Investors are worried. The big question – as always – is whether the primary uptrend remains intact.

And the answer is yes.

To understand just what that target should be, let’s take a look at where we are right now.

Just before Wednesday’s sell-off, measures of the supply of stocks moved to new lows, while demand moved to new highs. This means bull-market-trading rules remain in effect. But as the cyclical bull market matures a little, we need to change the target of our buying efforts.

Although it looked like losses would be cut in the early afternoon, a lack of demand resulted in the major U.S. indices settling gently at support near the high end of the August trading range. The Dow Jones Industrial Average lost 0.4%, the Standard & Poor’s 500 Index lost 0.6%, the Nasdaq Composite Index lost 0.8%, and the Russell 2000 lost 0.5%.

All the major sector groups save healthcare finished in the red. The declines were the most severe among industrial conglomerates. The Industrials Select SPDR (NYSE: XLI) lost 1.4% thanks to a 2.5% fall in Textron Inc. (NYSE: TXT). Bank stocks were also weak as Bank of America Corp. (NYSE: BAC) dropped 2.2%. Defensive healthcare and utilities stocks were relatively buoyant with a gain of 0.1% for the Healthcare SPDR (NYSE: XLV) and just a 0.3% loss for the Utilities SPDR (NYSE: XLU).

Homebuilders were under some heavy selling pressure over the past week, likely the consequence of the U.S. Federal Reserve’s decision to slow its purchases of mortgages. By spending $1.45 trillion, the Fed kept the difference between mortgage rates and the yield on U.S. Treasury debt very low.

Now, as these purchases taper off, mortgage rates will creep higher and erode some of the awesome affordability levels that are driving buyers to take advantage of the government’s first-time homebuyer tax credit and stabilize the housing market. As a result, the iShares U.S. Home Construction ETF (NYSE: ITB) lost 2.7% on Friday and dropped 8.3% last week.

The declines of the past week have been in alignment with our expectation of a short-term correction before equities push on to what should be a more meaningful top near the 1,200 level on the S&P 500. A number of technical indicators, including the percentage of stocks over their 10-day moving average as well as breadth and volume measures, had begun to deteriorate after having moved well into overbought territory the prior two weeks.

We aim to run our portfolios for long-term holds during bull markets, so although we warned of weakness ahead we did not expect it to be serious enough to merit exiting positions. Still don’t.

The big question – always – is whether the primary uptrend remains intact. And the answer is yes. Just before Wednesday’s sell-off, measures of the supply of stocks moved to new lows, while demand moved to new highs. This means bull-market-trading rules remain in effect. But as the cyclical bull market matures a little, we need to change the target of our buying efforts.

However dramatic the action of the past few days has been, it is a sign that some normalcy is returning to the equity markets. Moving forward, it is unlikely we will see long strings of uninterrupted up days, super-strong performance in the lowest quality stocks, and high correlations between stocks. In the final push to the stimulus- and recovery-Fed reaction high that we will likely see over the next three months or so, the emphasis may shift to fundamental analysis and quality.

As you can see in the chart above, stock-performance correlations tend to spike during times of economic stress. When investors enter panic mode and analyst estimates become much less accurate, the focus shifts from individual assets to asset classes and broad sectors of the economy. In other words, when all hell breaks loose investors don’t differentiate between great companies and good companies – they throw them all out.

Once this unease subsides and economic volatility wanes, fundamental analysis once again becomes the most important driver of investment performance.  And that’s okay, because there will be plenty of opportunities as investors shift their focus from stocks that were priced for Armageddon to stocks that are poised to benefit from renewed economic expansion.

The foundations for the transition are already being laid: UBS AG (NYSE: UBS) analyst Jeffrey Palma notes that after nearly a year of downward revisions to earnings, analysts are starting to upgrade their forecasts for 2010. Estimate rebounds are largest in the cyclical materials and retail sectors. Breaking it down by region, the most promising opportunities are in commodity-related stocks in the United States, consumer stocks in Europe, and British banks.

We have recommended SPDR Metals & Mining (NYSE: XME) in our Strategic Advantage service as a great vehicle to play this trend, even though it stumbled last week. Another good one is iShares Australia (NYSE: EWA). Check out our newsletter for a much-expanded list of recommendations.

The Week in Review

Monday: The index of leading indicators jumped 0.6% in August after a 0.9% jump in July and a 0.8% jump in June. The indicators’ August performance represented the fifth consecutive monthly increase. Moreover, the 4.7% increase during these five months was the strongest showing since early 1983, which marked the beginning of one of history’s greatest bull markets.

Tuesday: Home prices backed by Fannie Mae or Freddie Mac jumped 0.3% in July. There were also indications that retail sales plummeted in the week following the Labor Day Back-to-School blitz.

