Market Outlook: It's Still All About Housing 16 comments
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The S&P500 is down 17% since October, but it's up 7% in the last month. There is always the temptation to think we have entered a new long-term bull market run, and it's time to get long before it's too late. However, over the next 12 to 18 months, I believe the housing market will continue to be the fundamental driver of the US economy, and conditions in housing are still deteriorating.
First, let's examine some housing market facts. July housing starts data will be released on August 19, and if the trend remains intact we are headed downward. For example, last month's release showed single family starts declined at a rate of 5.3%, and this figure is down nearly 50% since January 2006. On August 26, we'll receive new home sales figures, which are also trending downward (down over 30% in the last year). Some bullish commentators will point to the inventory-months metric which seems to be bottoming around 10 months, but this can be misleading because it's based on a much smaller total amount of inventory and sales when compared to several years ago.
So why do we care about housing? A deteriorated housing market cripples the US economy in multiple ways. First, let's not forget that the hundreds of billions of dollars in write-downs by financial institutions have been caused almost entirely by deteriorating housing conditions, mainly securitized subprime mortgages, and many experts believe this figure could reach well over one trillion dollars before it's all over. Second, it's become almost cliché at this point, but tens of millions of Americans were using their home equity as credit cards, and now that home equity values have fallen, so too has the consumer's ability to spend. As home equity evaporated, consumers turned more heavily to actual credit cards, and the current record levels of credit card debt will drag on consumer spending and the US economy for quite some time to come.
Some bullish observers will point to the slowing rate of deterioration in housing as a sign of the bottom and better days ahead. I think this is a valid point, but even if we are bottoming in housing, I don't believe the recovery will be immediate. I understand the market is forward looking, but I have a hard time believing the subprime securities markets will return to their prior glory anytime soon. And even if housing is near a bottom, I just don't see home prices bouncing back to the levels of 2006 overnight (maybe I'm wrong, only time will tell).
Anyway, there are many tempting reasons to say the S&P 500 has bottomed and it's time to get long. For example, housing may be near a bottom, the US dollar has gained impressive momentum over the last month, ECB seems to be holding off on rate hikes, fed fund futures are forecasting lower chances of near term fed rate hikes, oil, commodity, and materials prices are finally bursting, and hard-core value investors are so excited about P/E ratios that they're foaming at the mouth. However, hard-hit home prices aren't going to increase 30 and 40% overnight, subprime mortgages aren't going to stop defaulting, consumers' credit card debt won't suddenly disappear, oil prices are still over $110 a barrel, the impacts of the economic stimulus checks are largely behind us, many experts are still predicting hundreds of US banks are going to fail, and you and I are going to pay (via taxes) to keep Freddie Mac and Fannie Mae afloat.
One month ago, I wrote about the increased likelihood of a bear market rally in the near term, and I believe that is exactly what we're experiencing as the S&P500 is up 7% in the last month. I certainly don't know when (or if) it's going to end, but I like to follow the VIX an estimator. The VIX is a stock market fear indicator which has bounced between 16 and 31-ish repeatedly over the last year. The last five times it broke 30 a bear market rally began, and when it gets down to around 17 the bear market rally ends (the VIX is currently around 20, and heading downward). If you believe the longer-term downward market trend of the last year remains intact (like I do), then we're closer to the end of a bear market rally than the beginning.
As always, no one can predict the future, and I am certainly not claiming to be able to. However, I still believe the market is headed downward due to the deteriorated housing market, and I have positioned my personal portfolio accordingly.
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This article has 16 comments:
The wonderful thing about having legions of economists measuring every
aspect of the US economy continually, is that we don't have to make these
things up.
The Federal Reserve published flow of funds data on the US economy and
its various sectors. The June 2008 version includes positions as of the
end of 2007, and there is coverage for prior years going clear back to
1954. When someone wants to allege that US households are using debt to
do X or have shifted borrowing by amount Y, we don't have to take their
handwaving word for it. We can go get the actual numbers and see if
they bear out the speaker's line of spin.
When people talk of the housing bubble and its financial underpinings
and effects, they are talking essentially about the period from
2002 to 2007. So, what happened to the financial position of the
US household sector over this period? What happened to the position
of the corporate financial sector?
