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Bank of America, National City, and American International are all at 52-week lows. Countrywide Financial and Wachovia are almost there, too.
Oh and those home builders? The ones Wall Street experts fell all over themselves to re-recommend earlier this year? Don’t look now but they’re faltering again:
Condo and single-family home builder WCI Communities recently plunged as low as $1.45. The company is losing money hand over fist and Standard & Poor’s just downgraded its corporate credit rating deeper into junk territory, citing concerns over the firm’s liquidity. A bankruptcy filing can’t be ruled out.
Standard Pacific — a California-based builder — went for $6.50 as recently as early April. It’s worth a bit over $2 now. No wonder: The company lost $216.4 million in the most recent quarter thanks to a steep sales decline and hefty impairment charges.
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| Home Depot, which recently reported its first annual sales decline, will fire 1300 workers and close 15 underperforming U.S. stores. |
Larger builder Centex is getting close to setting a fresh 52-week low, while shares of home improvement retailers Home Depot and Lowe’s are hitting the skids again. The problem? Home Depot’s same store sales are falling at a greater-than-6% rate, while Lowe’s reported an 18% year-over-year drop in first-quarter profits.
Frankly, this should not come as a surprise to you. I have repeatedly warned you that many of these stocks were “value traps.” That’s financial jargon for stocks that look cheap … but that will probably get even cheaper — and in some instances, disappear entirely.
So what’s going on? Why are many financial stocks and home builders faltering again? How did Wall Street get these sectors wrong … again?
I blame it all on …
A Toxic Cocktail of Higher Interest Rates,
A “Hands Off” Fed, And Endless Capital Raising
I think these threats are rather straightforward — a toxic cocktail of bearish developments that underscore why I’ve been warning you not to buy the B.S. Wall Street has been selling …
Higher long-term interest rates: I don’t know if you’ve been shopping for a mortgage recently, or if you’ve been following the price action in long-term bonds. If you have been, you’ve probably noticed something: Long-term rates haven’t been falling along with the Fed cuts. They’ve been rising. And naturally, since bond prices move in the opposite direction of interest rates, bond prices have generally been declining.
U.S. long bond futures topped out at around 121 earlier this year. They’re going for 116 and change now. Thirty-year fixed mortgage rates bottomed out at 5.48% in mid-January, according to Freddie Mac. They were recently up to 6.01%.
And what about all those Fed rate cuts? Have they helped? Well, a 30-year fixed loan went for 6.38% in September when the Fed started slashing the funds rates willy-nilly. So that means 325 basis points of Fed cuts have bought you essentially 37 basis points in long-term, fixed rate mortgage relief.
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How could this happen? Why haven’t fixed rates plunged? Because the Fed cuts have helped underwrite a dramatic bout of commodity inflation!
Just consider a simple example: The price of a barrel of crude was $80.57 on September 17, the day before the Fed first cut the funds rate. It topped $135 a barrel this week — a gain of 67.5%. Import prices are now rising at a 15.4% rate, the highest in history. The Consumer Price Index is now climbing by just under 4%, and even that figure is likely understated.
Bottom line: The Fed’s “Let’s throw easy money and rate cuts at every problem” approach to monetary policy has cemented in the minds of bond traders and consumers that the Fed could care less about fighting inflation.
A recent University of Michigan survey found that consumers expect inflation to run at 5.2% over the next year, the highest 1-year expected inflation rate since 1982. A separate measure of the difference between yields on nominal 10-year Treasury Note yields and yields on 10-year Treasury Inflation Protected Securities (TIPS) is now running around 256 basis points. That’s the highest since August 2006, a red alert warning from the bond market that investors think the Fed is losing control.
Naturally, none of this is good news for potential home shoppers. They’ve gotten little bang from the Fed’s rate-cutting buck, and now, long-term rates are starting to climb. Meanwhile …
The Fed is shifting into “neutral.” We’ve established that long-term rates are not going down due to concerns about inflation. But what about short-term rates, the ones the Fed controls more directly? The news has been better there.
The Fed’s cuts in the federal funds rate have helped bring down the London Interbank Offered Rate (LIBOR) and the prime rates quoted by major banks. That has helped lessen the magnitude of rate and payment adjustments for many adjustable rate mortgage holders. It has also lowered the rates on things like home equity lines of credit, which usually track the prime rate.
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But even here, the news is getting grimmer. The Fed is belatedly realizing that it has helped turn smoldering inflation into a five-alarm fire that is burning out of control. So policymakers are signaling that they’re ready to abandon their policy of rate cuts and shift into “neutral.”
For instance, Fed Vice Chairman Donald Kohn said this week:
“With the information now in hand, it is my judgment that monetary policy appears to be appropriately calibrated for now to promote both rising employment and moderating inflation over the medium term.”
Another Fed governor, Kevin Warsh was even more strident in his anti-inflation speak, saying:
“The inflation news since last summer offers little solace. Oil prices are near record levels, food prices have risen rapidly, prices for a wide range of commodities are up, and dollar depreciation is among the causes pushing up import prices. Some indicators of expected long-run inflation have also risen.”
The message coming through loud and clear? Don’t count on us for more rate cuts. If anything, the focus is now shifting to when the Fed will start HIKING rates.
Financial firms can’t stop “Dialing for Dollars.” If you think political fund raising is out of control this election year, you should see what’s happening in the financial markets. It seems like every few days another bank, broker, or insurance firm passes the hat around, seeking billions of dollars to shore up its capital base.
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| The credit market damage is so severe that some of the largest U.S. banks on the NYSE are raising billions of dollars in an attempt to stave off insolvency. |
Sovereign Bancorp just raised $1.9 billion through the sale of stock and debt. National City raised $7 billion by selling common and preferred shares. UBS is raising $15.5 billion by selling rights to purchase shares. And AIG is topping them all, raising a whopping $20 billion via various stock and debt offerings.
The problem? These financial firms are being forced to offer exorbitant yields to attract investors. They’re selling shares at sharp discounts to current values. And they’re dramatically increasing their share counts. Result: They’re massively diluting the value of the stakes that current shareholders own and raising their cost of capital. That, in turn, will pressure future profitability.
As if that weren’t bad enough, every new capital raise seems to be accompanied by a “This one is the last, we swear!” pledge. And then a few months later, another dilutive deal gets announced. It’s a total joke!
The fact is that many financial firms — even NOW — continue to underestimate the depth and scope of the housing and credit market downturns.
So the next time your broker tries to serve you up a heaping platter of home builder or financial shares, tell him to take a hike. There are very few true bargains out there (unless you’re looking overseas), and the big picture trend still looks down for these mangy dogs.
Until next time,
Mike
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