US house pricing stabilized after over 2 straight years of monthly decreases, and it took prices 32% lower than they were in 2006, plus near record low interest rates, plus a special tax break for first time home buyers, and moratorium on foreclosures. The real test of home price stabilization will be in December – when the tax credit expires, and when we’re not in the strong part of the annual house selling cycle. 

 

Look at foreclosures & the rising amount of homes that are under water (graph on left). This foretells of disaster, not improvements / green shoots.

 

As long as bank balance sheets are carrying a lot of US mortgage debt (and they will for a few more years), we will not see an expansion of bank lending. This will continue to stall a recovery. Add increasing lay-offs at levels not seen since the 1930s, and we have a 50/50 chance of a perfect storm setting up for late 2010 & into 2011.

 

What are the ingredients for a large stock market correction / collapse?

  • Reduced and/or stagnant earnings       
  • Rising income taxes (we will have to)   
  • Large budget deficits (a record)            
  • Inability of consumers to spend             
  • Rising / high unemployment (near record) 
  • Rising interest rates (Fed at 0% now)  
  • Continued bank lending contraction     
  • Bank failures                                         
  • Loss of confidence in stocks (on the way) ! ! !

 

The most important ingredient is the last one. It is also the ingredient that is hardest to predict. When the S&P500 hit 666 in March (down 60% from its peak 1.5 years previous) we had all the above ingredients but the last one. As of now, we have investor sentiment as high as it was in the summer of 2007 (way too optimistic). This winter we will see the perfect storm conditions build –perhaps including the final ingredient. First though, we’ll see a small positive GDP figure for Q3, perhaps even Q4. This is already baked into the market. Then we’re likely to return to our regularly schedule programming – the recession that unwinds 3 decades of over-indulging. The green shoots may get frostbite this winter & die on the vine. FYI, this pattern would follow the 2000-2003 stock market.

 

Look  at the level of mortgage resets in 2009, 2010, 2011, 2012. Things do not return to normal levels until 2013. In order to avoid more foreclosures, we’ll need to see continued low interest rates for 3 more years, as well as nothing else going wrong / worsening.

 

If we do not get continued economic growth this winter (and I do not see how we will unless the US consumer decides to resume their spendthrift ways), we’ll see investor sentiment tank to the level of the average consumer. It will take many months for consumer & investor sentiment to hit bottom – just as it took 1.5 years to get to the March 2009 lows. Only then will we have an opportunity to see P/E ratios that reflect the bottom of a bear market. That is likely to be in the fall of 2010 or winter 2010/2011.