Busting The Boom One Step At A Time

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Includes: AUSE, EWA, FAUS, FXI, FXP, GXC, ITB, PGJ, PKB, QAUS, XHB, YINN
by: Ilargi

Increasingly, the way the "booming recovery" is presented to the public is so out there you could be pardoned for thinking someone is getting desperate. Like, really? Let's start off with US housing. Here's a few tidbits from a piece on Bloomberg today, and then we'll compare that with something that's 180 degrees different, and I strongly suggest you be the judge. It's not like you'll be needing me to do the judging for you (not that you ever do, that's not what I mean). I'll give you a fair bit of quotes, just so you get a real good idea what exactly the picture is Bloomberg tries to paint here:

Housing to Outrun Capital Spending in Next Leg of US Growth

Residential investment grew at a 7.2% annualized rate in the second quarter and business outlays for equipment, structures and intellectual property rose at an 8.4% pace. Longer-run projections from Goldman Sachs show home construction will grow 10% to 15% by 2015-2016, while capital spending eases to about 5%. It's a reminder of how "very different" this recovery is, Chief Economist Jan Hatzius said in an e-mailed response to questions.

"Normally, people think of housing as an early-cycle sector and capex as a late-cycle sector," New-York based Hatzius said. "It is quite unusual for a housing recovery to lag a capital-spending recovery." Given housing's far-reaching ripple effects, an upturn in homebuilding would bring about a more viable expansion, and one that has a longer life, according to Ellen Zentner, a senior economist at Morgan Stanley in New York. Business outlays are more exposed to the ups and downs of global markets and tepid U.S. demand.

"Rather than waiting, waiting, waiting for an acceleration in capex, maybe modest growth is as good as it gets," Zentner said. On the other hand, "we still have a lot of recovery left in housing."

Homebuilding, which accounts for about 3% of gross domestic product compared with about 12% for capital spending, matters because of its "broader linkages that will feed back into the economy" to spur household spending, wealth, hiring, and confidence, said Michelle Meyer, senior U.S. economist at BofA.

So far, though, housing has yet to provide the "typical jolt," she said. Residential investment has added 0.15% to GDP on average since the recovery began in June 2009. Business spending contributed 0.59 point. "It'll be a bumpy housing recovery, but the path is higher," Meyer said, citing tailwinds from improving employment, credit and historically low mortgage costs. "We just don't have the housing stock we need to meet demand. Housing has by no means plateaued here."

Companies will find reason to invest in the U.S. in the next decade, said Joe Carson, AllianceBernstein LP's director of global economic research. The economy-wide spillover from the domestic energy boom is still nascent, state governments have a growing ability to fix aging infrastructure, and companies "will have to invest to grow" in order to boost profits, he said. All this will "unleash a powerful cycle" for business investment, helping stem the productivity slowdown that has restrained growth, Carson said.

The housing market probably has more potential. Beginning home construction has averaged a 976,000 annualized pace this year. Longer term, the demand for new houses may reach 1.5 million to 1.6 million a year, in part because millennials, those born after 1980, will start families and become more open to homeownership, according to Goldman Sachs analysts. Luxury-home builder Toll Brothers Inc. is hoping for better times ahead even as fragile consumer confidence and limited wage growth have led to "choppy seas and a sloppy boat ride" so far in this recovery, Robert Toll, the Horsham, Pennsylvania-based company's chairman, said.

Based on trends over more than 40 years, "the industry should be building 50% more homes this year than its current pace to meet the increased population demographics," Toll said on a Sept. 3 earnings call. "At some point, this pent-up demand will be released, which will add momentum to the entire housing market."

That sounds boomy, doesn't it? We're preparing for lift-off, that's what that says. But then Martin Andelman, aka Mandelman, had this a month ago on Aaron Krowne's ML Implode site, h/t Dave Stockman. And then the picture changes and looks, let's say, somewhat different. Long quotes again, I'm sorry, but it's because Mandelman is such a great writer.

