There's a simple reason you shouldn't get too excited about the "green shoots" of an economic turnaround.
In the housing market, a lot of prime mortgages are becoming subprime as a new wave of foreclosures begins to hit. Mainstream homeowners -- those previously "safe" borrowers with sound credit who have conservative, fixed-rate mortgages -- are getting into trouble at an alarming rate.
In the first quarter, the percentage of these borrowers who were behind on their mortgages or in foreclosure had doubled from a year earlier, to nearly 6%. For the first time in the housing crisis, these homeowners accounted for the largest share of new foreclosures.
Job losses are a major reason once-safe borrowers are falling into trouble. With unemployment likely to rise, the problem will only get worse. So the core challenge at the heart of our economic crunch -- a poor housing market that infects banks and the whole credit system -- is not going away soon. That's bad news for the stock market and the economy in general.
"A couple of months ago, a lot of people had hoped that the housing collapse was about over," says money manager and forecaster Gary Shilling, a well-known bear who called the housing problems early in the cycle. "But it was more hope than reality."
More from MSN Money
The 3rd wave of woe
Economists call rising delinquencies and foreclosures among prime borrowers the third wave of trouble. The first two waves were housing speculators going bust and subprime borrowers -- those with poor credit histories and some version of no-down or low-down adjustable-rate mortgages -- getting into trouble.Mark Zandi, the chief economist for Moody's Economy.com, calls the third wave a "significant threat" to the economy. "It is gathering momentum," he says. "The problem is now well beyond subprime and deep into prime."
It will cause at least three problems that could shrivel the "green shoots":
- Mounting foreclosures among prime borrowers will destroy their credit ratings, making it tough for them to contribute to growth by spending on credit.
- Rising foreclosures will add to an already high level of housing inventory on the market, pushing down home prices even more. That will make people feel poorer, so they'll spend less. It also will tempt more people to walk away from mortgages, adding to the problem.
- Foreclosures will mean more loan losses at banks, deepening the problems in the financial system.
Investment opportunities?
How do you play this as an investor? Well, if you missed the 30%-plus move off the bottom since early March but you're still confident enough to tiptoe back in, don't do anything more than that. Average in on down days.Better yet, wait for the market pullback that this third wave makes more likely. Shilling has a bearish forecast of a trip down to 600 for the S&P 500 Index ($INX), more than a 30% decline from recent levels of 940.
Investors confident and daring enough to short stocks -- selling borrowed stock with the hope of buying it back later at a lower price -- may find profitable targets in the housing sector and among the regional banks. Homebuilder stocks look particularly tempting; they have risen more than 50% off their March lows on hopes for a quick recovery.
Whitney Tilson, a co-portfolio manager of the Tilson Focus Fund (TILFX) who also spotted the housing crisis early on, was recently short KB Home (KBH, news, msgs), Lennar (LEN, news, msgs) and Toll Bros. (TOL, news, msgs) in housing. He also has bearish bets against regional banks Regions Financial (RF, news, msgs), First Horizon National (FHN, news, msgs), Zions Bancorp (ZION, news, msgs) and New York Community Bancorp (NYB, news, msgs).
Continued: The 'subprime society'
Rate this Article
High