Very little has changed this week on the price front. The front line indexes were largely unchanged for the week, barring Thursday's fierce sell-off partly fueled by events in Pakistan. In this relative quiet of the holiday season, investors and analysts alike are likely to be unsure of what to make of any news flow.
The week also saw the release of a flurry of housing data... and to put it mildly, they were ugly. Sales of new homes dropped 9% in November to a 12-year monthly low of 647,000, far below the consensus estimate of 720,000. On a yoy basis, sales were down 34%, the largest annual drop since the 35.3% free fall in January 1991. New home sales are down 53% from their July 2005 peak. Although the actual number of homes of sale decreased ever so slightly, the inventory of unsold homes still represents almost 9.3 months at the current sales pace. The outlook for 2008 is not very bright either, with Fannie Mae, the largest US mortgage buyer, recently estimating that sales of new houses will tumble 8.9% in 2008 on the back of the 25% drop this year. Factoring in the rising cancellation rates, Calculated Risk estimates that new home sales are probably overstated by about 100,000 and the months of supply would balloon up closer to 11.3 months.
The S&P/Case-Shiller report was even more dire; home prices in 20 metropolitan areas fell a massive 6.1% in the 12 months to October, the most in at least six years, raising fears that Americans will walk away from properties that are now worth less than what they owe. This is the 10th consecutive month of negative annual returns, the 23rd consecutive month of decelerating returns and the biggest decline in this down cycle.
On the back of shrinking sales and slumping prices, foreclosures registered a 68% surge in November from a year earlier. Foreclosures are more likely to increase than decrease from current levels as sub-prime adjustable rate mortgages (ARMs) reset.
As repeatedly pointed out by us, the housing market slump has the potential to undermine consumer spending in a major way. The holiday sales postmortem began in earnest this week with several data points confirming retailers' worst fears: 2007 witnessed the weakest holiday spending in five years. MasterCard's SpendingPulse, that tracks purchases made by more than 300 million debit and credit card users, estimates that the period between Thanksgiving and Christmas Eve saw nominal sales gains of 3.6%, the lowest in three years. However, excluding food and energy (supermarkets, restaurants, gasoline sales), back of the envelope calculations suggest that sales would have risen approximately 2%... a tad below the core rate of inflation. To put it differently, real sales may have actually declined over last year despite the longer shopping calendar in 2007.
We are entering 2008 with significant headwinds. Martin Feldstein, head of the National Bureau of Economic Research, which determines the dating of economic recessions, put the probability of a recession at 50% in 2008! But the turmoil has also unearthed opportunities for savvy investors. Warren Buffett, often criticized for not deploying his $45Bn cash pile more effectively, is moving quickly. In just a week, Buffett spent $4.5Bn to gain control of Marmon Holdings - a motley collection of 125 diverse businesses, agreed to a $440M purchase of a reinsurance unit of ING Groep NV and revealed plans to enter the $400Bn+ a year municipal bond insurance business. It suffices to say that if Buffett smells an opportunity, his track record suggests that there is indeed one!
With the support from the Santa Claus rally gone, would the indexes have the resilience to hold on to the recent gains? Earnings season kicks off next week; blended earnings growth rate for the S&P 500 in 4Q (combining actual numbers for companies that have reports and consensus estimates for those yet to report) are a dismal -3.8%, a far cry from the 11.5% estimated at the start of the quarter. Once the holiday hiatus comes to an end next week, traders are likely to take stock of the state of affairs in the equity markets and hopefully provide further clues that would help predict the short term course of the front line indexes.
Speaking of taking stock, this is the last WMR of 2007... a year that saw both extremes of greed and fear and all the shades of gray in between. Forecasting the roller-coaster ride in the financial markets has been a challenging exercise and our team, and indeed our report, has evolved with time. Our reports now have a lot more talk on the economy, encompass a wider array of subjects and carry far more graphs as we endeavor to dig deeper beyond just the numbers. In the next few paragraphs, we present a recap of the hits and misses this year and how we kept pace with the developments all through. It will be our sincere effort to keep the good stuff coming in 2008 as well.
The Panic Of 2007
In better times (read: start of 2007), most pundits would have considered the Panic Of 1907 to be a bolt from the past - an episode depicting the great excesses and venality of the era, shattering of business expectations by a cataclysmic disaster in California, manipulation of financial markets by unscrupulous hands and the eventual restoration of faith in the nation's banking system by one man, John Pierpont Morgan.
