The continuing deterioration of the housing market and economy with no end in sight is likely to prove highly disappointing to those looking for an imminent bottom in the stock market. Until we get a better idea of the length and depth of both the credit crisis and the economy along with far lower valuations, any attempt to bottom fish is subject to extreme risk.
March housing starts dropped 11.9% from a month earlier while single-family starts have now declined 63% from the peak, the largest drop on record going back to 1960. Permits similarly dropped 63%, also the biggest decline in history. With inventories still exceedingly high and a huge number of foreclosures to come, home prices will fall substantially from current levels.
March foreclosure filings, as reported by Realty Trac, were up a whopping 57% year-over-year. Auction notices were up 32%, indicating that a large number of homeowners are walking away from their mortgages. Unfortunately, there is lot more to come. $460 billion of adjustable rate mortgages (ARMs) are due to reset this year with the peak reset period occurring from January through June. Due to the nature of the legal process, foreclosures tend to lag resets by about six months. Therefore the large number of foreclosures reported for March largely reflects resets that took place in October when the number of resets was far lower than it is today. The huge number of resets occurring in the January-to-June period will result in an explosion of foreclosures six months later-from July through December. This will result in ever-expanding number of homes up for sale with further significant price declines. The weakness in labor markets can only exacerbate this trend.
The effect of the continuing housing debacle make it unlikely that the credit crisis in near an end. As significantly more mortgages default, the massive amount of structured securities that include them will lose even more value and lead to further big writeoffs in coming quarters. Given this scenario, we don't see how so many economists and strategists are so confident the worst of the credit crisis has been seen--and we havn't even mentioned structured securities related to credit card loans, auto loans, student loans and commercial real estate.
Furthermore, it is not true that the economic malaise is confined to housing and finance. First quarter growth in retail sales ex-autos and gasoline was down 2.2%, the most since the first quarter of 2002. When we eliminate food and restaurant sales, two areas boosted by big price increases, retail sales have been down since mid-2007. Ominously, the University of Michigan's consumer confidence index for April was the lowest in 26 years. The industrial production index was off 0.4% for February and March combined, indicating a potential January peak. The Philadelphia Fed Index for April was at its lowest level since 2001. On the labor front, payroll employment has declined for three straight months while continuing initial unemployment claims are the highest in almost four years. We also note that the Conference Board's CEO confidence index is at its lowest point in eight years. This is certainly not a good sign for increased hiring or upcoming capital expenditures.
In sum, it is far too early to look for a bottom in the market. It is the nature of bear markets that investors continually look for bottoms until the very end when they give up and throw in the towel. First they deny the existence of recession, and when they finally recognize it they say it's discounted and that we should "look over the valley" to the recovery ahead. Over the last 50 years bear markets associated with recession have declined an average of 30% from peak to trough. The maximum decline in the S&P 500 in the current cycle has been slightly short of 20%. Furthermore, given the nature of the housing boom and bust and ongoing credit crisis, this bear market has a good chance of being far worse than average. When we also consider that second-half earnings estimates seem far too high and the S&P 500 is selling at an historically high 20 times trailing reported earnings, the case for a significantly more serious market decline is even more compelling.
