Contrarian Statistic: Credit Card Delinquencies Drop to 8-Year Low!?

From CNNMoney.com

"The number of consumers behind on their credit card payments fell to an eight-year low in the first quarter of 2010, the American Bankers Association said Wednesday. Overall, delinquencies across a wide-range of consumer debt categories have also fallen. High unemployment and plummeting home values during the financial meltdown appear to have spurred consumers to shore up their finances and banks to limit their lending, resulting in fewer Americans being late with payments, the industry group said. About 3.88% of bank credit card accounts were past due by 30 days or more in the first quarter of the year -- the first time since 2002 that the rate has fallen below 4%, the ABA said Wednesday."

As a contrarian investor I always find these kinds of figures interesting because people often do the opposite of what they should be doing (as is often the case when they make stock decisions). Common sense would dictate to many people that when the economy gets rough outstanding consumer credit would increase, as would delinquency rates, and when the economy is doing well people would use their additional wealth to pay off debt.

In reality, however, historical data shows the opposite, as this story does. When times are tough and they have less money consumers choose to repay debt faster. Conversely, they pile up debt when times are good even though that is when they actually have the money to pay cash! Very odd, but not at odds with other data that has shown that consumers and investors often do the opposite of what might be considered obvious to many (such as buying more stock after a price decline and selling shares into a significant rally).

Is a Boom in U.S. Homebuilding Coming?

Crazy headline, right? At first I thought the same thing. After all, with nearly 10% unemployment and a flood of foreclosed properties hitting the market, why would anybody need to dramatically boost new home construction anytime soon? Last week I saw a statistic from a former Goldman Sachs economist that estimated new home demand in the United States (from the combination of new household formation and the replacement of old homes) of approximately 1.5-1.6 million units per year. Given that the U.S. population is around 300 million, this figure does not really stand out as being unreasonable, and it is in-line with other forecasts I have seen.

In the short term, current inventory combined with foreclosures, weak loan demand from the recession, and tighter credit standards all contribute to the fact that new housing starts in the U.S. today are near record low levels, coming in at an annualized rate of around 500,000 per year. At some point, however, it does seem likely to me that housing starts would have to begin to trend upward toward that 1.5 million figure, which is three times the current annual run rate.

Before you dismiss this potential need for new homes as being years and years away, consider the graph below showing annual U.S. housing starts from 1991 through 2009.

You can easily see the effects of the housing bubble (from the early 2000's through the 2005 peak of more than 2 million units), which resulted in home construction far outstripping demand (by 400,000-500,000 units if you use the 1.5-1.6 million base demand estimate). However, we also see if we ignore the bubble period that housing starts of 1.5-1.6 million per year would simply put us back to the level housing starts were in the mid 1990's, when the U.S. population was much lower than today.

Despite the foreclosure glut we have in many states nowadays, this chart makes me think that the current housing start rate of 500,000 or so per year really is not sustainable for any prolonged period of time. Such a thesis would lead one to consider analyzing the leading homebuilding companies to try and find some attractive long term investment opportunities. Accordingly, I will share some data and thoughts on specific companies with you once I conclude my work on the leading publicly traded U.S. homebuilders. Do you have any favorites, or do you think this investment thesis is unattractive?

Data Shows Trend Clearly Pointing To Job Gains Soon

There will be no way to argue that the job market is healthy until we see sustainable job growth but this morning's monthly non-farm payroll data (preliminary figures for November show net payroll declines of only 11,000 workers, the best monthly performance since December 2007) continues to show that the trend in layoffs is moving in the right direction.

The Obama administration will continue to get heat as long as net layoffs are still being recorded (and they will be in trouble if the jobs picture does not improve by the mid-term elections next year) but if we look at the monthly job figures so far this year, it is hard not to be optimistic about the trend:

From this chart it looks like those predicting net job gains by year-end or early 2010 at the latest may in fact be proved correct, which would be great news for the U.S. economy and stock market alike.

Corporate Tax Breaks For Hiring Workers Won't Work

There is chatter today that Congress is considering new tax breaks for corporations that hire unemployed workers. On the face of it this might seem like a good idea; incentivize companies to start hiring again. The only problem is that this is yet another example of a tax cut that won't work. Proponents of tax cuts seem to think they can solve any problem in a capitalist economy, but that argument defies logic much of the time.

I have long argued that cutting the capital gains tax from 20% to 15% (as the Republican-led Congress did under President Bush) did nothing to boost demand for stock market related investments. The argument seemed to be that lower tax rates on profits would encourage more capital being allocated to the market, but that conclusion falsely assumed that the chief reason investors buy stocks is to save money on taxes.

