Negative on Real Estate, Retail and Financials

by: Jason Tillberg

In 1999, the total value of residential real estate in America was $10.429 Trillion.  Today, there is total of $10.600 Trillion in home mortgages outstanding. 

Obviously, home values have increased and many new homes have been built since 1999.  What's most striking is the % equity of the overall home values of America has gone from being 57.5% in 1999 to a measly 46.2%.  ($19.7175 Trillion current value of household real estate and $10.600 Trillion in mortgages; see the links above.)

This is a big problem because we have seen the % equity in homeowners' homes go from being over 80% in the aggregate in 1945 to now 42.6%.  It's no wonder consumer confidence is as low as it is today when Americans have little equity in their homes and at the same time, house prices are falling, making the equity % even lower.

My Grandparents lived in an attic for 10 years after they first got married. Grandpa was a butcher and Grandma was a housewife.  As they lived in the attic apartment those 10 years, Grandma was able to save $3,000.  So in 1949, they were able to buy a house in the suburbs of Long Island for $8,000 using the $3,000 as the down payment.  The farmer who lived around the corner kept the $5,000 mortgage, not a bank. 

Boy have things changed.  In this past decade, we've seen single people in their 20s buying housing with little to no money down. Easy financing led to median house prices to soar to abnormal levels.  People were even quitting their jobs to become full time house flippers - and the list goes on.

Let me show some statistics:

We can see that median house prices kept a ratio of about 2.7 to median income from 1980 - 2000.  But we had a bubble boom in housing fueled by easy credit that took that ratio to 4.07 by 2007. 

Let's assume incomes rise 3% per year until 2010, and that house prices fall back to their previous ratio to income of 2.7.

Median income would be $52,671 in 2010 and if we times that by 2.7 we get a median house price in the United States at $142,213.  That would be a decline of 28% from 2007 house price level of $196,300.

Let's now assume that the number of households remains the same up until 2010 at 116,011,000 and now take a look at the total residential home value and outstanding mortgages.

116,011,000 X $142,213= $16.498 Trillion in total house value and Mortgages outstanding as of today being $10.600 Trillion, homeowners equity becomes 35.75%.

These kinds of ratios are unprecedented.

My thoughts about investing with this in mind leads me to be extremely pessimistic about real estate, retail and financials.  It also leads me to believe that it's going to be very tough for the Fed to fight inflation, which is coming on fast and hard, by raising rates when there is so much debt outstanding to the average American household. 

If the Fed is reluctant to raise rates as I suspect and inflation heats up more, it's also then probable in my opinion that we return to negative real interests rates, which hasn't happened since 1979 and 1980 when inflation CPI was higher than AAA rated corporate bonds by -1.7% and -1.6% respectively. What happened then was a huge run-up in commodity prices.  So I'm bullish on commodities for that very reason.  

Disclosure: Current holdings with this theme in mind include SKF, SRS and SSRI for being short financials, short real estate and long a silver mining company respectively.