Bad Data Makes a Tough Environment Tougher

Before launching into today's column, I thought I might clear something up. Lest there be any confusion, Tuesday's column on the aggressive chicken bank stock trade was not a call to outright bullishness. It is a special-situation trade that uses the option premium to create a huge cushion that creates a margin of safety while preserving much of the upside. The stocks mentioned all trade at low valuation ratios and have solid balance sheets with lots of equity and excess capital.

As for today, the stock market is oversold, and the Fed has the pump turned on full blast, so a rally here is to be expected. The long-term picture is still quite cloudy and many of the negatives remain in place. Let's take a run through where we stand today.

Housing Declines Continue

Today's Case-Schiller report on real estate prices was overlooked amidst all the bailout and political discussions, but it was horrible. Housing prices fell 16% on a year-over-year basis in July. For the fourth straight month, not one of the cities surveyed showed an increase in price.

A separate survey by The National Association of realtors revealed that median home prices fell another 9.5% nationally in August. For the market to fully recover, real estate has to stop going down in value. At this point, we have no evidence that this is happening. In fact, a report form Moody's investor service today suggests that the housing woes will not end until 2010 instead of the 2009 time period they originally envisioned.

In August, 308,000 homeowners got default notices, threatening to add to the supply of foreclosed properties on the market. It is impossible for housing inventories to be worked off when the new supply of distressed properties is growing by double-digit percentages every month.

Right now, the housing inventories are at 11.2 months of supply, twice the historical average. Basic economics tells us that excess supply leads to lower prices. Add to this the fact that much of the supply is available at distressed prices, and housing faces a perfect storm. The downward pressure on price does not seem likely to stabilize for several months, if not longer.

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At the time of publication, Melvin had no positions in the stocks mentioned, although positions may change at any time.

Tim Melvin is a writer from Stevensville, Maryland, who spent 20 years a stockbroker, the last 15 as a Vice President of Investments with a regional firm in the Mid Atlantic area. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Melvin appreciates your feedback; click here to send him an email.