Dightman Capital - Global Market Monitor : U.S. Real Estate

Credit & Real Estate Remain Key

Brian Dightman — Mon, 23 Nov 2009 16:07:00 GMT

After easily topping low Q3 earnings expectations, stocks are finding it difficult to advance from highs reached in October. Hesitation may be coming from new reports of continued struggles in the housing market where mortgage delinquencies continue to rise and new construction has slowed.

The credit market continues to remains tight and while problems in the commercial real estate market percolate. Commercial borrowers are finding it difficult to refinance loans and recent regulatory guidelines make it easier for banks to extend terms on many properties, potentially delaying foreclosures. Banks are also hesitant to foreclose on troubled properties because selling at current prices would require write-downs they don't want to realize. The key for commercial borrowers is leasing revenue, a function of lease prices and occupancy rates. As long as borrowers have the cash flow to continue servicing loans the market should remain somewhat stable but defaults have been rising as vacancies increase and rents fall.

As the economic recovery continues to unfold we can see how the performance of banks, commercial real estate, and home builders has transitioned from leading the market to lagging the market, possibly offering a sign of caution as we enter 2010.

The first chart below shows all three groups leading the S&P 500 from market lows in March up through the middle of October. Over the last month the tide has shifted. Commercial REITs have fallen to just match the performance of the S&P 500 and Banks and Builders are lagging by a significant margin.

NOTE: CLICK ON IMAGES FOR FULL VIEW

Given the role real estate and banking played in the market selloff in 2008 we would expect them to play a leading role if markets are going to advance from current levels.

We have also seen a shift in stock leadership. As the November rally kicked off the Dow Jones Industrial index has outpaced the S&P 500 potentially signaling a shift to larger, more stable companies. The transportation index has lagged as have small cap stocks, another disappointing development.

The balance of 2009 may see a continued rally in stocks as we enter into the holiday season, often credited with what has been called the "Santa Claus Rally", but the clouds may be forming for what could turn out to be very challenging start for stocks in 2010 unless more fundimental improvement of the economy is reported.

Partial Profits and Toxic Debt

Brian Dightman — Tue, 24 Mar 2009 23:06:00 GMT

Markets made the most of the details released Monday on how the government plans to deal with toxic debt at banks. The new information helped continue the rally started March 9th. The action overall, however, is suspect. Consider the following:

The rally was touched off with partial quarter reports by Citigroup, JP Morgan and BofA saying they were profitable in the first two months of the year. Gee, we only have to wait another month to find out what happens to their profit after they factor in write-downs and other costs over a full quarter.
This was followed by The Fed announcing a huge quantitative easing program which may offer some short term benefits but has very negative long term costs. The same day the dollar took a dive and prices for several inflation sensitive asset rose.
Monday morning Treasury Secretary Geithner announced his private-public toxic debt plan. Let me see if I get this right. The government wants investors to buy bonds that a judge can modify (Home Affordability Act - an unintended consequence?) using cheap financing and 6 to 1 leverage (characteristics of what got us in this mess). The market was thrilled to at least have a Plan A and perhaps it will help banks clean up their balance sheets.
There was little stock leadership in the rally, mostly very depressed stocks (many big financials) coming up from very low prices. This does not bode well for sustainability.
The bond market does not seem to be as euphoric. Interest rate spreads on bonds issued by financial companies tracked by Merrill Lynch have only narrowed slightly from the high they hit on March 11^th. The bond market seems to be reserving judgment on partial quarter profits and toxic debt recovery plans.

In my opinion, these along with many other characteristics, call this market advance into question.

In terms of economic news, we have received the first signs that the U.S. economic contraction may be stabilizing. ECRI reported some improvements in the housing market, among other developments, contributed to a stabilizing of their leading U.S. economic growth indictor. This is a potentially positive development but will require confirmation in the weeks that follow.

Regarding how we could solve the toxic debt problem in other ways. One idea that has been suggested is to nationalize insolvent banks and transfer their operations to regional banks that are in better fiscal shape. This action would severely impact the capital structure of the insolvent banks and may send massive ripples through the global financial system. It would probably require coordination with monetary authorities in other countries. It is entirely possible that a Plan B of this sort is in the works. Congress is already considering non-bank takeover power of financial companies. What is surprising to me is how long it is taking the government to address the severity of the problem and a willingness to come clean about what it is going to take to fix it.

The risk in Geithner's plan is that asset sellers (banks) and buyers (institutional investors) will not be able to agree on price, even with the incentives offered to buyers and the government arm twisting sellers, so few transactions will actually result. Banks will continue to hoard their capital and the much needed stimulus to constructive lending will be non-existent. I am also surprised by the degree to which our government has rewarded the management of institutions that managed risk so poorly. Since when is failure not an option? In cases like this we want failure to be orderly, but at some point we have to recognize the losses (unless we can continue to defer it).

With Medicare, Social Security, deficits and national debt, it is difficult not to be disturbed by the path our government has taken. I don't even want to think about what the future will hold if the plans being unveiled, and there is little room for error, fail and they don't have a Plan B.

An Important Clue About Stocks In 2009

Brian Dightman — Mon, 05 Jan 2009 18:52:00 GMT

For those of us interested in what 2009 holds for stocks the next few weeks may offer an important clue. December failed to produce a meaningful "Santa Claus Rally". Stocks did trend up most of the month but only closed up 0.8% above November's close. Not a bad feat considering the first trading day of December started with a nearly 9% decline on the S&P 500. The end of the year did see some impressive gains. From the 24^th - 31^st the S&P 500 advanced just over 4%. Unfortunately, most institutional investors were on vacation and trading volumes were very light. However, we did see an improvement in stock leadership with companies like Life Partners (LPHI), Tower Group (TWGP), and Gentiva Health Services (GTIV) breaking out and companies like McDonald's (MCD), Stanley (SXE) and Mantech (MANT) approaching good entry points. As a broad measure of stock leadership, however, the IBD 100 lagged the other broad indexes in last week's rally.