Mortgage Originations Are Down by 60-70% Year-Over-Year... But Everything's Okay

Mortgage originations for the first quarter of this year fell off a cliff. JPMorgan reported a decline of 71%, as I recall, and I think Citibank reported a drop of 66%. Now, the second quarter's bloodletting has come in and the numbers are about the same... down more than 60% year-over-year, if memory serves and it often does. I'm not bothering to look any of these numbers up and doing this by memory because the details don't matter... my point will be the same regardless of a few %age points in one direction or another on any given statistic. I'm close enough in all cases, anyway.

Forbes reported that the first quarter of 2014, "saw the lowest mortgage origination volumes since Q3 1997." And the headline, "MBA Lowers Mortgage Originations Forecast", came with a story explaining that "the updated refinance total is around 60% lower than 2013 refinance originations." Even credit unions went straight into the tank this year, originating an annualized $42.6 billion in real estate loans in the first quarter, down from $102.9 billion in the first quarter of 2013, according to an Nation Credit Union Association (NCUA) press release.

Black Knight Financial Services released in March that loan originations were down 60% year-after-year, declining to the lowest level since November of 2008. And on August 12th, Origination News ran the headline: "The Refi Boom is Officially Over - And Won't return Soon," explaining that Freddie Mac has finally recognized that the refinancing boom that ended last summer... has ended... last summer... and that home sales this year have remained "lackluster."

The Mortgage Bankers Association released its first 2014 forecast last October, predicting $1.2 trillion in total originations for the year, but those numbers were revised down in January and again in May. The current forecasts are for $1.01 trillion in total origination volume for the year. Last year total volume was $1.8 trillion, and $1.1 trillion of that volume came in the form of refis.

And finally, HARP origination volume has been down a staggering 70% year-over-year with only one third as many eligible loans remaining as compared with 2013. Estimates are that cash sales are running at 40% of sales, which combined with the data provided above, should tell you how few sales there actually are in the aggregate. My grandmother would say the mortgage industry is furchtbar, I would use a similar sounding word also beginning with the letter "F," but we'd mean roughly the same thing.

Now, name another industry that's ever seen year-over-year drops in sales volume like that. I've been trying to come up with one... maybe typewriter sales in 1996, 1987 or 1988? I don't actually think there has ever been an industry that reported year-over-year declines in sales volume of 70%, and if there was, I'm betting the industry became the corporate equivalent of the Dodo bird sometime shortly after that.

In April of this year, the New York Times ran a story about, "Why the Housing Market is Still Stalling the Economy." The author seemed to think housing is pretty darn important to our economic growth or malaise.

"Investment in residential property remains a smaller share of the overall economy than at any time since World War II, contributing less to growth than it did even in previous steep downturns in the early 1980s, when mortgage rates hit 20%, or the early 1990s, when hundreds of mortgage lenders failed." "If building activity returned merely to its postwar average proportion of the economy, growth would jump this year to a booming, 1990s-like level of 4%... The additional building, renovating and selling of homes would add about 1.5 million jobs and knock about a %age point off the unemployment rate... That activity would close nearly 40% of the gap between America's current weak economic state and full economic health."

You don't need to be any sort of economist to understand that people forming households would be a major driver of any country's economic growth, right? I mean, all you'd have to do is look in my garage to figure out why that would be the case. If I weren't married, I might not even own a full set of dishes. So, if household formation is running at 569,000 annually for the last 4-5 years, but was 1.35 million for the prior five years... well, how is everything okay?

So, the mortgage industry has seen originations fall in a single year by 60-70%, but the housing markets are okay, in fact they're recovering all around us every day, and prices are up. Mortgage originations get more than cut in half over six months, but everything's okay... GDP is still rising and the June jobs report was strong... because obviously the mortgage industry and housing doesn't contribute to any of it. But that can't be right, can it?

Any industry that experienced a 70% drop in sales would see bankruptcies popping like popcorn, but not this one. Not this industry... not mortgage originators. Somehow housing and mortgages have been painted with invisible ink, and can no longer be seen by anyone.

