More Random than Usual Thoughts
Courtesy of Vitaliy N. Katsenelson at Contrarian Edge
I have not written anything earth-shaking in a few months (rewriting the China article for Christian Science Monitor doesn’t count). I don’t know whether I just haven’t felt inspired, didn’t have any good ideas to share, or have simply suffered from a mild version of writer’s block. I did however update my China presentation.
Consumers are behaving as if they didn’t read the memo on the new normal: they should be unemployed (or underemployed), scared, deleveraging, and frugally buying necessities – but so far the data is not supporting this. AmEx reported a 16% growth in credit-card balances in the first quarter; and retail sales, though coming off a low base, are recovering. (Capital One, however, saw a 6.8% contraction of card balances. I need to dig deeper to understand the differences.)
I keep picturing the consumer debt-to-GDP chart, where debt as a percentage of GDP was gradually growing for decades until 2001, reaching about 60%; and then in less than a decade it skyrocketed to over 90%. The market is a discounting mechanism; it spends little time dwelling on the past and focuses on the future. Maybe consumers are doing the same, looking past their current problems, and so their spending reflects tomorrow’s (expectations of) a robust job market. Or maybe old habits die harder than we expected? Of course if you fall into the 10% of Americans that are unemployed, or the 17% that are underemployed and can barely pay today’s bills, you may find it hard to spend the money you don’t have. There is another (though slightly cynical) explanation: consumers are diverting their mortgage payments, which they are not making, towards their everyday purchases.
Uncle Ben went off quantitative easing in the mortgage market in late March, or, in plain language, the Federal Reserve stopped buying mortgages of Fannie and Freddie in the open market, which had been keeping mortgage rates artificially low. Of course, the Fed stopped doing this after going through a trillion dollars (billion doesn’t impress anyone, not anymore). I am watching mortgage rates closely, because the Fed’s sudden absence from the mortgage market should, in theory, drive interest rates up. Practice so far disagrees with theory: mortgages rates ticked up a little in early April and then declined again. Mortgage rates are extremely important to the housing market, as they determine housing affordability – higher interest rates, in the 6-7% range, may reignite a double dip in the housing market.
Today, you’ll have a hard time finding a bank that wants to originate and keep fixed-rate mortgages on their books when interest rates are at 5% (this is why almost all mortgage originations are backed by Fannie or Freddie). First of all, they don’t want to expose their balance sheets to significant interest-rate risk if/when rates rise, which is a common expectation, but they can hedge that. Second, and most importantly, at 5% you are not charging enough for risk; and finally, why bother with extra paperwork if you can borrow at close to zero percent and buy risk-free (or so we truly hope) government bonds instead? Higher, free-market-set long-term rates may change this behavior.
If you positioned your portfolio for a less-than-robust recovery, the tape was not on your side over the last few months. I am writing the following as much for my sanity as well as for you, my dear reader: the stock market is a marathon not a sprint, and there will be periods of time when the strategy (temporarily) stops working and the best thing to do is to do nothing. Last week a few of my stocks reported what I thought were terrific earnings, and the market either yawned or took the stocks out and shot them (that is what has happened to eBay). Instead of letting market get to me, I took a day off, went with my kids to the museum, and didn’t think about the market.
Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo. He is the author of "Active Value Investing: Making Money in Range-Bound Markets (Wiley Finance)
