WAVETECH ENTERPRISES, LLC
Private Account Management Services
Newsletter Issued 08-10-05:
By: John T. Moir
Chief Editor: Sara E. Collier
Position overview . . .
Our recent newsletter, dated July 13th, forecasted that the DOW, along with the other major stock indices, was still completing the topping process — peaking in price. We anticipated a DOW trading range for the month between 10,000 and 10,570. The actual range proved to be slightly higher, between 10,175 and 10,717, as investors responded to stronger-than-expected second quarter earnings reports during the month.
The US treasuries were forecasted to continue their retracement — declining in price and rising in yield — at least for the near-term, as they remove their overbought condition before resuming the primary bullish trend. This proved to be very accurate with the 30-year US Treasury bond having a trading range in price for the month between 119-04 and 114-29, while closing the period at 115-10. Yields on the 10-year US Treasury note rose from 3.9% to nearly 4.4%, as inflation concerns increased with rising crude oil prices.
The US dollar was expected to remain within a large trading range, between euro fx equivalent of $1.19 and $1.25, as the long-term primary direction still remained uncertain. The actual range was narrower than anticipated, however quite accurate with regards to the US dollar support level, with the range for the month between euro fx equivalent of $1.1907 and $1.2285. The US trade imbalance and current-account deficit remain formidable reasons for the US dollar to resume a long-term decline; however, these twin deficits have widely been factored into the global marketplace, causing us to remain neutral until our wave pattern technical analysis can prove otherwise.
Looking forward . . .
Investors should never forget that lower-quality credits are really equities in disguise, and as such, should not be valued or priced based on interest rate yield spreads — the difference compared to US treasuries yields. However, since they are priced based on this differential of spread, they are mispriced — rather overpriced — and will eventually succumb to the risks inherent in equity instruments offering bond-type returns. Today, the average price of a high-yield bond is a mere 342 basis points (3.42%) above US treasuries, which is a paltry return for a security that, over time, is likely to experience a significant number of defaults. These corporate bond defaults can vary from 40% for single-Bs ratings to as high as 80% for triple-Cs ratings. We happen to be in a very low-default environment today, but this too shall change as these bonds mature. Moreover, companies who are in need of immediate cash will commonly sell their corporate receivables at a discount or offer a high yield to investors for their funds, can be faced with defaults as well, based on their respective credit ratings.
After all, weaker credits are competing in a globalized economy with few barriers of entry, and there remain strong deflationary forces suppressing revenues, but not reducing the value of their debts. The market, for some inexplicable reason, is still willing to fund dividend deals to financial sponsors of weak credit. As some point, these inconsistent trends will collide, causing the price of corporate bonds to decline and yields to rise — excluding, of course, the already or soon-to-be defaulted bonds.
GROWING EVIDENCE OF A MAJOR HOUSING BUBBLE:
There is growing evidence of a major housing bubble, which is especially recognizable in the following areas: the influence it is having on the overall US economy, the over-leveraged consumer, the lack of affordability, and the speculative rampant that exists in the housing marketplace.
Housing is dominating US growth activity and is having enormous influence on the US economy as a whole for the following reasons:
a.) Real estate has accounted for nearly 70% of the rise in household net worth since 2001
b.) Over 40% of private-sector jobs created since 2001 have been housing-related.
c.) Excluding housing, real final sales slowed sharply in the first quarter of 2005 to a 2.3% annual rate, from 3.3% in the fourth quarter and 4.8% in the third quarter, of 2004.
Consumers are severely over-leveraged, producing creative methods to acquire real estate, as outlined below:
a.) Sub-prime market loans have accounted for a 27% share of new mortgage funding in the past six months, compared with a 5% share only 5 years ago.
b.) The Federal Reserve’s loan-officer survey shows that mortgage standards have eased by a massive 12 percentage points in the past three years — confirming the loosening of requirements for loan approvals.
c.) It is estimated that 41% of first-time buyers made no down payment in their home purchases last year.
d.) In the hottest price areas, adjustable rate mortgages (ARMs) now account for over 50% of new mortgage originations.
e.) Over 60% of new mortgage loans, especially in the State of California this year, have been in interest-only loans or opting for ARMs.
