WAVETECH ENTERPRISES, LLC
Private Account Wealth Management Services
Newsletter Issued 10-10-06:
By: John T. Moir
Chief Editor: Sara E. Collier
Position overview . . .
Our recent newsletter, dated September 8th, anticipated that the DOW was in the process of topping in price and would soon be resuming its bearish trend, with a projected trading range for the month between 10,700 and 11,490. The actual result produced an extended DOW advance, between 11,323 and 11,741, as investors presumed that a slowing US economy with lower interest rates would produced higher levels of corporate earnings and bottom line profits.
The DOW may have reached an all-time high, but the rest of the market is not even close. The DOW indeed is at a new high mark, but that means it has returned virtually nothing for almost seven years. The situation is even worse if the performance is adjusted for inflation. Furthermore, General Motors, a money-losing company, is the best-performing stock in the DOW so far this year. The next two best performers, AT&T and Merck, have had serious troubles of their own. In addition, while the DOW may be reawakening, most other major stock indices are nowhere near their all-time highs. The S&P 500 is still 12.5% below the peak set on March 24, 2000, and the Nasdaq is 55% off its high-water mark set on March 10th 2000.
The US dollar was forecasted to remain within a larger trading range, between euro fx equivalent of $1.25 and $1.29, for the month. Investors still are uncertain what the long-term trend will be for the US dollar, but it could be more clearly understood once it trades outside the current range that has persisted for the past four months. The actual US dollar trading range for the month proved to be slightly narrower than forecasted, between euro fx equivalent of $1.2658 and $1.2888.
The US treasuries were expected to consolidate within a large trading range, after its strong rally in price and decline in yield during the past few months. The projected yield range for the US 10-year Note was between 4.72% and 5.00%. The actual result saw the US treasuries continue their rally in price and decline in yield, as additional economic data released during the month further confirmed that the US economy is slowing. The US treasury 10-year Note had a yields span during the month between 4.55% and 4.81%, slightly elevated from our forecasted range.
Looking forward . . .
All of the turmoil in the markets this spring was caused when the Federal Reserve reversed what it had previously signaled to the market on May 10th, by indicating that it would continue to increase interest rates. The markets subsequently declined 8% on average, with small and mid-cap stock falling significantly more. Then slowly but surely, every industry that was cyclical rolled over: housing, transports, industrials, and eventually energy and commodities.
The major stock indices bottomed around July 15th, which was close to the date of the last Fed interest rate hike. Since then, there has been a stealth big-cap stock market rally, and most investors were unaware of the advance, since they did not own the large-cap indices.
The month of September saw the market in agreement with the Federal Reserve, in theory, that they are on hold regarding further interest rate hikes and that the US economy and corporate profits are in for a soft landing. The stock market advance during the month was propelled partly by end-of-the-quarter “window dressing,” which results in fund managers buying more of their favorite stocks to improve their short-term performance.
The stock market is up against longer-term issues of economic softening and various internals: real estate, continues to decelerating; market advances have taken place on lower-than-average volume; energy is oversold, and may bounce upward; despite the DOW rally to all-time highs, stocks reaching new highs are lagging while the number of stocks achieving new lows are expanding; fewer stocks are participating in the advance.
The DOW rally is focused on fewer and fewer stocks as it hits all-time highs, while the other major stock indices remain further away from their all-time price peaks. This distinctive divergence is of no coincidence.
FURTHER EVIDENCE OF THE DETERIORATING HOUSING MARKET:
The three-month average for new home sales are 1.05 million, the lowest since May of 2003, and are now down a whopping 19.3% from a year ago. Inventories continue to swell; at last count, there was 6.6-month supply of unsold new houses, up from 4.7 months at the end of August 2005. Prices for their part, continue to do what the smart money said they could never do — go down.
The bursting housing bubble will hit financial’s as well as companies involved one way or another in home building. Banks have not shrewdly offloaded all of their mortgage risk and still hold $3 trillion in direct mortgage loans, about 42% of total assets. They also have another $1 trillion in mortgage-backed securities, bringing their total real estate exposure to a record high of 55% of assets. Banks may, at the very least, be compelled to rebuild their loan-loss reserves, which have declined to 20-year lows.
The decline in the housing market is very prevalent in Florida where August existing home sales dropped 34%, with condo sales off by 41%. The rest of the United States should be forewarned, since these type of decline in sales, and eventually home prices, have no boundaries.
The housing industry has been fed by reckless investors feeding money into a real estate bubble during the last few years. Investors, not just Florida, have fueled all of the hot housing markets, including Arizona, California, Northern Virginia, Nevada and many of the Eastern Seaboard markets.
In Florida, the most extreme example of the investor frenzy, may be the Miami condo market, followed closely by Naples, Orlando, and the Panhandle. Right now, Miami alone has more than 50,000 condos under development, with thousands more in the planning stages, but from 1995 through 2005, the absorption rate in Miami has averaged 2,500 units per year.
Most of Miami’s new condos are not being built along the world-famous beach. Instead, many so-called luxury condos are going up in some of Miami’s most blighted areas. These investors who scooped up these condos from as far away as Europe and Australia saw slick Web sites and magnificent marketing materials.
The Orlando and Tampa areas have more single-family developments with the same problems. Investors simply did not care if the home was built somewhere they would not consider living or if the builders cut corners in construction to enhance margins. It did not matter where or what the builders offered, as investors were only concerned with one key word: “Pre-construction.”
Investors are pleading with real estate brokers to find them a pre-construction “deal.” By early 2006, however, real estate brokers could only find two developments that made any sense, even though there were more than 200 offered throughout the State of Florida.
