Friday, June 16, 2006

U.S. housing boom is biggest since 1890

By Amy Hoak, MarketWatch

CHICAGO (MarketWatch) -- The recent housing boom is the biggest the United States has ever seen, but its underlying reasons may have been psychological, economist Robert J. Shiller said on Friday. New data also suggest the market might be at the end of a cycle, he added.
The only time since 1890 that compares to the recent residential real estate market is just after World War II, the Yale University professor said during a presentation on U.S. home prices, held at Standard & Poor's in New York and broadcast to journalists on the Web.

"After World War II, the soldiers came back and they wanted houses and started the baby boom. And when you had babies, you wanted houses with at least two bedrooms -- and that wasn't so common back then. They went on a buying spree and it pushed home prices up," he said.

The recent boom, however, doesn't have the same fundamental variables causing prices to soar, he said, adding that variation in such things as building costs, population and interest rates doesn't adequately explain the reason for the housing boom.

"I don't see why home prices should be shooting up that strongly," Shiller said, adding that speculation may have played a role. "It's a sign of concern."

Shiller was co-author of "Irrational Exuberance," a book that chronicled the stock-market bubble of the late 1990s. He also co-developed the S&P/Case Shiller Home Price Indices, designed to measure the average change in U.S. home prices. The indexes are based on 10 cities -- Boston, Miami, New York, San Diego, San Francisco, Washington, D.C., Chicago, Denver, Las Vegas and Los Angeles -- and are now the basis of new futures and options trading at the Chicago Mercantile Exchange.

Within that index, Shiller has noticed a short-term trend of cooling home prices that could signal an end to the cycle of steep appreciation increases. Investing in the index could help homeowners hedge against price fluctuations in their homes, he said.

Shiller said he is not allowed to invest in home price index futures.

During a question-and-answer session, he said that the stabilization of home prices could also have some effect on consumers' means of gaining equity. Low interest rates inspired people to refinance their homes, and the increasing value of their houses allowed them to pad their pockets with spending money; consumers will now have to turn to other means for financing, including credit, he said.

Wednesday, June 07, 2006

Wall Street finally goes bearish on housing (about time!)

The stock market is now almost flat for the year with housing being one of the worst performers because of the selloff in the last few weeks.

What has surprised me is that all of the information has been mounting for a long while now. Anyone who googled 'housing bubble' over the last few years should have come up with Ben's Housing bubble blog, arguably the most convenient way to track daily housing bubble news. Ben pulls together relevant bubble commentary from respected news outlets throughout the country. I have been reading his blog daily, for over a year, and watched as the mainstream press slowly turned from (NAR spoon-fed) Bulls, to recent Bears.

Consensus is rising that the 'soft landing' scenario emitted by Bulls is in my opinion, er well Bull.. And finally some of the analysts are starting to agree. I expect more homebuilders to cut forecasts (or those who have cut, to cut them further) leading to further downgrades. Speculation in ending and the cold hard facts of fundamental affordability are beginning to return, as always.

The problem is, as goes housing, so goes the economy.

Mark Kessel of PIMCO has this very timely piece out on housing and the economy:

"Housing is a leading indicator of the overall direction of the economy. As housing slows, economic growth will surely follow. As such, we should expect to see tighter terms on credit extension, less liquid markets and a pick-up in the overall corporate default rate over time with a slowdown in the pace of economic growth. An eventual rise in the default rate, combined with higher near-term volatility, should lead to a more challenging market environment for credit. Watch the 'for sale signs' in both the housing and corporate bond market my sense is more of both are coming as the market transitions from a mode of risk taking to that of risk aversion."
Mark does an excellent job of explaining why we are heading for a downturn. I came to a similar conclusion last year and as of January 06 moved to cash, gold, and housing shorts.

As the housing market grinds to a halt, I believe the economy will drift into recession, possibly as soon as the end of 2006. It's been one hell of a party, but there is a hangover coming. If you are long in homebuilders, you may want to rethink things.

Wednesday, May 31, 2006

Psychology Moves the Market

After watching Mark Leibovit on Nightly business report, I looked up his website,

His commentary was interesting to me because what he said made sense to me. He was bearish, suggesting being long on gold and short on the dow. When I read the transcript of his appearance on the show 6 months prior, it was interesting that he was one of the few bullish-on-equities commentators at the time. Given that his forcasts are short-medium term, he appears to have called it very well. (the dow to above 11, 400 from the then 10,766 at least). I also hunted around his site and found this frigteningly accurate description of investor psycology!

