11/20/09 London, England – What happened yesterday? The Dow sold off 93 points. Investors had been hesitating. Thereâs supposed to be a recovery going on. But the latest news is unsettling. Housing and employment numbers are weak. Whatâs going on? Maybe this recovery is not a sure thing after all.
âRecord numbers late on US loans,â says a headline in The Financial Times.
The story is easy to understand. People without jobs canât 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.
Whatâs 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… Theyâre selling 18 times as many shares as theyâre buying. Go figure.
The insiders know that their businesses are not really in good shape. Theyâve been able to maintain profit margins by cutting staff. But sales are down. And they donât see where additional sales will come from.
Meanwhile, investors have been hallucinating about a real recovery. Theyâve 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 donât 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 â such as higher sales and lower costs.
Donât count on it, dear reader.
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