Morningstar.com
Don't Let Mr. Market's Good Cheer Fool You
Tuesday October 22, 6:00 am ET
By Mark A. Sellers
Last Thursday, we found out that the number of new residential-building construction projects in September came in at their highest level since Top Gun was the number-one movie in the land, as consumers took advantage of once in a lifetime mortgage rates to buy, buy, buy. The markets took the news in stride, with the S&P 500 rising 2.2% that day (the index finished the week up 5.9%).
ADVERTISEMENT
Although no doubt many investors and analysts are giddy over this year's consumer-spending miracle, it scares the heck out of me. We've got a new bubble forming right before our eyes, a tale of two economies going in opposite directions from one another. Just like in the late 1990s, almost everyone sees it but most are choosing to ignore it.
Let's look at the facts:
Consumer-finance companies are booming, recession or no.
Revenues for Capital One (NYSE:COF - News), Americredit (NYSE:ACF - News), and Household International (NYSE:HI - News) grew 57%, 21%, and 17%, respectively, in the most recent quarter. Some of these companies are now actively trying to slam on the brakes, at the bequest of regulators and investors who are worried that insane growth rates now will lead to higher default rates later as subprime borrowers max out. Even Harley-Davidson (NYSE:HDI - News) has been getting in on the action; its financing arm grew profits 83% year over year this quarter.
Mortgage lenders are booming, recession or no.
As an example, Countrywide Credit (NYSE:CCR - News) announced that in September, its mortgage pipeline grew 22% from August--a 22% month-to-month increase. Year over year, Countrywide's pipeline grew 141%. This makes mortgage lender Washington Mutual's (NYSE:WM - News) 59% year-over-year growth look like chopped liver.
Meanwhile, in other news:
Auto companies have no pricing power.
Unit sales at GM (NYSE:GM - News) are right around their peak 1999 levels, and the entire industry--at least until September--was on track for a fourth straight year above 17 million units. But these companies are essentially buying sales by offering discounts (mostly in the form of zero-percent financing). The auto industry makes up 5% to 6% of U.S. GDP.
Business spending stinks.
Advertising, semiconductors, computer hardware, consulting, capital goods, and telecom all have way too much capacity. This is causing a deflationary spiral in these areas of the economy as companies compete aggressively on price to try and cover their high fixed costs. Intel's (NasdaqNM:INTC - News) warning last week was scary--things are still getting worse, not better, in tech and telecom land. There are more layoffs and bankruptcies to come. Lucent (NYSE:LU - News) and Nortel (NYSE:NT - News) may not make it out alive. Worse, a debt-free WorldCom (Other OTC:WCOEQ.PK - News) may.
Banks don't look healthy.
Despite Alan Greenspan's recent attempts to ease investor fears, some of the big banks don't look very healthy right now. Any bank that has lent money to any of the industries I just mentioned is hurting. If default rates continue to rise, banks will be forced to further tighten the reins on lending. Spreads between corporate bonds and Treasuries would widen further, and many businesses would be essentially locked out of the capital markets. The probability of this happening seems to be much greater than 0%.
A Tale of Two Economies
In short, the problem is twofold:Consumers are spending like there's no tomorrow to lock in lower rates while they can. This is great in the short term, but there will undoubtedly be a big hangover as soon as rates start to rise. Looking at the 10-year Treasury bond yield, that may already be starting to happen. The yield on the 10-year has risen more than 60 basis points in the past eight trading sessions, a huge runup for such a short period. Cheap money has made it logical for consumers to borrow from tomorrow to pay for today. When rates rise, the reverse will happen.
Businesses are still in full defensive mode. Even though consumers are spending gobs of money, most businesses are still laying off employees, cutting capital spending, and reducing advertising budgets. Three of the largest sectors of the economy--tech, telecom, and autos--are in the midst of a deflationary environment. The businesses in these sectors have no pricing power because there's so much excess capacity still out there.
So we've got an economy that is driven purely by consumer spending, with little underlying support if consumers start to falter. If that's not a bubble, what is it?
At the very least, the U.S. economy is looking top-heavy right now.
biz.yahoo.com |
