Trading
Tip
Surfing the Current Market Wave
by
D.R.
Barton, Jr.
“The
only function of economic forecasting is to make astrology
look respectable.”— John Kenneth Galbraith
I’m sitting here this evening on a
porch in North Myrtle Beach, South Carolina watching the
waves. Earlier, I spent about an hour body surfing those
same waves and had a great time with my whole family,
including my dad.
There are lots of different types of
waves to ride, but I do have my favorite.
The best waves for me are the ones that don’t
look like much on the surface but have lots of underwater
pull. They
always give the best ride.
For an added benefit, the casual onlooker doesn’t
really understand how you went so far, so fast.
In my opinion, that’s the kind of
wave that the housing market is about to ride.
The state of the residential housing
market is one of the most debated topics in economics
right now: has it bottomed and started back up or is the
worst yet to come? If
you listen to the media, you probably have the impression
that housing has hit bottom and is on its way back up.
Then there’s this complicated but compelling
graph that has been cited a lot recently that paints a
less rosy picture. We’ll
study both items this week.
Why
the Housing Market Matters
[Editor's note: Due to spam filters we can not use the proper spelling of mort-gage in this article, that's why we've used the
hyphens.]
Understanding the big economic
picture is not just an exercise for institutions and
fundamental investors.
Traders of all stripes benefit from understanding
the long term economic trend. These
longer term trends are initiated by and sustained by
changes in macro influences that affect nearly every
household and business in the country.
When these things change, they tend to affect
(move) the markets for a long time.
For example, interest rate changes will affect the
economy for months and years.
One big driver of the economy is
housing. The
housing market is such a huge part of the economy that it
has a major effect on investor sentiment and the financial
markets. Housing
reports move markets and have done so significantly in the
last two years as there have been a lot of changes in that
sector recently (Understatement!).
This was evident again last Friday
(8/21) when the National Association of Realtors reported
that existing home sales had higher volume figures than
expected. The
market popped on the announcement (and this was on top of a
very strong up week).
Of course, all the giddy reports of
the better volume news failed to mention two other points:
the continuing drop in the existing home prices and the rise in the inventory of homes for sale. Those
points were a few more paragraphs down in the press
release. With
the current strong near term bullish sentiment, the
positive news gets accentuated and the negative news gets
ignored. (Now
even my third grade economics students know that if supply
goes up and prices go down, demand is not going up.)
Adding
Some Longer Term Data to the Outlook
The following Credit Suisse graph has
been getting a lot of play recently and for good reason.
It shines some much-needed light on the broad mort-gage market story.
For those not familiar with terms
here, mort-gage rate resets are the periodic adjustment in
interest on home loans that have some type of variable
rate.
Naturally, changing the interest rate also changes
the mort-gage holder’s monthly payment.
Many homeowners in the last few years bought homes
with adjustable rate mort-gages (ARMs) or balloon rate mort-gages that had very low initial or “teaser” rates.
Those low initial rates are then reset higher at
some point.
Option ARMs give mort-gage holders
alternative payment options.
The lowest cost option is a minimum payment that
does not even cover the interest accrued in the last
month. This means it's fairly simple for a homeowner with
an option ARM to end up underwater (the homeowner owes
more money on the mort-gage than the property is worth).
This can occur even in a market where prices are
holding steady. If
real estate prices are dropping though, it is even more
likely that a homeowner with an option ARM will end up
upside down, which then makes refinancing nearly
impossible.
Alt-A is the category of loans made
to borrowers with credit scores just above the subprime
level. You
have heard, no doubt, about the high foreclosure rates in
the subprime area over the last two years and the global
financial havoc it wreaked.
Many reputable analysts anticipate Alt-A to be the
next big problem.
As you look at the graph, what do you
see? A huge
amount of Alt-A and option-ARM resets will happen in
2010-2011, with that peak being even bigger than the
subprime peak of last year.
Potentially, a lot could happen to reduce the
effect these resets could have on the banking system but this
is the 800 pound financial gorilla in the room that you
ignore at your own peril!
It is not my intent to paint a
negative picture but to paint a fuller picture with a
greater depth of data for your own evaluation.
Without some consideration about what is happening
in the economy and where it’s going, you lack very
important context for trading the market.
Simply taking in the headlines at face value like
last Friday’s existing home sales rise can be dangerous.
What does your big picture look like right now?
How do the current market levels fit in with
your big picture?
I believe the current market rally is
driven by force-fed liquidity (cash injections).
As I have said recently, this artificial stimulus
causes us to toss to the sidelines much of our traditional
analysis as this market
powers upward on excess currency.
In today’s market, you can’t see the underwater
pull by just looking at the surface.
If you are riding this wave, be sure
you have a firm exit plan or else the wipeout could be
nasty…
Great
Trading!
D. R.
About
D.R. Barton, Jr.: A passion
for the systematic approach to the markets and lifelong love of
teaching and learning have propelled D.R. Barton, Jr. to the top
of the investment and trading arena. He is a regularly
featured guest on both Report
on Business TV, and
WTOP News Radio in Washington, D.C., and has been a guest on
Bloomberg Radio. His
articles have appeared on SmartMoney.com and Financial
Advisor magazine. You may contact D.R. at
"drbarton" at "iitm.com".
|
