A big bull turns and runs

I interviewed Justin Urquhart Stewart of Seven Investment Management a few weeks ago. He’s a sensible sort – not too bearish, not too bullish. I asked what he thought was the key thing to watch for those hopeful of economic recovery. His answer? The American housing market.

Until that recovers, or at least stabilises, he says, nothing else will. So what’s going on in the market? Listen to the bulls and you’d think the crash was all but over. Numbers out this week showed that new home sales rose 0.3% between March and April, enough to bring on mutterings all over the place about green shoots and bottoms. But this number, 0.3%, is a statistical irrelevance. It’s not final – it’s an estimate from the US Census Bureau and the Department of Housing and Urban Development. And it comes with a margin of error of well over 10%. So when it’s revised we could find that sales in fact fell, say, 12%.

Look instead at the more representative year-on-year estimates and you’ll see the numbers show house sales down 34% (the margin of error here is also big, but 34% is large enough to be statistically relevant). Prices aren’t looking up either: the median new-house price was down 15%, and the Case Shiller house-price index shows prices down 19% year-on-year and over 30% from their highs.

It’s hard to see how this trend can change. There is still a huge oversupply of houses and undersupply of credit. More and more foreclosures are coming on to the market and no subprime mortgages are being given out. Worse, mortgage rates aren’t falling any more. Here in the UK, over-leveraged property speculators and ordinary home owners are being helped by very low rates.

As Graham Turner of GFC Economics points out, while recently there has been a slight rise in the average rate offered on two-year fixes (3.98% to 4.02%), the rate is still 2.58% lower than last June. Not so in America, where the 30-year rate is “threatening to move above 5%”. No wonder US consumers, with their ravaged pensions, lack of home equity and fragile labour market, are refusing to go shopping and bail the rest of us out. Note that credit-card usage is actually falling (credit-card debt levels were down nearly 7% in March).

So what do you do? One of our regular Roundtable members, Jim Mellon, chairman of Burnbrae Limited, has the answer. Jim has been a big bull for much of this year – at the start of the year he thought the market was “grossly oversold and due a bounce – one helped by a flood of freshly-minted credit”. He doesn’t think so any more. After the stunning rally of the last few months, he thinks it’s time to “sell most equities”, bar the odd undervalued small cap, “with takeout potential”. I’d agree: the risks of something nasty happening in the market before the summer is out are high.