"Life is 90% mental and 10% physical. The nine-hole round of golf I just completed was a great reminder. Financial markets are the same, driven totally by human emotion. Let's track the rise & fall of a fictitious stock to examine this natural law in action."

"ABCD company is a tech-widget manufacturer modestly received at IPO. A number of funds buy the early blocks and insiders hold the rest. ABCD rolls within a trading range between $20 and $30 shortly after that."

"Well, tech-widget business is good and initial first-quarter earnings beat the street by several cents. This stock had been mostly ignored but all of a sudden it's now a media hit. Would you believe there are investors out there who blindly buy anything they read or hear about? It's true."

"Most of the current shareholders got in between $20 and $30. After favorable news ABCD shoots up to $40 per share. Some investors who bought early are now sitting on 50 - 100% gains and get itchy. Fear compels them to take profits while greed tugs at them to stay in. Stop orders are placed at $38 just in case there's further downside."

"A few sellers decide it's time to exit and wait for pullback before buying again. This drops the price to $38 and all those resting stop orders are triggered. They become market orders for sale and prices fall to $35."

"Of course most of the recent volume bought in near the high end at $40. These traders aren't happy to be down $5 in a matter of days. Some "weak hands" want out no matter what and sell the stock down to $30. Call it a loss and wait for the next hot play to come along."

"Early buyers sold near $40 and prices now at $30 seem a bargain to them. They buy it back and create "support" at the $30 level. Price action has proven this area will be bought by the dip crowd as prices retest here in the future."

"New buying drives prices up to $40 where all that volume bought in on the first rally. A number of these impatient types are planning to exit close to breakeven at first opportunity. They sell into the rally as prices hit $40 and stall out there. We've just witnessed resistance created. Prices bounce off $40 and fall back to the mid-$30s."

"Our buy-the-dip crowd waits for prices to drift down near $30 while those holding buys at $40 are chagrined to have missed their first shot at exiting without loss and vow not to pass again. A number of other traders bought near $40 last time, jumping the gun in anticipation of a breakout before it fully developed and confirmed with volume. Some of them want out at par the next trip around as well. We could say that overhead resistance has built."

"ABCD price action bounces between support at $30 and resistance near $40 for quite some time. Neither buyers nor sellers are able to push the market outside this range. Those content to trade within this channel glean several points profit each time it cycles."

"One day, an announcement is made by XYZ, the biggest tech-widget Producer. T-widgets are in hot demand and they cannot make enough to supply the burgeoning market. Hot dog, that index is off to the races! Every company involved with t-widget production is bid through the roof, including ABCD. Prices sail above resistance at $40 and climb to $50 in a single session."

"Everyone who owns this stock is extremely bullish; who wants to sell when it's headed to the moon? Individual investors and fund managers will pay any amount to own this company, P/E ratio be darned."

"Prices break out and run straight up to $95 in just a few days time. ABCD is featured in every financial newspaper and TV show. The company's C.E.O. does his first round of interviews. There's our boy - right on the tube being congratulated in front of millions. Who'd want to sell?
ABCD doesn't pause until it reaches the magical $100 mark, a mental barrier invented by traders. The company doesn't construct better t-widgets with the stock at $98 than above $100 but you wouldn't know that by investor behavior. New buyers resist entering the market until it punches through that $100 ceiling on strong volume. ABCD stutters and stalls near this psychological benchmark to form the next level of support."

"Some buyers enjoying this wild ride decide to sell and lock in massive gains as new buyers dry up near $100. This puts added pressure on the stock, driving prices back down to $90. A new trading range develops between $90 and $100 with the same dynamics that held it between $30 and $40 not long ago."

"Most traders value ABCD as a $100 stock because more buyers entered near this point than at anytime during its existence. Is it a great buy at $90 or 300% over-priced from the last dip at $30? Depends on emotional perspective. Those actual t-widgets keep rolling off the assembly line just the same."

"Out of the blue, t-widget giant XYZ is rumored to be in takeover discussions with an unnamed company. All widget companies including ABCD surge on the rumor. Prices pop through $100 and rise to $110. Momentum traders confirm the breakout above $100 on volume and bid shares up past $120 in after-hours trading. ABCD's C.E.O. endures countless interviews as he declines merger specifics but adds that the company would be open to any proposals. Prices now surge to $150."