The affordability of housing is stretched nationwide, as illustrated below:
a.) It is estimated that 37 of the 50 states in the past year have seen home-price appreciation far outpace personal incomes — and nationwide, home prices grew 6.8% faster that personal income levels.
b.) From 1955 to 1995, home prices rose with inflation, or basically 0% in real terms. Since 1996, home values have risen 45% in real terms. The end result is a $5 trillion increase in housing-bubble wealth,
c.) Over a third of homeowners are devoting at least a third of their income to monthly mortgage payments; 13% are devoting over half of their income. This stretched affordability is also the result of worker compensation piece of personal income is badly lagging below the norm — currently some $260 billion, in real terms, below what it should be were this a typical expansion.
d.) Homeowner affordability is now at a 13-year low and the total household debt-service ratio in the first quarter hit a peak at 13.40%.
e.) Oversupply may be a looming risk to prices — housing starts at two million units per year are now outpacing new household formations of 1.6 million. Excess supply could be a reflection of speculative buying.
Rampant speculation within the real estate market is fostering a number of alarming concerns as displayed below:
a.) It is estimated that 23% of the homes sales in the past year were “investor”, which we defined as being speculative based, and another 13% were second property purchases.
b.) We define speculative buying as namely units sold but not yet started, are up 48%, year or year, a record high. Nearly one in four Americans believe that now is a good time to buy a home because it is a good investment and/or prices will continue to appreciate. This represents a 25-year high in bullishness and overall complacency.
c.) It is estimated that 60% of the United States is currently in a housing bubble — where the ratio of house prices to personal income levels are greater than one standard deviation from the historical mean. This includes the Northeast, the Pacific Coast, and any number of regions in between.
d.) We estimate that a decline from double-digit growth in home prices to no growth would trim 1% from the US Gross Domestic Product (GDP) next year. The U.K., where the housing bubble has already burst, is experiencing the estimated economy slowdown — due to declining demand for real estate. Such a dramatic change in the trend of housing would reverberate through the length and breadth of the US economy, so it’s real affect could be far more profound — substantially reducing the overall level of US economic growth. Reason being, the scale of US property holdings was over $17 trillion at the end of 2004, which is three times larger than the U.K. housing stock. Also, US consumption is so much more fevered — over 70% of GDP versus 62% in the U.K. — while the US savings rate is virtually non-existent.
Some of our previously released newsletters offer additional detailed evidence to support our beliefs on the bubbling housing market condition, including our October 2004 newsletter, which provided a special report titled, “Evidence of the Bursting Housing Bubble;” Our February 2005 newsletter, which outlined, “Additional Indicators of the Housing Bubble Soon to Burst;” and Our May 2005 newsletter gave added insight with, “The Real Estate Bubble Continues.”
Long-term conclusions and current month expectations . . .
The US employment report, released last Friday, showed a gain of 207,000 in non-farm payrolls, exceeding the broad consensus for 180,000 new jobs. Furthermore, the May and June gains were revised upward to 166,000 and 126,000, respectively. But despite a strong expansion of the labor force, the unemployment rate held at 5%
A more comprehensive — and we feel more accurate — reading suggests the real jobless rate is near 6%, not 5%. And if we include everyone who should be working full time but is not, the rate approaches close to 9%.
The largest contributor to this employment report by sector was retailing, up 50,000 jobs, paced by car dealerships (nothing like giving cars away to attract a crowd), clothing, and department stores. Health care again came through with 29,000 new jobs. Also, bars and restaurants, which have been responsible for one of every eight new jobs added this year, swelled last month’s payrolls by 30,000. Housing, be it directly or indirectly, added as well.
The job data, while a bullish surprise, failed to erase the long-term concerns — with the gains still below the 50-year average. Also, over the past year, construction, health care, retail trade, along with eating and drinking establishments, have contributed nearly half of the added jobs, even though these sectors account for just a third of the total employment.
