by Lastwear
Quote for the day:
Silly rabbit.
Trix are…
…for kids.
Stagflation whispers are starting to be heard. Per Google Trends, news references to stagflation reached a 3 year high this week. Google searches this week for stagflation were topped only when Greenspan warned that stagflation was a possibility in December 2007.
Stagflation refers to a stagnant economy and inflation coinciding. Typically as the economy heats up, inflation will start to pick up. The Fed can then raise rates to slow the economy down and inflation with it. Or vice versa, lowering rates would stimulate the economy at the risk of inflation. Currently we have the economy starting to slow down with inflation appearing to pick up steam.
The Bureau of Labor Statistics reported the Producer Price Index (PPI) this Tuesday. PPI is a measure of the average price level for capital and consumer goods received by producers. This measures price changes before they are passed on to consumers.
The PPI for Finished Goods rose 0.99% in January 2008 over December 2007. PPI rose 7.71% January 2008 compared to January 2007. Core PPI (excluding food and energy), rose 0.43% month over month and 2.37% year over year. PPI is much more volatile than CPI. It also leads CPI. Price increase are not immediately passed on to consumers. However CPI does seem to follow the patterns formed by a 24 month average of the core PPI. Increases in PPI will eventually turn into increases in CPI; the same with decreases.
Most of the recent surge coming from increases in food and energy. However, if there isn’t a quick reversal, it looks like core PPI and core CPI will be heading up as well.
photo by Sister72
Quote for the day:
My imagination makes me human and makes me a fool; it gives me all the world and exiles me from it.
- Ursula K. Le Guin
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photo by ps70
Quote for the day:
"An inventor is a man who asks 'Why?' of the universe and lets nothing stand between the answer and his mind."
- Ayn Rand, Atlas Shrugged
The S&P/Case-Shiller Home Price Indices were released today reflecting data through December 2007.
Prices for the Composite-10 declined by 2.28% from November 2007 to December 2007. Prices for the Composite-10 declined by 9.82% from December 2006 to December 2007. This was both the largest monthly and annual decline on record for the Composite-10. For 3 months in a row, a new record in declines has been set for monthly and annual declines. Prices in the Composite-10 are now 11.37% off their peak set in June 2006. Seattle, Portland, and Charlotte are the only cities in the Composite-20 to show annual gains.
Using the CME futures, I have constructed what the futures market is expecting home prices to do over the next few years. The futures market is expecting the U.S. Housing market to bottom in 2011. The CME futures market is thinly traded. This previous post goes into detail on the CME futures market and my methodology for constructing the futures info.
Here are the charts for the 10 cities in the Composite-10 with their projected future values. This is followed by the 3 cities in the Composite-20 showing annual gains (Seattle, Portland, and Charlotte). These cities are not traded on the CME and therefore do not have projected values. You can click on the charts for a larger view.
Here is an update to Robert Shiller’s chart going back to 1890. The home prices in this chart have been adjusted for inflation, whereas all the previous charts have not. This previous post had some more of his charts. The historical data from this chart comes from his website that gives supplemental data to his book, “Irrational Exuberance”, a book I highly recommend.
photo by Matthew Fang
Quote for the day:
"I try to avoid commenting on my successor because he has enough problems."
- Alan Greenspan at a conference yesterday in Abu Dhabi
The National Association of Realtors (NAR) released the Existing Home Sales figures for January 2008 which were down 0.4% on a seasonally adjusted annual rate of 4.89 million units in January from an upwardly revised level of 4.91 million in December 2007, and were 23.4% below the 6.44 million unit mark in January 2007.
Existing Home inventory rose 5.5% in January to 4.19 million which is a 10.3 month supply at the current sales pace, up from a 9.7 month supply in December.
This follows downward numbers in both Pending Home Sales and New Home Sales. A Pending home sale occurs when the sales contract is signed. When the house’s sale is finalized, the home counts as an Existing Home Sale. Pending Home Sales lead Existing Home Sales by a month or two. New Home Sales are also counted when the sales contract is signed.
Here are charts showing Existing Home Sales as compared to Pending Home Sales and New Home Sales.
When there are less than 6 months supply on the market, it is generally considered a buyers market. Existing Home Inventory typically increases in the spring. Calculated Risk has a good chart on this. He expects that we will cross the 12 month supply mark this year.
