The Real Picture on Housing Starts--Chart

They say a picture is worth a thousand words. You can decide for yourself.

HOUSING STARTS

Privately-owned housing starts in February were at a seasonally adjusted annual rate of 583,000. This is 22.2 percent (±13.8%) above the revised January estimate of 477,000, but is 47.3 percent (±5.3%) below the revised February 2008 rate of 1,107,000.

Single-family housing starts in February were at a rate of 357,000; this is 1.1 percent (±11.0%)* above the January figure of 353,000.

The February rate for units in buildings with five units or more was 212,000.

Source: ST. Louis Federal Reserve, Census Bureau

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Bold Endeavors: How Our Government Built America, and Why It Must Rebuild Now

$1.75 trillion Deficit

The big number is bad enough but this amounts to 12 percent of Gross Domestic Product. Once again I have to start wondering to myself, is the U.S. in for a future downgrade of its bonds. The thought of this is horrific.

Highlights:

• $250 billion in new aid to the financial industry (could be $750 billion)


• $635 billion for nation’s health-care system (first down payment)


• $75 billion this year for Iraq and Afghanistan war

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Sources and more information:
In President's Budget Plan, Broad Agenda and a Few Gaps
Obama’s Proposes Up to $750 Billion More for Bank Aid
Obama budget moves toward universal health care

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Option ARM--The Toxic Mortgage

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Restoring Financial Stability: How to Repair a Failed System (Wiley Finance)

PIMCOs Gross: Find ways to prop up the Values of Assets

To PIMCO, the remedy for this deflationary delevering and mini-depression is simple and almost axiomatic: stop the decline in asset prices.

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Investment Outlook
Bill Gross | February 2009

BEEP BEEP!

The current financial and economic crisis is difficult to appreciate, not only for the drop in elevation, but because of the swiftness of the declines. It’s been a Wile E. Coyote 12 months – straight down like a dead weight. A year ago, global equity prices were nearly twice today’s levels and recession was only a whisper on the lips of the gloomiest of economists. Today, descriptions drawing parallels to the Great Depression make it obvious that a major shift in economic growth and its historic financial model, as well as policy prescriptions for its revival, are underway. Most of the world’s connected economies and its citizens are in shock, conscious but not fully aware of the seismic shifts that will unfold in future years.

PIMCO’s thesis for several years has held that the levered global economy long ago morphed from a banking-dominated regime to one that hid behind securitized lending and structures resembling a “shadow banking” system. SIVs, hedge funds, CDOs and increasingly levered mortgage and investment banks fueled asset appreciation in all investment markets, which in turn propelled real economic growth and employment to unsustainable levels. But, with U.S. housing prices as its trigger, the delevering process did a Wile E. Coyote and headed over the cliff in mid-year 2007, dragging down almost all asset prices except government bonds. The real economy followed shortly thereafter, not just in the U.S., but globally, proving that linkages work on the “down” as well as the upside. To PIMCO, the remedy for this deflationary delevering and mini-depression is simple and almost axiomatic: stop the decline in asset prices. If that can be done, the real economy will level out as well. When home prices stop going down, newly created households will be more willing to take a chance on ownership as opposed to renting. If stock prices consolidate, recently burned investors will be more willing to invest, as opposed to stuffing their 401(k) mattresses with Treasury bills. Business investment, jobs, and profits should follow quickly behind.

The simplicity of the solution, however, is not easily achieved once deflationary momentum takes hold. Animal spirits, once dampened, are hard to reignite; “fear of fear itself” dominates greed. Under such circumstances, the benevolent hand of government is required and Keynes is reincarnated in an attempt to plug the dike via fiscal spending and imaginative monetary policies that support asset prices. PIMCO has recently been contracted to assist in several publically announced programs which have helped in that effort: the CPFF, which has benefitted commercial paper yields, and the Federal Reserve’s purchase program for agency-backed mortgage loans, which has lowered 30-year mortgage rates to 4.5% and fostered the affordability of new and secondary housing prices. These two programs, in our opinion, have been the major policy successes to date – not because of our involvement – but because they have supported and increased asset prices whose decline has been the major deflationary thrust behind the real economy. Stop asset prices from going down and with a 12-month lag, unemployment will stop going up, and President Obama’s targeted three million new jobs will have a fighting chance of being achieved.

