The Wisdom of Wall St.? Sometimes It's Wrong

By FLOYD NORRIS at New York Times

As 2006 begins, the great American housing boom is going to weaken, if not collapse. But that will not hurt the economy very much, and growth will continue at a good pace.

Or so goes the conventional wisdom.

Mortgage applications are down, and surely home sales will follow. Homes in many markets are far less affordable than they were a few years ago. There is a lively argument as to whether prices will fall sharply in some markets or simply level off for a few years, but another record year for the housing industry seems out of the question.

Sometimes, conventional wisdom proves correct, and a year from now that may be exactly what has occurred. But lately Wall Street's consensus forecast has seemed more likely to miss than to hit, a fact that investors may want to take into account before they sell their homes and await the bargains that will inevitably follow in the great housing bust.

A year ago, the one verity in market commentary was that the decline of the dollar was real and was going to continue. The United States was running a huge and unsustainable trade deficit, and the dollar's 2004 decline was likely to accelerate.

So what happened? China did grudgingly allow a small devaluation of the dollar against the Chinese currency, albeit one so small that it made no difference at all. But the dollar rallied against the other major currencies. It ended 2005 up 14 percent against the euro and up 15 percent against the Japanese yen.

A year earlier, at the end of 2003, market seers were united in expecting long-term interest rates to rise. The Federal Reserve was going to increase short-term rates, and virtually everyone was sure that long-term rates would follow. But they actually fell in 2004, and the yield of the longest-dated Treasury, which matures in 2028, fell again in 2005, although yields on the benchmark 10-year Treasury note rose 17 basis points, to 4.39 percent.

That rate was, however, lower than the two-year Treasury yield, which climbed 133 basis points, to 4.41 percent during the year. That yield-curve inversion, as bond jargon terms it, set off talk of a slower economy this year.

If the conventional wisdom this year is going to be as wrong as it was the last two years, there are at least two ways for it to be wrong. One would be for housing to continue at an extraordinarily strong pace. An accompanying chart shows sales of single-family homes, both new and previously occupied, for 12-month periods over the last 20 years. The totals can be a little misleading, because new home sales are usually reported when contracts are signed, while sales of existing homes are reported a month or two later, when the transaction closes.

But no sign of slowing is to be seen in those charts, and, as Robert J. Barbera, the chief economist of ITG Hoenig, notes, if the next move in long-term interest rates is down, sales could rise even more.

The stock market clearly was forecasting a decline in the housing market a few months ago. The Philadelphia Stock Exchange index of housing sector stocks reached a record high in late July and by late October had lost 21 percent of its value, leaving it down a little for the year. But it rallied 11 percent by the end of 2005, as profits continued to be strong.

Another way that the conventional wisdom could be wrong is that the impact of a declining housing market could be less benign than expected. Most economists say they think that the United States economy will grow around 3.3 percent this year, a little, but not much, slower than the 3.7 percent estimated for 2005. If the housing market were to decline, that could be reflected not only in lower construction spending but also in some retrenchment on the part of consumers who suddenly felt less well-off.

Another factor that could weigh on consumers, and on business investment, is oil prices. As it happens, the last four years have all ended with spot oil prices seeming high. What is different now are market expectations. At the end of 2002 and 2003, the expectation was that prices would come down quickly, as soon as the Iraq adventure was over. By the end of 2004, spot prices were significantly higher and the expected declines much smaller.

Now, the oil futures market sees no evidence of quick relief. The nearby oil futures contract, expiring in February, is at $61.04 per barrel. That is down from its peak of more than $70 reached in August, when Hurricane Katrina raised fears of oil shortages,. but it is well above what anyone expected a year ago. Moreover, the futures contract for the end of 2008, three years from now, sells for $61.99, a little higher than the current price.

That is persuading oil companies to step up spending on exploration and development, and there are limited signs that consumers now care more about fuel economy than they did in recent years. General Motors, which had the unfortunate distinction of being the worst-performing stock in the Dow Jones industrial average in 2005, losing 52 percent of its value, plans to promote fuel efficiency when it advertises its new sports utility vehicles.

Oil was the place to invest in 2005. Although the S.& P. 500 eked out an overall gain of only 3 percent, 8 of the 10 industry sectors were up, led by energy with a gain of 29.1 percent. The losing sectors were telecommunications, amid worries that competition with cable companies would leave little in the way of profits, and consumer discretionary, a sector that includes both auto companies and newspaper publishers. The latter suffered from worries that the Internet was eroding newspaper profitability at a faster pace than expected.

Later in the year, measured from when Hurricane Katrina hit, the place to be was not in oil stocks, which registered most of their gains before that, but in materials stocks, many of which hope to benefit from the rebuilding effort in the devastated areas. U.S. Steel rose 20 percent after Aug. 26, although it still ended the year 6 percent below its level a year earlier.

Despite the small gain for the S.& P. 500-stock index, gains were widespread. Of the 499 stocks in the S.& P. that were trading a year ago, 288 stocks showed gains for the year. It was the third consecutive year that more stocks rose than fell, and a sharp contrast to 1999, the last year of the bull market before it faltered, when the index gained 19.5 percent but only 241 stocks in the index were up.

The S.& P. 500, like most indexes, is calculated on a capitalization-weighted basis. That means that the four largest stocks - General Electric, Exxon Mobil, Citigroup and Microsoft - account for 10.7 percent of the index movement. Of the four, only Exxon Mobil, up 9.6 percent, had a good year. Citigroup finished up less than 1 percent, and the others had losses.

Of the stocks in the S.& P. 100, which are generally the largest in the 500, just 51 showed gains. And just 14 of the 30 Dow industrials showed gains.

Standard & Poor's also computes the S.& P. 500 index on an equal-weighted basis, in which each of the 500 stocks counts as much as every other. That presents a far different picture. While the capitalization-weighted S.& P. 500 ended 2005 down 18 percent from its 2000 peak, the equal-weighted index has been setting records with regularity, although it is down from the peak set on Dec. 14. Its 2005 close was 33 percent higher than the highest close in 2000.

Another example of conventional wisdom being wrong could be in the performance of Hewlett-Packard, whose 2002 merger with Compaq Computer was generally viewed as ill advised and led, in February 2005, to the ouster of Carleton S. Fiorina as the company's chief executive. The company ended the year up 37 percent, better than any other stock in the Dow 30.

Other companies whose chief executives left under pressure during the year did not fare as well. Morgan Stanley posted a 2 percent gain, but that was the worst showing in the brokerage industry. Fannie Mae, which not only ousted its top management but has so far been unable to produce audited financial statements, fell 31 percent. Another company that has been unable to calculate its finances since a boss was fired, Krispy Kreme Doughnuts, lost 54 percent of its value. And Walt Disney, where Michael D. Eisner left earlier than he had planned, dropped 14 percent.

Given the severance packages that are routinely given to former chief executives, none of them would have any trouble buying a new home. But a big issue in 2006 may be whether a lot of their less well-off fellow citizens discover that, for those who are treated less generously, homes are no longer affordable.