Tuesday, March 15, 2011
“So looking back on the past few days, we just had a normal sideways correction within what has been a strong uptrend. The important point it that these uptrends remain intact.
We have been waiting for silver to get disorderly and so far that hasn’t happened. Usually you will see multiple upside breakaway gaps as you get frothy, but we haven’t seen that yet. So there are no obvious signs of a top. Given the strength we saw on Friday, it seems the correction is nearing an end and the uptrend is about to resume.
Eric it took from August until March to get from $18 to $36 so there might be a temptation to sell here and take profits. But the biggest move comes at the end of the trend and it comes much more quickly. So to see silver move $14 from $36 to $50 by the end of June is consistent with the way major trends develop and unfold.
Perhaps the final climb to the intermediate top will not be of that magnitutde, but it would not surprise me if the move was that strong. Let the trend speak for itself until it ends and so far the trend shows no signs of being over so we have to give it every benefit of the doubt.”
When asked about gold specifically Turk stated, “You have almost six months of work underneath the market in the $1,300’s. That provides a massive base that has created the launch pad which will send gold higher.
There is a little bit of a battle going on at the previous high of $1,430, but the momentum is clearly starting to shift in favor of the bulls. The gold bulls have been very patient as gold has essentially moved sideways for the past six months, but their patience is about to be rewarded.
For KWN readers globally if we have gold move to $1,800 and silver to $50, the gold/silver ratio would fall slightly to 36 to 1. In that scenario, all precious metals holders will be happy.
In other words Eric, both precious metals will be rising more or lesss at the same rate. This will be in contrast to the last six months where silver was significantly outperforming gold with the ratio falling from 60 to 39.5 during that time.
Although a lot of people have been focused on the move in silver, but the coming rocket launch in gold will shock the markets.”
Turk is right, the coming move in gold will shock the markets. This will be the wake-up call for investors who have ignored the gold market up to this point.
Ouch. It was the biggest drop in the Dow Jones Industrial Average since August. Markets tumbled yesterday, while fears surged—about jobs, Spain and Saudi Arabia.
But what does this mean for you, the investor?
Was this just a one-day wonder, a buying opportunity, a small but passing cloud on an otherwise sunny horizon? Or was it something more ominous?
The market's next move is always a mystery. It could go up 500 points next week or down 500 points, or stay in range. You shouldn't let one day's price movement govern your financial decisions. It's never sensible to panic. And sure, this could be just a passing storm.
Yet there are reasons to be concerned about what just happened. Maybe I'm being too nervous here. I hope so. When the market sells off, I usually like to find reasons to buy stocks more cheaply. But here are 10 reasons why this 228-point slump in the Dow makes me sit up and take notice.
1. It happened when the price of oil was falling.
For weeks, the market has been worried that the rising price of oil was going to knock the economy back into the hole. But the price of light sweet crude fell $2 a barrel on Thursday to $102. That followed a $1 fall earlier this week. It's still above the critical $100-a-barrel figure that may spell economic trouble. Nonetheless, some relief on oil should have been good news. If the market sells off at the same time it suggests investors may be reevaluating the fundamentals of the recovery.
2. It was across the board.
It wasn't just isolated to a few exchanges here or in Europe or in the Middle East. Exchanges fell around the world. Wall Street was down 1.9%. Shanghai and Tokyo both fell about 1.5%. Brazil's Bovespa was down 1.8%. London fell 1.5%. Even gold fell. The Standard & Poor's 500-stock index is now down about 4% from the peak seen last month. Since then it's tried three times to get its mojo back, and it's failed each time. Not cheerful.
3. The financial cockroaches are back.
The European debt crisis. Our continuing jobs gloom. Oh, and let's not forget the rocketing national debt that is financing the entire stock-market boom. In past months I've been watching with amazement as Wall Street—and a lot of investors—have been trying to sweep these under the carpet. But they won't stay there. On Thursday, markets were spooked when Moody's downgraded Spain's government debt. But why is anyone surprised? The market for default risk was already sending serious signals that Spain and Portugal may default. And it has all but given up on Greece.
