U.S. stocks ran into a little trouble on Friday as the IMF is headed to Greece, the latest consumer confidence reading erased three-months of gains, the potential for conflict on the Korean peninsula got a little hotter and Goldman Sachs is now officially under investigation for defrauding investors. 

Pre-market trading, which was pointing lower very early Friday morning, weakened just before the open when South Korea stated there’s a high possibility the sinking of their warship last month was due to an external explosion – one would think if their ship ran into a mine or was hit by a torpedo that they’d know by now.  But if it was external, it has North Korea written all over it. This concern extended into the official trading session.   

But concerns on that front were suddenly overcome by an SEC charge that Goldman Sachs defrauded investors.  The deal is Goldman stated a financial product they marketed that was tied to subprime mortgages, as the housing market was beginning to crumble, was structured by an independent, objective third party.  It appears though that the product, a synthetic CDO, was not structured by an independent source, but rather the portfolio selection was influenced by John Paulson’s hedge fund who was betting the securities underlying the CDO would default.  This resulted in new fears that ramifications from the financials chaos of late 2008 may not have completely blown over.  More on this below the jump…

The market has become incredibly complacent, and while stocks improved from the session’s low point, the news out of Korea and yet another case of financial fraud may have reminded traders of the various risks that lurk in the marketplace today.  There are always risks, but they are abundant right now and when the market is so complacent, as illustrated by the VIX index, its sets up for stocks to get rocked. 

Friday we held in there pretty well, a 1.6% decline is not getting rocked in my view.  Hopefully, Friday slapped enough people from their pretty little wonderland to lower expectations just enough so we don’t endure something that scares traders and makes a harmful move lower self-fulfilling.    This still fragile economy will not respond well to such an event.

Market Activity for April 16, 2010

Goldman Continued

At the center of this 20-month long investigation is the allegation that hedge fund Paulson & Co. either selected or heavily influenced the mortgage securities that were included in a synthetic CDO that was structured by Goldman.  (A CDO, or collateralized debt obligation, is an asset-backed security in which the value and payments are derived from a portfolio of underlying securities.  A synthetic CDO is a product that involves credit default swaps, or insurance against default of the underlying bonds.  Take the long position and collect what are essentially premium payments on the insurance, so long as the underlying securities continue to pay principal and interest.  Take the short position and collect the insurance when the securities default – and the short position, or the buyer of credit default swaps in this case, doesn’t need the securities to default, ratings downgrades are enough to come out a huge winner.)  Goldman sold these CDOs to investors – investors that took the long position, the sellers of the insurance.  Paulson & Co., which understood the junk securities underlying the product, had the short position…voila, count your billions.   

The biggest downside to all of this is not that we’re likely to find that other investment banks failed to fully disclose how derivatives products were set up (you never see just one cockroach as they say) but the political fallout.  You have current Attorney General Cuomo with the gubernatorial election coming up in New York, Congressional mid-terms and Parliamentary elections in the UK next month.  This news will embolden politicians to go for it with regard to financial regulations, in a show to the public that they’re here to protect the populace from the “nefarious” Wall Street bankers – and what Goldman has been accused of gives the argument credence.  If they are successful in putting in place a very austere regulatory regime, which always carry unintended consequences, the economy in general will feel the adverse effects. 

Housing Starts

The Commerce Department reported that housing starts rose 1.6% in March to 626,000 units at a seasonally-adjusted annual rate (SAAR) following an upwardly revised 616,000 units in February.  The expectation was for starts to increase to to 610,000 from the originally stated 575,000 units in February.

As we’ve been discussing for a very long time, we certainly don’t need any more homes coming onto the market.  Even though new home building remains floored (as the chart below illustrates – yes, up 30% from the all-time low hit in March 2009 but historically floored) the supply of homes is going to ramp up as the pipeline of foreclosures are beginning to be processed; a process that has been delayed by government moratoria and directives to lenders to do everything they can to get mortgage loans modified.  Even slight home building will only extend the time it takes for the housing market to find supply/demand equilibrium. 

And speaking of foreclosures, RealtyTrac’s monthly figures showed foreclosure filings rose to 367,000 in March – a 19% jump from February 2009 and up 7% from the previous quarter.  The March increase in filings is the largest total since this string of 300K-plus in monthly foreclosures began 13 months ago. 

The good news is that it appears the backlog of foreclosures is finally beginning to clear, a process that inevitably had to happen.  The bad news is that it will cause the home supply figures to jump over the next 12-18 months and if the sales aren’t there to absorb this supply then pressure will remain on prices.   It appeared that home prices were on the way up again after bottoming in January 2009 as the initial phase of the tax credit helped foster a bounce in prices.  However, since August existing home prices have slid again, pushing the median price back down to that cycle low.  A new low may be in the cards with an influx of supply. 

Building permits, a gauge of future building, jumped 7.5% in March and are up 38% from the very depressed bottom hit in April 2009.   Builders are really digging a hole for themselves.  Activity is certainly low, but it needs to statistically shut down for several months – this would speed up the process of reducing this supply glut. 

Consumer Confidence

The latest confidence reading, this one from the University of Michigan, fell to the lowest level since November.  The number came in at 69.5 for April from 73.6 in March.  The index consists of two main gauges: the economic conditions survey, which is meant to measure consumer sentiment about current conditions and the economic outlook survey, meant to measure perceptions about the economic environment a year out.

The economic conditions survey fell to 80.7 from 82.4 – this accounts for 40% of the overall index.  The overall index was pressured heavily by the outlook survey as it slid to 62.3 from 67.9, marking the third-month of decline .  This is not supposed to be occurring as the perceptions of conditions a year out have been believed to be improving. 

The questions to households on the economic outlook portion of the overall survey are:

“Now looking ahead --- do you think that a year from now you (and your family living there) will be better off financially, or worse off, or just about the same as now?”

“Now turning to business conditions in the country as a whole – do you think that during the next twelve months we’ll have good times financially, or bad times, or what?”

Looking ahead, which would you say is more likely – that in the country as a whole we’ll have continuous good times during the next five years or so, or that we’ll have periods of widespread unemployment or depression, or what?”

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900

www.acrinv.com