Happy New Decade!
Consultants have noted that we compare quite favorably to Absolute Return Funds …
Also, both funds have had strong returns in a down decade…
Update: Will 2010 continue 2009’s strength?
What a difference a year makes! 2009 closes with some vastly better circumstances. Weekly Unemployment Claims are well off their highs. Leading Indicators are up strongly from their lows. Consumer Expectations have risen smartly. Credit spreads have tightened from a year ago and GDP growth is back. The question is, will all of this good news continue. The short answer is yes. We expect GDP growth to be strong for Q4 2009. However, the future is bit less certain…
Let’s look at some of the drivers from 2009 and see if they are repeatable in the 2010.
Government Stimulus
First Time Homebuyer credit. This program helped spur both sales and an increase in median home prices. It was a way of bringing back no down-payment loans. The credit was used for the down-payment (or a large portion of it) to be able to qualify for a loan. Since the mortgage insurers are largely out of business and the GSEs, Fannie and Freddie, are back to large down-payment loans, the credit bridged the gap for savings challenged buyers who could qualify for the payments but not the down-payment.
This program has been extended, but phases out by April, 2010. Most of the bang was probably used up in the first program, so any effect should be muted and late in showing up.
Cash for Clunkers
This program helped spur sales and is leading an inventory rebuild which is additive to GDP. Auto sales should come back slowly on its own as the cars wear out. It should however take a few years before we see the 16 million unit level of a few years ago. Large credit spreads led to higher financing costs when financing could be had. A meltdown in the securitization markets cut off available auto credit for potential buyers. This was largely due to the credit crisis which is over for now. So while this program will probably not be back, auto sales should continue to rise. About 12 million is the replacement run rate. November was 11 million.
Hamp
This program allowed lenders to make trial modifications of loans that were delinquent or about to be delinquent, in the hope that the loan would not have to be foreclosed on. The program allowed a five month trial program which kept the mortgage out of foreclosure, generally until the end of the year.
Most of these modifications have not become permanent and will go back into foreclosure after the end of the year. This was a way to keep many foreclosures off of the market to give the bad news a breather and allow the banks to claim less write-offs this year. Other than helping the banks extend the issue, this program has failed.
Federal Reserve buying Treasury paper
The Fed has bought $300 billion of US Treasury paper. This program ended October 29, 2009. Since then, 10 year Treasury yield have gone from 3.4% to 3.8%. This program is over and there are more bonds to sell in 2010.
Federal Reserve buying GSE paper
The Fed has said that it will buy $1.25 trillion of Fannie Mae and Freddie Mac debt and mortgage backed securities guaranteed by the two GSEs. The Fed has already bought $1.0 trillion as of Q4 2009. Therefore it only has $0.25 trillion left to buy in Q1 2010. There are estimates that these purchases have lowered mortgage rates by 50-100 basis points. This has kept home prices elevated and more affordable. What happens to mortgage rates when the program stops?
Stimulus
The roughly $800 billion is to be spent over 2009-2011. The largest impact from the spending occurs in Q2 09 – Q1 10 (see chart below). After Q2 10 the stimulus is neutral to GDP and is actually negative later as larger stimulus is compared to smaller stimulus. So while the stimulus was additive in the first half, it may not be additive in the second half.
Elections
Perhaps the largest reason to expect a strong 2010 is that this is an election year. With one party controlling the White House and Congress, one can expect them to do everything they can to make sure that the economy has turned around by the end of the year. The Treasury, the Fed, the Congress and the White House have shown themselves to be particularly creative when it comes to new government programs. One should expect more of the same this year. However it is difficult to analyze what new programs may or may not be passed.
So the government played a huge roll in 2009. What the consumer took away in more saving and less big ticket debt-financed spending, the government made up for, especially the debt-financed part. Most of the programs though have already had their impact and it is yet to be seen if the economy is now self-sustaining. More stimulus will probably be needed.
Housing Market
Median Home Price Increases
Due to the First Time Homebuyer credit, as well as lenders keeping foreclosures off the market through HAMP and other programs, and the peak home buying summer months, median home prices have been increasing. (see chart) This, we believe, has accounted for most, if not all, of the good economic news we have seen the past few months.
Higher home prices lead to expectations that banks will have lower expected losses from delinquencies and foreclosures. It also means that fewer homeowners will be underwater on their mortgages and thus fewer will be tempted to walk away and default on their homes. Both of the above mean that banks will not have to raise as much capital to protect from such write offs. This, we believe, is what has allowed banks to raise capital and repay their TARP loans.
However, foreclosures in process have skyrocketed while completed foreclosures have risen slowly. (see chart) This backlog of foreclosures will hit the market in Q1 and Q2 2010 and may turn home prices back down. This could lead to a double dip recession, something Nobel laureate, Paul Krugman, puts at a 30 - 40% chance.
Existing home sales fell 16% in November. This is what happened when Cash for Clunkers expired. If existing home sales stay soft, expect lower prices as the backlog in foreclosure supply hits the market in Q2 2010. Banks are still valuing homes too highly on their balance sheets so they are vulnerable to a downturn in home prices again.
Problem mortgages have been spreading to higher credit borrowers as well…
Mortgage Resets/Recasts.
Another challenge will be the number of mortgages that came with negative amortization. These loans re-amortize over the next couple of years. No longer will the borrower be able to make interest only payments. Now the loan has to fully amortizeThe payment shock could lead to more defaults.
We believe Housing to be the single most important factor for 2010. If prices continue to trend up, or at least not go down, then the economy should muddle through and the market should be fine. However, if Home prices head down, then the economy and the markets may face pressure and banks may have to raise more capital due to more write-offs.
Government Debt
The US Treasury expects to issue over $2 trillion in new government obligations in 2010. They were successful in floating a similar amount in 2009. At some point the world becomes satiated. No one knows when that happens, but China has been saying that with a lower trade deficit, there are fewer dollars floating around to buy US debt.
While we believe that at some interest rate there will be buyers, higher interest rates could slow the economy and put pressure on markets. Stock markets discount long term cash flows of companies and are especially sensitive to long term interest rates. The higher the rates, the less longer term cash flows are worth.
We have not seen a problem with government financing so far. But that does not mean that it could not happen.
US Dolllar
The USD has fallen from 1.25 to 1.45 against the Euro. A falling dollar tends to drive commodity prices and inflation higher. Continued large deficits and government borrowing could lead to an even lower dollar.
This would benefit oil and other commodity companies as well as US manufacturers. If it leads to inflation and higher interest rates it pinches consumers and stocks. To the extent that higher inflation leads to higher incomes, then mortgages may be paid off more easily which would strengthen the banks.
So as you can see, 2010 is set to be another exciting year with plenty of cross currents. We believe that without more government stimulus, a double dip “W” recession has a 50/50% chance. However, we think that there will be more stimulus, especially if home prices soften again. The wild card is interest rates going up due to selling more Treasuries.
Going forward we intend to find strong companies that are undervalued and have exceptional appreciation potential. We will also keep one eye on controlling risk. We expect continued market volatility and will position the fund accordingly. We are grateful to have thrived so far in this environment and will continue to execute our strategy.
Best regards,
Thomas H. Forester
CIO and Portfolio Manager
For more complete information on the Forester Funds, including charges and expenses, obtain a prospectus by calling 1-800-388-0365 or visiting www.forestervalue.com. The prospectus should be read carefully before investing.
The foregoing does not constitute an offer of any securities for sale. Past performance is not indicative of future results. The views expressed herein are those of Thomas Forester and are not intended as investment advice.
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