JANUARY 4, 2008
JANUARY 2008 COMMENTS - HOME PRICE EROSION STILL IMPACTING THE ECONOMY
-
In recent months we have expressed concern over the turmoil in the housing sector and the fallout for the US economy. Those concerns have not gone away. Some economists believe that housing prices in the aggregate may fall another ten percent in 2008 owing to the backlog of inventory which is as high as it's been since the early nineties. According to the Case-Shiller Home Price Index the drop in prices has been, with few exceptions, across the board. The worst hit areas are the ones you have been reading about in the papers with Miami -21.2% (all 3 month percentage changes annualized), San Diego -14.2%, Las Vegas -14.3%, Phoenix -12.9% and even Washington DC which was seemingly invulnerable to housing price erosion, -8.8%. So evidence points to a continuation of the unwind of the recent housing boom.
-
An unfortunate side effect of this price erosion and the concurrent sinking of homeowner's equity is the inability of consumers to use their homes as a "piggybank" by extracting equity for consumption. This is clearly evidenced by consumer's rising delinquency on credit card balances. Consumer revolving debt currently is 37% of total consumer credit and in the aggregate is $2.5 trillion. Without the ability to borrow on home equity credit, consumers are being forced to cut back on revolving credit. Growth in revolving credit balances slowed significantly in the fall of 2007. This will become increasingly apparent in consumer spending on discretionary items and on durable goods.
-
We expect, for the aforementioned reasons, that the US economy will be weak well into 2008. Growth will be markedly slow with the risk of a recession still omnipresent. As we have pointed out recently, the interest rate actions on the part of the Federal Reserve as well as the weakened dollar are coming to the rescue of the economy and may be just enough to keep the economy from slipping into recession. We have experienced a marked improvement in the non-energy current account as the weaker dollar has made our goods very competitive overseas. Currently, exports of manufactured goods are up 12.4% year-over-year with imports up only 1.7%. This is cushioning the consumer spending drag on domestic manufacturing.
EQUITY MARKET OUTLOOK - EQUITY PRICES WILL LEAD THE RECOVERY
-
While clearly the sloppy lending standards of the past several years are proving to be an impediment to sustained economic growth, there is a silver lining to the negatives. Inflationary pressures that seemed problematic only a few months ago are clearly not as much of a risk today. Lower interest rates are likely in the near future and this has historically been a precursor to better equity performance. As we mentioned last month, equity prices tend to be leading indicators and anticipate an ensuing recovery anywhere from six to nine months in advance. We believe the latter part of the second half of 2008 will begin to show signs of stabilization in the economy with the market focusing on that improvement earlier in 2008.
THIS MONTH'S FOCUS - AN UPDATE ON MUNICIPAL BOND INSURANCE
-
Municipal bond insurance typically gives the issuer Aaa insurance financial strength rating to a bond that is rated, on its own merits, below Aaa. The policy regarding municipal bond insurance at the Beacon Trust Company has always been that nothing can substitute for fundamental credit analysis of the underlying security, and that if a highly-rated bond also has "insurance" that is a "bonus". As a matter of practice, this means we tend to avoid lower-rated investment-grade municipal bonds (those rated A3 through Baa3), even if they are insured and thus nominally rated Aaa.
-
On December 14th, Moodys's credit rating agency affirmed 2 of the 6 major municipal bond insurers/financial guarantors (AMBAC and FSA) at Aaa insurance financial strength and with a stable outlook. The 4 other bond insurers were placed on various levels of review.
- The reasons Moody's cited for these ratings adjustments included the exposure of the insurers to potential losses stemming from both residential mortgage-backed securities and asset-backed securities, and the status of the insurers' plans to strengthen their capitalization.
-
On December 28th, Warren Buffet announced that he was starting a bond insurer, Berkshire Hathaway Assurance Corp. Needless to say, this appears to be an extremely positive and stabilizing step, with perfect timing, as a fresh, high-quality name enters the business.
-
Please feel free to contact us with any questions you may have on this or any other topic.