Stocks are trading at high multiples of earnings and at a time when earnings are also at record levels. How much higher could they go and if you did buy at this level, could the reward really be worth the risk? Ultimately, don't stocks depend on the economy? Dear reader, we give you the short answer: Stocks are not a good investment. Not at these prices. That doesn't mean they won't go up any more. Nor does it mean that some stocks, well chosen, won't make you good money. It just means that it is unwise for you to follow them. There's more downside to worry about than upside to hope for. Take this little boost as a gift from the gods; sell the market on rallies.
Having said this, we return to our confession. It is true, we did not expect the market to hold up as long as it has. Our error was one of over-estimating the good sense of our fellow man. He is a bigger blockhead than we ever thought. Given the lure of easy credit, interest-only house payments, and "stated income" lending - he took the bait greedily. Now, he's on the line for more money than any man in history...with no greater income than he had before to pay it off. How much pain remains to be seen, but even Ben Bernanke now admits that US housing has begun a "substantial correction". In New York, for instance, the number of apartments for sale has reached a level not seen in 15 years. This year, prices dropped 2.2% from the 2nd quarter to the 3rd quarter. And at the high end, sales have collapsed 40% from a year ago.
Meanwhile, US homeowners will soon begin to show signs of cracking. About 20% of all homeowners in the US are going to face higher payments in the next 2-3 years as their complicated contracts start kicking in. In Washington, US, for example, interest-only loans account for 28% of house payments, while sub-prime loans make up a similar amount. Roughly the same holds true also in Florida. In California, the interest-only loans are even higher, at a shocking 39%. And on the sell side of things, the numbers are also ominous. Brokers and builders are beginning to hurt. According to a CNN Money article, during the housing boom's zenith between 2002 to 2004, membership in the US National Association of Realtors (NAR) rose 26% so that there are now over 1.2 million realtors on record in the world's largest economy. But with sales predicted to fall 7.6% in 2006, the flood of agents is drying up. The article quotes Gayle Henderson, a REMAX agent in Phoenix: "Our realtor population had swelled to over 70,000 in a population of 3.6 million. Now people are talking about getting another job or leaving the business altogether."
Meanwhile, at leading homebuilders in the US, the CEOs have jumped ship. Matt Krantz writes in USA Today: "Bruce Karatz, CEO of KB Home (KBH), sold 950,000 shares worth $76.1 million July 12-13 in 2005. After the sales, he still owned 1,668,070 shares. In a June 2005 press release, Karatz also was upbeat, saying, 'Consumer demand...remains vibrant, fuelling strong growth in unit deliveries and selling prices.' Results were strong in fiscal 2005, ended in November, when net income jumped 75% to $842.4 million on 34% higher revenue. But KB also has seen a shift since then. On Sept. 21, the company reported a 53% decrease in fiscal third-quarter home orders in the USA. 'Conditions in formerly strong markets...have weakened considerably in recent months," Karatz said in an accompanying press release. KB declined comment.
"Robert Toll, CEO of Toll Bros. (TOL), sold $110.1 million of stock in February 2005 and reaped $134.1 million more through four sales by July 2005. Toll also didn't seem overly worried at the time. The company's profit jumped 135% to $170.1 million in the quarter ended April 30, 2005. But results began to flag a year later. Net income fell 19% during the quarter ended July 31, 2006, from the same period in 2005, to $174.6 million."
How long can US housing and US stocks go in different directions, following different rules as though they breathed different air and ate different bread? Not long, we suspect. If houses are already beginning to climb down from the clouds then stocks can't be far behind.
Bill Bonner: 05/10/06
