Grim reality overtakes the markets once again

Like it or not, the UK's economy is built on houses. And with more bad news for property on the way, now is the time to take cover and wait for the carnage to pass, says John Stepek.

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Some good advice from an ex-estate agent

Looks like the market's latest little bounce is petering out in the face of the overwhelmingly grim economic reality again.

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US stocks fell yesterday as sales of existing homes fell by more than expected in June, down 2.6% on the month and 16% on the year. At current sales rates, 4.86m homes a year would be sold. That compares to the record level of 7.25m reached in September 2005, and is the lowest level in ten years.

The US "housing recession" as Bloomberg calls it, is now incredibly into its third year, and yet there's "no end in sight."

That can't be good news for us over here on the other side of the Atlantic...

US house sales have hit a ten-year low

US housing is in its third year of hard times, and yet times just keep getting harder. News from June from the National Association of Realtors was dreadful. Not only did house sales hit a ten-year low, but the number of empty properties on the market hit a fresh record. A full 18.6m properties stood vacant in the past three months, while in June, there was 11.1 months' supply on the market. A balanced market, the NAR says, is five to six months' supply. So in other words, the number of properties on the market needs to fall in half to just get back to a balanced market.

Meanwhile, well-known bond investor Bill Gross compounded the gloom by warning that he reckons that banks and brokers will end up writing off $1 trillion over the housing slump. As Bloomberg reports, this would imply and bear in mind it's not even the most pessimistic forecast "that credit market losses are less than halfway over."

And the figure for jobless claims rose by more than expected, to above 400,000, the highest in nearly four months. "You are starting to see a lot of the problems in the financial area drifting over into more of the real economy," said the eagle-eyed Tobias Levkovich of Citigroup.

Financial stocks saw their biggest one-day percentage fall in eight years as jitters returned after the recent rally.

Why the British housing market won't be perking up any time soon

What does all this mean for us? Well, misery in the US is bad news for everyone. But here in the UK, we're if anything even more reliant on property to prop up our little economy. And that's really bad news, because anyone who thinks that the British housing market will be perking up any time soon is just deluding themselves.

A telling example was in the Evening Standard yesterday. The paper carried an interview with Jon Hunt, the former head of one of the most reviled estate agencies in the UK and that's really saying something Foxtons.

But having sold Foxtons earlier this year for £370m, he clearly has no great interest in even attempting to talk up the market. "I've been through two major recessions, in 1972-74 and 1988-1994. This will be the third."

How long will the crash go on for? Well, it would be nice, he says, "if a house drops by 25% one week and comes back the next But the property market isn't like that it doesn't go off a cliff and climb back at the same rate. It goes down rapidly and comes back slowly. In 1988, prices started falling, they stayed down and it took until 1998 for them to get back to their 1988 level."

You may not be keen on the company he spawned, but he's not daft. Like any sensible contrarian, he reckons the time to buy is when everyone else has finally shut up about property and is fed up with the whole topic. And of course, we've got a while to go before that happens.

The Bank of England likes to suggest that the link between property prices and retail sales is unproven. But they'll probably be looking at the figures again after we learned yesterday that June's slump in retail sales was the worst since records began in 1986.

Like it or not, this economy is built on houses. And the news for houses will be surprising on the downside for a good long time to come.

This is a key reason why the rally in banking and housebuilding stocks in particular, looks "overdone", as JP Morgan Cazenove said about the homebuilder sector yesterday.

"The newsflow over the summer and the outlook statements during the reporting season in late August and early September will take the shine off the sector again," said analyst Anthony Codling.

Banks and consumer stocks aren't bargains yet

So don't be getting tempted by the rallies and bid rumours. Sure, some of these stocks may get bought by other companies (in the banking sector at least). And if you think you can time the next spurt of optimism in the markets and are willing to take that risk, then you might get lucky. But for anyone who prefers investing for the long-term and hasn't got the time to stay glued to a trading terminal minute-by-minute, the message is straightforward banks and consumer stocks aren't bargains yet, and they won't be for some time to come.

As Mr Hunt told the Standard about the property market, the time to buy is "when there's blood on the street, but it's drying it's stopped flowing." There's plenty more blood coming this way for the British economy for now it's time to take cover and wait for the carnage to pass.

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Turning to the wider markets

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UK shares came down to earth with a bump, reversing the previous day's rally, as the FTSE 100 index lost 88 points, or 1.6%, to 5,362. Mining stocks led the market down, with ENRC slipping 6.5%, Lonmin 6% and BHP Billiton 5%. Retailers also had a poor day, as Next dropped 4.5% and Marks & Spencer 4% on the poor UK retail sales figures. Banks were mixed, with Lloyds TSB sliding 2.5% but Alliance & Leicester nudging higher by the same percentage. London Stock Exchange bucked the general trend, rising 3% on a broker upgrade.

European markets also erased their previous day's gains, with the German Xetra Dax shedding 1.5% to 6,441 while the French CAC 40 lost 1.4% to 4,348.

US stocks fell back sharply, as further mortgage write-down fears caused financial stocks one of their biggest one-day falls since the start of the credit crisis. The Dow Jones Industrial Average plunged 283 points, or 2.4%, to 11,349, while the wider S&P 500 lost 2.3% to 1,253 and the tech-heavy Nasdaq Composite declined 2% to 2,280.

Overnight the Japanese market eased with a 2%, 268 point, drop to 13,335 and in Hong Kong, the Hang Seng did worse with a near 500 point slide to 22,592.

Commodity prices were slightly firmer this morning, with Brent spot trading at $126, spot gold at $932, silver at $17.57 and platinum was at $1743.

In the forex markets this morning, sterling was trading against the US dollar at 1.9893 and against the euro at 1.2658. The dollar was trading at 0.6364 against the euro and 106.66 against the Japanese yen.

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.