In reality, we buy stocks if we think we can make a profit from doing so. Nobody was avoiding the stock market because of a 20% tax rate of capital gains (which, if anything, would encourage investing since it was lower than the income tax rate). They were avoiding the market because they didn't think they could make good money in it. Cutting the tax rate on stock gains from 20% to 15% doesn't make investing any more attractive to people because a 20% tax rate wasn't what was holding them back to begin with.

The situation with any corporate tax break for hiring unemployed workers is essentially the same. Companies don't hire workers based on tax rates, they hire them based on whether they need them in order to produce the amount of goods and services demanded by their customers. No competent CEO is going to hire a worker he or she doesn't need simply to get a tax break. That would be like making a charitable donation simply to get the tax deduction (you wind up foolishly spending a dollar in order to save 30 cents).

Don't get me wrong, I am all in favor of incentives (unfortunately, our country all too often needs to rely on them to get people to do productive things they otherwise wouldn't), but we have to match up the incentive with the desired behavior. If we don't, it's just wasted time, money, and effort.

Income Tax Rates Must Rise To Offset Higher Deficits? Not So Fast.

Per one's request, my latest quarterly letter to Peridot Capital clients included a section on the current macro-economic outlook for the United States. The question they wanted me to address had to do with possible hyperinflation resulting from ever-increasing budget deficits at the federal level. As with any question like that I try to completely ignore everything I have heard and instead rely on what the numbers tell me to form an opinion. Numbers don't lie, people do.

The latest set of numbers I have looked at are very interesting and so I thought they were worth sharing. The consensus viewpoint today is that higher budget deficits will ultimately lead to higher income taxes on Americans, which is likely to hurt the economy over the intermediate to longer term. Interestingly, historical data does not necessarily support his hypothesis. Let me explain.

Despite current political debates, which are more often than not rooted in falsehoods, the United States actually saw its level of federal debt peak in 1945, after World War II. Back then the federal debt to GDP ratio (the popular measure that computes total debt relative to the size of the economy that must support it) reached more than 120%. Even after a huge increase over the last decade, currently the ratio is around 80%. As a result, our federal debt could rise 50% from here and it would only match the prior 1945 peak.

Given all of that the first question I wanted to answer was "how high did income tax levels go after World War II to repay all of the debt we built up paying for the war?" After all, the debt-to-GDP ratio collapsed from 120% all the way down to below 40% before President Reagan spent all that money in the early 1980's. Surely tax rates went up to repay that debt, right?

The reality is that the top marginal income tax rate went down considerably over that 35 year period and even if Congress maintains the top rate at 39.6% (up from 35% under President Bush) the rate will still be near historic lows since the income tax was first instituted nearly 100 years ago.

Below is the actual data in graphical form. All I did was plot the top marginal income tax bracket along with the federal debt-to-GDP ratio. This makes it easy to see what was happening with tax rates as debt levels were both rising and falling over the last 70 years.

As you can see from the data, tax rates did not go up even as debt was paid off dramatically. As a result, it appears to be a flawed assumption that increased federal borrowing automatically means we will have to pay higher taxes in the future. Political junkies won't like what this data shows, but again, numbers don't lie.

Contrary To Media Reports, Rising Housing Starts Are Not A Good Sign

From the Associated Press this morning:

"Construction of new homes jumped in May by the largest amount in three months, an encouraging sign that the nation's deep housing recession was beginning to bottom out. The Commerce Department said Tuesday that construction of new homes and apartments jumped 17.2 percent last month to a seasonally adjusted annual rate of 532,000 units. That was better than the 500,000-unit pace that economists had expected and came after construction fell in April to a record low of 454,000 units. In another encouraging sign, applications for building permits, seen as a good indicator of future activity, rose 4 percent in May to an annual rate of 518,000 units. The better-than-expected rebound in construction was the latest sign that the prolonged slump in housing is coming to an end, which would be good news for the broader economy."

Pretty lousy analysis if you ask me. It is true that more construction will show up in GDP calculations as so-called "economic growth" but the idea that growth in housing starts is good for the housing market and means the housing recession is coming to an end is completely wrong.

In case the AP hasn't noticed, housing prices are cratering due to a supply-demand imbalance. When supply exceeds demand, prices drop (economics 101). It is widely believed (and I agree) that a bottom in housing prices (and therefore an end to the housing recession) is needed before the U.S. economy can really begin a sustainable recovery (such an event would boost consumer confidence and spending, and help the banks feel better about extending credit). In order for home prices to stabilize, we need the supply-demand picture to balance out.