Wednesday: The Federal Reserve announced it would leave interest rates unchanged. Stocks initially bounded higher before abruptly shifting direction and screaming lower. The bulls gunned the Dow Industrial Average close to the 10,000 level before things fell apart. At issue wasn’t the Fed’s target policy rate, which affects short-term interest rates. Instead, traders were apparently concerned that Fed chairman Ben Bernanke and his cohorts failed to expand its direct purchases of mortgages and government debt. This will likely result in higher long-term rates.

Credit markets, though, didn’t care, and carried on with their bull market run. Crude oil fell 4.8% to $68.33, its largest percentage loss since July on a surprise increase in inventories.

Thursday: Some momentum was lost in the housing market after weak existing homes sales numbers put an end for four straight months of gains. Sales last month came in at a million seasonality adjusted annual rate of 5.1 million — a 2.7% drop from July. We continue to see an emphasis on foreclosures with distressed sales making up 31% of total sales. The highlight: Supply of homes fell to just 8.5 months of sales, a level that is believed to reflect a balanced market. There are, however, the issues surrounding a “shadow” inventory of homes waiting for foreclosure proceedings to complete or the slightest whiff of a recovery before being listed.

Friday: The G20 wrapped up its meeting in Pittsburgh with a commitment to tighter regulation of the financial system and system to subject each country’s economic policy to a type of peer review to try to avoid the types of global imbalances — China’s export obsession and America’s credit binge — don’t happen in the future. While the latter can only be enforced by a public shaming by other countries and the International Monetary Fund, it lacks an actual penalty. But it’s a good first step.

Consumer sentiment, as measured by the University of Michigan, improved to its highest level since early 2008 after rising by nearly one-third since late last year. According to Haver Analytics, over the last 10 years there has been a 69% correlation between sentiment and growth in consumer spending.
Unfortunately, the good news didn’t extend to durable goods orders in August: There was an unexpected decline that reversed half of July’s 4.8% gain. A drop in orders for transportation equipment was fingered as the main culprit. However, this metric is quite volatility and the overall trend still points towards a rebound in the manufacturing sector.

The Week Ahead

Monday: A quiet calendar with no economic releases.

Tuesday: The latest on nationwide home prices courtesy of the excellent Case-Shiller Home Price Index. Also, we get another update on consumer confidence.

Wednesday: The government makes its final revisions to second-quarter GDP. The last revision made no change to the initial estimate of a 1% decline. In the first quarter, GDP plummeted 6.4%. Traders will be looking for indications that inventories have dropped and demand is increasing ahead of a projected inventory rebuild in the months ahead. We will also get an update on the health of the manufacturing base in the latest ISM – Chicago Business Barometer.

Wednesday will also mark the end of the third quarter.

Thursday: A busy day with an update on auto sales, personal income and spending, the latest ISM Manufacturing Index, and construction spending.

Friday: The September jobs report is expected to show a loss of 170,000 jobs compared to the 216,000 that were lost in August and a 463,000 decline in June. The unemployment rate, currently at 9.7%, will move closer to 10%. Also, we get an update on factory orders.
In summary, the start of the fourth quarter is on the horizon. We expect it to be a plus for investors, though not without growth and geopolitical scares that create S-turns and potholes. Stay positive amid the turbulence as long as corporate credit markets remain strong and the primary trend is up.

Source: Long-Term Stock-Market Uptrend to Continue

This from Money Morning:

The U.S. housing market is already being pounded by the “perfect storm.” And the outlook for the New Year is for the stormy weather to continue – and probably to get worse.

As if a locked-up credit market and tidal waves of foreclosures weren’t already enough, we’re now watching unemployment climb and consumer confidence plunge.

But even when the housing market is taking on water, there are ways to stay afloat. Indeed, investors nimble enough to maneuver can even make money.

The watchword on this market, though, is caution.  If an investor decides to test the waters, beware of the extraordinary financial undertow.

Here’s a look at what’s happening now, and what the implications there are for investors in the New Year.

Rising Unemployment Feeds into Sinking Demand

The grim reality is that skyrocketing unemployment is a major threat to the recovery of the U.S. housing market.  And consumers shackled with record levels of debt are unlikely to ride to the rescue this time.

Since this recession is expected to be long and deep, economists are projecting high rates of unemployment. And the latest statistics released by the U.S. Labor Department show the crucial jobs market deteriorating at an alarmingly rapid pace.

The U.S. unemployment rate jumped to a 14-year high of 6.5% in October as another 240,000 jobs were cut – an uptick from 6.1% in September and the 10th month in a row the jobless rate has risen. Most forecasts are calling for unemployment to spike as high as 8.5%, which would be the worst showing since 1980.

