Impact of Fed Tightening Still Ahead Comstock Partners, Inc. Thursday, March 16, 2006
For both technical and fundamental reasons, the market’s move to new multi-year highs over the last few days is unlikely to spark a dynamic new move to the upside. The intermediate uptrend is already six months old and therefore does not indicate a trend reversal. In addition the daily volume during the price rise of the last few days was actually lower than the volume on the down days that preceded it, a most unusual occurrence if this was to be the start of something big. In fact the action of late resembles an aging intermediate trend that is slowly running out of gas.
Fundamentally, the main reason for the rise seems to be the widespread opinion that the impending end of the Fed tightening policy will spark the economy and market. An important contributing factor is the seeming strength of the economy that is reflecting a bounce back from hurricane Katrina, the warmest January in 100 years and the continuing flow of cash from home equity withdrawals (MEW).
It seems to us that the impetus from the pending end of Fed tightening is already in the market and that the question from this point is what effect the long series of interest rate hikes will have on the economy. History tells us that the Fed always stops tightening too late and that the economy then slows down sharply or goes into recession. The lead time between interest rate hikes and their effect on the economy is anywhere from six months to as long as two years. Therfore when the central bank stops raising rates the impact of the last few hikes continue to impact the economy for some time thereafter.
As we have pointed out previously the long period of gradually rising rates is already resulting in a distinct softening of the housing market. This alone, however, is not reason enough for the Fed to stop raising rates as they are also considering the potential inflationary effects from what they term tightening resource utilization, the Fed’s shorthand way of referring to a low unemployment rate. In a speech given today at a European Central Bank forum in Frankfurt, Fed governor Donald Kohn attacked the notion that the Fed would always protect investors from sharp asset drops including housing. He stated, “All else being equal, interest rates are higher now than they would be were real estate valuations less lofty; and if real estate prices begin to erode homeowners should not expect to see all of the gains of recent years preserved by monetary policy actions.”
The evidence pointing to a slowdown in housing is overwhelming, and it is highly likely that home prices will decline, possibly by a lot more than most investors think. Existing home sales have been down for five consecutive months and new home sales for four of the last six months. Even the National Association of Home Builders (NAHB), never an organization prone to pessimism, is forecasting a drop in home sales this year. The ratio of inventories to monthly sales is at a nine-year low. We could cite a lot of other numbers, as we have in previous comments, but you get the picture.
As home sales start to decline and inventories of unsold homes (both new and existing) continue to rise, home prices will likely decline and lead to a sharp slowdown in consumer spending. According to Goldman Sachs, an estimated 68% of MEW go into consumer spending. In addition, according to a recent Wall Street Journal article, Moody’s Economy.com estimates that the real estate industry created about 1.1 million new jobs of the 2 million net jobs crated in the U.S. in the five years ended October 2005. In sum, we believe that the market will soon stop cheering the impending end of Fed rate rises and start to worry about the severe impact of these rate rises on housing, consumer spending, the economy, and the stock market.
Market Data 
Markets 
AI