4. One of the smartest bulls I know has suddenly turned very edgy.
He's a European hedge fund manager who turned bullish in January 2009—on high-risk financials, no less—and has stayed upbeat for most of the past two years. He was a raging bull last summer. Even a handful of weeks ago, he thought we'd see more momentum. Today? He's singing a slightly different tune. One of his biggest worries now is China—in particular the strength of its economy and its sudden, surprise trade deficit last month. He's still looking for opportunities, as always, but I thought he'd be buying aggressively in this correction. He isn't. (Another manager I know thinks there is some juice left in the rally, as first-quarter earnings roll in. But she expects to turn more cautious after that.)
5. The bull market has just come so far, so fast.
Too far? From the lows of two years ago, the S&P 500 has almost exactly doubled. By any measure, it's been a remarkable boom. The Russell 2000 index of smaller stocks has soared 130%. So has the S&P Mid Cap 400 index of medium-sized companies, taking it to a new record high. But look at the fundamentals. Over that time economic growth has been sluggish. The economy today is no bigger, in real terms, than it was three years ago. The true jobs picture remains a disaster, and far worse than the official data will tell you. Wages have been stagnant. Yes, companies have boosted profits—to near-record levels—by slashing costs. But how far can that take you? (Perhaps in the end there will just be one, very productive guy left with a job. It would be Apple ( AAPL: 353.56, +1.57, +0.44% ) 's Steve Jobs, of course. But then, alas, he'd have to buy all those new iPads himself.)
6. There's no "margin of safety" left in stocks.
While Wall Street was backing off a cliff Thursday morning, I was interviewing one of the brightest and most original thinkers in the market—James Montier, strategist for tony fund shop GMO and author of "Behavioral Finance." Mr. Montier pointed out that stocks are now so expensive, they leave investors with almost no "margin of safety" in case things go wrong. Anyone investing now, he said, is taking a big bet on sunny skies and plain sailing ahead. It can happen, but life is not always so kind. "We're not completely 'priced for perfection,' but we're not far off," Mr. Montier said. And, he added, the risk curve was wrong as well: Based on GMO's calculations, investors in small-cap stocks at these levels actually face worse returns than investors in large-cap stocks. As small caps are more volatile, they should offer better returns to compensate. (My full interview with Mr. Montier will be published on MarketWatch on Monday.)
7. Wall Street looks unappealing by the numbers.
The dividend yield on the S&P 500 is well below 2%. According to data compiled by Yale economics professor Robert Shiller, stocks are a thumping 24 times cyclically-adjusted earnings. That's extremely high. The historical average is about 16. In the past, today's levels have been associated with bubbles and hot markets, and have generally been followed, sooner or later, by a correction. A similar conclusion is reached by comparing equity prices to the cost of replacing company assets, a metric known as "Tobin's q." It also says Wall Street is heavily overvalued. Maybe worst of all: It is just extremely hard to find any cheap stocks out there. If I saw some great bargains, I'd say, "Don't worry about the market, buy this terrific company on six times earnings." But these types of opportunities are so thin on the ground right now. No one measure has all the answers. But plenty of metrics are signaling, at least, caution.
8. The public was just starting to buy stocks again.
Oh, brother. The U.S. private investor, who spent most of the 2009-10 rally getting out of stocks, started piling in again earlier this year. According to the Investment Company Institute, investors cashed out a net $31 billion from equity mutual funds between the start of March 2009 and the end of last year. But since Jan. 1, they have shoveled a net $33 billion back in. History has frequently shown that the public gets in—and out—at the wrong times, buying near peaks and selling near troughs. Is it happening again? I wish I felt better about this.
9. The insiders have been getting out.
Executives and directors across the market have been cashing out stock at a fast clip. "The pace and volume of insider sales hit a four-year high during Q4 '10," reported InsiderScore, a firm that tracks such data. While many of the top brass may have been locking in capital gains before a possible tax hike in 2011, it said, the pace of insider selling actually speeded up after the December tax deal, which gave a last-minute reprieve on taxes. And that suggests "it was valuations and opportunity—not the Taxman—that were the main catalysts for the record surge in insider selling," said InsiderScore. "Each sector and market cap group experienced heavy selling." So far this year insider selling has remained at a strong pace, too.
