WAVETECH ENTERPRISES, LLC
Private Account Wealth Management Services
Newsletter Issued 07-11-06:
By: John T. Moir
Chief Editor: Sara E. Collier
Position overview . . .
Our previous newsletter, dated June 8th, anticipated that the DOW, along with the other major stock indices, were showing technical signs that the bear market decline had resumed. We forecasted a DOW trading range for the month between 10,600 and 11,285. This projected range proved to be fairly accurate, with the actual trading range between 10,698 and 11,286. It appears the resumption in the stock market decline is underway, however, the transitional process from counter trend rally to bear market decline will increase the level of volatility — resulting in larger monthly trading ranges.
The US dollar was forecasted to be technically poised to rally in price, and we anticipated a euro fx equivalent trading range for the month between $1.26 and $1.30. This technical assessment proved to be very accurate, as the US dollar rallied in price, producing an actual euro fx equivalent trading range between $1.2537 and $1.2975. The fundamental reasons for the US dollar advance remains unclear, but our technical interpretation proved to properly forecast its movements for the month.
The US treasuries were expected to rally in price and decline in yield, as further economic data confirmed the slowing of the US economy. We forecasted that the US treasury 10-year Note would have a peak yield for the month of 5.11%. The projected peak yield initially held, with it dropping to as low as 4.96%, before rising to as high as 5.24%. The near-term inflation concerns drove interest rates higher, especially at the front-end of the interest rate yield curve, from 3-month T-Bills to 5-year T-Notes. There was an 11 basis point (0.11%) increase in the 10-year Note yield during the month; however, we still feel that the US economy is beginning to slow, which will result in higher bond prices and lower yields going forward.
Looking forward . . .
The employment situation, just released this past Friday, was another weak report, with few signs of strength under the surface. There were 121,000 new non-farm payroll jobs added, which brought the average monthly gain in the second quarter to a meager 108,000 — sharply below the first quarter’s 176,000 and even more significantly below the long-term average of 235,000.
A full 25% of the gain was from government hiring, mostly local and state workers. A large chunk of the 75,000 new jobs produced in the private sector were from health care, bars and the restaurant sector. It appears that vigorous eating and drinking inspired a lot of doctor visits, which reinvigorated consumers for a fresh round of eating and drinking.
There was some good news from the Bureau of Labor Statistics employment report. They consisted of the advance in the average work week (0.1 hour), the gain in aggregate hours worked (0.4%) and the brisk rise in average hourly wages (0.5%). However, the longer work week might mean that employers are pushing their existing workers harder rather than adding new hires. Also, real wages — adjusted for inflation — are not growing at all.
The unemployment rate held steady in June at 4.6%; however, a detailed review of the data within the report reveals the percentage of people who want a job but cannot get one edged up to 5.8% of the labor force from 5.3% in May. The percentage rises to 8.7%, from 7.9% the month before, if you include the folks who work part-time, even though they would rather be working full-time.
The June non-farm payroll gain fell below the expectations for the third month in a row, adding to the accumulating evidence of a slowing US economy, and giving ample reason for the Fed to consider pausing its interest rate hikes in the not-too-distant future.
DECLINING HOUSING MARKET IS EXPECTED TO AFFECT FUTURE US ECONOMIC GROWTH:
There appear to be mounting reasons that the current housing bubble will have a broad and overwhelming impact on the US economy in the coming months and years. It is estimated that over $1 trillion of adjustable-rate mortgages (ARMs) are due to be reset this year and another $1.7 trillion next year, which will force homeowners to cough up between 25% to 60% more every month to meet their mortgage payment obligation.
These borrowers will have to make major adjustments in their current spending habits, if they intend to remain homeowners, which will affect the level of consumer spending and US economic growth.
There are those bullish real estate advocates who argue that new land is not being created every day: It just goes vertical instead of horizontal. These advocates also state that housing never declines, which translate into housing prices and housing-stock shares never decline. The telltale signs are everywhere, particularly among the stocks of home builders, which read “for sale.”
Sales are slowing and inventories of unsold homes are at record levels. Builders have a tendency to keep building so long as some lenders are willing to keep giving them money. The decline is home sales and buildup in inventories is not limited to new homes. Existing-home inventories were up by more than 30% compared to a year ago, which represents the biggest rise ever since this type of information was first monitored in 1983.
The buoyancy of the housing market saw its latest reading at 42, down from 68 only eight months earlier; which is the worst eight-month slump ever.
The term “boom” does not really begin to describe the extraordinary upswing that is ending within the housing market. The normal housing cycle, lasting four to five years from the bottom to the peak, sees sales, starts, building permits and home builders optimism rise between 100% to 150%. This housing cycle, in striking contrast, lasting over 15 years, has seen gains in the aforementioned indicators ranging from 130% to 300%.
This housing bubble has been kept aloft and steadily inflated by a host of new mortgage gimmicks and financial engineering wonders, with a few of them being downright evil. The mounting disenchantment with ARMs demonstrates that they are coming back to bite the very souls that they were designed to initiate into the pleasures of home ownership.
The flip and ugly side of the blazing boom in housing is that it’s still early in the current downswing adjustment, which could easily go on for perhaps five years or possibly even longer. The decline could range between 40% to 60%, before the adjustment is complete. This level of decline will represent some serious pain, given the whopping gains that housing has raked up during its remarkable run.