So far this year, a staggering 1.2 million jobs have disappeared. More than half the decrease occurred in the past three months alone, Money Morning reported in its “Outlook 2009” series economic forecast story. Even worse: A year ago, job cuts were concentrated in the financial-services and homebuilding sectors. Now they’re rising across the board; virtually every part of the economy is feeling the squeeze.

For instance:

• U.S. automaker Chrysler Corp., one of Detroit’s wheezing “Big Three,” is laying off 25% of its white-collar work force of 18,500.
• Appliance maker Whirlpool Corp. (WHR) recently announced it would cut 5,000 jobs to cope with declining sales.
• Worldwide shipping giant DHL, a subsidiary of Deutsche Post AG, is laying off 9,500 people, and threatening to close its U.S. distribution center.
• Onetime Internet search giant Yahoo! Inc. (YHOO) plans to let 1,100 workers go – on top of the 1,000 already jettisoned in January – the result of several botched merger attempts.
• Ailing banking giant Citigroup Inc. (C) heaped more bad news on the financial sector, announcing whopping 50,000 layoffs in the next 12 months.

Layoffs of this magnitude are more than a mere shot across the bow of the housing market – they’re actually a direct hit amid ship. People who are unemployed cannot buy homes. Period. But even consumers who are afraid that they might be joining the jobless ranks are loath to take on the added risk – making them unlikely candidates to buy a new home.

Foreclosures Still Rising

As unemployment climbs, foreclosures will continue to multiply. That only exacerbates an already unappealing combination – more houses being dumped onto the market even as the pool of potential buyers grows increasingly smaller.

RealtyTrac Inc. reported that more than 81,000 homes were foreclosed on in September – 71% increase from the same period just a year ago. For 2008, foreclosures rose to a record 765,558.

“I wouldn’t be surprised to see foreclosures increase as the economy slows down,” said Rick Sharga, RealtyTrac’s vice president of marketing. “The people living paycheck to paycheck are at risk if they lose their jobs. It will cause more people to lose their homes.”

And while foreclosure volumes are outpacing projections, the cumulative losses by banks on bad mortgages may have yet to hit their books.  Since loan losses don’t get recorded until the property is sold, it’s likely there’s a lot of bank-owned inventory that hasn’t been unloaded – meaning there may be more foreclosures out there investors don’t yet know about.

“We are in uncharted waters,” said Brian Bethune, an economist at research firm Global Insight (IHS).

Making the waters even rougher was the decision by Standard & Poor’s Inc. (MHP) to cut the ratings on $34.1 billion of “Alt-A” residential loan packages that had been issued in 2006 and 2007.  Alt-A mortgages are those written with little or no documentation, i.e., without proof of income or assets. Even worse, S&P put an additional $351.7 billion of Alt-A securities up for possible review reflecting the rating company’s “belief that further declines in home sales will depress prices further and push loss severities higher than we had previously assumed.”

On top of all that, record numbers of borrowers are already “underwater,” or “upside down” on their mortgages, making it more attractive for them to default by simply walking away, than to hang around and drown.

About 18% of homes nationwide are now “upside down,” according to a report from First American CoreLogic.  Almost two-thirds of those homes are in just seven states: Arizona, California, Florida, Georgia, Michigan, Nevada and Ohio. In Mountain House, Calif., an unincorporated planned housing community located in the foothills of the Diablo mountain range, the housing crisis right now has nearly 90% of the homeowners owing more on their houses than they are worth – the highest percentage in the country, The New York Times reported on Nov. 10. The average homeowner is underwater by $122,000, the newspaper said.

Other areas are suffering almost as much: In Nevada, alone, borrowers owed a whopping 89% of the value of their homes.

Despite such dramatic anecdotes, this housing slump is nationwide in nature. It’s more severe than any other such downturn since World War II, mostly because of the risky lending practices that inflated the real-estate bubble in the first place.

The Downdraft in Housing Prices

Meanwhile, while unemployment rises, the downward spiral in housing prices is gaining momentum.

“The No.1 thing that drives housing values is incomes,” said Todd Sinai, an associate professor of real estate at the Wharton School at the University of Pennsylvania. “When incomes fall, demand for housing falls.”

The S&P/Case-Shiller Index of home prices plunged 16.6% in August from the year before, following a 16.3% drop in July. The index has fallen every month since January 2007 (See accompanying chart, “Plummeting Prices.”).

Prices were lower in all 20 of the major cities the index covers, with Phoenix and Las Vegas down nearly 31% from last year.

Nationwide home prices have fallen 20.3% since peaking in June 2006.

And the skid isn’t over.

