As indicated in last week’s report, major market indexes continued building support. The latest Commerce Department report showed that second quarter GDP was much stronger than initially believed. The annual rate of 4% compared to earlier estimates of a 3.4% rate. That is the highest GDP rate since a 4.8% rate in the first quarter of 2006 and it provides more evidence that economic fundamentals remain strong.

Analysts are forecasting that GDP for the third quarter could fall to an annualized rate of 2% because of the mortgage industry problems and the resulting market turmoil. Others believe that the Federal Reserve will take whatever action it must to avert any threat of recession by cutting interest rates or adding more liquidity to the markets.

Several times over the past couple of years I’ve written that concerns about the problems in the housing markets are being exaggerated and needlessly hyped. This week  I got some support for that view in the latest column from Tobin Smith.

Allow me to quote from his Aug. 29 WaveWire newsletter:

First, we have 75 million homeowners in the United States, and about 65 million have seen 100% gains in their homes from 2001 to 2005 — that’s a 25-year gain in just five years.Almost 40% of homeowners own their houses free and clear. (I know that might be hard for the East and West coasters to believe, but it’s true.)

Of the 60% of homeowners who have mortgages, 80% are prime mortgages, and 97% of those people are making their payments just fine.

About 14% of the 60% of mortgages in the United States are sub-prime or alt-A, and we are going to have to assume that a lot of those will go bad.There is around $150 billion worth of mortgages at risk, so for argument’s sake, let’s say that $75 billion of that gets foreclosed.

It’s not as though that money vanishes into thin air. About two thirds of it will come back to the banks. So, I figure less than $50 billion will have gone to money heaven when this is all said and done.

And we have a $10 trillion –with a “T” — mortgage market to absorb that $50 billion.

Furthermore, we have $18 trillion in major stock value and $30 trillion in bonds. So, while sub-prime mortgages are a problem, they are a relatively minute one.

This panic was about fear, not reality.

This is not like the Internet bubble bursting, which wiped out $7 trillion in 18 months. And, remember that we only witnessed a mild recession following the historic attack of the United States on 9/11, and we bounced right back.

You can subscribe to Tobin Smith’s newsletter at www.changewave.com

I have not had the time to verify these numbers, but the point he is making is sound. The overall impact to our economy because of these problems will not be significant. However, the effect can be much more pronounced if investors get caught up in the fear and frenzy and start reacting emotionally to reports that are hyped by the mainstream media.

As a former member of the mainstream media, I can assure you that most reporters do not understand the mortgage industry or the financial markets. I doubt that even 5% could correctly define a mutual fund, let alone explain a P/E ratio. So when you are hearing reports about how problems in the sub-prime mortgage market are going to cause the collapse of Wall Street and usher in the next Great Depression, don’t believe it.

Let me leave you today with an interesting chart. The black line is the Nasdaq over the past two years. The gold line is streetTRACKS Wilshire REIT (RWR) a real estate ETF. You can clearly see that this fund corrected sharply beginning in February. But notice that over the past two years, it has a total return of about 16%–slightly less than the Nasdaq over the same period.

Real estate is not exempt from the laws of risk and reward. Over the past few years, real estate has been the strongest sector of the market, posting some impressive and unusual returns. It is a sector that was overdue for a correction, just like technology in 2001.

Here is one more tidbit from Tobin Smith’s column for you to mull over. During the past 30 years, the United State economy has endured 14 months of recession. Remember, about the only stock market variable shown to have and predictive ability is trends. Given that trend of 30 years, do you want to be an optimist right now, or a pessimist? I’ll choose the best case outlook nearly every time.

Have a great Labor Day weekend.

F.S.

This entry was posted on Thursday, August 30th, 2007 at 3:23 pm and is filed under Newsletter. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.