we’ll watch to see if the extension of the borrowers subsidy offers a similar effect as we get closer to spring. A contract must be signed though by April 30 to still get the tax credit.The months’ worth of supply for all existing homes rose to 7.2 months from 6.5 in November – up to 6.9 months from 6.2 for single-fam. only. (This means at the current sales pace it would take 6.9 months to sell off all currently available supply – the 20-year average is 6.4 months.)
The number of homes available for sale fell and is getting closer to a level that makes more sense as the chart below illustrates. The caveat is that estimates of foreclosed, or soon-to-be foreclosed on homes, that have yet to hit the market range from 3-7 million properties -- taking the low-end of this estimate the number of previously-owned homes available for sale doubles.
The median price of an existing home rose 4.8% during December to $177,500 from $169,300 in November – this proved quite unhelpful and is yet another example of the economic distortions that occur when the government gets intensely involved. They have done nothing but extend the period of time with which the market must accomplish supply/demand equilibrium.
I don’t think we’ve seen the extent of the downside. When more foreclosures (which are running at 300,000-plus per month) hit the market, prices will fall if the sales are not there to support this coming supply. With the jobless rate at 10% and the under-employment number at 17.3%, sales are unlikely to be there. It will take either lower prices or a sudden boom in job creation to boost sales in a durable manner. I’m betting the former is more likely to occur – not exactly going out on a limb with that one.Have a great day!
Brent Vondera, Senior Analyst
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