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Michael “Mish” Shedlock over at Mish’s Global Economic Trend Analysis posted an article with a screenshot of one of Washington Mutual’s Mortgage Backed Securities that they securitized in May of 2007. You can read his analysis and see the screenshot here. He doesn’t go into detail on the the age of the loans, but these loans had a weighted average age of 12 months in January 2008 (originated on average in February of 2007). You can see the age each month on the line that starts off WAM/Age.
Just 12 months after origination, 15% of the loans are in foreclosure or are REO. It looks like the delinquencies will continue to rise for some time.
Here is the prospectus that WAMU filed in April of 2007. 
Here we can get details on the makeup. It was comprised of 1,765 loans. Only 12.7% of the loans in the pool were Full Documentation Loans. 87.3% were less than Full Documentation (Reduced Documentation or Stated Income, No Ratio, or No Documentation Loans).
The next chart shows that most of the loans had a DTI over 40%. This is using Stated Income. Who knows what the DTI would have been if they had qualified Full Doc. These type of loans are typically qualified as Interest Only based on the start rate (over 80% of these loans were 5 year fixed ARMs).
Finally, here is a chart showing the average CLTV.The weighted average LTV at origination was 78.1%. The weighted average CLTV (combined 1st and 2nd Loan amounts to the value) was 91.2%. 65.6% of the loans had a CLTV over 90%. The weighted average CLTV for the loans in the bracket over 90% was 98%. That means the vast majority were 100% followed by 95% CTLV.
47.27% of the original principle balance were comprised of loans for homes in California, 14.38% were in Florida, and 6.81% were in Illinois. Home prices in these states started declining in late 2006/early 2007. You can find charts of values for San Diego, Los Angeles, San Francisco, Miami, and Chicago on this previous post. They future values in the charts are based on the S&P Case Shiller CME futures contracts.
Here is a chart showing the delinquencies compared to the decline in values based on the Case Shiller Composite 10.
The rapid rise in delinquencies is much faster than the rise in delinquencies in Option ARMs. I have charts and analysis in this previous post. We all know the damage caused by subprime delinquencies. However, with subprime, the delinquency expectancies were a lot higher from the get go. With ALT-A and Option ARMs, the delinquency expectations were a lot lower, but they are performing much worse at a rapid clip.
Here is a quote from the prospectus on who originated the loans: “Ameriquest Mortgage Company, approximately 40.6%; and The Mortgage Store Financial, Inc., approximately 16.8% No other entity originated more than 10% of the mortgage loans.” Ameriquest was a subprime lender and The Mortgage Store Financial was mainly an Alt A lender. I find it amazing that Moody’s was able to give 92.6% of this pool a AAA rating (their highest rating). Moody’s expected a collateral losses to range from 1.30% to 1.50%.
This is despite the fact that these were largely originated from a subprime lender, were only 12.7% full doc, were mainly high CLTV loans, had high stated income ratios, high geographical exposure to CA and FL (states with high appreciation), and finally were originated when prices were already starting to decline.
Who could have known?
ABN AMRO released their annual Global Investment Returns Yearbook (hat tip CXO Advisory Group). Per ABN AMRO's synopsis “It is produced for ABN AMRO by London Business School experts Elroy Dimson, Paul Marsh and Mike Staunton, with a contributed chapter by Rolf Elgeti, ABN AMRO’s former Head of Equity Strategy.”
They have a database of stocks, bonds, and foreign exchange going back to 1900 for Australia, Belgium, Canada, Denmark, France, Germany, Ireland, Italy, Japan, the Netherlands, Norway, South Africa, Spain, Sweden, Switzerland, the United Kingdom, and the United States.
Here is a chart that they provided showing the correlation of the U.S., U.K., German, and Japanese stock markets since 2000. The returns are adjusted for inflation and are in the local currencies. So much for diversification.
They also have a chart showing how stocks have performed in the U.S. and the U.K. since 1900. $1 invested in the U.S. in 1900 would have grown to $239 by the end of 2007. With Dividends reinvested the $1 would have grown to $22,745. £1 invested in the UK would have achieved almost exactly the same results of £22,252 with dividends reinvested.
They also updated a study published by Griffin, Ji, and Martin in the Journal of Finance.
