The markets vaulted north last Thursday and took nearly everyone by surprise. The top news story from Yahoo Finance on the day entitled, "Stocks Surge on Retail Sales Reports," had the following explanation for the markets move:
Wall Street soared Thursday, propelling the Standard & Poor's 500 index and Dow Jones industrials to record highs as bright spots among generally sluggish retail sales allowed investors to toss aside concerns about the health of the economy.
But investors, heartened by signs of a happy and spending consumer, clearly decided to put some money on the table. Though retail sales generally appeared to be crimped last month by higher gasoline prices and a tepid housing market, and the outlook for the coming months was difficult to ascertain, the overall reading wasn't as dour as some investors expected.Several reports beat Street expectations -- notably that of Wal-Mart Stores Inc., the world's largest retailer, which posted a better-than-expected 2.4 percent jump in sales at stores open at least a year.Martin Goldberg's WrapUp last Thursday painted the negative technical picture on the retail sector that stands in stark contrast to the news reports released on the day. His commentary is provided below:
Intermediate Term Technical Evaluation of US Broad Line Retailers (07.12.2007)The broad line retail sector is one where the charts are telling us the fundamental story of weakening US consumers. This is happening in much the same way that the US homebuilder's charts were telling of a crumbling housing market in the third quarter of 2005. While the intermediate term charts were painting the bearish picture, the news was generally good, while short term rallies were sharp and convincing. But then it was wise to focus on the intermediate term and ignore day-of-earnings rallies and bullish economic data from the government. Remember all the talk of housing 'scraping along the bottom' you heard around the end of year? It is likely that similar erroneous rhetoric about the retail environment will be put out there for the investing public. Also, rallies will be sharp and convincing while the longer term trend will be down.Reality UNSPUN! - Thursday's Chain Store Sales Report Shows Consumer Spending Shift
The rally in the markets sparked by the chain store sales report last Thursday was not only overdone but unwarranted. Closer inspection of the actual numbers and trends does not paint a rosy picture for investors to 'toss aside concerns about the health of the economy.'
Source: International Council of Shopping Centers
Chain store sales rose 2.4% in June on a year-over-year (YOY) basis, but the areas of strength in the report does not point to a healthy consumer. The strongest group adding support to chain store sales was wholesale clubs (+6.3%) such as Wal-Mart and Costco, followed by drug stores (+4.8%) and discount stores (+2.1%).
The areas of strength show that the consumer is shifting their spending habits and making more use of their dollars by spending their money at lower cost stores, and continuing to spend on non-discretionary items at drug stores such as medications while cutting spending at department and apparel stores. This type of shift in location of consumer spending was last seen during the 2001 recession in which sales at discount and wholesale retailers spiked northward.
Figure 1
Source: Moody's Dismal Scientist
Figure 2
Source: Moody's Dismal Scientist
While lower-cost retailers saw an increase in chain store sales during the last recession, department, apparel, and furniture store sales crumbled as they are currently, with a sharp decline seen in department stores.
Figure 3
Source: Moody's Dismal Scientist
Figure 4
Source: Moody's Dismal Scientist
Figure 5
Source: Moody's Dismal Scientist
One of the sales surprises last Thursday came from Wal-Mart Stores Inc. which posted a better-than-expected 2.4% jump in sales at stores open at least a year. The rebound in Wal-Mart sales may not be as encouraging to the economic outlook as investors viewed it in last week's chain store sales report.
During the last recession, Wal-Mart saw its YOY sales rise from 2.35% in December of 2000 to 9.9% in March 2002, and the recent rebound in Wal-Mart's sales may be signaling consumer weakness, not strength.
For example, wholesale club retail sales diverged from annualized GDP growth in the last recession and the pattern is repeating once again with current wholesale club sales rising while GDP growth is decelerating.
Figure 6
Source: Moody's Dismal Scientist
Figure 7
Source: Moody's Dismal Scientist
Last Friday's Retail Sales Report Worse Than Expected
Further supporting the argument that the market's reaction last Thursday was unwarranted, and consumer spending not encouraging was the Commerce Department's report on U.S. retail sales on Friday. June retail sales fell 0.9% from May in stark contrast to the consensus expectations of a 0.1% increase for the month. Retail sales for June were hurt by sharp monthly declines seen at furniture stores (-3.0%), motor vehicle and parts dealers (-2.9%), building material dealers (-2.3%), and clothing and accessories stores (-1.4%).
