Analyzing Market Worries: Housing, Recession, and FASB 157
There are plenty of market worries, and major indices broke technical support today. Our TCA model flipped negative as a result, but there are still plenty of attractive sectors.
What does this mean for investors?
Housing and Recession
Regular readers of "A Dash" know that we do not expect a recession. We have acknowledged problems in the housing market, as does anyone with a pulse. The real question is how far this goes and whether it can be contained. There are plenty of pundits who are calling for the worst. Here is an alternative viewpoint:
The key to housing is the employment rate. As long as the employment
stays basically full–say, under 5.5%–I see no major crisis in the
housing market. Yes, we have a sub-prime issue. Yes, we have a lot of
investors who got hung out, but I don’t see the crisis the way the
media portray it. And consequently, as long as employment stays strong,
I don’t see any issue as far as rental housing is concerned.Q: Where do you see the economy going? Are we heading for a significant
slowdown or recession in 2008, as some economists have predicted?A: Not
2008. If you had to pick the next cycle change, logic would say it
would be sometime in 2009 because of a new presidency and because of
the various factors in the market. And that’s a probability. But I
don’t see it as 1990 or 1974 or any of those periods where we had a
real serious downturn.
When looking for real experts on real estate, Sam Zell would be high on the list. The quotation comes from his recent interview in Time.
Bogus Doomsday: November 15th
The usual suspects are citing the FASB 157 requirements that they say "take effect" on November 15th. The actual requirements have been implemented by major firms throughout the year, as David Faber (along with other sources) reported today on CNBC.
Many are expecting a Y2K-type event on November 15th, and this is not going to happen.
FASB 157 will help to show the actual exposure of financial institutions. Much is already in the public domain. Some announcements have already occurred. Some will occur during the next quarter. There is nothing special about November 15th, despite all of the hype. This is merely the dividing line for corporate fiscal years to start using the new method. The concept has been in play for almost a year.
Conclusion
There has been a reckless dumping of some leading growth stocks. Leading mutual fund manager Noah Blackstein today (on RealMoney, subscription required) called this "a gift" and we agree. We see little fundamental change in the prospects of these companies, so we added today to positions in Apple Computer, Inc. (AAPL) and initiated a position in Research in Motion Limited, (RIMM). We suspect forced dumping by some hedge fund managers. Their loss, your gain.
In options expiration week, big moves are possible. Long-term investors have a chance to initiate a position in growth stocks.
This is a time when individual investors can buy great companies at prices not seen in a while. The hedge fund lemmings will throw the babies out with the bath water as the run over the cliff (metaphor alert!). Sharp investors will take advantage.
If many are seeing Doomsday on FAS 157 on 11/15, they are missing the bigger issues. First, the effects only begin when the companies report; many have started to do so already. Second, this is just one in a continuing series of downgrades of our accounting rules. FAS 141, 142, 157, and 159 have all made our accounting less conservative. The forthcoming ability to use IFRS in place of GAAP will be no different. Mandate the use of IFRS if we want international uniformity, fine, but don’t let accounting standards be optional.
Now, in the end, only cash flows matter. Valuations versus free cash flow will not be affected, difficult as those are to measure. But valuation versus book will shift marginally lower, because the balance sheet accounting will be less conservative.
There are issues here on a micro level, and good analysts should be aware of them, but accounting doesn’t affect the cash flows, only how we interpret the cash flows. The market as a whole should not be affected, but individual stocks may look more or less desirable as the accounting rules change.
David, we run into definitional problems with Free Cash Flow.
http://www.billakanodoodahs.com/2006/09/fundamental-analysis-for-solvency-and-earnings-quality/
“… there is no real consensus on the definition of cash flow or free cash flow … This can lead to considerable misinterpretation when investors are relying on differing cash flow information provided by companies.”
It’s ALL speculation, the only question is the degree of research and planning we use to speculate …
Hey Jeff! I just realized that this is a classic “appeal to authority” argument!
The quote I made was referenced in my blog article, it was from
http://www.nysscpa.org/cpajournal/2002/0102/features/f013602.htm
See sidebar 2 link at the bottom of the page.
Supposedly the CPA Journal of the NY State Society of CPAs is an “authority” on Free Cash Flow ….
Bill – You are quite right about the appeal to authority aspect. I actually had your blog quiz in mind as I wrote this piece.
One feature of ‘A Dash’ is that our expertise is in identifying experts. We are consumers of information. Most other bloggers are also, but they do not realize it!
I subject every source to the LINQCRED approach, and try to select the best to highlight, e.g., Malpass, ECRI. It does not mean that they are always right, but rather that they are worth listening to. Sam Zell on real estate has to be regarded as first rate, unless we think he is talking his book somehow.
Thanks for a good observation.
Jeff
“Consuming information” comes on my list right behind consuming chocolate chip cookies and potato chips. I often do all three at the same time, btw.
Recession unlikely. AGREED! The doomers and gloomers must’ve missed the last few GDP numbers. While the economy isn’t rippin’ and roarin’ it isn’t tankin’ either. Kind of a slow thing that folks feel uncomfortable with, like kissing your sister.
It’s the Kiss Your Sister Economy. KYSE.
Nice stock pick-ups at the end of your column, Dr. Jeff.
I deleted Tai as a spammer from one of my sites. Every vid they posted to YT is an ad for Zecco, as is the video. Do not click it, not that it’s dangerous, it’s just stooopid, but there’s no need to give them the traffic.
Thanks, Bill. I took care of him!