Personal Savings Rate - May 2009

Americans continued their uncanny ability to save last month, with May's personal savings rate increasing to 6.9%. While lower consumption will undoubtedly have a negative affect on GDP, the restoration of consumer balance sheets serves as a necessary prerequisite for a fundamentally healthy domestic economy upon which sustainable growth can be achieved.

CA Home Sales – May 2009

The greatest story never told continues to be the remarkable stability in Southern California’s home prices (ground zero for the housing bubble). Home prices rose a modest 0.8% last month and have essentially been flat since the beginning of 2009 (though over 50% off its peak levels). While California remains way over-inventoried, with a high level of foreclosures still in the pipeline, year-over-year transactions remain brisk (up 23% last month) suggesting that the inventory is finally starting to clear. This stable pricing, despite foreclosures sales representing over 50% of transactions (which undoubtedly weigh on home pricing), suggests the market is firmly in the healing stage.

Commentary on New & Existing Homes Sales

Existing and new home sales and inventories were released by the National Association of Realtors and Census Bureau, respectively. As suggested in the first chart below, new home inventories continue their steady assent downward. At 292,000 units available for sale, inventories have retrenched to levels reflected in prior housing downturns. Though seasonally adjusted months of supply remains elevated at 10.2, the metric is somewhat skewed by extremely low levels of new home sales (which are off 75% from the peak hit in July 2005). Most economists believe 4-6 months of supply generally reflects a more normalized housing market, though I posit that by the time we see these levels, housing will firmly be in the correction phase.

While several data points in the new home market are encouraging, the existing home market still faces several challenges (and note that existing sales generally comprise more than 80% of total home sales). Positively, homes for sale have declined by 13.9% and now stand at 3.8mm. Negatively, this is well above the 2-2.5mm homes reflected in a healthy market. Further, months of supply still stands at 9.6, though down from the peak of 11.2 months recorded in November 2008.

As demonstrated in the chart below, we probably need to work through another 1.5-2mm of excess homes before pricing will comfortably find a bottom. With that said, prices are artificially being suppressed due to the overwhelming presence of distressed sales, which comprised about 1/3 of home sales last month and up to 70% in the most troubled markets. However, I view the high proportion of distressed sales as a positive since it demonstrates that the market is clearing. Unfortunately, it could take some time for this overhang to abate as several states recently extended foreclosure moratoriums that were previously implemented at the end of last year (CA being the most prominent).
In summary, I continue to believe that the housing market is in the midst of a prolonged bottoming process that will reward investors with a long-term time horizon. At approximately 500K, housing starts remain 1/3 of “natural demand” and approximately 35% below trough levels hit in the 1987-1991 housing recession. While the bubble exceeded any of the post-WWII housing upturns, the correction has been equally as severe. Further, low prices and record affordability (off the charts frankly) have skewed the rent vs. buy equation squarely in favor of homebuyers. Finally, the $8,000 federal tax credit and a friendly lending environment (thanks to the FHA) have made homeownership a viable option for a whole new crop of homeowners who prudently avoided buying during the bubble.

Weekly Railroad Data - Still Negative

There is still little evidence of a rebound in the US economy based on the weekly carload data reported by the Association of American Railroads. While year-over-year declines have moderated to 19-20% in June vs. 25-26% in May, this is hardly a cause for celebration. Perhaps one positive takeaway gleaned from the data is that “Farm Products, Excluding Grain” experienced 4.8% year over year growth, though the other 18 categories were decidedly negative. Since transports generally serve as a leading indicator for a recovery, its hard to get on board with the “economy is healing” train in the face of such negative data (though I'm trying!).

S&P Earnings - 1st Favorable Revision for 2009

Below is an interesting chart I put together tracking consensus earnings forecasts for the S&P 500 over the prior year (when S&P actually starting tracking 2009 estimates). As evident in the chart, the sell-side completely overestimated the earnings power of the S&P last year when a bottoms-up forecast of the individual components resulted in a $110 per share estimate. Each subsequent week resulted in a downward revision to the forecast, which appears to have bottomed on May 19th, when S&P reported a mean estimate of $54.20/share.

Perhaps the most bullish takeaway, and one to keep track of over the coming weeks, is that consensus estimates have started to increase. As of June 16th, the mean forecast was $55.80/share, valuing the S&P at a reasonably comfortable 16x earnings. While certainly not cheap, an important milestone may have been reached with the street’s bearishness being fully reflected in the earnings power of the S&P. Historically, favorable earnings revisions have been a harbinger of future stock market gains so I will continue to follow closely.

As someone who is trying to identify fundamental data points to support the rally over the prior 3 months, this chart provides reasonable confirmation that the bulls may be justified in their early enthusiasm. With that said, 2010 consensus earnings growth of 33.1% ($74.32/share) bake in a sizable rebound in the economy. In my opinion, little evidence has emerged to support this bullish scenario, though I would love to be disproved and admittedly the industries I cover (housing and media) have fundamental secular challenges that may unfairly taint my view of the overall economy. As companies begin to report 2Q earnings, investors will be able to judge whether the supposed "green shoots" are actually finding their way from politicians' lips to corporate earnings.

