Stock Traders D...'s  Instablog

Stock Traders Daily
Send Message
Thomas H. Kee Jr., is President and CEO of Stock Traders Daily and author of 'Top of the Market to You!' Mr. Kee's reports and analysis are currently featured by Reuters Research to their institutional clients. He serves on the board of many companies and provides economic analysis and... More
My company:
Stock Traders Daily
My blog:
My book:
Buy and Hold is Dead
  • QE2 – lower dollar – housing prices 1 comment
    Oct 13, 2010 9:12 AM

    With QE2 virtually in the books, I began to think more seriously about inflation and the risks inflation brought to our economy.  This newsletter will focus on that subject.  First, I will discuss my perception of lower dollar higher commodity prices as those relate to corporate earnings and economic stability going forward.  Then, I will discuss the housing market and the perceived relationship between quantitative easing and housing prices.

    Everyone is aware of the relationship between quantitative easing and the dollar.  If the government starts printing money the value of the dollar declines and the risks of inflation increase.  Inflation, when we focus on the core components of the consumer Price Index and the producer Price Index, which exclude food and energy, has thus far been non-existent.  Lower dollar higher commodity prices do influence inflationary pressures, but the initial burden is solely on the shoulders of corporate America.  The ongoing debate asks if corporations can pass on higher commodity costs to the consumer.

    I consider this a major gamble.  First, unemployment rates are still extremely high.  There is no sign that unemployment levels will decline.  In fact, given the weakness in the public sector, additional layoffs are likely to come.  The government hopes that the private sector will balance those layoffs, and given the upcoming holiday season retail will likely offset that for awhile, but sustained increases in employment, or a real decline in the unemployment rate, it's highly unlikely.

    Without that, the velocity of money is not high enough to influence true inflation.  Yes, commodity prices will increase when the dollar declines no matter what, but if money doesn't find its way into the hands of the consumer, more money than was there earlier, the consumer will not be able to pay more for the goods and services he has been used to.  This is where the risk lies.

    Without an increase in the velocity of money, no matter how big it might be, QE2 will do nothing but weaken our currency, increase some prices that consumers can pay, and tighten the margins of corporate America.  Those companies who cannot pass along costs to their customers will burden those costs, their margins will contract, and earnings growth will be subdued.

    Therefore, as initially appealing as quantitative easing may be, the risks are extremely high.  Unless money is directly in the hands of the end user, the consumer, there is virtually no chance that core inflationary pressures catch hold over time.

    Those hawks, the ones who warn that spiraling inflation can occur, will be found correct only if the velocity of money increases, and from my observations the likelihood of an increase in the velocity of money is slim at best.  The Federal Reserve simply cannot force businesses to hire workers.  They are not investing in businesses, but they will invest somewhere.

    Given the utter certainty of QE2, where will that money be invested?  Some think the government will buy more treasuries, some think more loans, some think inflation protected notes, but no matter where it goes it will be assured to have one material effect on our economy.  The dwindling value of the US dollar makes US treasuries far less attractive to foreign investors.  The never ending cycle of revolving US treasury debt requires demand from foreign investors, but those who have watched the value of their holdings in US treasuries decline on a currency basis have very little interest in buying more US treasuries with the understanding that the government will not stop printing money and the value of the dollar will not stop declining.

    Therefore, once we know where the government will spend the money, and wants they have finished propping up those assets without merit, I expect a complete reversal.  For example, if the government proposes buying U.S. Treasury bonds over extended maturities and causes US treasury bonds to increase in price and decline in yield like it did last time, once the government has finished I would  expect an unabated sell off in US treasuries.  This is an example only, a likely one, but not something that has yet been defined.  We do not know where QE2 will be invested yet.

    What we do know is if the dollar continues to plummet, and if interest rates begin to trickle higher, which ultimately will happen if the FOMC gets the inflationary pressure it wants, mortgage rates will go up.  In addition, with the lower dollar, commodities like steel, aluminum, lumber, and other materials that go into the construction of a home will also increase.  Normally, that means the value of existing homes would also increase.  For now, higher costs are real, and that will dampen new construction projects unless buyers are willing and capable of paying more.   They are not capable or willing now.