10. Sentiment had become giddy.
Jim Cramer on his TV show "Mad Money" has on occasion recently decried "all the negativity that's out there." I like Mr. Cramer, with whom I once worked, but he must be hanging out with an unusually gloomy group of people. I can hardly see any bears anywhere. They're in hiding from a two-year-old bull. As reported here not long ago, fund managers had turned downright euphoric about the stock market. Hedge fund managers are now once again betting heavily on rising stocks—and rising oil—with borrowed money. Equity analysts have been hiking their forecasts. Oh, and the hot stocks were back—like Salesforce.com ( CRM: 124.94, -2.93, -2.29% ) , which recently hit 100 times forecast earnings. That's a hefty multiple for an $18 billion company. Whether Salesforce stock turns out well or ill over the longer term, you can hardly deny that its investors are cheerfully—some might say remarkably—optimistic.
None of this is a reason to start panicking. But these are grounds for investors to be cautious.
DJIA Price Oscillator
March 11, 2011
The McClellan Price Oscillator is one of the more prominent indicators that factors into our analysis of various markets. It is calculated in the same way as the McClellan A-D Oscillator, except that instead of using the daily Advance-Decline difference as the raw input, we use the closing price or closing market index value.
On that closing price data, we calculate two exponential moving averages that we call the 10% Trend and 5% Trend (AKA 19-day and 39-day EMAs). The difference between those two moving averages is the Price Oscillator. These moving averages are not included in this week’s chart, because too many lines tend to clutter up a chart.
When the two moving averages are getting farther apart, the value of the Price Oscillator gets more positive or negative, depending on the relative value of each moving average. Generally speaking, when the Price Oscillator is rising, the presumed trend direction is upward. The strongest and most reliable uptrends tend to occur when the Price Oscillator is above zero and rising.
If the Price Oscillator is above zero and falling, it may be the start of a new downtrend, or it may just be a sign of a temporary pullback within a continuing uptrend. The most risk occurs when the Price Oscillator is below zero and falling.
Also included in this week’s chart is an indicator we call the Price Oscillator Unchanged line. That line represents the closing value for the DJIA that would be needed in order to make the Price Oscillator go precisely sideways. If the DJIA is above that line, then the Price Oscillator moves upward. A close below that line takes the Price Oscillator lower. It is calculated by adding the value of the 10% Trend (19 EMA) to the value of the Price Oscillator.
As I write this, the DJIA’s Price Oscillator is falling, but it has not yet gone negative. So we can still make the presumption that the price weakness since February is just a pullback and not a new downtrend. That presumption would be harder to support if the Price Oscillator crosses below zero.
It is an interesting point that the DJIA’s Price Oscillator can be doing one thing, but the individual Price Oscillators of the 30 DJIA component stocks can be doing entirely different behaviors. And we have found that there is useful information in those differences.
The chart below shows an indicator we developed years ago that looks at what is happening with all 30 of these stocks’ Price Oscillators, and measures how many of them have a Price Oscillator that is above zero and rising.
The interesting point about this indicator is that by the time we see it move to a very high or very low level, the price trend for the overall market is about done. It takes a lot of energy for either the bulls or the bears to get everybody moving in one direction, and by the time you see all of the stocks’ Price Oscillators behaving the same way, that energy has been expended. The current low reading in this indicator is suggestive of a bottoming condition for the market overall.
As global oil prices surge above $100, consumers are once again reminded of the fact that oil prices are subject to the whims of geopolitics, weather, and growing demand. And unfortunately little is still being done to eliminate dependence on fossil fuels.
Pain Is a Good Teacher
The recent run up in crude oil is reminiscent of the surge crude took back in 2008 up to $147 a bbl. Back then as crude broke through the key $100 mark and surged to the record high, consumers and the government went into panic mode.
Suddenly alternative energy stocks were hot again, talk of hybrid cars was all the rage, drilling off shore became a national emergency, and people even talked about car-pooling.
Unfortunately as soon as crude prices dropped, all that went out the window.
Crude prices dropped from $147 and fell to around $38, essentially nailing the coffin shut on many good energy solutions that had been gaining momentum.
As equity got pulled out of alternative energy companies like solar, geo thermal, coal, wind turbines, etc. may of those companies went bankrupt.