Household Net Worth - as of Q1 2009

Household net worth declined by an additional $1.3 trillion in Q1 2009 and now stands at $50.4 trillion. From its peak in Q3 2007 (when household net worth touched $64.3 trillion), American households have lost an astounding $13.9 trillion or 21.6% of their total net worth. Declines have been most severe in corporate securities (down $4.6 trillion or 47.2%), mutual fund shares (down $1.7 trillion or 33.8%), pension fund reserves (down $3.5 trillion or 26.2%), and real estate (down $3.8 trillion or 16.3%). While $1.3 trillion of net worth destruction is significant, the decline was well below Q4 2008 and Q3 2008’s decline of $4.9 trillion and $2.7 trillion, respectively.

P&G Media Spending in Q1 2009

Despite cutting its total measured media spending by 18% in Q1, P&G more than doubled its spend on internet display ads, which now comprise 4% of P&G's total spend (up from 2.2% of total US measured media in 2007). Even more startling is the substantial cuts P&G made in certain traditional forms of media, including network & spot tv (down nearly 50%) and magazines (down 30-35%). As the US's largest advertiser (and more generally CPG's high reliance on TV), the reallocation of P&G's marketing spend will continue to have dramatic impacts on the major broadcast networks.

E-books Penetration Taking Off

The chart above puts to rest any doubt over the rapid growth of e-books, which accounted for 2.6% of book sales in March 2009 from only 1.1% in Jan. With the introduction of Amazon's Kindle in June and other competitive products in the offering (with Plastic Logic's creating the must buzz) we are sure to see continued increases in this metric. While I have little conviction on who will be the biggest beneficiary from the adoption of e-book, I think it is safe to say that the business model of traditional book retailers will come under considerably pressure over the coming years (Barnes & Noble and Borders being the most obvious). Just as there are no pure play big box music retailers still in existence, I am hard pressed to imagine a world necessating 25K-40K square foot book retailers.

Reflections on the Recent Market Rally

After living through the fierce market rebound since March 9th, I thought it prudent to distill some key takeaways from Q4 of last year to now:
1. The market is very smart – when the rebound started occurring in early March it was important to question one’s bearish orientation and continuously strive for positive data points in a sea of negative news – both of which I think I did sufficiently well)
2. Government stimulus works – whether you are politically or morally opposed to it is irrelevant when considering its short-term implications on the market and psychology. On a longer-term basis, perhaps we will be debating the merits of TARP, TALF, PPIP, and other government programs (frankly, I am still unsure what to think). However, stimulus generally works and in this instance I think the government played its exceptionally difficult hand right (at least in terms of infusing capital in the banks)
3. The market and economy are all about confidence – the world was ending in Q4 and early March only because the media would have you believe that was the case. Now that the media has moved on to the next story, the American public can go about the business of living (admittedly, a bit more frugally)
4. It is always darkest before the dawn. I remember listening to a few earnings calls with CEOs commenting that orders were down 40-50% in their businesses and the outlook appearing just as grim. I don’t care how bad things are – the world was not decelerating at such a pace. After two quarters of 5-6% GDP declines, it should be apparent to everyone that we would need to rebuild inventories.
5. Investing is all about valuation (and this is where I fault myself for not truly appreciating the potential magnitude of this rally). I’ve said it many times, but it bears repeating. When industry leading businesses with solid franchises begin trading at single digit PEs off of trough earnings, you have to buy. You just never know when the bottom will hit and people will always miss the “easy” move off the lows if they obsess about trying to catch this elusive trough. One has to buy prudently, but once the market recedes into “the world is ending territory” the name of the game is to consistently average down (and try and contain your glee as great businesses get handed to you at generational lows!).
6. I think in many instances I saw a lot of the credit excesses coming. However, in 2005 & 2006, I certainly didn’t appreciate the magnitude of the housing decline (almost to the point of being clueless). I remember reading how subprime accounted for more than 20% of mortgage originations in 2006, but somehow never put the pieces together that it would cause 35% peak to trough declines in housing (and still counting). I was extremely skeptical of the private equity bubble (even mystified), but never considered how that should be wrapped up in a truly macro bearish scenario. In short, I would grade myself a C over the last 4 years as an investor (and believe me I take no pride in that self-evaluation). However, I would argue that a lot of other supposedly smart investors didn’t see the tsunami as well. In fact, many that didn’t see the storm in 2005/2006 have convinced themselves in 2008/2009 that the world was ending. Why the media hangs onto these bearish views at market bottoms from people who failed to forecast the current situation is beyond me. However, the media loves a good scare story and there were plenty of investors willing to provide the fodder. Our economy has tremendous self-correcting mechanisms built into it and the world was no sooner going to end in Q4 2008 as it was going to continuously operate at the peak levels of 2006.

As always, I could very well be wrong and perhaps the worst is yet to come (certainly if history is any guide, the former will prove correct).