But stopping the decline of asset prices can be and has been attempted in numerous, seemingly uncoordinated ways. Recapitalization of the banks has been the major thrust, in the hopes that banks would extend credit which would reinvigorate asset pricing. Those who argue strongly for a recapitalization of the banking system, however, may be missing the distinction between the banking system as we once knew it, and the “shadow banking” system that superseded it. Jim Bianco, who heads up the research tank bearing his own name, brought the difference to mind in a recently produced piece entitled, “When Will The Banks Start Lending?” His conclusion was that banks already were – lending – but it was the “shadow system” (my words) that was holding up the parade. According to his analysis, shown in Chart 1, securitization has for several years exceeded bank loans as a percentage of private credit market debt. In contrast to recent headlines, however, banks have been picking up their lending, but it has been the “shadow banks” that have faltered. That makes sense. While banks may have tightened their lending standards, fresh capital from the TARP has made it possible to make new loans. The shadow banks, however – hedge funds, investment banks, and structured financial conduits – have been forced to delever as government funds have been directed to more visible institutional lenders. Granted, Goldman Sachs and Morgan Stanley have been TARP recipients, but only under the conditions of downsizing and degearing on their way to becoming regular banks, which have cut their holdings of assets significantly in percentage and actual dollar terms. It should not surprise, therefore, that with the exception of specifically directed government programs directed at commercial paper rates and 30-year mortgage yields, past policies have been unsuccessful. Banks have been recapitalized – yes – and banks have cautiously started to lend. But shadow banks are still delevering due to disappearing and unavailable fresh capital and, as they do, they continue to drag asset prices with them. PIMCO’s Ramin Toloui has produced Chart 2 which correlates the contraction in household debt to the decline of the securitization market. He estimates that there is a one trillion dollar hole that needs to be filled by policymakers in this area alone.




Stressing the importance of the shadow banks is not the same thing as suggesting that they should be next in line for government largesse and bailouts. Lord knows, the Obama Administration is not going to bail out hedge funds, CDOs, private equity firms (Cerberus?), or Donald Trump. There are levered risk takers that will be, and should be, allowed to fail. But in permitting failure, policymakers must still be cognizant of the need to support asset prices – hopefully by inducing confidence and trust in private investors, as pointed out by Robert Shiller in a recent Wall Street Journal op-ed, but if need be by the financing or purchase of assets themselves. It’s not so much that the stock market needs to go back to 10,000. That would be nice for millions of 401(k)s that have been cut in half over the past 12 months, but it is not likely. Rather, asset prices securitizing commercial real estate and credit card receivables, as well as plain old-fashioned municipal bonds, must stop going down if the real economy has any chance to revive by 2010.

Example: CMBS or commercial real estate mortgage-backed securities are now priced to yield over 12% vs. 5% in recent years. As real estate financing comes due and rolls over in the next few years, it is imperative these yields return to mid-single digits if shopping centers, retail malls, and office buildings are to remain viable. How best to bring those yields down is debatable: another CPFF-like structure with self-insurance and contributed fees as its equity backstop? A generous portion of remaining TARP billions providing a reserve cushion for Federal Reserve funding? A good bank, bad (aggregator) bank structure? All three are being debated by policymakers and we should have clarity within a week’s time. But one thing is certain: an economic recovery is dependent upon commercial real estate prices stabilizing and most retail stores staying open for business in the months and years ahead.

Similarly, municipal yields are now trading at nearly twice their Treasury counterparts, implying that municipal bonds are trading at 80 cents on the dollar instead of 113 cents like the average Treasury. To enable states and cities to return to normal functioning, those bonds must return to par. Modern day capitalism depends on the successful refinancing and issuance of securities at a price and yield level not significantly divorced from past experience. That is the same thing as saying that current yields must come close to matching the economy’s embedded cost of debt if default is to be avoided. Not only municipalities, but the efficient operation of hospitals, nursing homes and even universities depend on the leveling and returning of municipal bond prices to higher levels. Similar arguments can be made for corporate bonds as well.

PIMCO’s advice to policymakers is as follows: you can’t bail out everyone, yet economic recovery is not possible unless certain critical asset sectors are not only reliquefied, but rejuvenated in price. The prior Administration’s focus on the banks has been critical but unidimensional. The shadow banking system with its leverage and financial innovation, powered a near 25-year global economic expansion, but it is the delevering of those hidden quasi-banks that is now threatening its petrification. Policymakers should not focus entirely on one-off bailouts of large real estate developers, municipalities, or even credit card issuers like they have with Citi, BofA, and AIG. Rather, they should recognize that supporting critical asset prices such as municipal bonds, CMBS, and even investment grade corporate bonds is a necessary step towards eventual economic revival. Capitalism at its philosophical and practical center depends on credit, and while new loans can be and are being advanced via the banking system, it’s a much more difficult task to force shadow banks to lend. That lending depends on securitization which in turn depends on stable and eventually higher asset prices than currently exist. The original focus of the TARP was on asset prices, but the prior Administration quickly lost its way or perhaps its nerve. Like his Road Runner nemesis, Wile E. Coyote must now extend some infrequently used figurative wings to avoid the deflationary precipice below. Support asset prices. Beep Beep!