Prices for crude didn’t stay low for long and here only a couple of years later we are seeing crude rallying above $100 again.
So is pain at the pump the only solution. My question is, why does it always have to get to that point?
While the global recession and credit crunch have severely impacted global demand for energy, it's only temporary. The problems that propelled oil prices to $147 haven't gone away, in fact there worse now.
Traders are seasick from the oil markets lately; the volatility has been so extreme. Aside from the obvious macro-factors, the weak dollar is absolutely the biggest culprit in high commodity prices. The Fed’s ongoing decimation of the greenback has undermined any stability in pricing and this in turn has led to unrest all over the Middle East and soaring prices in much of the World.
So what were the major factors that drove oil to record levels the last two years? There are many.
Global demand is among the biggest. Pent-up demand is exploding in growth areas like China and India. Once that global manufacturing engine begins firing again, you can count on energy prices ramping up quickly. If we are seeing over $100 a barrel crude while the global economy is still in crisis, what will prices be like when economies are functioning full speed again? $300 may seem cheap.
There's been almost no progress in alternatives since 2008. The global investment engine has ground to a halt. After all when the markets crashed and oil prices dropped, the last place investors wanted to put their money was in the alternative energy space. Every sector from uranium miners and clean-coal technology to bio-fuels and oil drillers saw investment and share prices dry up. But here we are again, back at $100, so what’s different?
The Middle East Powder Keg
OPEC has been of little help during the unrest in the Middle East. We already are seeing supplies start to taper off. Eventually, demand will catch up with supply and we'll be right back in the same boat of higher prices.
The realities are chilling. The largest oil field in Mexico Cantarell is still in major decline and when it does run out civil unrest in that nation could explode. These types of chokepoints, both political and physical, still exist with several major oil exporting nations.
Another key factor, that will lead to $300 oil is that the building of new refineries and pipelines has all but been non existent.
Buying Alternatives on the Cheap
With oil prices rapidly creeping back up, and consumers feeling the pinch, alternative energy stocks may all get a boost soon. Solar companies, wind technology, natural gas stocks, and even rare earth stocks that have all kinds of “green energy” end users for key rare earth elements. Don’t discount opportunities to buy traditional energy plays at these levels too, fossil fuels are not going anywhere soon.
Look at major oil companies that have pulled back significantly, equipment makers and drillers that will be key in exploring in remote regions and deep water for more supply.
Unfortunately for consumers, when it comes to energy, a lot of pain is on the horizon. However investors can essentially hedge themselves from the coming storm by investing in the incredible opportunities oil is affording us at $100, yet again. After all, this may be the last time we see prices at or below the $100 mark for any sustained amount of time.
There are now warning signs that this counter trend rally may have topped, and even if it hasn't the potential upside is so small that it's not worth the risk of getting caught in the next bear leg to catch a few more percentage points.
As of Thursday and Friday the stock market has now broken below the prior daily cycle low. When a daily cycle low gets violated it invariably signals the start of an intermediate degree correction.
The warning bells are going off not so much because an intermediate degree correction has begun, those happen like clock work about every 20-25 weeks, but because of how quickly this daily cycle has topped. In only three days. That means we are now locked in an extremely left translated daily cycle.
It is those extreme left translated cycles that do the most damage. The daily cycle following the flash crash last year was a left translated cycle that topped in only 4 days. We all know what that led to.
The bigger picture is the intermediate cycle. Notice the market is now on week 16 of the current intermediate cycle. I noted earlier that an intermediate cycle low is due about every 20 to 25 weeks. On an intermediate term basis the market is now due to move down into that major cycle low. The next larger cyclical structure is the yearly cycle. That is also due to bottom with this daily and intermediate cycle. The combination of all three cycle durations bottoming at the same time will almost always produce a very severe correction.
Because of how the dollar cycle is unfolding (available to premium subscribers) I expect the stock market cycles to bottom pretty close to the 1 year anniversary of the flash crash.
As a point of reference the last intermediate cycle low occurred in November. The danger is that both the industrials and transports might drop below the November bottom during this correction. If that happens a Dow Theory sell signal will be generated. If a Dow Theory sell signal is generated the odds will be very high that this counter trend rally is over and the next leg down in the secular bear market has begun.
