Volatility and choppiness continue to characterise major stock market behaviour although the highs achieved in late April still stand above subsequent price levels.
One of the latest key news items concerned a sharp fall on Tuesday, 25th July, of 15% in the share price of UPS, an express delivery group; the Financial Times' headline was UPS battered by retail weakness'.
A few days earlier, on Thursday 20th July, the Dow Jones Transportation Average fell an alarming 204.03 (4.36%). We could well be witnessing one of the most important signals from the US stock market, especially when set against the share price of major retailers such as Wal-Mart whose share price is currently at a 5-year low.
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We repeat that consumers represent about 70% of America's GDP and are the plankton of the economic food chain. Any slowdown in their activity will have major implications for the global economy, especially stock market investments. If consumer activity is slowing, goods will stay on the shelves longer and the transportation of new stock will back-up, hence the potential importance of the UPS story and the recent decline of the Transportation Average.
For over-stretched consumers to continue buying, they need access to savings - but in the US there are very little of these left. Most consumers have, for a long time, been living well beyond their means, achieving that self-destructive process by borrowing even more money, supported by a sense of increased wealth arising from higher house prices. For that reason, we have repeatedly said that the house market in the US is key to just about everything.
US property market: important news
Before commenting upon new specific house market news, we would draw your attention to the share price of one of Florida's major property developers, The St. Joe Company. Extraordinary though it may seem, they own 2% of Florida. More likely than not, that is the reason why their share price since July last year has fallen dramatically by 50%.
Most of the assets in St. Joe's balance sheet are its predominantly Florida-located land-bank. If US house prices are believed to be in decline, then it is land values that suffer the worst of the deterioration. The price of a finished house comprises the land value, the building cost, plus the builders' profit. Only the builders' profit and the value of land can be varied. The market seems to believe pretty firmly that the land owned by St. Joe has seriously declined in value and their profits will slump.
The two weeks since our previous issue have been littered with important news about the US housing market as follows:
Housing starts in June were down 5.3%.
Mortgage applications in June down 4.5%.
Building permits are down 14.9% over the past 12-months.
Existing annualised home sales in June fell 1.3% to 6.62 million compared to 6.71 million in May.
Median price of homes sold £231,000, compared to a year ago, up 0.9%, the smallest year-on-year gain since May 1995.
Inventories of unsold homes at a new record of 3.725 million units. At June's sales rate, this represents 6.8 months' supply.
Price action for companies like St. Joe and more generally the Philadelphia Housing Market Index represent an instant snapshot of the health of the American housing market. Given their dramatic declines, it can't be very good. Some may therefore wonder why the house prices themselves are not falling more dramatically. The reason is quite simple, the stock market looks forward whereas house prices are what is happening now.
The question is, at what point will the reality of serious house price declines justify the much reduced price of house building companies? The clue is to be found in the record inventory levels. Houses are being offered for sale at prices that do not interest prospective buyers of whom there are insufficient. Therefore, the number of unsold houses is constantly rising.
Eventually, unsuccessful sellers will be forced to accept lower prices. As yet, there would appear to be insufficient distressed sellers to force the pace. Possibly, the resetting of Adjustable Rate Mortgages (ARM) that starts in the second half of this year and continues into next year, will trigger the moment of panic that is needed for house transaction prices to relate more correctly to market conditions.
US property: the impact of excess borrowing
It has been reported that, particularly in property hot spots that four out of five mortgages effected in the US last year were ARMs. Of those, $1 trillion will be reset this year and $1.7 trillion next year. The outlook for these borrowers who are, in many cases, fragile could not be worse. The resetting will cause their mortgage payments to increase by 25% to 60%.
Real wages are in decline, savings have been exhausted. If the Transport Average is any kind of guide, the plight of the over-borrowed American consumer is getting worse and it is now impacting upon their willingness to continue their spending spree that until recently seemed to have no end.
The recent weakness of the Transportation Stock Market Average could, in due course, lead to a key Dow Theory sell signal. Such a weakness would apply if the Transports and the Dow Jones Industrial Stock Market Average both simultaneously fall below their recent June lows of 4,441 and 10,670 respectively that would be a bleak signal for stock markets generally.
Economists at HSBC recently said that there is a greater risk of a hard landing for the world economy arising from the big increases in energy prices and rising interest rates. In their view, there is a real risk of monetary overkill with Central Banks raising interest rates too much. We would not disagree.
If events continue to pan out as we expect, then stock markets are going to head much lower; bear funds will benefit from that. In due course, huge opportunities will arise to invest in Japan, India and China as well as other key emerging markets as the world inevitably moves from being US-centric to Asia-centric.
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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