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Thoughts on Housing, Bullish Market Stance, and the Loonie

Am I Ever Going to Stop Talking About Housing?

I don't think I'm going to stop talking about housing until... oh... late 2008. On top of it impacting the economy, it also presents potential opportunities. Housing-related sectors are some of the most contrarian sectors out there.

Paul Krugman of New York Times recently summarized some key housing charts in his blog entry. The charts easily illustrate the high-level view of what is unfolding. Check out the link to get a quick overview of the unprecedented boom in housing, and the inevitable unprecedented collapse that is unfolding.

All the charts that were referenced by Paul Krugman are important but the one that contrarians may want to pay attention to is the one on defaults by mortgage origination year. The key insight, to me, is that securitizations before 1995 were fairly good--even for subprime. But anything after 1995 (or thereabouts) is highly questionable. I am thinking of investing in Ambac (ABK) (I reviewed it yesterday) and one reason I have greater confidence in ABK's ability to survive and do well is because most of their insured securities are pre-1995 securities.

The real question for contrarians is how much further can this sector get hit.


(source: finance.yahoo.com)



The chart above is of some homebuilder stocks that have price data back to the early 90's. There was a housing collapse and a recession in 1990/1991. Interestingly there was also a Savings & Loan crisis which wiped out many banks and the present situation sounds eerily similar. I'm reading John Neff's book, John Neff on Investing, and he talks about how Citigroup (called Citibank back then) was beaten down badly in 1991 due to the financial crisis arising from housing. He analyzed the company and thought that it was being sold off for the wrong reasons. His investment in it turned out to be a success. I'm thinking that some of the leading Wall Street businesses, whether it is Bear Stearns (BSC) or Merril Lynch (ML), or mortgage lenders like Countrywide Financial (CFC), or whatever else, may be home runs for some investors. I personally think Ambac (ABK) may be similar to what Citigroup was in 1991 (although ABK has much lower upside). Read my investment evaluation of ABK yesterday if you are interested in my feeling (I have no position in ABK but may take a position).

A quick look at that chart shows that homebuilders have declined as much as they did during 1990/1991 (do note that the companies would not have been the same back then so this is just a very rough guide). Since the present housing boom is the largest in a many decades, I suspect homebuilder stocks can decline even further (but probably not much further). John Neff says that a contrarian should buy something like 6 months(??) before signs of a turnaround. My guess is that the best time may be between now and 2Q08. There is a big inventory of homes that need to be worked off, along with big ARM mortage resets early next year, but I am guessing that the market will price that in within two quarters. Practically every leading publication has been talking about housing non-stop for many months now.

John Mauldin also shares some thoughts (req: e-mail registration) on the subprime lending in this week's write-up. He also refers to the Fortune article that I wrote about here. The article by Allan Sloan is one of the best write-ups on the doings--and undoings--of ABS securities so check it out.


Bullish Stance of the Market

Of late--although this has been the case for last for the last 3 years--the market is betting on cyclicals, commodities, and emerging markets. I believe there are two reasons for this.

One reason is the belief by some that inflation is going to high given the Federal Reserve rate cuts (the JCB is also changing their tightening stance and I believe the Yen carry-trade has a bigger impact than even the Federal Reserve). This is why commodities keep going up very few changes on the economic front. For instance, oil has been going up a lot lately but a huge chunk of that is due to the US$ decline. I personally don't think inflation is going to be high in the future.

The other reason, and this is what I was going to talk about, is the view that the rest of the world will hum along while the US economy slows down. The hope is pinned on the BRIC countries. My view right now is that USA will impact the rest of the world. I don't see how the rest of the world can keep their economies going when most of them are export-oriented. Michael R. Sesit of Bloomberg shares my view:

China's growth has been fueled by exports and investment, not consumers, whose share of the country's gross domestic product is declining. From almost 80 percent in the first half of the 1980s, Chinese household consumption fell to 46 percent of GDP by 2000 and shrank further to 36 percent in 2006.


A lot of investors simply look at the overall growth rate in China but fail to realize that most of the growth is due to exports or fixed-investment (fixed-investment refers to building roads, stadiums, etc). It is questionable that emerging markets can keep chugging along at a high growth rate if USA slows--and it looks like USA will slow down (consensus GDP estimates are below 2% for the last quarter right now).

Furthermore, the size of their economies are small:

Although developing countries are projected to account for about three-quarters of global growth in 2007, their size is still too small to power the world economy. Take the four BRIC nations: Collectively their GDP amounted to $5.6 trillion at the end of 2006. That's 43 percent of U.S. GDP, 56 percent of the 13- nation euro area's and 130 percent of Japan's.

When it comes to stock markets, the gap is even wider. The aggregate free-float value of the Brazilian, Russian, Indian and Chinese stock markets is a mere 4.9 percent of world market value, according to Morgan Stanley Capital International. The four BRICs are 12 percent of the U.S. market value, 16 percent of Europe's and 56 percent of Japan's.


The GDP of developing countries in raw terms is quite small as mentioned above. In PPP-adjusted terms they are much larger but the raw numbers are what drives corporate sales numbers for multinational companies.

Nonetheless, ``there are still plenty of vulnerable economies in the emerging-market space,'' says Gray Newman, New York-based senior Latin America economist at Morgan Stanley. South Africa, Turkey, Hungary and the Czech Republic have run current-account deficits averaging more than 4 percent of GDP for three years, while Turkey, Poland, Hungary and India have posted fiscal deficits of 3 percent to 8 percent of GDP in the last three years.


The aforementioned countries are vulnerable and one should be careful investing in them in the near-term. On top of economic issues, countries like Turkey seem to be developing some political problems of late.


Flight of the Loonie

The Loonie for those not familiar refers to the Canadian dollar. It is named after the Canadian bird (loon) that is on the $1 coin:
(source: Image courtesy P199 at wikipedia.org)


The Canadian dollar is up around 30% in the last 2 years, with most of the gains coming this year.

(source: stockcharts.com)


The CDN$ appreciation has killed my portfolio since I hold mostly US$-denominated stocks. But offsetting portfolio losses is the fact that my earnings are in CDN$ (since I'm in Canada). Given that my portfolio is small relative to my (admiteddly somewhat low) working-class salary, this is an overall positive for me. I am bearish on commodities and that's why I don't avoid US$-denominated stocks. The Canadian stock market is heavily concentrated in commodities and financials, and has run up a lot in the last 5 years. I had been expecting the US$ to appreciate (or at least hold steady) this year but that has been completely wrong. Even now, I think the US$ may hold off any losses if the US economy slows.

My long term stance is a bullish call on the Japanese Yen. I have written many times on why (mostly due to the massive Yen carry-trade). My long-term plan is to move more of my money into Japanese stocks. My strategy is to start researching more Japanese stocks, think about their economy and their business climate next year. I'm also planning to read some books (not that books necessarily mean anything). Right now I'm concentrating on the beaten-up housing-related sectors (homebuilders, mortgage lenders, mortgage insurers, housing material suppliers, etc).

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