So there's your US recovery, and as I said, you be the judge. Do we still have a lot of recovery left, or does a 60%-70% drop in mortgage originations basically doom the industry?

Tokyo-based Bill Pesek had a nice piece at Bloomberg of all places, about Australian real estate. He has Oz Treasurer Joe Hockey claim that "fundamentally, we don't have enough supply to meet demand." As if, fundamentally, nothing matters other than available "products", as if available wealth or income don't matter.

Irrational Exuberance Down Under

In "Australia: Boom to Bust," Lindsay David sounds the alarm about an Australian housing bubble he argues makes the 12th-biggest economy a giant Lehman Brothers. His thesis can be boiled down to the number 9 - the ratio of home prices to income in Sydney. The multiple compares unfavorably with 7.3 in London, 6.2 in New York and 4.4 in Tokyo (Melbourne is 8.4).

Housing is one of the three pillars of the Australian economy, along with financial institutions and natural resources. Politicians and investors alike, David writes, don't get "how deeply intertwined and connected" these sectors are and "how they can easily take each other down in a domino effect." The most obvious trigger would be a Chinese crash that simultaneously hits bankers, miners and households hard.

I caught up with David last week in Sydney at a Bloomberg conference where I helped grill Treasurer Joe Hockey about these very topics. When I asked Hockey point blank whether Australia faced a huge property bubble, he dismissed the entire premise out of hand. "It is just an easy mantra for international commentators and for analysts based overseas to say, 'Well, there's a bit of a housing bubble emerging in Australia,'" Hockey retorted. "That is a rather lazy analysis because fundamentally we don't have enough supply to meet demand."

Two hours later, Australia's central bank raised concerns about "speculative demand" that "could amplify the property price cycle and increase the potential for property prices to fall later." [..]

There's something dangerously wrong when Australia's top economic official is blowing off fears of asset bubbles and heightened leverage. Hockey's acerbic dismissal of the danger smacks of hubris. Home prices are seen rising between 8% and 12% in 2015 in Sydney and roughly 9% across Australia's major cities. How can that make sense, in an already frothy market?

In a striking bit of serendipity, G-20 officials met in Australia over the weekend to chew over the very risks Hockey had just dismissed. The communique they issued concluded: "We are mindful of the potential for a build-up of excessive risk in financial markets, particularly in an environment of low interest rates and low-asset price volatility."

Funny you should mention China (I'm sure you feel the same way). Obviously, there have been "rumors" about challenges to Chinese growth for a while, but they get real now. China runs a lot of its industry on coal, but lately there's not so much industry. Oh wait, let's set this one up properly with another one of Bloomberg's happy pieces. And only then touch down on reality.

Manufacturing Rebound Relieves Growth Concerns in China

A Chinese manufacturing gauge unexpectedly increased this month, suggesting export demand is helping the economy withstand a property slump. The preliminary Purchasing Managers' Index from HSBC Holdings Plc and Markit Economics was at 50.5, matching the highest estimates in a Bloomberg News survey of analysts and up from August's final reading of 50.2. Asian stocks pared declines, the Australian dollar rallied and copper advanced.

"We thought the weakness would continue, but there is a slight pickup, so this is definitely positive for the market," said Lu Ting, Bank of America Corp.'s head of Greater China economics in Hong Kong. Robust export demand is helping China weather a property slump. China's trade surplus climbed to a record in August as exports rose on the back of increased shipments to the U.S. and Europe. New-home prices fell in all except two of the 70 cities monitored by the government last month, the statistics bureau said last week, the most since January 2011, when the government changed the way it compiles the data.

Isn't that great? We're saved! Only, there's this:

Chinese Coal Industry Deepens Push For Output Cuts

An industry body representing China's coal-mining industry has vowed to continue its push for output reductions in a bid to lift power-station coal prices by 20% from their trough, according to state media. Wang Xianzheng, the chairman of the China National Coal Association, told an annual meeting of the Coal Industry Committee of Technology at the weekend that more than 70% of the country's coal miners were losing money and had cut salaries. About 30% of the industry's miners had not been able to pay their employees on time and a further 20% had cut salaries by more than 10%, the Economic Information Daily, a Xinhua-affiliated newspaper, reported on Monday.

