Since our last Financial Update the stock market has moved higher. The primary catalyst for this movement was the better than expected earnings from corporations and the absence of any major negative headlines.
Corporations demonstrated an amazing ability to cut expenses dramatically in the face of declining revenue over the past year. Most reported a decline in revenue that was generally in line with expectations. The net income was higher than expectations because they were able to cut expenses more than predicted.
The two most watched segments of the economy are vehicle sales (car and light truck) and new home sales. Both sectors have benefited from Congressional intervention and stimulus. During July & August we had the Cash for Clunkers program to help stimulate automobile sales.
The Cash for Clunkers program generated more sales than initially anticipated. The original funding was quickly exhausted and an additional round of funding was provided to extend the program. This second round of funding has been depleted. The latest estimate is that 700,000 vehicles were sold under this program.
Vehicle sales have been running below replacement rates. Each year we average 14.3 million new auto and light truck sales. We typically scrap about 12 million automobiles each year. In 2008 automotive sales dropped below 10 million. Earlier this year sales were running at an annualized rate of approximately 9 million. In June, prior to the Cash for Clunkers program annualized sales were at 9.7 million. In July, with the benefit of the Cash for Clunkers program, annualized sales rose to 11.2 million. Please note that this is still below the rate at which cars are scrapped and still below the average sales of 14.6 million. It will be interesting to see how September’s vehicle sales fare and whether this indicator of the economy can sustain itself without government incentives.
New and existing home sales have also begun to improve. This is a result of the first time home buyers credit of up to $8,000, low interest rates (current mortgage rates still average near 5.25%) and substantially reduced housing prices (median prices are down 24% over the last 3 years). On an annualized basis there are 2.2 million new households created each year. Although new home sales have recently increased they are still running at an annualized rate of 433,000. Inventories have therefore declined to 271,000 or approximately a 7½ month supply down from 419,000 in July, 2008.
In addition to the first time home buyers credit, the government has intervened in the real estate market in numerous other ways. The government passed the Mortgage Forgiveness Debt Relief Act to allow homeowners the ability to restructure their mortgages. The Federal Reserve has been buying mortgages to keep interest rates low. Both Fannie Mae and Freddie Mac have suspended foreclosure actions on delinquent mortgage. The combined impact has been to reduce the cost barrier to purchase a home, to reduce the cost of home ownership for both existing and new homeowners and to reduce the number of houses being listed for sale due to foreclosures.
Like automobile sales, the real estate market is improving but the critical test will be if the improvement continues after the tax incentives and government intervention end.
This data as well as other economic data indicate that the economy has stabilized. Critical tests remain. Money supply has expanded and credit is still tight but expanding. This expanded credit availability will be tested by the commercial real estate markets as loans secured by commercial properties balloon over the next few months. It will also be tested as the government (both federal, state, and local) borrow more money to cover their current budget deficits.
The stock market has responded positively to the early signs of an improving economy and the better than expected corporate earnings. If you are concerned about the future of stock prices this might be a good opportunity for you to reassess your exposure to the stock market and to give us a call to review your portfolio. The stock market has enjoyed a nice rebound from the March lows and is overdue for a correction. Unfortunately we do not know at what level the correction may come nor the timing or magnitude of the correction.