And unfortunately Bernanke is not going to be able to just crank up the printing presses and rescue the markets like he did last summer. The problem isn't that there is a shortage of liquidity. The problem is that there is too much liquidity. It is causing commodity prices to surge out of control.
Oil is back over $100 despite continued high unemployment and impaired demand. Food prices are going through the roof and have already trigger social revolt throughout the mid east and most emerging markets. Once the next leg down in the dollar crisis gets underway it won't be long before we here in the US will be looking at $4.00 or $5.00 for a gallon of gasoline.
As the dollar crisis intensifies Bernanke will be forced to end QE or risk breaking not only the currency but also the bond market. Without an endless supply of fresh money the markets and economy will quickly start to collapse. We saw this last summer when QE1 ended. The same thing will happen this time only Bernanke's hands will be tied by the dollar crisis and surging commodity inflation. He will be powerless to prevent the return of the secular bear forces. Well unless he's prepared to risk hyper inflation that is.
Personally I don't think Ben is willing to completely destroy the dollar and crash the bond market just yet. I suspect when he finally realizes that Keynesian economic principles have led us down a path of no return he will resign and someone else will put the finishing touches on his master piece.
The only question is whether those finishing touches will be to allow the deflationary depression that is required to cleanse 5 decades of debt from the system or whether we will choose the hyper-inflationary path to service the debt spiral we've gotten ourselves into.
In any case it is time to exit all general stock market funds and position oneself in cash to ride out the next leg down in the secular bear market. If one has a gold or precious metal fund available in their IRA we should have about two months left of spectacular gains as the parabolic finale unfolds in the gold and silver markets. But once that has run it's course even those positions will need to be exited as there is no real way to diversify against another severe bear leg down.
The simple fact is that in a severe bear market everything gets taken down to some extent. Gold will hold up much better than practically all other assets but even gold will take a 20-30% hit during a D-wave correction. And all parabolic C-wave finales are invariably followed by an severe regression to the mean profit taking event.
Unless one has the option of a gold fund, it's now time to get out of general stock funds and move IRA's to a money market fund until the next four year cycle low is reached (probably in late 2012).
Of the myriad of technical indicators available, moving averages have risen as not only one of the most popular, but also one of the most effective. Perhaps the popularity is due in part to their simple yet versatile nature. Traders can use them for anything from identifying trends and reversals to measuring momentum and crossovers. Moving averages are trend following in nature making them a particularly potent indicator during strong trending markets. In choppy environments they lose much of their mojo and can become downright useless. Though they can be measured on any time frame, the 50-day moving average has become a staple for most chartists. Indeed, it is usually displayed by default on most charting platforms and is often used to aid in identifying the intermediate trend of the market.
When it comes to trend reversals, the 50-day moving average has provided particularly timely signals in the S&P 500 Index over the past few years. When prices break above or below this moving average, many traders consider it a sign that the intermediate trend is reversing. To avoid too many false signals some wait for prices to break the moving average by 1% or more to confirm it’s a bona fide break. Consider the chart below highlighting the most recent signals (green for buy, red for sell). While the signals are far from infallible they do have a good track record of keeping traders on the right side of multi-month trends.
Whether or not the current signal proves as fruitful as the last few signals remains to be seen. Also, we have yet to break the 50-day moving average by 1% leaving some to contend that we need more confirmation before passing judgment. At the least, the resolution of the current testing of the 50-day moving average will be something many traders monitor with increasing interest.
He points to the fact that a similarly huge decline occurred within days of the Kobe earthquake in 1995, which did far less damage than Friday’s massive earthquake and tsunami.
“There was a huge worldwide stock market drop a full week after that earthquake. That’s the kind of thing we have to worry about now,” Shiller told CNBC.
One big reason for such a shift: Japan has the second largest public debt in the world, just behind Zimbabwe, a third-world nation. Shiller and other experts say the huge damage done by this earthquake could be the tipping point for a nation whose population is rapidly aging while its bloated bureaucracy remains imperious to tough economic reforms.
In the United States and Europe, the Japanese disaster could be the kind of fundamental change in perspective that causes a stampede for the exits in risk assets,
“What happened in the United States, a week after the Kobe earthquake, is the Nikkei fell 5 percent in one day. Now, there wasn’t necessarily any connection to the Kobe earthquake,” Shiller says.