Despite a horrible retail sales season, deteriorating employment conditions, and continued weakness in residential real estate, the stock market is always looking forward and we should have a pretty good idea in the next few weeks if the market thinks the U.S. economy will be on better footing by this summer. With lower oil prices, a large economic stimulus package in the works, lower mortgage rates and resilient U.S. workers, perhaps we will be able to look back on November 2008 as the lows of the Credit Crisis Bear Market.

On the other hand, if stocks fail to rally meaningfully in January the likelihood that the November lows will be tested and potentially broken increases. If you are on the sidelines with cash, or in positions you would like to exit, it is a good time to pay close attention to market action.

Important Week Ahead

Brian Dightman — Mon, 01 Dec 2008 01:24:00 GMT

As the month of November came to a close stocks rallied and in the process gain 19% in the last 5 trading days to close down only 7.5% for the month. November 21st kicked the rally off but the day ended with Nasdaq volume falling 4%, generally not the way you want to start a new advance. Breadth was also light with winners beating losers by a modest 9-to-5 ratio on the Nasdaq, and less than 2-to-1 on the NYSE. The last 4 trading days took place during a holiday shortened week causing volume to taper off as the advance developed. While some individual stock leadership has appeared it is still very thin and combined with some of the previously mentioned shortcomings; the overall action leaves me skeptical this rally will be sustained.

In terms for the bond market, corporate junk bonds remain under price pressure and yield nearly 24%. As the stock market improves you would expect junk bond yields to decline as prices rise. On the other hand, 10 year treasury bonds continue to appreciate, sending their yields down to 2.94%. In response to the most recent government action to bring relief to the home market mortgage rates did see a drop with average 30 year fixed rates around 5.76%.

A series of cabinet and administration appointments by President-Elect Obama helped kick start the stock buying. He tapped New York Federal Reserve President Timothy Geithner to be the next Treasury Secretary. Mr. Geithner's intimate knowledge of NY based financial institutions and his direct involvement in several of the rescue deals already announced could prove to be helpful as the government continues to navigate the volatile credit crisis.

World economic data continues to be mostly weak and domestic leading economic indicators I follow indicate the worse may still in front of us. The residential housing market remains under pricing pressure base on the most recent data released by S&P/Case-Shiller. Inflation in the U.S. and many other places around the world appears to have cooled, but when I pay nearly $4 for a stock of celery I'm not so sure.

Next week will be an important test for U.S. stocks. After big price advances for the broad indexes, additional volume and wider participation would be a welcomed development in the days and weeks that follow if we expect recent lows to mark a bottom in the current bear market.

Time To Buy?

Brian Dightman — Sat, 18 Oct 2008 19:34:00 GMT

Many investors are wondering if we have found a market bottom. With Warren Buffett out buying stocks, shouldn’t all investors be doing the same? The risk of entering the stock market at this point has declined. However, the major bias is still down. During the last week we did have some constructive activity and if we see more in the near future it would help to signal an even lower risk entry point. We plan to deploy some capital in a newly created “opportunity fund” by one of our investment partners designed to take advantage of idiosyncratic opportunities the credit crisis has created. We have also identified two high yielding dividend investments, one of which is tied to the energy industry. With the decline in the price of oil, it may be a much better time to enter that market. The best thing an investor can be doing at this point is to scan the horizon for attractive opportunities, build watch list, and under some circumstances carefully deploy capital. We do not expect to reinvest our capital at the bottom, but we would prefer to do it after the bottom has passed versus watch our investments decline in value. That being said, we are willing to take some risks at this point, but are not yet ready to fully commit our cash.

There are several other reasons for caution. U.S. indexes have not witnessed a new group of strong individual stocks to lead the market. A few candidates have emerged, but the quality of any rally improves dramatically when strong stock leadership accompanies it. Stock markets internationally have also delivered little bullish conviction. While some markets are seeing price improvements, most remain muted and lack volume.

One way to take advantage of a depressed stock price is to use this opportunity for gifting. At current prices you are most likely able to gift a much larger number of shares, within the same dollar limitations, then you were a year ago. If transfer of wealth is on your radar, from concentrated stock or a large portfolio, now is a great time to consider action.

Part of our investment process involves an analysis of the business cycle. We are keenly aware the stock market usually improves ahead of evidence of an economic recovery. Our trusted provider of leading economic indicators, an institution with three generations of expertise, continues to indicate more trouble ahead. We prefer to see an improvement in the stock market coincide with a turn up in leading economic indicators for our investment strategy to become aggressive. Still, we are willing to take some risk ahead of data alignment, especially in asset classes with a unique characteristic.

On the economics front, the Cleveland Fed lowered the U.S. inflation rate to 4.94% from 5.37%. Our inflation outlook remains muted and asset prices sensitive to high future inflation have not signaled a reason for change. The government borrowing tied to the recovery program may be causing an unintended negative side effect, that of pushing some borrowing costs higher; the rate for 30 year mortgages jumped to 6.47%, up from 5.98% a week earlier. Short-term money rates have come down but the negative Ted Spread remains very wide. Housing starts are at 17-year low which could eventually reduce the supply glut of homes on the market, partially the result of an increase in foreclosures.