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ALL IS WELL?

 
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PostPosted: Sat Feb 18, 2006 9:11 am    Post subject: ALL IS WELL? Reply with quote

By Sy Harding

ALL IS WELL? February 17, 2006.

The Commerce Department reported this week that 'housing starts', that is ground-breakings for new home construction, soared 14.5% in January. Wall Street and the media loved the news as an indication that the real estate sector remains strong and is not in trouble after all.

My take on it is just the opposite, that it was terrible news for the real estate sector, where the glut of unsold houses is growing rapidly, and the only hope of preventing a plunge in prices is if that oversupply can be quickly absorbed by an increase in demand.

Unfortunately, the tide is running in the opposite direction. Sales of existing homes have been down for three straight months. Mortgage applications, a harbinger of upcoming sales, have been steadily declining. Meanwhile, more existing homes are coming on the market, with 'For Sale' signs springing up like dandelions in most neighborhoods. With sales declining and more houses coming on the market, the inventory of unsold homes is growing rapidly. And into that glut of unsold homes a huge increase in the number of additional houses (14.5%) being started in January is good news? I think not.

The market was also able to ignore several other less than positive reports.

The Federal Reserve reported that U.S. industrial production declined 0.2% in January, versus the forecasts that it would rise 0.2%. The Treasury Department reported capital flows into the U.S. fell to $57 billion in December from $92 billion in November, led down by a decline in investments in U.S. Treasury bonds by private foreign investors. The University of Michigan Consumer Confidence Index fell to 87.4 this month from 91.2 in January. Wall Street's Goldman Sachs Group warned that analysts will soon be cutting earnings forecasts by as much as 50% for thirty large corporations where accounting rules now require them to treat employee stock options as expenses. David Zion, an analyst at Credit Suisse Group, said outstanding options issued by S&P 500 companies alone have a cumulative value of $393 billion, and the impact of such deductions from earnings "may be painful".

But this week the market seemed not to care.

The market's optimism stemmed from the appearance before Congressional banking committees by Ben Bernanke, Alan Greenspan's replacement as chairman of the Federal Reserve. Wall Street and investors had been concerned about how much Bernanke's views might differ from those of Greenspan. However, there were no surprises. On all subjects Bernanke pretty much reiterated what Greenspan has been saying right along.

Regarding the U.S. trade deficit he said it is not a problem now, but a potential problem down the road, since the current account deficit it creates cannot be sustained forever.

Regarding inflation, he implied additional interest rate hikes might be necessary in the Fed's fight against inflation, but their degree will depend on how economic numbers come in over the next few months. That quite closely echoed what Alan Greenspan had been implying recently, that with the Fed Funds rate now at 4.5%, up from just 1% in 2004, the Fed's goal of steady rate hikes 'at a measured pace', to get the rate up to a neutral level, could now be altered to allow economic numbers to play a larger role in the decisions.

Bernanke's testimony left Wall Street's consensus opinion unchanged, that the Fed will raise interest rates at least one more time, at its March meeting, but that, just as Greenspan had implied, economic numbers will now have more influence on its subsequent decisions.

It was normal that the market liked that there were no surprises in Bernanke's testimony, but perhaps strange, given the larger role that economic numbers will play in the Fed's interest rate decisions, that it paid no attention a day later, when the important Producer Price Index for January was released.

The PPI measures inflation at the producer level, and showed producer prices rose an unexpectedly large 0.3% in January. Worse, when the cost of food and energy is deducted to arrive at the so-called 'core rate' of inflation, it was up 0.4%, an annualized rate of 4.8%. That was a strong indication that the Fed's rate hikes have still not come close to slowing inflationary pressures.

The market's gain this week closed the Dow at a new 5-year high, which is making the headlines, but only 0.6% above its high of January 11. That was encouraging, but it is not likely to modify the risk warnings just yet from corporate insiders and Wall Street institutions, since the 30-stock Dow's new high was not confirmed by the broader market. Other major indexes, including the S&P 500, Russell 2000, NYSE, and Nasdaq, did not make new highs. Additionally, this week's rally was on mediocre volume, and took place under the usually positive influence of position squaring in an options expirations week.

Next week will be more important as to whether the overall market will finally be able to break out of its trading range to the upside.
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