The usual narrative you see in a thousand news stories is that people
borrowed to the gills, and presumably are therefore deep underwater,
unable to spend a dime because they have pledged their entire future
earnings five times over to their creditors. Does this remotely
correspond to reality? Not for 3 anecdotal bankrupts, but to the
whole US household sector? Do we have to make up an answer?
At the end of 2007, the US household sector owned $72.055 trillion
in assets, and had $14.389 trillion in liabilities. Disposable
income after taxes was running at a $10.182 trillion annual rate.
At the start of the bubble period, in contrast, the sector owned
$47.891 trillion in assets and had $8.836 in liabilities, with
after tax disposable income running at a $7.830 trillion annual rate.
Yes, liabilities increased $5.553 trillion over that span. But
the value of assets owned increased by $24.164 trillion or 4.35 times
as much. Yes leveraged increased - from 18.45% of assets to 20%.
Hardly nosebleed territory. Income advanced 30% and net worth increased
48%. US households are worth $18.6 trillion more than at the start
of the period and are receiving an extra $2.35 trillion per year.
Every inch of upward movement in real estate prices into "insane"
territory was enjoyed by someone, and frequently multiplied by
substantial leverage. Real estate prices are higher now than they
were five years ago. It is really hard to bankrupt the nation by
that process. Can some latecomers get into trouble? Surely. Can
leveraged speculators who piled in at the top get wiped out? Surely.
But everyone who overpaid, overpaid somebody else, who got the
proceeds.
Also, very large portions of the losses are being stuck onto the
banks who financed it all. The US household sector was the group
that had the "heads I win, tails you lose" side of this bubble.
Yes, there were capital losses in the whole thing through misallocation
of resources, when houses were built for more than they can fetch
now. Most of those losses fell on the equity of the builders, some
on their lenders or suppliers and the like. In case no one noticed,
those companies have already been taken out and shot.
A household sector with over $10 trillion a year in disposable income
and a net worth of $57.7 trillion isn't bankrupt and isn't going to be.
Can we have a slowdown? Sure. But the pretence that Americans are
poor, put-upon wards of greedy bankers and will henceforth slave away
just to pay debt service, is utter nonsense from start to finish.
While all that household net worth and disposable income sounds great, those of us who follow the real details know that all that net worth and disposable income belong to the top 10% of this country that control 90% of all that net worth.
If everyone was so well off, flush with cash, and so wealthy, the country would not be in the situation it is today. Also, consumer credit card debt owed, is now just a hair under a trillion dollars and as reported just this week, is expanding at an even faster pace, due to the lack of real disposable income that the "average" american has at their disposal.
If we are such a wealthy nation, how come people just dont pay off all that credit card debt? Why do they happily pay 15,20,25% and more in annual interest when they cannot even get those returns in the stock market?
I'll tell you why...they cant.
They cant because the majority of americans are broke, living paycheck to paycheck while the top 10% (like me..sorry to sound so arrogant) control 90% of the wealth.
I think JasonC has been brainwashed by the govt which does its best to convince everyone that we are all equal and everything is right with the world.
Wake up pal. It is not. Trust me, I know. When you are not like everyone else, and are not part of the system you know exactly how things are.
It's Frank, your Edward Jones Buddy.
I think the most financial stocks have bottomed. The best time to buy financial stocks are during the credit crunch. i.e. lot less competitions in lending business, thus higher net interest margins, and better quality clients.
I think we entered a recession in December 2007 and we are approaching a recovery phase now.
Many financial stocks are on sale right now. It's time to be very very bullish. This is a "once lifetime" opportunity to buy many high quality finanical stocks cheap
Commodity bubble is bursting. Jim Rogers is the next Angelo Mazilo.
the average period of home ownership is what, 7 years? the source of the problem is not ma and pa kettle, who lived in the same house 30 years and who grew up when credit was little used and unwanted even if offered. the problem rests with the millions of homeowners who bought houses at inflated prices they couldn't afford, on credit they didn't deserve.