“What happened? I think it was the news stories, the stories of human failure, of mistakes, that the Japanese government couldn’t handle that earthquake. It kind of created a different emotional atmosphere. It brought up reassessments of our general, basic outlook,” Shiller says.
Even worse, Japan’s woes are already being felt in oil prices that have climbed in the last few weeks because of the revolts in the Middle East.
That's because the 8.9-magnitude temblor forced the shutdown of a number of Japan's oil refining facilities as well as some of its nuclear power plants. The loss of substantial refining capacity in the world's third-largest economy is likely to inject more volatility into gasoline prices — raising the risk of even higher pump prices for American motorists, the Los Angeles Times pointed out Monday.
Industry experts say that if Japan can't get its refineries back on line quickly, there will be a spike in that country's demand for gasoline, diesel and jet fuel. Global suppliers, including refineries in California, may find it more profitable to increase shipments to Japan instead of selling the fuel domestically, resulting in a bidding-up of prices, the Times reported.
"It's a 'yikes' situation," James DiGeorgia, editor of the Gold & Energy Advisor, told the Times. "The sudden importation of large amounts of distilled products is expensive and it's a heavy logistics burden. That is going to drive up the market price for everything from diesel and gasoline to jet fuel."
Stock prices today reflect what’s to come, Shiller adds. “It prices the indefinite future. It’s very vulnerable to news stories that suggest new information and new emotions relating to that,” he says.
Shiller, who is widely credited with being the first to predict the collapse in home prices in the United States, is this time being echoed by other economists in saying that Japan could turn into a giant sinkhole for the global economy.
As aid pours into Japan, investors are eyeing events nervously for signs that confidence might be shaken by the disaster. Moody’s, the ratings agency, said that the quake could push Japan to a tipping point in terms of its enormous, long-standing debt problems. The agency had Japan on Aa2 sovereign rating with a negative outlook before the quake hit.
Shiller suggested that the markets might react by this Friday, as week after the earthquake, as happened in 1995. “That would be too precise of a mirror of what happened in ’95, but it’s the kind of thing to watch out for,” Shiller said.
Shiller is a professor of economics at Yale University and chief economist at MacroMarkets and is co-author, with George Akerlof, of “Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism.” He also is co-creator of the S&P/Case-Shiller Home Price Indices, the widely followed measure of U.S. home prices.
Japan’s massive debt burden, now more than double the size of its economy, is part of the problem, Shiller says.
Stimulus from the energy and construction rebuilding effort to come might offset some of the economic problems, following the quake and the obvious immediate humanitarian need. But “I don’t know if it will offset all the negatives,” Shiller said.
The indirect bids at today’s 13 week and 26 week bill auctions were down sharply from both last week and from the auctions of the expiring paper. That’s a sign that Japan and other central banks did not show up at today’s auctions. The bid tendered on the 13 week bill was just $5 billion, the lowest it has been going back to at least February of 2010. Typically the bid tendered totals between $8 and $15 billion. The indirect bid taken was $4.8 billion, down from $13.6 billion last week and $7.3 billion on the maturing paper at the time of that auction.
The story was similar on the 26 week bill. The indirect bid tendered was just $7.8 billion, far lower than the typical $10-25 billion. The indirect bid taken was just $5.87 billion, which compares with $8.8 billion last week and $12.6 billion back in September when the maturing paper was auctioned.
This tends to support the warning that I posted in this weekend’s Fed Report that the BoJ would probably need to start selling their holdings of US Treasuries to raise cash for the rebuilding effort. Stopping their purchases would go hand in hand with that. This would be just another bearish knock on effect of this horrendous human catastrophe.
So far the effects have not shown up in the yields on longer term paper. That could be coming next week when the Fed auctions 2, 5, and 7 year notes and 10 year TIPS. Foreign Central bank participation at these auctions has been gradually weakening for months. This could exacerbate the situation, although with the BoJ pumping $226 billion into the Japanese financial system today, some of that could create residual demand for US Treasuries. We’re in uncharted waters here. The initial signals look bearish, but that could change. We’ll get more clues from the 4 week bill tomorrow, and from the note auctions next week. I’ll have a complete update and perspective in the next Treasury update to be posted Thursday.
