Pay your mortgage & grab your scuba gear

Good morning everyone!

I have some not very good news to report. Santa Ana, California’s First American CoreLogic is reporting that 23% of homeowners in the U.S., or a staggering 10.7 million households, owe more on their house than the house is worth!! What’s more, as I reported yesterday, home prices continue to fall as home sellers keep dropping their prices to sell their houses. [If ever there were a buyer’s market, this is it.]

Clearly this is not a good thing and bodes extremely ill for the economy and especially for investing in the financial markets. Like it or not, one of the big sources for a soaring stock market is people feeling good about themselves and about their finances. In the credit/real estate bubble many people were taking excess risk in their investments by willing to pay crazy prices for both homes, stocks and mutual funds. Why? Because many people knew their approximate net worth as it stood on paper. This fueled over confidence which fed a lift off in asset prices which fueled yet more over confidence. Unfortunately, the reverse is also now possibly true.

What causes a rise in asset prices? Demand for those assets above the supply of those assets. There are only so many stocks, bonds and houses to invest in. So our focus should be on the demand for those assets. What drives that? Typically it is excess funds. Where do those funds come from? A raise or bonus at work, an inheritance, lower monthly expenses garnered by refinancing your house, more cash freed up by a home equity loan, etc. The two biggies can be roughly characterized as: work and mortgage. So where does the U.S. economy stands with those two sources of excess liquidity?

Unemployment is hovering around 10.0%. But even if you aren’t unemployed rationality dictates that you have to be concerned and careful about your job performance and your spending until the unemployment situation improves, yes? That means that raise and that bonus are likely going to pay off debts or into savings accounts, not into stocks.

Today’s news about 23% of U.S. households being underwater on their mortgages is clear evidence that no new borrowing is really going to be taking place for quite sometime by these unfortunate folks.

Yet the stock market is partying like its 2006-2007 all over again. True overall valuations stand at a P/E of about 15x vs. around 29x in that era, but 15x is at the upper end of rationality at this juncture. My point is that there continues to be very shaky news about the health of the U.S. economy. I felt that equities were a screamin‘ friggin‘ buy in March, but right now I would be very, very, very selective.

Dark spectres still loom over the economy:

1. Unemployment of 10%.

2. The number of negative equity homes in the U.S. stands at 23%.

3. The lack of revenue growth of U.S. corporations – all profit growth is coming from cost cuts. The problem is that one company’s cost cut is another company’s lost revenue or a household’s lost paycheck.

4. Rising commodities prices are a damper on profits. And the threat of war with Iran still is a possibility.

5. A distracted Congress still not fully addressing reform of business practices and better regulation.

6. Over reliance on foreign debtors to finance the U.S. economy, especially consumer spending.

I could go on, but except for #4 these are big, big structural problems that require aggressive effort to rectify. In conclusion: I am no bull right now on U.S. equities.

Jason