William H. Gross
Managing Director
Investment Outlook

PIMCOs Gross: Find ways to prop up the Values of Assets

Wall Street strategists predict 17 percent stock gain in 2009

The average 2009 year-end S&P 500 is 1,056, or 16.9% above the S&P's year-end price of 903.25.

clipped from www.bloomberg.com Firm Strategist Target %Change Barclays Plc Barry Knapp 874 -3.2% Citigroup Inc. Tobias Levkovich 1,000 11% Credit Suisse Andrew Garthwaite 1,050 16% Deutsche Bank Binky Chadha 1,140 26% Goldman Sachs David Kostin 1,100 22% HSBC Holdings Kevin Gardiner 1,000 11% JPMorgan Chase Thomas Lee 1,100 22% Merrill Lynch Richard Bernstein 975 7.9% Morgan Stanley Abhijit Chakrabortti 975 7.9% Strategas Research Jason Trennert 1,100 22% UBS AG David Bianco 1,300 44%

Strategists See 17% S&P 500 Rise After Saying ‘Buy’ (Update3)
By Lynn Thomasson

Jan. 5 (Bloomberg) -- The same Wall Street strategists who told investors to buy stocks in the worst year since 1937 are even more bullish than a year ago, predicting the Standard & Poor’s 500 Index will rise 17 percent.

UBS AG, JPMorgan Chase & Co. and Deutsche Bank AG say the Federal Reserve’s decision to cut interest rates to as low as zero percent will help revive the U.S. economy and drive investors back to equities. Cheaper fuel prices and more than $850 billion in spending on roads, bridges and health care will send stocks higher, the strategists said.

Even if they’re right, the S&P 500 would end 2009 at 1,056, 28 percent below where the benchmark index for American equities started in 2008 and 35 percent lower than where the analysts said it would be now, based on the consensus of 11 strategists surveyed by Bloomberg News. Some of the biggest investors are growing more optimistic as the S&P 500 advanced 24 percent since reaching an 11-year low on Nov. 20.

“Equities usually find a bottom about halfway through a recession,” said Binky Chadha, the New York-based chief U.S. equity strategist at Deutsche Bank who predicted the S&P 500 would climb 12 percent in 2008 and expects a 26 percent surge this year. “If policy gets it right, we should find a bottom and start to turn around. And if that happens, then it’s time to buy stocks.”

$29 Trillion

Wall Street analysts lost credibility in 2008 when none predicted a down year and the average forecast was for a gain of 11 percent, according to data compiled by Bloomberg. Instead, the S&P 500 tumbled 38 percent to 903.25 and $29 trillion was erased from global markets. The projections for this year would represent the best annual performance since 2003, when the S&P 500 climbed 26 percent.

U.S. stocks fell for the first time in four days as concern that a slump in corporate profits will stretch into 2009 overshadowed speculation the government will revive the economy with tax cuts. The S&P 500 slipped 0.5 percent to 927.45 today, halting its longest stretch of gains since November.

Concern that stock losses will deepen remains elevated even after falling from record levels in October and November.

The Chicago Board Options Exchange Volatility Index, which measures price swings, ended 2008 at 40, up 78 percent from a year ago and more than triple the level at the start of 2007.

TED Spread

The Libor-OIS spread, a measure of cash scarcity, closed 2008 at 121 basis points after averaging about nine basis points in the year before credit markets started freezing up in August 2007. The difference between what the U.S. government and banks pay to borrow for three months, the so-called TED Spread, is about three times higher than before the credit crisis started, according to data compiled by Bloomberg.

Treasuries returned 14 percent last year, the most since 1995, according to Merrill Lynch & Co. indexes. Investors sought the relative safety of government debt as losses and writedowns at the world’s biggest financial companies rose toward $1 trillion and the economies of the U.S., Europe and Japan fell into the first simultaneous recessions since World War II.

“People have been telling the investing public for the past six months to stay the course or buy this great opportunity, and it’s turned out to be a liability,” said Randy Bateman, who oversees $15 billion as chief investment officer of the asset management unit of Huntington Bancshares Inc. in Columbus, Ohio. “Any outlook right now is subject to a great deal of skepticism.”

‘All Available Tools’

Stocks rallied at the end of the year as the Fed said it will “employ all available tools” to revive the economy and President-elect Barack Obama pledged to boost growth through the biggest infrastructure investment since the 1950s.

The combination of government stimulus and oil’s 69 percent drop from its July record of $147.27 a barrel may pop the “bubble of pessimism” toward stocks, according to David Bianco of UBS, Wall Street’s biggest bull.

“The consensus outlook for 2009 is a full year of gloom,” Bianco, 33, wrote in his annual market outlook last month. “We believe 2009 will bring signs of a dawn in confidence with the first faint light appearing earlier than most investors expect.”

The S&P 500 began recovering an average five months before recessions ended in 1975, 1982, and 1991, data compiled by Bloomberg show.

