Case Shiller Index - Jan 2009

The Case Shiller Index declined by another 2.8% in Jan 2009. This represents the steepest sequential decline since the index began to turn negative in July 2006. From the peak, the index is now down 29.1%, with some of the worst regions down in excess of 40% (see below). Directionally, it is pretty frightening even if one disputes the methodology (which admittedly is somewhat flawed).

KB Home Q1 2009 Orders - Signs of Life?

KB Home reported a healthy 23.9% increase in net orders for their Q1 2009 period. This is the first time that I have seen any homebuilder post a year over year increase in net orders since I began tracking the industry in July 2007. The strong increase was anchored by a 169.3% jump in its Central region, which primarily consists of Texas and Colorado (two of the stronger markets in the country). Even the Southwest region, composed of Arizona and Nevada saw a 19.4% jump vs. prior year. KB Home has aggressively repositioned its inventory to better compete against foreclosure properties. While pricing and margins have been impacted, the pickup in orders is a nice bit of news in an otherwise very troubled industry.

Sale of British Bonds Falls Short

Pretty bad omen for Europe - the British government failed to find enough buyers for its sale of
£1.75 billion of 40-year bonds. This follows Germany's failed bond sale I reported on in early January (see Jan 9th post - "Germany's Failed Bond Sale - Omninous Sign?")

Of course several people are coming out and saying that one failed auction shouldn't be a cause for concern. However, I beg to differ and believe that such announcements will become more frequent as Western governments try to fund their ballooning deficits.

Perhaps even more concerning for the US is that the Chinese keep on scolding us for our fiscal deficits - though thankfully continuing to dutifully send us their money. Unfortunately, there appears to be a limit to their generosity and I fear we are bumping up against it.
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Sale of British Bonds Falls Short

By AGENCE FRANCE-PRESSE
Published: March 25, 2009
LONDON — An auction of British government bonds failed to find enough buyers for the first time in almost seven years in a sign that investors’ appetite for risk remains low and raising concern about Prime Minister Gordon Brown’s plan to revive the economy.
Investors bid for £1.63 billion of the £1.75 billion of 40-year bonds. Britain plans to sell a record £146.4 billion of debt in a year to help its economy back on its feet but the government received an unusual warning from the Bank of England governor Mervyn King on Tuesday about rising government debt levels. His caution raised concerns among debt investors about Britain’s ability to increase debt further.

But some analysts said that one failed auction is no cause for concern and pointed out that the market ended higher on Wednesday. “One undersubscribed auction doesn’t mean the U.K. will have trouble funding but they won’t want to make a habit of it,” said Laurence Mutkin, head of European fixed-income strategy at Morgan Stanley in London. “This is not about the gilts but about the market. Balance sheets are under pressure and the risk appetite is low.”
The last bond auction in Britain that failed was for inflation-linked bonds in 2002.
Britain’s economy shrank 1.5 percent in the fourth quarter and the government put together a fiscal stimulus package together with monetary easing to help pull the economy out of the recession. The Bank of England, which already lowered the interest rate to almost zero, decided earlier this month to start printing 75 billion pounds in money to buy bonds.

The International Monetary Fund predicted Britain will have a deficit of 11 percent of G.D.P. in 2010, the highest in the Group of 20. The popularity of Prime Minister Gordon Brown, who has to call an election before the middle of next year, declined over the last month as consumers become increasingly concerned about the level of government debt that is expected to translate into higher taxes in years to come.

A government spokesman played down the significance of the failed auction, saying the shortfall can be made good in future auctions. The Debt Management Office, which manages bond auctions on behalf of the British Treasury, said in December that it was aware that selling debt in the current environment could be challenging and that it might join Ireland, Spain and Belgium in using banks to ensure sufficient demand.

Governments compete to sell records amounts of debt to revive their economies. Germany plans to sell 346 billion euros of bonds this year and Goldman Sachs Group estimates U.S. sales would reach a record $2.5 trillion this year.

Southern California Home Pricing in February

Another encouraging data point in the housing market came from the DQNews release of February housing data in Southern California. February represented the first month since I have been tracking the data (about 18 months now) where home prices were flat on a sequential basis. Obviously, one month does not make a trend, but this is certainly something to keep a watch over. From their peak, pricing has declined by 50.5% in Southern CA and 55.6% in the Bay Area. No doubt a lot of this decline is being driven by foreclosures, which accounted for 56.4% of sales in SoCal, but it is nice to see the market is actually starting to clear. Since September, year over year volumes have been up at least 25%, and in nearly all months over 50%.

In Riverside and San Bernardino (the two key locations in the badly decimated Inland Empire) prices are off 56% and 59.7% from their peak, though volumes have been up significantly in both regions (clearly, being driven by foreclosure activity).

The Wall Street Journal ("Home Buyers Stir Hope in California") wrote a nice piece confirming a lot of the positive data starting to show up in the numbers. The article gives several anecdotes where homes are starting to receive several bids – with many above asking. With home prices down 57% in CA, it is encouraging to see opportunistic buyers finally coming out of their shell.

Housing Affordability as of February 2009

Housing prices continue to approach historical affordability levels as demonstrated in the chart above (note: I have defined "affordability" as median home prices divided household income). While rising unemployment and increasing foreclosures will likely drag down prices further, it is comforting to see that prices are reaching "fundamentally" healthy levels. Further, extremely low mortgage rates should continue to provide some downside support to house prices.

Growing Capacity Glut in China

Interesting chart from the Wall Street Journal showing the production glut building in China. Quoting from the article, "According to China's industry ministry, as of this month about 30% of the nation's aluminum production capacity is idle, as is 20% of cement and plate-glass capacity and 70% of semiconductor production....China also has auto-sector concerns. The country has the capacity to produce about 12 million automobiles a year, but only 9.37 million were sold in 2008."

The chart to the right is particularly troubling since it suggests that China is investing more as a share of its economy than Japan or South Korea did even at the peak of their industrialization. China's leaders also appear to lack the political will to force the closure of unneeded plants, not unlike US leaders who seem unwilling to force a dramatic capacity reset in our automotive industry.

While China's consumer economy is structurally more sound than that of the United States, its heavy reliance on exports to the developed world and growing excess capacity, will likely restrain economic growth in the near-term. The government's 4 trillion yuan investment program has been well-received by the market, with China's local stock market up approximately 30% year-to-date, but without a pickup in the global economy, it would seem that the stimulus program could further widen China's output gap. Finally, lets hope the excess capacity doesn't spark a trade war with other countries striving to keep their domestic plants operating.