How will the US housing slump affect stocks?

The US housing bubble is exploding - but what will the impact be on stock markets, and what warning signs do you need to watch out for?

The US housing market has moved to centre stage. At RH Asset Management we religiously document important items of news. A simple analysis of the last two weeks' news concerning only the US house market amounted to a massive 33 separate items.

Looking back over the previous four two-weekly periods, the numbers were much lower, respectively 19, 11, 18 and 11.  This past two weeks culminated in the shock figure for the July sales of existing homes.  Analysts had predicted a fall of 1%; in fact the reported figure was a fall of 4.1%.

Coupled with that was the news that inventories of unsold properties are at a further high, amounting to 7.3 months' supply  at recent sales levels. This compares with only four months' supply early in 2005. The source of this was the National Association of Realtors who would have been busting their gut to put the best possible shine upon the numbers; they could not because they were just too bad.

Meanwhile, purchasers of new homes in the US which account for 15% of the market dropped 4.3% in July.  

The only recent good news coming from the sector was from US luxury house builder, Toll Brothers. Although their third quarter orders were down a big 47%, earnings were down only 19%, less bad than the market had feared. On the day their share price rose.

The Philadelphia Housing Index is having a rough time. The index is over 30% down from its high last year, a bleak indictment by investors in house-builders' shares. Investors in real estate should take it as an important early warning. 

Apparently one Denver realtor said that it's just a blood bath'. The Financial Times reported that new single family home sales in the US are down 11% year-on-year and existing home sales are down 8% year-on-year. The FT also said that the number of building permits in America have been down every month since February.

The latest issue of Barons, Dow Jones and Company's business and financial weekly magazine, included an article "The no-money-down disaster" by Lon Witter, which can be accessed in its entirety by visiting www.witterwestlake.com

Among the fascinating information included was that 15.2% of the 2005 buyers owe at least 10% more than the value of their houses. It therefore follows that a huge number of US home owners are living through a period of personal financial devastation. It is almost certainly the case that for many their mortgage is unaffordable. These owners are living on the edge, a large number of them are probably destined to lose their houses and those houses will be sold at fire-sale prices; probably following repossession.  When sold, it is these prices that will correctly price the house market for the conditions prevailing so expect the horses to be frightened! The ongoing US housing market saga remains the key to the global economy.

Historically, an inverted yield curve is an unusual occurrence that has accurately predicted, not just an economic slowdown but the strong probability of a recession. As we have explained before, the yield curve is inverted when yields from long-dated government bonds are at rates lower than the prevailing short-term interest rates. The yield curve is inverted both in the US and in the UK. On its own, such an unusual circumstance is a dire warning; coupled with the very bad news from the US house market, the gravity of that warning is much greater.

Most of the world's stock markets topped out in May, since when they may be carving out important tops. Taking into account what we have said already in this issue, it is perfectly logical to expect that such tops are in the process of formatting; following which stock markets should go much lower. The first indication of this will be a FTSE 100 Index close below 5,750, particularly if coupled with that good old regular level, oft mentioned in Onassis for the Dow Jones Industrial Average of 11,000. This year so far, the Dow has crossed and re-crossed the 11,000 level eighteen times. 

In a previous piece, we referred to Dow Theory which is based on the confirmation or non-confirmation of the Dow Jones Industrial Average and the Dow Jones Transportation Average. The recent lows set by the Transports have not, as yet, been confirmed by the Industrials. The worst of all worlds for stock markets would be expected if the Industrials fall below 10,700 which would then confirm the recent new low set by the Transports. 

If that is accompanied by further bad news from the US house market and the continuing inversion of the yield curve, one would have to expect stock markets to spiral downwards. 

By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.

For more from RHAM, visit https://www.rhasset.co.uk/

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