Wkly. Rcp. & Outlk. – 10.22.10

Tower Private Advisors


  • Not much
  • Earnings
  • Foreclosures

Capital Markets Recap

The Australian index (-5.83%, above) reflects the tight connection of that economy to the Chinese economy, the authorities of which announced the first change to its equivalent of our Federal Funds rate.  The proactive Chinese monetary authorities, in contrast to our bubble-blowing Fed, seem intent upon throttling inflation.  At the margin, that will slow its economy, reducing its voracious commodity appetite, much of which is satisfied by the proximate commodity producer, Australia.

Top Stories

The big stories of the week continued to be centered around earnings.  Thus far, 117 companies have reported earnings this week. 

  • 88% (103) beat their earnings estimates
  • 12% (14) missed estimates

The average earnings surprise was 10.55% better than the estimate, and year-over-year growth averaged 51.62%.  The best year-over-year results were reported by companies in the finance sector, where growth ran at a 232% year-over-year pace.  Next week will see results from 179 (35.8%) of the S & P 500 companies.  That will mark the busiest week of the third quarter earnings reporting season.

As usual, the earnings vis-a-vis expectations mattered little to the stocks.  Pictured below is a scattergraph of EPS results and 5-day stock price change.  The earnings surprise is on the horizontal axis.  If it’s to the right of the y-axis, the surprise was a positive one; to the left, a negative one.  The vertical axis measures the 5-day price change for the stock.  If above, the change was positive; if below, negative. 

The red line is fitted to the results such that it best captures the data.  It uses the least squares method.  It says that there is almost no connection between EPS results and stock price–or at least for this week.   Technically speaking, the EPS results explain less than 1% (0.81%) of the stock price movement.  That’s why I’m not going to bother you with individual company results.  They really didn’t matter, in aggregate.  A former colleague was fond of reflecting on the importance of earnings reporting season, but very often the results don’t matter at all.

Foreclosuregate seems to be making a fair number of headlines, and the foreclosure subject is showing up in Google searches in record occasions in 2010, as the chart below indicates.

One of my three esteemed colleagues recently penned a missive intended to cut through the media feeding frenzy on the so-called foreclosure crisis.  I asked his permission if I could reprint it in this format.  Taking silence as consent I include it below.  While every emanation of mine undoubtedly induces a cringe in my coworkers–and keeps the pink paper close at the hand of my superiors–no doubt this one more.  Here it is, hoping I’ve removed anything you shouldn’t see–oh, and here’s Jim.

With all of the negative press heaped on banks recently, I’ve been a little reluctant to go out in public for fear that I’ll be dragged into another conversation about how poorly we bankers are treating the public–the latest issue of course being foreclosure abuses. There are a lot of misconceptions floating about on foreclosures so I thought I’d use this opportunity to give you some straight talk so you can feel comfortable discussing the topic in your public moments.

What really happened? A couple of fundamental issues conspired to create the current mess. The most important was that housing policy changed during the Clinton administration, which translated into Fannie Mae and Freddie Mac (the giant government sponsored entities created to make a market for long term mortgage loans) relaxing mortgage lending standards (think no money down, no-income no-asset verification, teaser rates, option ARMs, etc). This attracted money into the mortgage market, spurring home purchases and new construction. At first, end-user demand was sufficient to absorb the new activity, but a funny thing happened (as it generally does); people saw opportunity to invest in housing and another round of construction started. Eventually the supply of new housing was so great that it far exceeded real demand. Along the way cheap and easy financing contributed to housing prices being bid up well beyond the value of its underlying utility (that is its value based on the reasonable paying capacity of its occupant–think California where a 1,200 square foot house would sell for $500,000). The bubble was born; prices that didn’t reflect real value coupled with an oversupply. As they always do, markets corrected and the bubble burst. (Interestingly, one of the first recorded economic bubbles occurred in 1637 when people went crazy in Holland pushing the value of tulip bulbs to as high as $1,250 per bulb in today’s currency.)

So far I have described what happened nationally. Here in Fort Wayne we, fortunately, didn’t experience the price run-up and overbuilding problems. We did see an increase in homeownership as people previously unable to qualify for mortgage financing benefitted from the relaxed standards. While we avoided the worst of the issues, we are still connected to the larger economy, and when the national housing market collapsed (in California, Florida, Nevada and Arizona) pushing the US economy into recession, we felt it here. The recession impacted local jobs and borrowers at risk due to high DTI (debt-to-income) and LTV’s (loan to value) found it increasingly difficult to stay current on their loans; hence our local foreclosure problem.

So where are we today? According to Realtytrac.com, currently there are 1,475 homes somewhere in the foreclosure process in Allen County. While high, this number is actually down about a third compared to last year, perhaps suggesting that the problem is abating. Still, we have a modest excess of supply of housing in the local market, which continues to keep a lid on new construction. I suspect locally we have seen the worst of the foreclosure problem, but improvement will continue to be slow as it is dependent on employment growth which is tied to the strength of the national economic recovery.

Graig Stettner, CFA, CMT

Vice President & Portfolio Manager

Tower Private Advisors


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