it's the activity at the margin that sinks markets and stocks. the marginal activity that drove this "crisis" occurred over the last 5-7 years. anyone who doesn't understand the concept of marginal change need only consider what happens to a stock when it misses earnings estimates by even a penny. it's not the 95% of shareowners who don't sell that drives the stock down 10, 25 or 20%...it's the 5% who do sell. they set the price at which markets clear.
this is why the federal reserve took...and continues to take..the unprecedented, dramatic steps they did once they realized what was happening. the current fed funds rate, in a normal environment, with honest inflation statistics coming out of washington, would be at least triple what it is currently. that subsidy...the difference between where the funds rate is and where it should be...exists solely to help these ignorant financial institutions recapitalize their balance sheets without diluting shareowners. it's worth untold billions. that subsidy comes from anyone with a money market account. it's a transfer of wealth from the many to the few who helped father the crisis and if it doesn't enrage everyone it's because they're too naieve to understand what's happened.
the severity of this government-induced, asleep-at-the-switch, crisis is lost on people like jason. our financial system came close to collapse. greenspan helped cause it and bernake handed out the corporate welfare to counter it. but the bill has been footed by the taxpayer and it's a long way from being paid off.
Next, pick one please. Either debt is a crushing load that can't possible be paid, or rates are tiny and inflation rampant so borrowing is stealing from the lender. Pretending it is both at once is just plain pretending.
Nobody is putting a gun to your head forcing you to keep a pile in a money market account, so no, nobody is being robbed by low Fed-set rates.
Also, I thought 90% of the country had no money, so the ones being robbed are the nefarious rich who own everything, right?
Also, if banks are in trouble because of their horrendous loan losses, somebody stuck them with horrendous loan losses, which means borrowers took the money and got away with never paying it back. Some exploitation.
It is all a crock of class warfare bilge, from start to finish. The reality is most Americans own their houses and already owned them long before the real estate bubble took off. They got the whole "up", and the down since has barely dented their gains - which were only on paper to begin with.
Real estate is an illiquid market. Transactions are a tiny froth on the static long term holders. The average American family has 50% equity in their house - some older ones own them free and clear, some newer ones are underwater, everything in between happens to somebody.
The pauper American household sector has increased its holdings of foreign financial assets by xxx trillion dollars over the last 5 years, despite a huge net capital inflow. The Caribbean is a leading "foreign" holder of US assets "abroad", to the tune of $2 trillion at last count.
Are all these assets owned by a tiny group of super rich? Hardly. Assets of private pension funds - $4 trillion. State and local government pension funds, $2.2 trillion. Mutual funds, $3.6 trillion. Life insurance policies and annuities, $1.5 trillion. IRAs $4.7 trillion (1.9 of it mutual funds, don't double-count that portion).
Who are the big debtors? Mom and pop on their credit card? Nope. Total consumer credit in all forms is only $2.5 trillion, less than 5% of household assets and a quarter the size of mortgages.
But government has $8 trillion debt against $2 trillion in assets, and a negative net worth - the only sector that has one. Small business, $5 trillion in debt on $11 trillion in assets. Nonfinancial corporations, $12.5 trillion in debt on $28 trillion in assets. Taken together those are leveraged 3 to 1, compared to 6 to 5 for households, and have about twice the debt of the entire household sector combined.
Not that they are broke - US small business has a higher net worth than any stock market in the world other than our own. You know, the mom and pops. The typical US wealthy person isn't a trust fund kid but a successful small business owner.
Anyone who looks up from the spin in their newspaper for two seconds can see all of this. Best Buy isn't selling out big screen TVs to beggars, Whole Foods doesn't cater to the starving, $5 coffees aren't the typical recreational beverage of third world indigents, and gas prices hurt folks driving SUVs the size of yatchts somewhat more than they hurt peasants driving a plow behind a water buffalo.
It's spin. It's nonsense.
HOME PRICES WILL NEVER AGAIN SEE LEVELS OF 2006 - HOWEVER, THERE ARE PEOPLE WHO NEVER LEARN THEIR LESSONS.
