Complacency, Concern, and Now, Confusion

Complacency over the timing of Federal Reserve rate cuts morphed into concern yesterday. Today, confusion reigned.

Fears of Fed tightening were heightened by the 8:30 a.m. EST release of a stronger-than-expected report on core consumer prices for February, which rose 0.3% last month vs. expectations for a 0.2% gain. Headline CPI was in line with expectations at 0.2%.

But the 10 a.m. release of the index of leading economic indicators and the noon Philadelphia Fed index gave pause to the tightening fears. The LEI was flat in February vs. expectations of a 0.1% rise, although January's LEI was revised upward by 0.2%, to 0.8%. Separately, the Philadelphia Fed's index fell to 11.4 in March from 16 in January, its first decline since October and belying the consensus forecast for a rise to 17.5.

The mixed message from the data was reflected in the financial market's whipsaw action. In the wake of the CPI data, stocks -- notably blue-chips -- fell in concert with Treasury bond prices. But after the LEI and Philadelphia Fed reports, both stocks and bonds reversed course.

Once as low as 10,354.74, the Dow Jones Industrial Average recovered to close down a relatively modest 0.2% to 10,479.84. The Dow was restrained by ongoing weakness in General Electric(GE), which strained under the weight of yesterday's critique by Pimco's Bill Gross. International Paper(IP) and 3M(MMM) were also drags on the index.

The S&P 500 was also restrained by GE and rose just 0.2%, while the Nasdaq Composite gained 2%.

Similarly, the price of the 10-year Treasury June futures contract settled at 102 7/32 after trading as low as 101 19/32. The price of the benchmark 10-year note finished up 9/32 to 96 8/32, its yield falling to 5.37%.

The Comp's rally notwithstanding, the relatively subdued closing moves give us a chance to revisit everybody's favorite subject: housing.

Big Bubbles, No Troubles

The following is updated from today's Midday Musing

As detailed in recent columns, the question isn't whether housing and related stocks are in a bubble, but whether it's a bubble akin to Nasdaq circa 1996 or circa 2000.

Comparisons to the latter generated guffaws from advocates who note homebuilder's valuations are far below the triple-digit price-to-earning ratios sported by many tech stocks during the Nasdaq's heyday. The S&P Homebuilding sector is trading with a trailing 12-month P/E of 8.3, compared with 25.5 for the S&P 500, according to Baseline. Additionally, many individual homebuilders are trading in the midpoint of their historic P/E ranges, suggesting more upside would not result in outrageous valuations. (Anecdotal evidence suggests many readers are pinning their bullishness on the group's relatively low P/Es.)

Still, skeptics contend the group's earnings are peaking, or approaching their apex, which is the time to sell cyclical names. Recent activity has provided some fodder for those who believe the "Nasdaq 2000" scenario is appropriate.

Prior to the market's opening today, KB Homes(KBH) reported a 65% increase in first-quarter earnings, at 95 cents a share vs. consensus estimates of 79 cents. In its conference call, the homebuilder raised its forecast for second-quarter earnings to $1.10, from $1.07, and to a range of $6.10 to $6.25 a share for the full year vs. $5.75 to $6.10 previously.

Despite those rosy results and outlook, KB Homes' shares fell 2.3% today.

Homebuilders were similarly unable to rally on good news yesterday, tumbling even though housing starts were reported to have risen 2.8% in February to a seasonally adjusted rate of 1.77 million, the fastest pace in three years. Construction of single-family homes rose 7.4% last month to a seasonally adjusted 1.46 million, the fastest pace in nearly 25 years.

Nevertheless, shares of Lennar (LEN), which posted robust first-quarter earnings of its own, fell 4% yesterday. Elsewhere in the sector, Toll Brothers(TOL) stumbled 5.1%, Centex(CTX) shed 5.9%, Pulte Homes(PHM) lost 6.5%, and Ryland Group(RYL) slid 4.3%.

"Given the inability of the group to respond to good news [yesterday], we figure these stocks are going to work lower still," John Roque, senior analyst at Arnhold & S. Bleichroeder, commented this morning.

Today, Lennar lost 2.9%, Pulte slipped 1% and Centex dropped 3.4%, while Ryland gained 0.6% and Toll Brothers rose fractionally.

Housing and housing-related stocks have long confounded the skeptics, Roque included. Another being Seabreeze Partner's Doug Kass, who commented on RealMoney Pro today that the time had come to pare back short positions on homebuilders. Kass cited the group's recent weakness and an expectation that sell-side analysts will make bullish comments next week in conjunction with (and contribution to) mutual fund managers' quarter-end mark ups.

Still, "there will be plenty of opportunities to reload on the short side," Kass concluded, echoing the view of those who believe a pricking of the housing bubble is inevitable.

"February's extraordinarily strong data suggests to us that housing has hit a ceiling while the economy has hit a floor," commented Donald Straszheim, president of Straszheim Global Advisors in Westwood, Calif. "With the Fed moving its policy stance to neutral and likely tightening by midyear, rising mortgage rates in the 2002-2003 economic recovery should begin to weaken housing."

Supportive factors such as favorable supply-demand, demographics and recent tax-law changes have led some industry participants and supporters to declare that housing is immune to economic cycles. (Sound familiar?)

Phooey, say housing's critics, who note that mortgage rates, which are rising, will ultimately determine housing's fate.

"A good economy will lift incomes, encouraging homebuyers," Straszheim conceded. "But it will also lift mortgage rates, turning 2001's most important positive for house purchases into 2002-2003's most important negative."

The average 30-year fixed mortgage rate rose to 7.14% for the week ended March 22 vs. 7.08% the prior week, while average 15-year fixed mortgages rose to 6.65% from 6.59%, Freddie Mac (FRE) reported today. The averages are the highest since the first week of 2002 for 30-year and since the last week of 2001 for 15-year mortgages.

"In this climate, count on housing activity to slow," Straszheim wrote.

Returning to the Nasdaq analogy, tech stocks repeatedly defied the naysayers throughout the late 1990s. But they did suffer myriad sharp corrections which unfailingly brought out the "bubble is bursting" crowd, who kept being proved wrong.

That is, until they were proven right.

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