Matrix Analytix Equity to Real Estate Capital Reallocation Theory:
- Significant reassessment of traditional investment vehicles ongoing due to unprecedented concerns over deflation here in the US, with extreme focus on structural integrity of equity market yielding major concerns over asset classes' ability to act as a long-term investment vehicle,
- Concerns over deflation and structural integrity of equities causing major capital outflows in asset class with nearly $50B in domestic equity outflows year to date, and most recently the exit of major hedge fund players who have performed extremely well for decades (ie Stanley Druckenmiller's Duquesne Fund Management),
- Equity outflows causing major decline in overall market liquidity, making it more difficult for hedge funds to initiate and unwind large positions...equity outflows also causing a decline in pool of risk-taking capital which will result in additional hedge funds closing up shop over the next 6-12 months,
- Equity outflows have created decrease in market liquidity which is now leaving the door open for much more significant manipulation by larger players ... larger players now using manipulation in equities to yield significant profits in short-dated options (note weekly option instruments now expanded to several equities with very high volume in weekly index options) ... low volume 2% manipulated move in S&P producing 100-200% gains overnight ... note major banks under tremendous pressure to produce earnings as yield curve flattens, trading volumes decline, and FinReg disrupts traditional bank activity (in other words, sharks are very hungry and looking for any possible instrument to produce returns ... they are well aware that we are in an environment where only strong will survive),
- Increase in manipulation in equities yielding dramatic disruption in traditional correlations against bond yields and currencies which is posing major problems for black boxes....black boxes which have performed well in past environment of high volatility now being reconstructed to adapt to new environment in equities which continues to tend toward chaos...again, hedge funds finding it increasingly difficult to put on meaningful medium-term trades with many likely unable to survive this long period of chaos,
- As choatic period in stocks continues, capital continues to flee equity market ultimately reallocating into Treasuries where yields continue to sit at multi-year lows (nearly $200B in net inflows into bond funds vs $50B in net outflows in domestic equity funds)....relentless bid in Treasuries continues to signal major concerns over deflation and skepticism over current equity pricing,
- With significant amount of investment capital now sitting in Treasuries with record-low yields and/or money markets with near-zero yield, at some point this capital will become dissatisfied with lack of meaningful returns and look to reassess the two markets which can produce higher yields, namely the equity and real estate markets,
- As market participants look to reassess these traditional markets on a risk/reward basis we expect market participants will begin to note several attractive data points within the scope of the housing market which will produce a strong bias toward capital deployment into the housing market versus equities:
- With possibility of deflation likely modeled into most risk analysis models expect market participants likely take note of the fact that while equities have yet to deflate, the housing market has not only deflated but currently sits at extremely depressed price levels on a historical basis thereby yielding a much more favorable risk/reward profile versus that of equities.
- As average Americans reassess how to redeploy investment capital, expect skepticism over the structural foundation of the equity market to continue lingering within the psyche of Average investors which will ultimately lead to a focus on the intangible nature of the assets yielded in a stock investment (outside of a stock certificate) vs. the tangible nature of assets yielded in a real estate investment (an actual home, apartment, piece of property, etc.)...this tangible nature of an investment in real estate will further lead to the assessment that unlike stocks, real estate (especially homes) can not go to zero value and hence their downside risk is limited.
- Mortgage rates currently sit at historic lows acting as an extremely strong incentive for real estate investment (should you have the ability to get a loan, which we'll address shortly).
- Since Americans are significantly reducing their exposure to equities, the governments "interest" in seeing higher equity prices to perpetuate a wealth effect will decline (as equity appreciation now begins to affect less and less Americans), leaving the housing market as the most significant market which can have an effect on Americans' wealth...we expect to see significant government tailwinds for the real estate market (specifically aimed at price appreciation) over the next several years.
- The expiration of the Bush Tax Cuts at the end of 2010 which will raise capital gains taxes across the board will act as a significant disincentive to owning equities beginning in 2011 as the appeal of buying and selling equities especially for short-term gains declines (transactions now yield less and less profit due to increase in taxes)....we expect that the imposition of these new tax hikes will therefore increase the appeal of long-term investments such as real estate, especially as the downside risk of owning real estate is now diminished.
We acknowledge that we are making the significant assumption that should market participants come to the conclusion that an investment in real estate far outweighs an investment in equities, that they will indeed be able to qualify for a loan which would enable them to adopt this investment. And of course there is major risk to this thesis in the form of unemployment, as higher unemployment levels make buyers less and less qualified for large principal, high down payment loans and hence unable to carry out this transaction.
However, we believe that the marked increase in personal savings over the past 3 years, where savings rates as a percentage of disposable income have increased from just over 1% in 2007 to over 6% in Q2 of 2010 (according to the Bureau of Economic Analysis), will lead to higher consumption rates in 2011 (as Americans have traditionally been unable to save for prolonged periods of time), which will lead to higher demand for goods and services, thereby producing higher demand for labor and a bottom in the job market with a downtick in unemployment in 2011 ... this decrease in unemployment and most notably the increase in job security will lead to an easing of lending standards especially at the low end of the mortgage market (sub-$500K loans), and therefore an increase in the ability to finance real estate transactions.
Note, we also expect continued government incentives for real estate purchases over the next several years, as home prices remain a significant factor of wealth, consumption, and therefore economic activity which the government has a keen interest in seeing uptick due to much desired increase in tax revenue.
Now of course, should demand for goods and services increase and unemployment begin to decline in 2011, equities are likely to appreciate as well, however we believe that current widespread skepticism over the structural foundation of equities will remain pronounced for several years leading to continued declines in investment into the equity market and more notable increases in the traditional market of real estate especially as market participants look to take advantage of record low mortgage rates, depressed housing prices, and much more favorable risk/reward levels.
Conclusion and Investment Strategy:
While housing prices are expected to continue declining near-term, due to an uptick in foreclosures, we expect the significant amount of investment capital, which has been pulled from equities and currently sits in Treasuries and/or money markets, will become redeployed into the housing market in 2011. This will therefore begin clearing the supply of houses available and put a bottom under housing prices, especially at the low-end of the market.
We moreover, expect the recent increase in savings rates will lead to increased consumption of goods and services in 2011, which will therefore lead to an increase in demand for labor, a decrease in the unemployment rate, and ultimately an easing of lending standards (due to increased job security and increased confidence from lenders that borrowers will be able to repay loans) which will act as a significant catalyst to real estate purchases in an environment already ripe with record low mortgage rates.
As such, we expect to begin accumulating long-term January 2012 call options across the board in homebuilders heading into year end 2010 as we expect to see a bottom in these stocks in the next 6 months with significant price appreciation in 2011. We very much expect Housing Stocks to be the "Trade of The Year for 2011."
Disclosure: No positions