" Do you think the commodity bubble is done? "
I don't think commodities are a bubble. The stuff is scarce and getting scarcer, long term demand is increasing. A typical supply-demand squeeze. Once the price gets too high something breaks...like the world economy. Then demand drops as do prices. That's what we're currently experiencing. Things stabilize for a while. Then demand starts increasing again while supply has been droping all along. You get the next price spike and the economy will contract again, prices will drop again, etc.. I'll wait a bit longer for commodities to pull back and the economic situation to stabilize, then I am back in full force.
"Next, pick one please. Either debt is a crushing load that can't possible be paid, or rates are tiny and inflation rampant so borrowing is stealing from the lender. Pretending it is both at once is just plain pretending."
Let me introduce you to the concept of rate spreads. The Fed lends to its member banks and a select few other big boys at some rate r. They in turn lend to hedge funds, retail investors, traders, corporations, mortgagors, and credit card users at some other rates r plus delta. While delta varies widely based on the perceived credit risk of the borrower, the collateral offered, and the bank's desired margins, it is always positive. Right now, the spread between the Fed Funds rate and the rate at which most individual borrowers have taken on debt is very high.
Next, not every borrower has an equally strong balance sheet. I may owe next to nothing and have millions in good quality assets, while the man living in a suburb a few miles away may have negative net worth, shaky income, and an asset book dominated by a highly leveraged house that is rapidly losing market value. It may well be "stealing" for a bank to borrow at 3% from the Fed or from me at the same time that someone else does indeed have a crushing load of debt that probably will never be repaid. Both at once? Not exactly - it's all about the who. For some it's one, for others it's the other. The problem is that the number of distressed borrowers doesn't have to be very large to create trouble for banks and prod the Fed into opening the cash spigots. The result is that those with crushing debt loads gain little; their debt is inflated away, yes, but not rapidly enough to help them and in any case their incomes are not rising anyway. And instead of "reflating" prices in the bubble-damaged sector, the Fed's cheap money always fuels a bubble in some other sector instead. So there is really no reason to believe that more cheap money helps anyone except perhaps the banks. It certainly does, however, discourage saving; most banks have little incentive to pay much interest.
"Nobody is putting a gun to your head forcing you to keep a pile in a money market account, so no, nobody is being robbed by low Fed-set rates."
So what advice would you give that vanishing specimen, the young employed middle-class saver who has a 5-figure net worth, no debt, and a decent retirement plan in place? These are the ordinary sort of people who were once plentiful in America, and the wealth they built prior to the 1970s was a primary national strength. Today, of course, there are few such people; most have given up building wealth and instead buy garbage they don't need on credit. But back to our hypothetical case study. Presumably he could borrow cheaply, but what would he buy, either with his own cash or a bank's? The S&P 500 has a P/E of 26. Investment-grade bonds in intermediate maturities yield 5-6%. Even junk yields only 9% and who believes defaults will not continue rising? Perhaps he should take the NAR's advice and try to catch the falling knife in real estate despite prices still well above historical norms. Sure, no one is forcing him to stay in cash, but the alternatives aren't attractive either. Cheap money has forced yields down across all asset classes while credit market trouble has increased the cost of living and made most financial assets riskier. He is most definitely being robbed - of opportunity to create wealth by investing in productive assets at fair-market prices, and of ability to secure his own financial future by saving his earnings at a non-negative real interest rate. Your refusal to acknowledge that shows that you are either ignorant of basic finance or deliberately blind to the possibility that situations other than your own exist.
As for my advice to our young man? Quit working. Withdraw your savings, convert them to gold, and put it in your backpack. Now go see the world. Enjoy yourself for a while. Learn about people and the markets they make. Learn about the venality of government and the craft of business. When you find a place that offers a decent risk/reward calculus, open up that special pouch in your pack and invest directly in your own venture. The game you're playing now is for suckers. In America you may get rich and you may get poor, but there's no tolerance for the honest working man in the middle who wants to build modest wealth. The poor are too numerous and have the power of the ballot, to take from you by force. The rich have the power of debasement, to take from you by stealth. This country plays both sides against the middle. Get out while you can.
The whole point is that they already did that, and that's the root of the current problem. Like a tsunami, the damage is done on the upsurge. When the water recedes, the damage isn't undone, and another rise in water level isn't going to help. Too many people bought (or rebought via equity extraction) overpriced assets and there is little that can be done to fix that. The loss has already occurred.