How will supply and demand meet if we build more supply when the problem has been (and continues to be) an excess supply of unsold homes? They won't, which is why a pick up in housing starts will only serve to prolong the housing recession, not help to curb it. Hopefully the pick up in May is a one month phenomenon.

Merrill Lynch's David Rosenberg Gets Less Negative

For those of you who don't know Merrill Lynch chief economist David Rosenberg, he has been very bearish on the U.S. economy for a long time, long before the recession hit. Some give him credit for predicting how things would play out, while others criticize the fact that he was years early and therefore missed a lot of the upside before being right about the drop. Both points are reasonable, but I bring his name up because he was on CNBC this afternoon sounding much less bearish than any other time I can remember. Not bullish (heaven forbid), but not all that negative either.

Rosenberg pointed out that the stock market typically bottoms out about 60% to 65% of the way through a recession, which by his projections means we are about 90% of the way through this bear market. His downside target for the S&P 500 is 600, but he oddly adjusted that downward after his original level of 666 was reached "too early." He gets to 600 by taking $50 of earnings and applying a 12 multiple. As you can guess for my recent writings, a 12 P/E on trough earnings is much more reasonable in my view than some of the single digit predictions of other strategists.

I typically don't put too much weight in the absolute predictions of either the most bullish or most bearish people on Wall Street because both groups tend to stay in their respective camps far too long (Meredith Whitney comes to mind). That said, when long term bears begin to get more positive, it says a lot for where the market and economy are. If you can get people who hated stocks and panned the future prospects for the U.S. economy, to become even mildly bullish, I think that says something about how much negativity is priced into equities.

No, Canada Isn't Evil

Did you know that more North American cars are manufactured in Ontario than in Michigan?

Unfortunately, our country's political tensions are so elevated that anyone who even suggests the possibility that another country may do something better than the U.S. is labeled unpatriotic. Of course, those suggestions are made because the person making them cares deeply about our country's future, but that point often gets ignored.

Fareed Zakaria of Time Magazine penned an interested piece in the 2/16 issue entitled "The Canadian Solution." In it he points out several areas in which Canada's government policies appear to be working better than ours. Maybe if we finally can admit that not everything we do in the U.S. turns out to be perfectly right, we can begin to at least consider other kinds of policies without being labeled un-American.

It became clear from President Obama address last night that healthcare reform will be on his agenda in 2009. A likely focus for such reform will be making sure that every American has health insurance. Such a task will undoubtedly be bad-mouthed by many, labeled as socialism.

"Let the free market work, we can't be socialists like Canada and France!," they'll say. The free market is usually great, but if you have been diagnosed with a disease and lose your job and employer-based insurance plan, you often can't turn to private health insurance provided by the free market. Either the insurance company will refuse to cover you at all (because they won't make a profit on someone who is sick), or they'll charge you a few thousand dollars a month, which obviously you can't afford. The free market works most of the time, but not all of the time, as the sub-prime bubble has taught us so well.

Zakaria's article uses evidence from Canada to try and show us that sometimes other countries get things right more often that we do. Simply pointing out facts does not make Zakaria unpatriotic, it simply suggests that he believes we should keep an open mind about certain important issues. After all, if our system isn't working very well, but we refuse to adopt the ideas of other countries, then how can we ever expect to make improvements?

Below are some excerpts from Zakaria's article:

"Guess which country, alone in the industrialized world, has not faced a single bank failure, calls for bailouts or government intervention in the financial or mortgage sectors. Yup, it's Canada. In 2008, the World Economic Forum ranked Canada's banking system the healthiest in the world. America's ranked 40th, Britain's 44th."

"Canada has also been shielded from the worst aspects of this crisis because its housing prices have not fluctuated as wildly as those in the United States. Home prices are down 25 percent in the United States, but only half as much in Canada. Why? Well, the Canadian tax code does not provide the massive incentive for overconsumption that the U.S. code does: interest on your mortgage isn't deductible up north. In addition, home loans in the United States are "non-recourse," which basically means that if you go belly up on a bad mortgage, it's mostly the bank's problem. In Canada, it's yours."

"Ah, but you've heard American politicians wax eloquent on the need for these expensive programs (interest deductibility alone costs the federal government $100 billion a year) because they allow the average Joe to fulfill the American Dream of owning a home. Sixty-eight percent of Americans own their own homes. And the rate of Canadian homeownership? It's 68.4 percent."

"Its health-care system is cheaper than America's by far (accounting for 9.7 percent of GDP, versus 15.2 percent here), and yet does better on all major indexes. Life expectancy in Canada is 81 years, versus 78 in the United States; "healthy life expectancy" is 72 years, versus 69. American car companies have moved so many jobs to Canada to take advantage of lower health-care costs that since 2004, Ontario and not Michigan has been North America's largest car-producing region."