Perched on a chair overlooking a wood panel-lined room in Dublin’s High Court, a bespectacled Judge Elizabeth Dunne has become all-too-used to hearing from the victims of Ireland’s economic meltdown.
Each Monday, Dunne presides over repossession hearings, with one in 10 Irish mortgages now in trouble. At the end of last year, more than 79,000 borrowers were behind on payments or had loan terms altered due to “financial distress,” the country’s central bank said on Feb. 28.
“Things are getting worse and worse,” said Dunne, as she weighed the case of a couple about 114,000 euros ($158,000) in arrears on a 558,938-euro home loan, one of 74 cases on her list on March 7. “Putting off the evil day is not going to help.”
Irish mortgages account for more than a third of about 270 billion euros of loans that remain with the nation’s so-called viable lenders — Allied Irish Banks Plc, Bank of Ireland Plc, Irish Life & Permanent Plc and EBS Building Society. The country’s new coalition parties are not convinced “that there has been proper transparency or full disclosure by the banks” on home-loan impairments, Alan Shatter told RTE Radio on March 7, two days before his appointment as Minister for Justice.
“There has been a continual under-estimation of loan impairments in Irish banks over the past few years,” Ray Kinsella, banking professor at the Smurfit Business School at University College Dublin, said by telephone. “I am seriously concerned about mounting loan losses in their mortgage books.”
New Stress Test
The bad loans may be reassessed as early as this month when Ireland’s central bank concludes a third round of stress tests on the country’s lenders. The results will determine how much of a 35 billion-euro international bailout fund Ireland will need to draw down.
A year ago, Irish regulators stress-tested for a 5 percent loss rate on Irish mortgages. This year’s review “will take account of the deteriorating economic conditions and hence” loan-loss assumptions “may be higher,” said Nicola Faulkner, a spokeswoman for the central bank, by e-mail.
Ireland is suffering after a decade-long real estate boom collapsed in 2007. Already, the state has bought 72.3 billion euros of risky commercial property loans from the banks, at an average discount of 58 percent. Irish house prices, which quadrupled in the decade to 2007, have since plunged more than a third. Unemployment has tripled to 13.5 percent over the same period.
House Price Declines
This year’s tests may stress loan books against the unemployment rate rising to 16 percent, house prices falling 60 percent from their peak and “negligible” economic growth, said analysts including Jim Ryan and Michael Cummins of Glas Securities, the Dublin-based fixed-income firm, in a note to clients March 9. The central bank declined to comment.
More than 300,000 households, or about 40 percent of mortgages, may find their mortgages are worth more than their homes, so-called negative equity, before the property market bottoms out, said David Duffy, an economist at the Economic & Social Research Institute in Dublin, who estimates that house prices will fall by as much as half from peak to trough.
Morgan Kelly, a University College Dublin economics professor dubbed “Doctor Doom” for his bleak assessments of Ireland’s housing market, wrote in the Irish Times on Nov. 8 that banks face “mass mortgage defaults” and a “wave of foreclosures.” Kelly declined to be interviewed.
Iceland, where almost 40 percent of residential mortgages were in negative equity by December, decided that month to write off mortgages and other household debt by as much as $858 million. Unlike Ireland and other western nations, the Nordic nation placed its biggest lenders in receivership in 2008 rather than offer taxpayer-funded capital injections.
Ireland has bolstered its banks with 46.3 billion euros of additional capital over the past two years. The nation was forced to agree to an 85 billion-euro bailout on Nov. 28, led by the European Union and the International Monetary Fund. That package includes 10 billion euros to recapitalize the banks up- front and a further 25 billion euros of “contingency” capital to be used if required.
“When the teams from the EU, ECB and IMF arrived in November, they probably thought they would find huge holes remaining in the banks’ loan books, but they did not,” said Alan Ahearne, who was economics adviser to Brian Lenihan, the former finance minister. “It’s not that there’s some black hole in the Irish banks that hasn’t previously been discovered.”
