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April 18, 2006

Celebration Time

Equity markets gapped up on today's open, took a breather while waiting for buy programs to kick in, then went vertical into the early afternoon. The early strength was accredited to a lower-than-expected PPI number, which may be partly true, but I believe the stronger influence was anticipation over the release of the minutes from the most recent FOMC meeting. After all, the previous release of minutes set forth wild magic upon the markets as traders interpreted certain phrases as an indication that rate hikes were ending. In retrospect, that interpretation was wrong, but reality has rarely dampened the spirits of bulls.

When the FOMC minutes were finally released a couple hours before the close, stocks continued to spike and went out near the highs of the day, giving equities nearly 2% gains across the board. It was truly a wonderful day to be long stocks. Comments by several FOMC members clearly indicate that they are worried about pushing rates up too far. Traders rejoiced, and the party was on.

It is fascinating to watch how selectively the market reacts to news. A rally was launched in reaction to a number that is so manipulated as to be worthless and in anticipation of the (sem)antics of a group of wannabe economists who have done nothing but cause gross distortions in the flow of resources while guiding this great country to the brink of economic disaster. Yet a more telling number was released this morning... March housing starts... which provides a more direct and unadulterated view of economic activity than does the government's PPI or the opinions of the FOMC. Housing starts were down a massive 7.8% to their lowest level in a year.

This decline is not a blip, but the beginning of a trend. Housing construction, the biggest driver of our economy for four years, is slowing. The speculative fervor in housing prices also continues to be rapidly deflated. Already we are reading stories of people who are trapped with negative equity. Refinancing activity is also crashing... an indication that the housing ATM and its affects on consumption are going away. How did housing stocks react to news of their industry's cyclical decline? After a weak open, a buying frenzy took place, pushing the homeys to about a one percent collective gain ahead of the FOMC minutes. By day's end, the sector was up a whopping 3.6%! Even Building Materials Holding, a company whose profits are directly proportional to home construction activity, managed to rally.

I can only imagine news of weakness in housing was interpreted as further proof that the Fed will stop raising rates, and maybe even cut them, thereby coming to the rescue. But the Fed cannot rescue the housing industry, even with massive rate cuts. So much of the recent housing activity was bubble behavior... speculative buying and flipping... that cannot be re-ignited once cooled. Mass psychology will not allow for such a thing. In fact, should the Fed immediately start cutting rates, things will only get worse because the dollar will collapse, our government will not be able to sell bonds, and longer-term rates will soar. Then an unwary public will be trapped... trapped like the Fed... because long-term rates influence economic activity and asset prices to a greater degree than do short-term rates. Housing prices and stock prices will spiral, at least in real terms, and our citizens will find they have no escape from a declining standard of living.

This evening I will follow earnings reports from IBM, Motorola, Seagate, Texas Instruments, Washington Mutual, and Yahoo. How the market reacts to these companies will tell us more about the validity of today's rally which, by the way, I intend to use as an opportunity to sell more shares of companies I don't own.

Disclosure: Short BMHC; Long BMHC, YHOO puts


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