    These are crosscurrents.  Higher mortgage rates reduce the value where higher commodity prices and higher inflation would increase the value of existing homes.  This is where the conundrum exists.  Should an investor who is interested in buying property by a home in this market?

    There is an obvious distinction between an investment property and a home for your family, but this discussion is focused on investments only.  The objective would be, if an investment were to be made, to get in at a relative low, and avoid any declines like the ones witnessed in recent years.

    In evaluating this environment, we also must recognize an additional variable.  The number of foreclosures is likely to increase yet again.  Resets to adjustable term mortgages will begin in the next few months, probably when the moratorium on foreclosures is lifted as well, and those persons who own homes whose reduced values prevent them from refinancing at today's low rates will be subject to paying much higher monthly mortgage payments than they already do.  I expect, on the heels of this, foreclosure rates and bankruptcies to skyrocket yet again.

    My analysis brought my attention to the spiraling inflation rates in the 1970s and my observations show that home prices actually did quite well during that inflationary environment.  Although the investment rate was in a downtrend during that environment too, there is a distinct difference between now and then.  This time, like the Great Depression, deflation has been much more of a concern than inflation.  In fact, the FOMC is targeting a higher inflation rate, hoping to spur prices not tame them.  Thus far, there have been no signs of core inflation, and unless the velocity of money increases, there will not be.

    Therefore, if we do not see spiraling inflation rates, the effect of higher inflation on the price of homes will likely be subdued.  Two additional factors weigh on the value of homes as well.  First, mortgage rates are at all-time lows and even slight increases in that rate will have a negative material impact on the net value of homes in the United States.  Because the government is targeting higher inflation levels, printing money, and as essentially lowering the value of US treasury bonds, they are in effect taking steps to raise interest rates at some point.  Usually, that will happen in the open market before the government takes action.

    I am not predicting higher rates, but the perception is all that matters.  If the government is targeting higher inflation, it is eventually prepared to raise rates, and that is a negative for home prices.  That and the additional foreclosure risk, including the extremely high levels of inventory held at the financial institutions in our country, make the investment opportunities for homes right now much lower than they might otherwise appear.

    Only if inflation spirals out of control like it did in the 1970s would home prices be able to weather this storm.  No one is expecting out-of-control inflation; in fact the core level of inflation is not increasing much at all yet.  Therefore, the one positive in terms of potential support for home prices, as feeble as it is, is offset by two clear negatives.  I do not believe, on a general basis, that property is a good investment in this environment.  Eventually I will buy all the property I can get my hands on, but that is not something that should be done now.  There are too many headwinds and not enough support for home prices in this economy. 

    In addition, demand, as defined by the investment rate, declines precipitously from this point forward, and that means demand for investment property declines as well.  Do not buy property now, not for a while.  Expect QE2 to have risky if not outright negative repercussions, expect net demand to decline, and be prepared for a major pullback in the Market.

    Of additional note, and something not being discussed much yet, if the currency wars escalate, trade sanctions may be imposed.  Japan – Australia are already at odds with each other, threatening sanctions too.  The United States recognizes this dissention among other economies, and recognizes that unabated dollar weakness is not healthy for international relations.  The US, quite clearly, is the bad guy.  This time, the Government is positioned to hurt our real wealth, and further burden the economy at the same time.



    Disclosure: no conflicts to report
Back To Stock Traders Daily's Instablog HomePage »

Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.

Comments (1)
Track new comments
  • poor&unemployed
    , contributor
    Comments (77) | Send Message
    Excellent analysis. Looking at history, almost every country which experienced spiraling inflation started with assumption that they could control it. But again and again politicians around the world have shown reluctance to pull the plug in time and be accountable. Instead they have always waited for that fateful day when there was no other option. As we saw with our own politicians - who waited for the day to claim it was end of the world as we know it unless we bailout the banks. No one has questioned them about the timing. They knew about it years in advance but refused to be party-pooper. Why should it be any different now?
    3 Nov 2010, 09:38 PM Reply Like
Full index of posts »
Latest Followers


More »

Latest Comments

Most Commented
Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.