10 Billion Euros
Still, a previous regulatory target for banks to hold 8 percent core tier 1 capital, a gauge of financial stability, “wasn’t enough to support confidence in the banks” given the economy’s problems, Ahearne said. Ireland agreed as part of the bailout to increase lenders’ capital levels to no less than 10.5 percent by the end of this month.
The 10 billion euros of initial capital destined for banks under the rescue package “pretty much covers our base case scenario” for remaining losses in Irish banks, said Ross Abercromby, a London-based analyst at Moody’s Investors Service, by telephone. “The additional 25 billion euros contingency fund would cover our stress scenario, which is pretty severe.”
Moody’s estimates that losses on Irish mortgages may be as high as 14 percent where the loan-to-value ratio is over 90 percent. That rises to 16 percent “in our worst case,” the ratings company said.
Household debt soared from 48 percent of disposable income in 1995 to 176 percent in 2009, catapulting Irish consumers into fourth place in 2008 in an international league table of personal indebtedness from 17th place in 1995, according to Ireland’s Law Reform Commission.
On the other hand, Irish households’ net savings as a percentage of disposable income rose from zero in 2007 to 12 percent in 2009, according to the Central Statistics Office. The savings rate should remain around the same level for this year and next, the ESRI said on Jan. 20.
Irish Life & Permanent Plc Finance Director David McCarthy said he doesn’t believe there are undiscovered losses in banks’ mortgage books. The group, which has 26.3 billion euros of Irish home loans, saw arrears of less than 90 days peak in mid-2010, McCarthy said on March 2, and they’ve “been falling, albeit quite slowly, since then,” he said.
Bank of Ireland spokeswoman Anne Mathews referred to CEO Richie Boucher’s Nov. 12 statement to analysts that there was “clear evidence” that arrears were “beginning to stabilize.” Allied Irish and EBS spokesmen declined to comment.
The Irish home-loan market is “a totally different phenomenon” to the commercial real-estate market, said John Reynolds, chief executive officer of Belgian-owned KBC Ireland.
“Irish banks have been hamstrung by a narrative that has been allowed to develop that all their lending was as mad as their real-estate lending,” said Reynolds. “The reality is that the Irish banks, when they didn’t do the real-estate stuff, which was a seductive drug, did bog-standard, criteria-driven lending.”
“Banks are exercising huge forbearance on borrowers in arrears,” partly because of pressure from the authorities “but also because they don’t want to repossess houses as there’s no second-hand market to sell them,” said Kinsella, the banking professor. Lenders only held 585 repossessed residential properties at end-2010, according to the central bank.
The new government said on March 6 it may bring in a two- year moratorium on repossessions “of modest family homes where a family makes an honest effort to pay their mortgages.” Currently, mortgage holders can enjoy 12-month protection from legal action if they are co-operating with lenders.
The coalition also pledged to fast-track changes in laws requiring bankrupted individuals to wait 12 years before they are discharged from their debts.
Rising Interest Rates
The issue of full recourse for mortgage loans is positive for banks, if not for borrowers in negative equity, said Abercromby. “If that level of recourse is watered down, by introducing less stringent bankruptcy laws, you could be looking at higher losses,” he said.
There is also concern that rising interest rates will hit borrowers who have managed to remain out of trouble so far. ECB President Jean-Claude Trichet signaled on March 3 the bank may raise its benchmark rate from a record low of 1 percent as soon as next month.
Banks have already increased variable home loan rates from an average of 3.16 percent in mid-2009 to 3.87 percent by November, according to the ESRI. Lenders, including Irish Life and EBS, have hiked borrowing costs again since then.
Meanwhile, at least half of all Irish mortgages are so- called tracker products, with pricing linked to ECB’s key rate, according to the Irish Banking Federation.
While banks may be able to contain bad-loan losses on their mortgage books, “a big and ongoing problem is that a large part of their mortgage books are based on ECB tracker rates, which banks are funding at a loss,” said Karl Deeter, operations manager with Dublin-based Irish Mortgage Brokers.
Back in the High Court, Dunne is listening to how a house builder from Co. Cavan, close to the border with Northern Ireland, is 67,000 euros in arrears on a 360,000 euro home loan taken out three years ago.
Times are hard out there, says the man, who has a plant hire and quarrying business, but is making partial remortgage payments. “I understand that well,” says Dunne. “I see that every Monday.”