The original study took a look at stocks from around the world going back as far as 1975 up to 2000. The U.S. data went back to 1926. They looked at stocks that were in the top 20% and compared them to stocks that were in the bottom 20% in returns looking back 6 months. They found that the top stocks substantially outperformed the bottom stocks in the next 6 months. The gains reversed over 1 to 5 year timeframes.
The London Business School used a model that looked at the top 20% and bottom 20% stocks based on returns in the last 12 months. They would wait one month, hold for one month, and then rebalance.
Using this model, the top 20% stocks in the U.K. outperformed the bottom 20% by 10.3% since 1900.
Applying this model to 17 countries, they found that the top performing stocks outperformed the bottom stocks in 16 out of 17 countries since 2000. The exception was the U.S.
The U.S. Department of Labor released the Consumer Price Index today.
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Sales and Use Tax Revenue has been falling in Florida. It has leveled off in California and New York. Texas still shows solid gains, but the pace is starting to slow slightly. When adjusted for inflation, California and New York are both declining. The last time this happened was during and immediately after the 2001 recession.
The U.S. Department of Commerce released the details on the trade deficit of goods and services for the month of December 2007 and the complete year. The deficit for December decreased from November by $4.3 billion. The trade deficit for 2007 decreased from $758.5 billion to $711.6 billion. This was the first decline in the trade deficit since 2001.
The weaker dollar led to a fall in imports in December. Automobile imports led the way decreasing by $2.1 billion. This offset the increase in Crude Oil imports of $1.6 billion.
The U.S. had the largest trade deficit with China at $18.8 billion for the month and $256.3 billion for the year. Japan was next at $6.6 billion for the month and $82.8 billion for the year. Mexico was third at $6.5 billion for the month and $74.3 billion for the year. Canada was fourth at $4.7 billion for the month and $64.2 billion for the year.
The trade deficit is now around the same level it was at during 2005.
The U.S. Census Bureau announced January 2008 Retail and Food Service Sales figures today. Adjusted for seasonal variation and holiday and trading-day differences, January 2008 had an increase of 0.33% from the previous December 2007 and a 4.27% above January 2007. Economists had expected a 0.3% decrease.
This is the advance release. The figures are often heavily revised in the next two months. The sales numbers have been revised downward in recent months. If December 2007’s Retail Sales figures had not been revised down this month, then January 2008 would have decreased 0.01% instead of the strong 0.33% gain. November Retail Sales when initially released looked really strong, posting a 1.2% increase over October 2007. November 2007 has been revised 0.62% below the initial released figures.
Retail Sales were led by Gasoline station sales which were up 23.0% from January 2007 due to increases in gas prices.
Here are two charts on Retail Sales. The second chart is without Automobiles which is more volatile. You can click on the charts for a larger view.
photo by TheAlieness GiselaGiardino²³
Quote for the day:
All animals are equal.
But some animals are more equal than others.
- George Orwell - Animal Farm
Here is a hypothetical scenario I created to take a peek at the past returns of the S & P 500. I used the data collected by Robert Shiller as discussed in this post.
I took a person earning the Per Capita Income for the U.S starting to invest when they were 22 in 1965 and ending in 2007 at the age of 65. The Per Capita Income in 1965 was $2,563 and $33,712 in 2007. Using Shiller's S&P 500 index return and dividend yield for the last 43 years, if a person was to have saved 15%, they would end having accumulated $877,220. If a person was to save $100 a month and matched the S & P 500 return, then they would end up at $1,074,937. If a person was to save $100 a month and return 11% a year, then they would end up at $1,064,355. The S & P 500 has averaged returns of 11.15% from 1929-2007.
This illustrates the exponential nature of compounding interest. You can scroll down on this spreadsheet by using the scroll button on the right of the spreadsheet.
I visited some of Robert Shiller's graphs on Home Prices from his book “Irrational Exuberance” in this post last month.
Here are some updated charts on the historical prices of the S & P 500 index that Robert Shiller pieced together going back to 1881.
You can see his data here. S & P has a spreadsheet with 20 years of data that they update regularly here.
The real question for the stock markets going forward will be earnings. Real earnings adjusted for inflation dropped by 50% from 2000 to 2001. They started dropping in the third and fourth quarter of 2007 after rising steadily from over the previous 4 years.
