Recovery On 30 Houses Per Day

By: Michael Ashton | Wed, Jan 26, 2011
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It has always been amazing to me the way that investors will confuse levels and changes. When I was new in the finance industry, I figured that I must just be naïve, and that clearly the wiser people who were older than me must know something I didn't. After a couple of decades of watching the same mistakes made repeatedly, I no longer believe that to be true (partly that is because there are many fewer people who are older than me).

Today's New Home Sales is a great case in point. The November number was revised lower, the December number came out significantly better-than-expected at 329k versus 300k expected, and the combination of those two effects resulted in a headline that New Home Sales had risen 17.5%.

To be sure, the number was higher than expectations, but how important is this, really? For starters, note that the total difference in sales compared to expectations is on the order of 1,000-2,000 homes nationwide (29k over expectations, minus 10k downward revision, divided by 12 months gives 1,583 homes, and this likely exaggerates the case since the seasonal adjustments are compensating higher at this time of years because fewer homes are sold in the depths of winter). More importantly, consider the level of home sales itself, which even with this upside surprise is below the lowest level ever recorded prior to 2010. It's even level than sales seen as recently as 2009! (See Chart)

What 17.5% improvement in New Home Sales looks like
What 17.5% improvement in New Home Sales looks like.

But the release, and the 17.5% number, was good for a one-half percent gain in the stock market. So, if the total market capitalization is around $13.5trln, the additional sale of around $436mm of houses (1500 units * 291k average price, also reported in the New Home Sales report) added about $67.5bln in wealth to investors elsewhere. Now that's leverage, baby. If the government would just surreptitiously buy 30 houses per day, stocks would be on the moon in no time and consumer sentiment would be strong. (I am kidding.)

Stocks held their own, while bonds sank (the 10y yield finished at 3.43%). The FOMC report was, as anticipated, anticlimactic with no major changes to the statement and, for the first time in a while, no dissenting governors. This last part isn't as surprising as you might think - perennially dissenting hawk Hoenig was rotated off the voting roster this year - but it is a sign of how uncontroversial QE2 has become within the Fed that none of the other hawks felt any need to register a pro forma disapproval.

The Fed is not going to be easily derailed from finishing QE2, nor should they be since the interval between their actions and any effect on the underlying economy is much longer than the time remaining in QE2. But the arguments in favor are somewhat feeble. Let us take a look at what they said about inflation:

Although commodity prices have risen, longer-term inflation expectations have remained stable, and measures of underlying inflation have been trending downward.

Let's examine this. "Longer-term inflation expectations have remained stable." I suppose it depends on your definition of stable, but the chart below shows 5y, 5y forward inflation from US CPI swaps. If you mean "it hasn't exploded to the upside," then I guess that is accurate, but it appears to me to be neither stable nor particularly low compared to the pre-crisis period.

5y, 5y forward inflation
5y, 5y forward inflation hasn't been exactly stable, at least by pre-crisis standards.

I expect the FOMC would point to the University of Michigan survey of 5-year ahead inflation expectations, but (a) consumers are bad at observing current inflation, so I sure don't know why I'd care about their forecasts 5 years forward, and (b) in the inflation market, people are betting real money with real consequences to being wrong.

Now, measures of underlying inflation (that is, core or median or trimmed-mean varieties) have in fact trended lower. But that trend is over, and very few forecasters think otherwise, so it seems disingenuous to insert that statement with the carefully worded modifier "have been" which is clearly softer than "is."

Don't get me wrong, I wish the Fed would say nothing at all and let us guess. It would be healthier for the economy if we all were kept guessing and had to be more conservative - if we were responsible for maintaining our own training wheels, as it were. But if the Fed is going to release statements, then they're going to be picked apart and criticized. I promise.

The stock market and bond market merely shrugged at the statement and moved onward. The quiescence of the Fed is presently taken for granted and attention is turned outward. To Europe. To the labor market. To whether snowfall accumulations in Central Park will put your bet into the money and make your coworker buy lunch. You know: important stuff.

Thursday's data include the not-really-watched Chicago Fed Index (Consensus: 0.11 from -0.46), Durable Goods (Consensus: +1.5%, +0.9% ex-transportation), and Initial Claims (Consensus: 405k). It is remarkable to me that expectations for this latter number have so completely incorporated recent improvement although the range of Claims for the last four weeks has been 391k to 441k. Bloomberg reports the standard deviation of forecasts at just 9k, which is roughly average. But recent data have been highly uncertain and we are just finishing a wildly volatile period in the seasonal adjustment scheme anyway. There should be room for widespread disagreement, because one thing you can say for sure about the recent data ... and perhaps the only thing you can say for sure ... is that they don't demand the rejection of just about any null hypothesis with respect to Claims.

That isn't particularly helpful in setting a trading strategy, however. I feel the expectations are low, but there is a lot of other data being released simultaneously and my confidence in a Claims forecast would be quite low for those reasons just mentioned. I am inclined to lean short on the bond market, but stocks bewilder me right now.

 


 

Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA
E-Piphany

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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