According to Fitch Ratings Inc., U.S. home prices will fall another 8% to 10% before they show signs of stabilizing.  According to a Fitch forecast, the peak-to-trough price decline will be 30%.
And still one other reliable indicator of housing prices seems to confirm that, in many cities, home prices still have further to fall.

According to analysis by Moody’s Investors Service (MCO), Miami houses are right now priced at about 22 times annual rental income – versus an average of just 15 over the past two decades. This suggests that a home currently priced at $350,000 is actually worth only $238,600 – meaning the price would have to drop 32% to reach the fair-value point.

Congressional Missteps

In an effort to help more than 400,000 homeowners avoid foreclosure, Congress came up with the “Hope for Homeowners” program.  Unfortunately, in their infinite wisdom, federal lawmakers designed a program that is almost certain to fail.

The program supposedly makes as much as $300 billion available to at-risk borrowers, enabling them to refinance into a 30-year, fixed-rate loan insured by the Federal Housing Administration (FHA).

The biggest mistake Congress made was to make this program strictly voluntary for participating banks, experts say.

Just as bad: In an effort to make the program more affordable for beleaguered homeowners, it also requires the lenders to write the value of the home down to 90% of its current market value. So in a downtrodden market like Phoenix, if a lender holds a $400,000 mortgage on a home currently appraised at $300,000, the bank would have to settle for a new mortgage worth only $270,000.

Needless to say, the response has been underwhelming.  After four weeks, a whopping 79 people had applied for the program.

Not to be deterred, the Federal Deposit Insurance Corp. (FDIC) is proposing another package, which would extend the terms of at-risk loans from 30 years to 40 years, with interest rates as low as 3.0%.  Housing payments for delinquent borrowers could not exceed 38% of gross monthly income.

In order to sweeten the pot for lenders, the government would share as much as 50% of the losses if a borrower ended up in default anyway.  In addition, the FDIC would pay servicers who process these new mortgages a fee of $1,000 for each re-worked loan.

FDIC officials estimate that this anti-foreclosure program would cost $24.4 billion, and would prevent 1.5 million of the 2.2 million at-risk homes from falling into foreclosure.

But that also means the taxpayer will be on the hook for half the value of 700,000 mortgages that do fail.

Can you say “fuzzy math?”

Homebuilders on the Ropes

You can probably guess where this leaves the nation’s homebuilders – gasping for air.

D.R. Horton Inc. (DHI), one of the nation’s biggest homebuilders, just wrote down $1.1 billion in land, deposits and inventory in the third quarter, as sales fell by half. The Ft. Worth, Tex.-based company expects to post a fourth-quarter net loss of between $800 million and $900 million, 18 times more than it lost in the fourth quarter a year ago.

Other builders are in similar shape. Pulte Homes Inc. (PHM) and The Ryland Group Inc. (RYL) just reported quarterly losses of $280.4 million and $65.7 million, respectively.

Even Toll Bros. Inc. (TOL), which caters to the high-end buyer, said fourth-quarter revenue fell 41% from the same period last year.

The Forecast for 2009: More Pain Before Any Gain

No matter what happens in the U.S. housing market, until a large inventory reduction takes place, housing prices will not stabilize.

In a recent Forbes magazine column, A. Gary Shilling, president of an economic consulting firm of the same name, said the worst is yet to come. Says Schilling: “Excess inventory, the mortal enemy of prices, now amounts to 1.8 million homes, which is a huge number relative to the net demand (new families minus departures due to deaths and moves to nursing homes) which is only 1.5 million a year.”

And one of the architects of the U.S. housing debacle – former U.S. Federal Reserve Chairman Alan Greenspan – is also downbeat: “At a minimum, stabilization of home prices is still many months in the future,” Greenspan said in an October speech.

The question that needs to be answered, then, is this: In the current atmosphere, does anyone believe we actually need homebuilders to add even one new home to the market?

Some pundits claim this may be a golden opportunity to short U.S. homebuilders. Even though they’re already down 80% from their highs, the deadly combination of skyrocketing unemployment, deflating prices and tight credit continue to spell further pain for the industry.

Short sellers would obviously look at any of the companies mentioned above. They might also consider iShares US Home Construction (ITB), the prominent exchange traded fund (ETF) for the group. However, any such move would have to be made with extreme caution.

The reason: All bets are off if the new Barack Obama Administration implements a moratorium on mortgage foreclosures. There’s also the possibility that Obama will be able to shepherd through any one or more of the proposed mortgage guarantee programs now on the table.

Those kinds of moves could provide a boost to homebuilders and leave short sellers in the grips of an uncomfortable squeeze – just like the millions of homeowners saddled with mortgages they can no longer pay.

Source: New Year U.S. Housing Market Forecast: No Gain, More Pain