The consumer is tapped out. After consistent 25 basis point increases to the Federal Funds Rate, we are finally starting to see the effects on the stock market.

Yesterday morning we saw three headlines that caught my attention. The first detailed Sears’ guidance for this quarter – a reduction from $2.12 to from $1.06 to $1.32 per share. These revisions are, at best, a 30% reduction and, at worst, a 50% reduction from their previous optimistic estimates.

Notably, declines were across all categories. If you follow the theory that the consumer is on thin ice, then it is hardly surprising to find big ticket items are not being purchased. Sears is having trouble selling new stainless steel fridges and widescreen TVs because consumers do not feel confident about their financial situation. The only sector that wasn’t hit as hard was women’s apparel and footwear – suggesting stressed housewives may be engaging in retail therapy.

The second headline noted that Home Depot is now expecting a 15% to 18% drop in earnings per share for fiscal 2007, as opposed to their previous guidance of 9%. This is a further example of a, supposedly wise, management team who were unable to predict the severity of the downturn.

All should take note – when pundits tell you the housing crash will be over by Q4 of this year, they are making a foolish guess. Furthermore, even if they are right, do not expect the market to rebound. Burnt fingers will not be so quickly back into the fire.

Home Depot’s response to this downturn was particularly ironic:

Home Depot, which has more than 2,000 stores in the United States, Canada, Mexico and China, said Tuesday it will open approximately 108 new stores in fiscal 2007.”

Lastly, this tidbit was to be found in Yahoo’s summary of the Best of Today’s Business:

More than 2 million subprime, adjustable-rate mortgages will be reset to much higher interest rates over the next several months, raising monthly payments for people with weak credit. In October alone, a record $50 billion in ARMs will reset, said Mark Zandi, chief economist of Moody’s Economy.com. Consumer groups fear this could spark a new wave of foreclosures.” (emphasis added)

Many commentators speak about the small impact of subprime foreclosures (e.g. here) as if somehow the problems stop with subprime. However, the problem is a continuum, beginning in subprime and extending all the way into Alt A.

The housing sector is in far worse shape than the experts on Wall Street realize – yesterday we saw a pull back in the market, and the futures this morning point to a similar flat or down day. However, over the past months, Wall Street has failed to price in the poor economic outlook. Yet, here is an example of the situation consumers face:

Arizona’s only publicly traded home builder must write off $100 million on land and operations after a second quarter in which home orders fell 28 percent and new-home cancellations climbed to 37 percent, according to preliminary numbers released Friday.

New-home cancellations have left the Valley’s housing market with at least 20,000 homes built but unsold. Builders have offered hefty incentives of $50,000 and more to sell the houses, but many potential buyers can’t sell their existing homes.

The result is a glut of homes for sale…”

Granted, Arizona is one of the worst locations, but it isn’t the only region to suffer this problem. While subprime mortgagees have low credit ratings, they don’t necessarily purchase in low socio-economic areas. Subprime foreclosure properties can not be neatly segregated into a single suburb.

We are just starting to see the fall out.

With Wall Street starting to show signs of reduced consumer spending, both due to fear and also due to rising costs (see “M3 money supply”), businesses will be reducing inventory and preparing for leaner times. This will sap at business confidence and reduce capital expenditure. As more home loans reset from teaser rates to rates approaching double digits, consumer disposable income will further decrease. If foreclosures continue to rise, we may witness further financial strain, as seen with Bear Sterns two weeks ago.

In short, the situation is unlikely to improve from here. The next 6 months do not look good.

If you haven’t already, take a look at the S&P500 over the last 6 months – notice the recent double top and the market’s inability to rise to new highs. My thoughts? Consider moving at least a portion of your holdings to cash if you can.

Philip John

This post is for entertainment purposes only. No part of this post should be construed to constitute investment advice. The author is not an investment professional and assumes no responsibility for any investment activities you undertake. Prior to undertaking any financial decisions, you should contact an investment professional.

Great article! Countrywide announced the other day that they don’t see the housing market rebounding until 2009. With the amount of foreclosures that are coming (and there will be hundreds of thousands of them) those people won’t be spending money and their friends and neighbors will be afraid to spend money and fall into the trap that caught their friends.

Even people with good jobs are over extended. Everyone I know, most everyone in my neighborhood is leveraged to the hilt because, “Housing prices will go back up and we’ll be ok.” Yeah, if you can survive a number of years in the cellar, you might get back to the first floor.

To quote Dave Ramsey, “Cash is King.” If you don’t have it saved up, you’re toast.

– Invest in peace…

Comments are closed.