Due to weak economic conditions, coal output fell 1.44% year on year in the first eight months of this year to 2.52 billion tonnes, while sales dropped 1.62% to 2.4 billion tonnes, the association's figures show. Coal inventory last month stayed above 300 million tonnes for a 33rd month. However, the coal price has rebounded "slightly" this month as imports and stocks fell. China's main coal ports recorded an 8.3% year-on-year decline in inventory at the end of last month, and the national import volume fell 27.4% year on year to 18.86 million tonnes, the association's figures showed.

And no, China hasn't switched to wind or solar all of a sudden. Coal drives China's boom, or has so far at least, and now its coal industry is hitting pretty bad limits. Beijing is trying to keep the illusion of a 7.4% growth rate alive, but that's not going to work with its main energy source with coal output actually falling (not just growing less fast), is it? And it's not just coal either. China has the global Big Iron Ore industry trying to topple its domestic production. Which is not only a lovely set-up for a trade war, it's also a sure sign of a collapsing economy.

Big Miners Struggle To Tame China With Iron Ore Glut

Plans by the world's top iron ore miners to knock out high-cost rivals with a flood of cheap ore have had some success, but are meeting resistance where they had hoped to make the biggest inroads - in China. A large number of small, high-cost Chinese mines have been forced to shut by a collapse in global prices but, overall, domestic output is increasing as the big state-backed producers expand or consolidate. "Those mines that belong to steel mills or to central government enterprises - and those that were constructed relatively early and where resources are good - all have room for survival," said Lian Minjie, general manager of Sinosteel Mining, a subsidiary of one of China's biggest state trading firms, at an industry conference this month.

And:

Iron Ore Industry Heads For Brutal Shakeout As Prices Collapse

A bloodbath in iron-ore prices could get much uglier before things turn around. And it's not all China's fault, either. While Chinese demand, a major force in the market, has slowed, big iron ore producers, including Brazil's Vale, BHP Billiton, Rio Tinto and Fortescue plan to boost production and shipments despite the glut. Australian producers BHP Billiton, Rio Tinto and Fortescue aim to boost output by 170 million tons this year, equal to around 7% of 2013 global supply and 11% of global production outside China, notes Capital Economics. Vale and Anglo-American are also looking to increase output, too. Why are they boosting production in the face of falling demand?

"It's because their marginal cost of production is much lower than many of the smaller players globally; and because they operate in different segments, they can absorb a large hit in iron ore mining profitability that others cannot survive," said Ben Ryan, an analyst at Hedgeye Risk Management, in an email. "They're ultimately admitting we're in a downtrend in raw minerals mining (iron ore, copper, and coal) and the announcement to increase production despite prices [being down] 40% year-to-date works to squeeze lower cost producers on the way down. The expectation for the global supply increase works with the apparent decrease in demand to push prices lower. Eventually enough producers get squeezed out of the market and this supply/demand dynamic bottoms out then reverses."

If I were Washington, I'd be telling Big Iron to be careful about declaring war on China. But then, that's just me. For all I know, this is just what Capitol Hill wants.

The point I try to make is that most of what you read in the press is so far away from what is really happening, it's taken on absurd proportions.

No, US housing is not doing fine, and it doesn't have a lot of upside potential. It has none. And no, Australia is not going to be fine, with its one-dimensional dependency on China, And also no, China is not what even western media try to make it out to be; China is drowning in a sea of debt.

The whole global economy is still falling to bits, and you're about to fall with it. That's all I'm trying to point out to you. Debt is bringing us down, and because we have tried to prevent that from happening by issuing more debt, we will plunge that much deeper and faster. And that's not just one of multiple possible options, it's the only one.