"Everyone owns the hottest stock in the market and sellers are few & far between. Financial magazine covers are adorned with ABCD in some form or fashion. Just like Ty Beanies, there seems no end in sight."

"However, a few astute technicians note how overbought this stock price is and see the 50 and 200 day moving averages begin to flatten out and curl as current prices stall near $150. A few of them quietly sell at this level and bank substantial gains."

"Meanwhile, the FOMC decides to raise interest rates for the first time in awhile by .50 basis points. The markets are stunned! Everyone expected .25 points at most and a sell off begins. First to go are high flyers where all the gains have compiled and guess who tops the list? ABCD prices dive 40 points to $110 in a single session as traders storm the exits."

"Plunging prices spread panic through holders of ABCD as the weak hands in for quick profits fall like dominoes. No buyers are present for the sellers and market-makers skew the bid/ask accordingly."

"This wild sell off dwindles as ABCD settles near the $50 range. Most buyers who owned the stock bought in well above this price and are actually miffed at ABCD for causing their losses. Meanwhile, t-widgets are methodically produced much like they always were."

"XYZ announces that, due to recent market developments they have backed off possible acquisitions in the foreseeable future. All would-be candidates get pummeled, including ABCD. The stock returns to it's original $30 price range where buyers who made a killing not so long ago eagerly await to buy once again. Plenty of buyers at the high end of that rally still hold shares and wait for prices to rise in order to sell the rally."

"So the cycle continues."

"All along, tech-widgets are produced just like they were from the beginning. Can you see the logic behind this volatile price behavior? I thought so."

Monday, May 08, 2006

Buy vs wait, a rough analysis

Over the weekend someone (very close to me ;- ) said something like -

"When you buy a house, you always have a period at the start where you pay mostly interest and not much principle. So you should buy now and get past that point, otherwise you are putting of the 'painful' period of years of 'mostly interest' payments. "

I couldn't think of a good counter argument to this at the time, but thought about it, and came up with the following graphs to explain why I disagree.

This analysis has lots of assumptions, and is meant to illustrate the point, rather than be 100% accurate.

Let's assume someone wants to buy a house. The can afford about $4100 a month mortgage payment. As the graph below shows, if prices are likely to fall, then it is better to wait, then take out a shorter term mortgage, than buying now at bubble prices.

And of course this doesn't take into consideration higher tax, negative equity etc etc.

So let's look at the median prices for an area of San Jose, ca. (just because I have the numbers!) Also this is full of assumptions and guess work, but should highlight the basic point.

If you believe (like I do) that we are in for a correction of about 20% (in real terms) of prices over the next 5 years (equivalent to much more in inflation adjusted terms) that would equate to a picture something like the one below-

While this is a rough estimate, it highlights the point that waiting for prices to fall does not mean you will be paying the mortgage for longer (for the same monthly payment).

Thursday, April 27, 2006

Has Easy Al been blowing bubbles?

Eric Englund has an interesting guest editorial on financial sense university-

"This mortgage-debt bubble, as engendered by the Federal Reserve, is leading millions of Americans to financial ruin. This may become the most calamitous clustering of financial error in U.S. history. If anything positive comes out of this economic mess, perhaps it will be the demise of the Federal Reserve itself. Regrettably, the Fed’s failure will have come at an enormous price, including the possibility of volatile social unrest."

"A terrifying thought it is."

and a key point from a referenced book ( Austrian Theory of the Trade Cycle ) to consider -

"The Austrian theory of the business cycle emerges straightforwardly from a simple comparison of savings-induced growth, which is sustainable, with a credit-induced boom, which is not. An increase in saving by individuals and a credit expansion orchestrated by the central bank set into motion market processes whose initial allocational effects on the economy's capital structure are similar. But the ultimate consequences of the two processes stand in stark contrast: Saving gets us genuine growth; credit expansion gets us boom and bust."

Is GM the canary in the economic coal mine?

Excellent article from Bill Gross, head of PIMCO compares the fate of the GM with that of the US economy.

"How are we to pay for this future burden of healthcare and social security expenses? Aside from contractual legislative changes to both areas (which are surely just around the corner), the way a reserve currency nation gets out from under the burden of excessive liabilities is to inflate, devalue, and tax."