It appears that the US economy is now dominated by housing, shopping, eating and drinking — with some help from the expensive health care. These are not core productive sectors for long-term economic growth, leading us to conclude that we remain within a so-called jobless recovery.
Yesterday, the Federal Reserve, at their Federal Open Market Committee (FOMC) meeting, raised the prevailing fed funds rate another 25 basis points (0.25%) to 3.50%, representing their tenth consecutive rate increase. This may be their last upward adjustment in the fed funds rate, since the US treasury market, for the entire yield curve, has already factored in three additional 25 basis point rate increases before the end of the year.. The Federal Reserve stated after their meeting that, “longer-term inflation expectations are well contained”, leading us to believe that we have bottomed in price and peaked in yield for the entire yield curve. Our wave pattern technical analysis of the US treasuries confirm our beliefs that a bottom was put in place two days ago, just one day before the FOMC meeting and the adjustment in the fed funds rate. The US treasuries should rally in price and decline in yield going forward as the US economy begins to slow significantly, leading to future thoughts of cutting the prevailing fed funds rate, rather than raising them before the end of the year.
The US dollar could still remain within a large trading range, between euro fx equivalent of $1.19 and $1.25, but with the expected rally within the US treasuries, it is possible that the US dollar may rally further. A breach of the key resistance level for the US dollar at euro fx equivalent of $1.19 could propel it toward $1.15. However, the US dollar advance could be limited due to the large twin deficits — the US trade imbalance and the current-account deficit.
The DOW, with the conclusion of the higher-than-expected second-quarter earnings’ reports, should resume its bearish decline, with a forecasted trading range for the month between 10,075 and 10,720. Our wave pattern technical analysis indicates that a breach of the formidable support level of DOW 10,000 will confirm the resumption in the primary bearish stock market trend. We encourage investors to consider an investment strategy that can generate above normal rates of return on investment in either a rising or declining stock, bond and/or real estate market as outlined below.
SUGGESTED INVESTMENT ALLOCATIONS:
1. A 75% to 85% allocation of their taxable ordinary funds and/or tax-deferred funds into a conservative as well as flexible investment strategy using various no-load index mutual funds and exchange traded funds (ETF’s) offered through our Private Account Wealth Management Services. The minimum investment criteria are determined after reviewing the investor’s current assets and fund allocations. These services are ideal for individuals, trusts, foundations and privately held corporations who have liquidated large stock, bond and/or real estate holdings and are seeking an active management service to generate a positive rate of return between 12% to 35% per year (after fees) through either a rising or declining stock, bond or real estate market.
2. A 15% to 25% allocation toward cash, Treasury bills, CDs or money market funds with short maturities which will allow investors to rollover these instruments and obtain a higher level of return as interest rates move higher.
If there are any questions regarding the information discussed within this newsletter, the investment allocations mentioned above or our unique management service, please call the number provided below or e-mail us and we would be happy to provide further clarification.
John T. Moir
Worldwide Investment Manager
Wavetech Enterprises, LLC
Phone: (775) 841-9400
Acknowledgements: Federal Data, National Association of Realtors, Federal Deposit Insurance Corporation (FDIC), University of Michigan survey on Consumer Confidence, David Rosenberg, Economist, US Federal Reserve, Economist, National Bureau of Economic Research, Steven Roach, Economist, Liscio Report.
Note: These newsletters have no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. These newsletters are issued for informational purposes and are not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. These newsletters are based on information obtained from sources believed to be reliable, but are not guaranteed to be accurate, nor are they a complete statement or summary of the securities, markets or developments referred to in the various newsletters. Recipients should not regard these newsletters as a substitute for the exercise of their own judgment. Any options or opinions expressed in these newsletters are subject to change without any notice and the Wavetech Enterprises, LLC newsletters are not under any obligation to update or keep current the information contained within. Past performance is not necessarily indicative of future results. Wavetech Enterprises, LLC and its newsletters accept no liability for any loss or damage of any kind arising out of the use of any or all parts of these newsletters.