‘Greatest Roars’

Bianco predicted 12 months ago that the S&P 500 would climb 16 percent in 2008, and stayed bullish after the subprime mortgage meltdown spurred the collapse of Bear Stearns Cos., then the fifth-largest U.S. securities firm, in March. He said in a July interview with Bloomberg News that the rebound in stocks during the second half of 2008 would be the “one of the greatest roars we’ve seen.”

UBS’s New York-based equity strategist now expects the S&P 500 to reach 1,300 this year as share prices cheap relative to earnings become irresistible. Last year’s slump left S&P 500 companies valued at an average 12.9 times operating profit, near the lowest since at least 1998, monthly data compiled by Bloomberg show.

The S&P 500’s dividend yield may be the “most compelling” signal that stocks are inexpensive, Abhijit Chakrabortti, Morgan Stanley’s New York-based head of global equity strategy, wrote Nov. 25. He expects the index to advance 7.9 percent this year.

The dividend payout for companies in the index climbed above the yield on the 10-year U.S. Treasury note for the first time in 50 years in November and is now 3 percent. That’s 0.67 percentage point more than the yield on 10-year notes, data compiled by Bloomberg show.

‘Staging a Recovery’

JPMorgan’s Thomas Lee says the 47 percent drop in gasoline prices last year to an average $1.62 a gallon, according to AAA, combined with Obama’s plan for stimulating growth may revive consumer spending in the second half of 2009. Retailers are among the New York-based bank’s “top picks” for 2009. The S&P 500 Retailing Index trades at 12.5 times the earnings of its 27 companies, about half the average ratio this decade.

“Every year’s a new year,” said Lee, 39, who expects the S&P 500 to rise to 1,100. “One of the big hurdles is obviously going to be coaxing investors back. As we exit ‘09 we think the economy is staging a recovery,” he said in a telephone interview.

Economic Data

Economic statistics give little indication that a recovery is imminent. Consumer confidence sank in December to the lowest since records began in 1967, raising the risk that spending will weaken in 2009, data from the New York-based Conference Board showed last week.

Gross domestic product will contract in the first half of this year, while household spending is expected to fall 1 percent in 2009, the biggest drop since the aftermath of the attack on Pearl Harbor, according to Bloomberg surveys of economists.

Corporate profits have fallen for seven quarters, according to the U.S. Bureau of Economic Analysis. Should earnings drop through the first half of 2009, as analysts surveyed by Bloomberg project, it will be the longest stretch of decreases since the government started tracking quarterly data in 1947.

The decline in corporate profits will probably push the S&P 500 back to its 11-year low of 752.44, according to Barclays Plc’s Barry Knapp, the only forecaster calling for the index to drop. He says the index will fall 3.2 percent.

‘Little Bit Early’

“We do think there will be an economic recovery in the back half of the year,” Barclays’ New York-based chief U.S. equity strategist said in a telephone interview. “You can do OK with the equity market this year, it’s just a question of when you commit. Right now, it’s a little bit early.”

The biggest bears at the start of last year, Morgan Stanley’s Chakrabortti and Merrill Lynch & Co.’s Richard Bernstein, had called for the S&P 500 to climb 3.9 percent to 1,525.

The index ended the year 41 percent below their estimate, data compiled by Bloomberg show. More than half of the S&P 500’s decline for 2008 came after Lehman Brothers Holdings Inc., once the fourth-largest U.S. securities firm, filed the biggest bankruptcy in history on Sept. 15.

“The thing we all got wrong was that there would be a safety net to catch any and all large financial institutions,” Deutsche Bank’s Chadha said. “Letting Lehman go has had devastating effects.”

Merrill’s Bernstein forecasts a bigger advance for the S&P 500 this year than his 2008 prediction, saying the index will climb 7.9 percent to 975. With global growth likely to “negatively surprise,” the New York-based strategist recommended utilities and makers of household products and drugs in a Dec. 9 note.

‘Textbook and History’

The MSCI World Consumer Staples Index, which includes makers of food, beverages and consumer goods, is valued at 15.2 times earnings, the cheapest since at least 1995, monthly data compiled by Bloomberg show. The MSCI World Health-Care Index ended 2008 valued at 16 times profit after trading at a ratio of 15.1 in November, the cheapest in at least 13 years.

The MSCI World Utilities Index ended 2008 with a dividend yield of 4.4 percent, about twice that of 10-year Treasuries. The ratio was the highest since at least 1995, monthly Bloomberg data show.

“Looking at the textbook and history of the market, it looks like there’s potential for a rally,” said John Carey, the Boston-based investor who runs the $4.64 billion Pioneer Fund that beat 74 percent of its peers last year. “It would be risky to be out of the market right now.”


To contact the reporter on this story: Lynn Thomasson in New York at lthomasson@bloomberg.net.