Michael Shulman

The Obama Bounce Trade: Here Today, Gone Tomorrow

by Michael Shulman   11/06/08

The end of a presidential election cycle typically leads to a quick upturn in the market, regardless of the winner. But this time itchy traders jumped the gun and bid the market up on election, sold it off the day after and the bounce is officially over.

We are now back to waiting on the only thing that really counts -- economic data and the window it provides into the economy.

Right now, that window bears a strong resemblance to one in a jail cell. The economy -- and eventually the market -- is locked into behavior driven by three things: the housing crash, the credit crisis, and the evaporating consumer.

The Housing Crash

Every week or two, a new data point comes out and the pundits try to spin it -- "home sales ONLY fell 11%" or "average home prices fell only 16.6 % year-over-year" or some such nonsense.

I don't hate homebuilders, I have no axe to grind, but I passed third-grade math and eight-grade English, and here is what I see by reading financial and other documents:

• Defaults of subprime and Alt-A (near-subprime) mortgage holders will peak in December, which means foreclosures from these mortgages peak in December. And just as this is happening ...
  
  
• Defaults from option adjustable-rate mortgages (ARMs) -- the funkiest of all funky mortgages -- will accelerate. Wachovia (WB), now in the snug if increasingly shaky arms of Wells Fargo (WFC), already predicts 22% defaults -- it will be far more due to the severity of the recession.
  
  
• The recession will cause its normal share of mortgage defaults and foreclosures. So, pile up all these new homes on the market -- in addition to the historically high inventory -- and you see home prices falling.

Will buyers swoop in at this time and save the day to become the Marines of the mortgage meltdown marketplace? Nope -- 40% of all buyers in 2006 were subprime and ALT-A and they will be eligible for mortgages about the same time Obama leaves Washington after his second term.

Credit standards are tightening, mortgage interest rates are quite high compared to the past five years, and we have a dearth of real buyers. Inventory plus weak demand equals a continuing slide in home prices.

Instead of 2009 (when Wall Street is fantasizing about stability) or 2010 (when Fannie Mae (FNM) and Freddie Mac (FRE), those two paragons of analytical excellence), start thinking the second half of 2011 for stability and mid-2012 for a rise in prices.