What happened yesterday? The Dow sold off 93 points. Investors had been hesitating. There’s supposed to be a recovery going on. But the latest news is unsettling. Housing and employment numbers are weak. What’s going on? Maybe this recovery is not a sure thing after all.
“Record numbers late on US loans,” says a headline in The Financial Times.
The story is easy to understand. People without jobs can’t make mortgage payments. So, payments are late on 1 of every 6 FHA mortgages. Mortgage defaults are at a 3-decade high. Of all mortgages, nearly one homeowner in 10 is running late in his payments.
As predicted in this space, problems in the housing finance sector are now shifting from sub-prime to prime mortgages. The subprime borrower had few resources. He washed up as soon as the crisis began. But now the prime borrower, who lost his job and is running out of options, is sinking too.
What’s the smart money doing?
The Dow is now up more than 50% from its March low…and has regained more than 50% of what it lost. Are the insiders taking advantage of this dip to get bigger stakes in their own companies? No… They’re selling 18 times as many shares as they’re buying. Go figure.
The insiders know that their businesses are not really in good shape. They’ve been able to maintain profit margins by cutting staff. But sales are down. And they don’t see where additional sales will come from.
Meanwhile, investors have been hallucinating about a real recovery. They’ve bid up the price of shares as though they expected a stunning period of growth. Generally, earnings have held steady…but stock prices have gone up.
This has brought a 10-point increase in the P/E ratio, to greater than 27.
What would justify such an ambitious P/E? Only growth. Where might growth come from? We don’t know. David Rosenberg says stocks are priced as if investors expected profits to double next year. But it usually takes profits 5 years to double. And then, only when they have a reason to double – such as higher sales and lower costs.
Don’t count on it, dear reader.
for The Daily Reckoning Australia