Market Nugget Commentary
The Wall Street Journal today published a table of “The Nation’s Least Affordable Housing Markets”. The list contained few surprises; however, the part that piqued my interest was the next column which showed the percentage of interest-only mortgages in those markets. In 13 of the 29 least affordable housing markets, an interest-only mortgage was the financing vehicle chosen for more than 50% of new mortgages – astounding! In the footnotes, the article indicated that the national average for interest-only mortgages was 33%, which I also find astoundingly high.
Think about it: more than 50% of buyers, in the most expensive markets, are counting on home prices to continue increasing; I hope they are right. This plays right into another interesting statistic I read this week - the percentage of household disposable income that goes to debt service: 13.32%, close to an all time high and this with generational low interest rates. This statistic, and many others, can be found on the Federal Reserve Bank of St. Louis web site; a link is provided on the “Favorite Links” page of this web site.
Given the above numbers, how aggressive do you think the Federal Reserve is going to be in raising interest rates? My opinion: not very. I think it is more likely that tacit pressure will be applied to lending institutions to tighten up the credit standards. At the same time interest rates will remain relatively low, which will continue to fuel asset prices - the economic gas, albeit at a slower rate of increase. Whether such an outcome can be engineered by the Federal Reserve within the current environment we will only know with the passage of time.
Market Nugget Commentary
Index
Closing Value 01/12/05
Percent change between 01/12/05 & 12/31/04
Change 2003 - 2004
Closing Value 12/31/04
Dow Industrials
10,617.78
-1.53%
3.15%
10,783.01
Dow Transports
3,587.18
-5.55%
26.30%
3,798.05
Dow Utilities
327.13
-2.33%
25.50%
334.95
S&P 500
1,187.70
-2.00%
8.99%
1,211.92
NASDAQ
2,092.53
-3.81%
8.59%
2,175.44
Volatility Index - VIX
12.56
-5.49%
-27.42%
13.29
10 Yr Treasury Note Yield
4.24
0.47%
-0.96%
4.22
U.S. Dollar Index
82.17
-0.52%
-4.85%
82.60
Gold
426.15
-2.80%
5.37%
438.44
Silver
6.69
-1.91%
14.33%
6.82
Gold & Silver Index-XAU
95.02
-4.36%
-8.72%
99.35
Gold Bugs Index - HUI
205.77
-4.44%
-12.25%
215.33
West Texas Inter. Oil
46.56
7.16%
32.51%
43.45
Natural Gas
6.04
-1.79%
-0.63%
6.15
What is up with interest rates, or should I say down? Record trade deficit, record budget deficit, and record level of disposable household income going to servicing debt - and yet long term interest rates continue at very low levels. The Feds are pushing up short term rates and the markets are pushing down longer term rates; how flat can the yield curve become without inverting?
Each of the last recessions was preceded by an inverted yield curve; it is the most accurate indicator of an impending recession. An inverted yield curve is defined as having long term interest rates lower than short term interest rates. This causes a recession, because when long term rates are below short term rates, economic participants tend to postpone making purchases and investment decisions until the future when the cost of borrowing is expected to be lower.
A recession cures the inverted yield curve by lowering the demand for money. A lower demand for money causes the cost of money, i.e. the interest rate, to fall. The falling cost of money corrects the yield curve and economic activity once again begins to expand. Admittedly this is a simplistic explanation, but my point is it is time to watch the shape of the yield curve.
Recently I have heard some analysts forecasting that they expect, in the near future, the Federal Reserve to increase short interest rates by an amount greater than 25 basis points (1/4 of one percent). I disagree; at all costs I would expect the Fed to avoid causing a negative yield curve and risk a recession.
With the spread between the 5 year and 6 month maturities on US Government securities having already narrowed to barely over 1 per cent, the room for the Federal Reserve to continue raising short term interest rates is becoming limited. As I have said in numerous past Market Nuggets, the key to the future direction of the stock market will be interest rates.
Moving along, did you notice the numbers in the above table - fully 25% to 50% of the gains from 2004 have been given back in the just the first two weeks of 2005! A “pause that refreshes” or is it indicative of something more to come?
Last week I indicated that the key numbers to watch were 10,387.54 and 3572.55 for the Dow Industrials and the Dow Transports respectively. By the close of trading today the Transports had bounced off their intraday lows for the day of 3557.90 to close at 3587.18. For the trend from 2004 to stay intact these levels must hold on a closing basis.
The correction in the early days of 2005 appears thus far to be just that. It has served to take out some of the speculative froth that built up after the November elections. So far, most major averages have only corrected enough to test their trend lines, including the US dollar.
I included many charts and drew in trendlines in The Market Nugget on January 5, 2005. To refresh your memory please look that issue up in the archives. None of the trendlines have been violated yet, and therefore I conclude that this week, as I did last, the existing trends remain valid. This is true for Gold, Silver, the Dollar, and the major stock averages.
Given the White House’s preoccupation with the partial privatization of Social Security, it is in their interest to do anything, and I mean anything, to prevent the markets from having a major correction until after their version of saving Social Security is enacted. Wall Street firms will also be major beneficiaries if this reform comes to fruition, so it is also in their interest to prevent a resumption of the bear market at this time.
The low level of volatility as measured by the VIX for the S&P and the VXN for the NSADAQ does cause me some concern. But until they breach their trendline to the upside I will continue with my thesis that the current correction is just that and nothing more serious. The VXN, as you can see from the chart below, may have already seen its lows and is now testing support (dashed line). I am working under the assumption that the red trendline is more important; the markets will tell me soon enough if I am wrong.
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