Tax Cuts Alone Won't Boost Employment

Terry submits an email saying:

"Tax cuts to increase American companies' ability to compete, lower corporate tax rates, lower capital gains rates and repatriate that $500B plus overseas that companies don't want to pay 35% confiscatory tax rates on. Stop pandering to the lowest common denominator and grease the skids for what has made this country great, CAPITALISM!"

I agree with one of the three tax ideas Terry supports; the last one. The other two, while certainly fine on their own merits, don't do anything to boost job growth, which is why our economy is in the tank right now After all, consumers represent 70% of our GDP and when they are losing their jobs, they have less money to spend.

Corporate tax reductions would boost stock prices (which I would obviously be happy about) but they don't directly create jobs. But if companies have more money, won't they hire more workers? Not if they don't need more workers! Corporate America is shedding jobs because they need fewer people now that demand for their products has dropped. The current round of layoffs is being done to "right-size" their organizations for the amount of business they have now, which is less than it was during the loose credit, low unemployment era of 2004-2007.

Without increased demand, there is no need for a larger workforce, and therefore companies won't hire people. Profits would increase, making share prices more valuable and it easier to pay dividends and buyback stock to boost shareholder value (which is why Wall Street would applaud corporate tax reductions), but without the need for more workers, companies won't hire just for the heck of it, even if they have more money that is not being sent to the government.

I'm all for corporate tax reductions, but they aren't getting much traction right now because the focus is on job creation because the unemployment rate is on track to double between 2007 and 2009 (~4.5% to ~9.0%). With consumers representing the bulk of our economy, job loss is truly the thorn in our side.

I have written before about the capital gains tax argument, and I find it even less compelling than corporate tax reductions for two reasons:

1) Nobody has any capital gains

The stock market has fallen 50% and housing prices are down 25%. Most taxpayers who have investments are going to deduct capital losses on their tax returns because very few things are being sold for a profit right now. Now, they should certainly increase the annual maximum capital loss deduction (it has been $3,000 for too long), but reducing the capital gains tax rate actually hurts those of us who are deducting stock market losses on our tax returns because we would get a smaller deduction if the rate was lowered!

2) Investments are not made based on tax rates

The argument against that first point focuses on future investments, not money that has already been allocated. If capital gains tax rates are low, the argument goes, people will have more of an incentive to invest and capital will again flow into the economy.

I love the idea of incentive-based policy, but this idea assumes that investor capital is sitting on the sidelines right now because capital gains taxes are too high. I think that is completely wrong. People stop investing if they think they'll lose money and they invest more if they think they'll make money. Nobody is going to forgo an investment they believe they can make a killing on because they have to pay 15% capital gains tax on any profit they make. Incentives are great, but they have to target the things that prompt whatever behavior you are trying to promote.

Will Obama's Stimulus Plan Work?

As President Obama gets ready to sign the 2009 American Recovery and Reinvestment Act later today, a common question is, will it work? Of course we won't know for a while, but my honest non-partisan opinion is "a little bit." There is little doubt that parts of the bill are positive for our country and the employment situation, whereas others are likely to not do us any good. I think that the extreme views on either side, that this bill will either bring us out of recession or make it far worse, are both unfounded.

In particular, there are some people that insist FDR's New Deal in the 1930's prolonged the Great Depression, and only when World War II began did the economy rebound. They use this argument to imply that this stimulus bill (a mini New Deal of sorts) will further cripple our economy. I just wanted to share the chart below with everyone in order to debunk this myth.

Arguing that government spending does not create jobs is pretty silly. You can certainly take the position that government should not do anything (let the market work!), or that we are spending too much money when we are already in debt (to the tune of $10 trillion!), but denying that building a road, or upgrading a power grid, or funding medical research grants will require incremental workers is a pretty strange assertion.

The idea that tax cuts are a better means to create jobs is odd too because giving a tax cut to an unemployed person (who isn't earning any money) doesn't really help them very much, and it certainly doesn't get their job back. An extra $13 per week (or whatever the number is) might help people pay their bills, but it can't boost demand enough to force companies to need to hire more workers to meet that demand.

All in all, I think this bill is far from perfect and I don't think it will have the same impact as the New Deal did on our economy. That said, there is no reason to think it won't have some impact. Probably not enough to return to positive economic growth and falling unemployment anytime soon, but before we can grow again we have to halt the decline and hopefully this bill can contribute to that goal. Everyone should hope it works, whether you supported it or not.