Lotteries and limited releases for pre-construction homes fueled the investor frenzy, with no investor wanting to be left out, just as in the closing period of the dot.com frenzy. Many of the dot.coms did not have the business fundamentals to survive, and many of the developments that investors in Florida real estate that have been scooped up at premium prices are not what perspective occupants actually want. The result: thousands upon thousands of homes that have been built on speculative demand cannot command the original prices paid by investors.
The housing bubble is much more dangerous than the dot.com bubble. For the most part, dot.com speculators were only risking their original investment, where as housing speculators are risking loss of their primary residence, because they borrowed against it to finance their spec homes. Yes, homes, plural: Many speculators bought several spec homes with low down-payments.
Speculators’ losses will exceed their 3% to 20% deposits, since prices of spec homes purchased a year ago have gone down as much as 40%. Furthermore, closing costs may have added another 5% to the cost of the purchase. Moreover, there would also be investors’ commissions and carrying costs to this purchase. Investors would be faced with another 10% in selling expenses, even if they could sell.
Speculators have been hesitant to sell properties at a loss, since many economist are calling for a soft landing. The investors hesitation to sell has caused them to incur the continued monthly expenses for association fees, maintenance, utilities, taxes and mortgage payments worth 1% to 2% of the original purchase price. They are suffering an additional loss as the home drops in price each month, by 1% to 3%.
Meanwhile, home builders have been forced to go to war with the speculators. The only way for publicly traded home builders to attempt to meet Wall Street’s expectations is to offer massive discounts and incentives — outlined within our August 11th 2006 Newsletter — that will move unsold inventory. For example, a top-five publicly traded builder recently sold a home to a second-tier investor for $315,000, and the previous investor’s contract was at $490,000 until the deal fell through.
Florida real estate has three(3) groups interacting to feed the market with inventory: Builders, speculators and traditional sellers. The speculators initially undercut the builders, but now the builders are leap-frogging the speculators to unload inventory.
Speculators, who can do it, are walking away from substantial deposits, due to declining prices. The recent round of cancellation reports from builders will continue to grow, and some builders will eventually report negative sales — experiencing more cancellations than actual sales.
Some builders are even continuing to build spec homes, anticipating a turn-on-the-dime market, or just trying to get some value out of their inventories of land. There are no dimes to turn on, with investors gone and current historical levels of unsold inventory.
The Florida real estate is also flooded with people who work in the housing industry. The loss of jobs created during the housing boom will touch all aspects of the economy, including contractors, sales agents, suppliers, mortgage brokers, insurance agents, title-insurance companies, and home inspectors.
The housing industry was one of the largest components of job growth during the past few years, and so it will be one of the largest sources of job losses in the coming months. The level of interest rates will not necessarily help. The mortgage payment that bought a $500,000 home in July 2005 will buy a $420,000 home today, since the 30-year mortgage rates have risen by 18.5%.
Long-term conclusions and current month expectations . . .
Wages and salaries have been strongly rising recently, despite the slower gains in economic growth. The major reason for slower growth have been reduced consumption, especially with durable goods and lower housing activity.
A simplistic measure of savings is the relationship between consumer-durable goods expenditures versus wages and salaries. This comprises our monthly savings indicator, and the spread between the annual rates of change for these two series has widened — showing faster growth in wages and salaries than in consumer outlays for durables. This suggest a rebuilding of consumer savings, unbelievable as this may seem.
Liquidity conditions remain more likely to produce upside surprises on inflation than downside risks to output and employment. A rise in the US dollar could signal a modest reduction in excess liquidity, but not an end to the inflation threat, which could become a renewed dominate concern going forward. The US dollar could begin to forge ahead this month, with a projected euro fx equivalent trading range between $1.23 and $1.28.
The Federal Reserve, at their September 20th Federal Open Market Committee Meeting (FOMC), stated within their post-meeting policy statement that economic growth is moderating, and “some inflation risks still remain.”
The FOMC further noted that economic growth continues to moderate, “partly reflecting a cooling off of the housing market.” They acknowledged that the core rate of inflation remains “elevated.”
Furthermore, the FOMC gave no indication that a cut in rates is on the horizon, which the US treasuries had rallied in price over the past few months with such an anticipation. We welcome the fall in energy prices, but will not take it for granted — given the looming geopolitical tensions and instabilities, it would not take much for crude oil prices to return to an upward path. Also, labor costs in the US economy are clearly on the rise and will merit attention by the FOMC in the coming months — possibly at their next FOMC meeting being held on October 24th and 25th.
The US treasuries are pricing in a Fed interest rate easing for early 2007, which could be premature for the above reasons. We anticipate that the US treasury 10-year Note to have low base-yield for the month at 4.55%, as prices start to decline and subsequently yields rise.
The unemployment rate dropped to below 4%, previously between 1965 and 1997, when there was only one and two standard deviations separating profits and real compensation. Today, the divergence between profits and real compensation is nearly three standard deviations, suggesting the labor market will continue to tighten, even within a slowing US economy.
The major stock indices remain in technically overbought conditions and several investor-sentiment measures indicate that this stealth rally is getting pretty mature, confirming our belief that the market is close to at least a near-term top, if not a major top. Therefore, we are projecting a DOW trading range for the month between 11,150 and 11,880.
Investors should consider using this advance to reduce their stock holdings in anticipation of a correction or a outright resumption in the bear market decline that is likely to emerge sometime this month. We would suggest the investment allocations outlined below for prudent diversification through these changing economic times.
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 Wavetech Enterprises’ 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, Asha Bangalore of Northern Trust, Stephanie Pomboy of MacroMavens, Mike Morgan of Morgan Florida, National Association of Realtors, Forbes Growth Investor, ValueStockTips.com, Ritholtz Research & Analytics, Safian Investment Research, MKM Partners, Asbury Research, PNC Financial Services Group.
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.