Figure 8
Source: Moody's Dismal Scientist
June's monthly sales posted their biggest decline since August 2005, with housing-related sales especially soft with monthly declines of 3.0%, 2.3%, and 1.4% for furniture & home furnishings, building material & garden equipment, and computer & electronic stores respectively.
The YOY comparisons for the same groups (1.2%, -1.4%, and 2.8% using three month moving average) are the weakest since the economic expansion started in 2003. The weakness in these housing-related industries is significant as these three areas comprise 13% of retail sales and continue to retreat from their highs seen in 2005.
Figure 9
Source: Moody's Dismal Scientist
Housing Still Failing to Find a Bottom, Contributing to Consumer Weakness
The National Association of Home Builders (NAHB) released their Housing Market Index (HMI) yesterday, with the index falling to a new low of 24 in July, down four points from June, and was down in every component. The HMI now lies only 3 points above its all-time low of 21 set back in January 1991.
Figure 10
Source: Moody's Dismal Scientist
Commentary on the NAHB data by Patrick McPherron from Moody's Dismal Scientist is provided below:
The bottom of the housing market is unlikely to occur this year. The record low numbers in every subcategory for July may provide sufficient evidence to finally declare this as the worst March-July housing market in the history of the index. July's not seasonally adjusted profile of home builders who recorded optimism for the traffic of prospective buyers index is the lowest for any month in the 22 years of surveys.Sales of homes are very price-sensitive now, requiring fairly significant declines from peak values to close deals. The fed funds rate appears to be too high to help this sector recover in the current economy. Another concern is the rising number of bankruptcies and other insolvency issues for both mortgagor and mortgagee. There is little evidence that the expected return on these 'junk' mortgages justified the risk, so much tighter lending practices are evident this year. Tighter lending standards lower the demand for single-family housing, making it difficult to work off the already high levels of inventory.The housing recession continues to weigh on consumer sentiment as adjustable rate mortgages reset to higher payments with higher energy prices also pressuring the consumer. The ABC News/Washington Post Consumer Comfort Index data released yesterday shows this deterioration in consumer finances and sentiment that provides support to the decline seen in retail sales.
The State of Personal Finance Index peaked in February of this year and is rolling over. This is significant as consumer's perception of their finances shapes their consumption patterns by how they view the buying climate. This can be seen when looking at the close correlation between the State of Personal Finance Index and the percentage who believe the buying climate is positive.
Figure 11
Source: Moody's Dismal Scientist
Keeping Your Eye on the Ball: Erosion in the Housing Market Spreading Up the Quality Chain in MBS Market and into Other Debt Markets
It's important to keep things in perspective and not allow financial pundits on CNBC to take your eye off Main Street as Wall Street sees the major financial indexes break out to new highs. Don't take the pundits spin on economic news but look at the underlining details such as last week's retail sales that painted a far different picture than the mainstream financial media presented.
A great daily dose of reality is to view the asset-backed security indices measured by Markit. These indices show how deterioration in the housing-related credit markets continues to worsen, which will lead to more losses on Wall Street and possibly more hedge fund debacles.
The erosion in mortgage-backed securities (MBS) was initially limited to the lowest quality BBB tranche in the January to late February sell-off that saw the BBB tranche lose 35% of its value from the start of the year.
Figure 12. BBB-Rated Tranche
Source: Markit.com
The next wave of selling that began in June saw the BBB-rated index plummet to a 45% loss of its value since the start of the year, with erosion spreading to the higher A-rated tranche (Figure 13), which saw its value shed 20% since January.
Figure 13. A-Rated Tranche
Source: Markit.com
The latest round of selling that began in July saw the BBB-rated tranche fall to a 55% year-to-date (YTD) loss, the A-rated tranche fall to a greater than 30% YTD loss, and also the spreading of erosion to the highest quality tranches, AA and AAA. The AA-rated tranche plummeted since the start of the month, shedding 12% of its value while even the highest rated tranche, AAA-rated, has turned south with a 5% YTD loss.
Figure 13. AA & AAA-Rated Tranches
Source: Markit.com
The risks to the economy and stock market are mounting as the consumer retrenches and shifts its spending habits to get more 'bang for its buck,' and erosion in MBS continues. The deterioration in the mortgage debt market appears to be spreading to the junk bond and private equity loan markets as well.
A Bloomberg article entitled, "JPMorgan's Dimon Sees 'A Little Freeze' in Lending for LBOs," reveals the deterioration in the overall debt market. Excerpts from the article are provided below.
JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said demand for leveraged buyout debt is drying up and banks may be left holding more loans that they can't sell.There is ``kind of a little freeze in the marketplace,'' Dimon said on a conference call with investors to discuss the New York-based bank's second-quarter earnings. ``If you see this continue you will see the Street taking on a lot of bridge loans and more aggressive repricing of those things.''JPMorgan, the third-largest U.S. bank, is among lenders that have been saddled with at least billion of high-yield bonds and loans they haven't been able to readily sell, data compiled by Bear Stearns Cos. analysts show. Investors have balked at the increasing amounts of debt being taken on for LBOs.In most deals, investment banks promise to provide loans to the buyer. They then seek other lenders to take pieces of the loans and find buyers for bonds. When buyers vanish, the banks must either buy the bonds themselves or provide a bridge loan to the borrower, tying up capital that would otherwise be used to finance more deals. The banks typically parcel out portions of bridge loans to reduce their risk."Yes we have some writedowns," Dimon said. "There are some hung bridges, again nothing on our balance sheet we are particularly concerned about."Lenders have committed to about 0 billion of high-yield bond or bridge financings and 0 billion of loans, according to Dimon.Further evidence that the subprime mess is not behind us came from CIT Group Inc. (CIT), who reported significant losses related to its subprime exposure according to a Forbes article released today.
CIT Buckles Under Subprime PressureThe subprime casualty list is getting longer and longer. New Century Financial, Brookstreet Securities and even Wall Street's mega-investment bank Bear Stearns have all logged major losses from the subprime meltdown. Now, you can add one more name: CIT Group.In a bid to strip itself of its home lending business, the company said, it suffered major losses in the second quarter.In its bid to wipe its hands clean of home lending, and by extension the swath of subprime problems, the company was forced to revalue .6 billion in home-loan receivables. The move cost the company 5.3 million after taxes, or .58 a share. CIT also lost .6 million, or 4 cents a share, in home lending operating costs.For CIT, the subprime storm hasn't completely passed. The company cut its second-half guidance by 25 cents. "Due to the weakness in home lending operations, we are providing second-half guidance of .60 to .70 a share," the company said.The 'liquidity' that CNBC keeps ranting about that is driving up the markets may just be disappearing. Investment and commercial banks that provided bridge loans may be stuck with them for awhile, when they could have previously offloaded them into CDOs through financial alchemy. With liquidity possibly drying up and the consumer continuing to retrench, it's laughable how CNBC can continue to spin the news.
TODAY'S MARKET
Stocks fell from their record territory today as investors digested Federal Reserve Chairman Ben Bernanke's comments on the economy, and reacted to news that two Bear Stearns Cos. hedge funds were essentially worthless.
Bernanke told Congress that overall growth for the year will be lower than expected with inflation remaining the Fed's chief concern.
"Thus declines in residential construction will likely continue to weigh on economic growth over coming quarters, although the magnitude of the drag on growth should diminish over time," Bernanke said.
Bernanke added that "Rising delinquencies and foreclosures are creating personal, economic and social distress for many homeowners and communities -- problems that likely will get worse before they get better."
The markets reacted with the Dow down more than 145 points by the middle of the trading session before a late afternoon rally removed most of the day�s decline. The Dow regained 94.29 points from the low on the day to close at 13,918.22 (-0.38%), while the S&P 500 fared slightly better, falling 3.20 points (-0.21%) to close at 1546.17, with the NASDAQ closing at 2699.49, down 12.80 points (-0.47%).
The selloff in equities lead to a flight to quality as Treasuries rallied with the 10-year note yield falling 6.8 basis points to close at 5.01%. The dollar index was down on the day, falling 0.11 points to close at 80.43. Advancing issues represented 35% and 36% for the NYSE and NASDAQ respectively, with up volume representing 38% and 38% of total volume on the NYSE and NASDAQ, reflecting a broad selloff in the markets.
Energy prices were up on the day after a bullish petroleum inventory release, with one month gasoline futures up 4.49% and refining margins (3-2-1 Crack Spread) jumped 18.87%. Precious metals had a big day with gold breaking through 0/oz to close at 3.10/oz (+1.23%), with silver breaking through /oz, up __spamspan_img_placeholder__.28/oz to close at .19/oz (+2.17%). Base metals were mostly up with tin putting in the strongest performance (+3.56%), while zinc displayed the weakest performance (-0.27%).
The selloff in the markets was broad based as seven out of the ten S&P 500 sectors were down on the day, with the energy, utilities, and materials sectors putting in the only positive performances, up 2.05%, 0.81%, and 0.51% respectively. The greatest weakness was seen in financial and technology sectors, down 1.19% and 0.74% respectively.