At the end of the third quarter of last year, to further quantify the seriousness of the housing situation, the US household real-estate equity weighed in at slightly more than $19 trillion; subtracting total mortgage debt of $8.2 trillion leaves equity at slightly over $10.9 trillion. A 20% drop in housing prices would mean a loss in household equity of $3.8 trillion, a 25% drop a loss of $4.8 trillion.
These days either $3.8 trillion or $4.8 trillion is not exactly chump change. This kind of hit would be more than sufficient to send the consumer reeling and the US economy into recession. Just imagine what the impact would be if the drop in housing prices were 30% or even 40% — a loss of household equity of $5.7 or $7.6 trillion, respectively.
The US bank system is also more exposed to the real-estate sector than at any time since the end of World Ware II. Banks may have securitized a large portion of their mortgage debt, but they still have $3 trillion in direct mortgage loans sitting on their books — representing a record 43% of total bank assets.
Furthermore, banks have been avid buyers of the loans that they securitized. Since the beginning of this year, they have increased their holdings of mortgage-backed securities at a sizzling annual rate of 47%. Therefore, investors should also stay away from the financial sector, since it will also be impacted by the waning housing market.
Capital investment into the great bull market in stocks rose from 6.5% of Gross Domestic Product (GDP) in the early ‘Nineties to 9% of GDP by the end of the decade — peaking just months before the stock market climatic top in price. The severe downdraft created by the stock market crash quickly affected capital spending, and not for the better. As a percentage of GDP, it suffered a big slide that carried it down to 7%, before bottoming a few years ago.
Housing, in a similar comparison, began its big move in 1990, when it accounted for only 3.5% of GDP. And, as a proportion of GDP, it has gone straight up ever since, ballooning to an all-time peak of 6.2% in the first quarter of this year. The obvious point is that housing is just starting to slip, and could easily follow the pattern exhibited by capital spending. The housing advance has lasted longer and its impact is comparatively greater; therefore, it could become a more formidable drag on the US economy. This type of drag is not likely to disappear overnight, or even in the next few years.
Long-term conclusions and current month expectations . . .
Investors rediscovered fear this past month, after declaring no-end-in-sight for most of the global market advances. There was the broadest sell-off since the Asian and Russian financial crisis in the late ‘Nineties. The Federal Reserve is walking a fine line between fighting inflation and triggering a major economic slump. Worldwide, central banks have created the global liquidity excess, causing unlimited financial imbalances for many countries. Hedge fund managers, using 100 to 1 leverage would borrow in Japan — one of the leaders of cheap money for years — at nearly a zero percent interest rate and than purchase high-yielding foreign bonds, commonly referred to as the “carry trade.” The type of trade recently claimed its first two victims, in New Zealand and Iceland, where those countries high-yield bonds fall sharply in price. The dominos are starting to fall and there will be many other high-yielding bonds from unsuspecting countries to follow suit.
The US is also in a very precarious position, wondering how to service over $42 trillion of debt. The Federal Government is paying 21% more in net interest then it was just a year ago. They have to keep rolling the debt over and are running a large deficit as well. This causes us to draw a different conclusion that our major long-term concerns are not with inflation but rather deflation.
Our belief is that inflation is not going to be a problem, even though there are short-term factors pushing it upward to 4.2%. The core consumer price index includes rents, which is a sector that is rising right now. Normally, when the Federal Reserve gets to the 6.00% to 6.25% discount rate level, inflation tends to go higher for the next six months. Inflation is a lagging indicator, so it continues to rise even though the US economy is slowing. We feel that the US treasuries will start to recognize the signs of a slowing US economy over the short-term inflation concerns, and begin to advance in price and subsequently decline in yield. Therefore, we are forecasting a peak yield for the US treasury 10-year Note at 5.22%, since there is formidable resistance at a yield of 5.25%, with the prevailing fed funds rate also at that same level.
This month will encapsulate a majority of the second quarter earnings’ reports, which have factored in an average earnings growth level around 12.5%. Any reports at or above this level will cause the US stock market to decline, since the earnings’ estimates and subsequent actual results have been well-absorbed into the marketplace. Earnings’ reports below this level of consensus will simply amplify the decline, since it would represent an actual result less than what was already factored into the marketplace. The 50-year average level for US earnings growth is near 7% and the US economy has remained well above this average for over 3 years. The US economy is due to slow significantly for the various reasons mentioned, which will see earnings subsequently adjust back toward their long-term averages. The aforementioned near-term affects on economic growth could cause the DOW to have a trading range for the month between 10,525 and 11,260.
The US dollar has remained within a narrow range and continues to be supported by foreign central banks throughout the world, even though the US trade imbalance and current-account deficit continues to grow. Our technical analysis still supports the theory for a further US dollar rally and are therefore forecasting a trading range for the month between euro fx equivalent of $1.24 and $1.30. We do expect volatility to increase, which will result in a larger trading range, as the US dollar rally causes various foreign central banks to cover their short US dollar positions — offsetting their US dollar positions by buying them back.
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 that have large stock, bond and/or real estate holdings and are seeking an active management service to generate a long-term average rate of return on investment between 15% to 20% 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, Stephanie Pomboy of MacroMavens, National Association of Realtors (NAR), National Association of Home Builders (NAHB), Philippa Dunne and Doug Henwood, HSBC, KonLin Letter, and Ned Davis Research.
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.