"Another way the U.S. could escape the burden of its future liabilities is to “grow” its way out, much in the same manner GM is attempting to make its models more attractive and relevant to current car buyers. We could do that by accelerating relative productivity gains, by emphasizing innovation, and upscaling education. Other nations however, understand the same rules and it will be difficult to “grow” assets and/or reduce liabilities via increased savings if we have a reduced “product line.” With our manufacturing and service base being increasingly hollowed out by foreign competitors, the primary export we have that can be made more attractive are our Treasury bonds in the form of higher relative yields. It will be an easier task, in fact for GM to renovate its product line than for the U.S. to revamp its. "

"Owners of these liabilities (either existing/future debt holders, or tax paying corporations/citizens) will likely be the sacrificial lambs of the future. Investors, therefore, should factor in an increasing propensity for higher inflation in future years as debt principal is eroded much like the shaved edges of a Roman coin. Higher taxes, as well, are just around the corner. Finally, currency devaluation effected through a low Fed Funds policy vs. competitor nations and/or global policy coordination should apply the coup de grace for foreign holders of U.S. liabilities. Chinese, Japanese, OPEC, and other substantive holders of U.S. Treasuries will have two ways to lose in future years: they will watch U.S. inflation erode their principal and on top of that the real dollar value of their global purchasing power will decline as the dollar sinks. Actually, the same applies to U.S. citizens although the decline in global purchasing power can be masked by domestic asset appreciation in the short-term (houses, stocks)."

"If the U.S. chooses to pursue many or most of the above policies, the investment implications are significant, although it must be recognized that I am not speaking to “overnight” developments but instead to changes that should occur in future years. Higher inflation, higher personal and corporate taxes, and a lower dollar point U.S. and global investors away from U.S. assets and toward more competitive economies less burdened by health and pension liabilities – those personified by higher savings rates and investment as a percentage of GDP. Need I say more than to sell U.S. assets and buy Asian ones denominated in their local currencies; or if necessary to hire a global asset manager with sufficient flexibility and proper foresight to thrive in an increasing difficult investment environment?"

Tuesday, April 25, 2006

Some more sites to check out

Essential Reading

Get a quick snapshot of the market

Read up on the critical economic indicators:
-Orders for capital goods
-Initial jobless claims
-Home-builder sentiment
-Retail sales
-The bond market

And don't forget the commentary from Morgan stanley. In addition to Stephen Roach, Richard Berner has some food for thought.

Richard asks, "Does the latest energy shock represent another “perfect storm” for the US economy?"

Despite other economic factors, he sees engergy as the most critical component:
"A much sharper-than-expected jump in energy quotes seems likely to depress near-term US growth by more than we have anticipated. And such slower growth and rising headline and core inflation may even create another unappetizing whiff of stagflation. Equally, however, investors would do well to pay heed to the economy’s underlying vitality. As I see it, although near-term growth may slip, even modest energy price relief likely would contribute to a rebound soon."

Interesting article on saving tax!

The ultimate tax shelter: Owning your own business

By Jeff Schnepper

The surest way to reduce your taxes is to convert personal expenditures into allowable deductions. Turn even a hobby into a business and you'll cut your tax bill.

The No. 1 way to reduce your taxes with a smile is to convert your personal expenditures into allowable deductions. It sounds tricky, but it may not be so difficult as you think.

Here's how you do it: Turn yourself into a business owner. This is not complicated, expensive or difficult to do, and incorporation is not necessary.

Establishing a ‘profit motive’ is the keyTo be in business, you merely declare it. And by doing so, you can magically turn personal expenses into tax deductions. If you want to operate in a noncorporate format, as an individual proprietorship, but under a different name than your own, no problem. It’s easy.

In some states, you may have to file a “DBA” (doing business as) form with your local county clerk. Basically, you just fill out a form with your name, address and the assumed name under which you’re doing business. For example, I might be “Jeff A. Schnepper DBA Super Tax Savings Associates.”

Here’s the best part: Your business doesn’t have to make a profit for your expenses to be deductible. All you have to do is establish a “profit motive.” Under the Internal Revenue Code, a “profit motive” is presumed if you earn any net income in any three out of five business years.
It’s recognized and expected that new businesses probably won’t make a profit in the early years. In fact, in the early years, you can insist that the IRS defer any challenge for the first five years as to the legitimacy of your business by filing Form 5213.

Remember you don’t have to show a profit -- just a “profit motive.” In one case, despite 20 years of losses, the court found a profit objective and allowed the deduction of business losses in full for one company. The case was not unusual.

The test for deductibility is whether you have an actual and honest profit objective. You need not have a reasonable expectation of a profit. While the Tax Court requires a primary or dominant profit motive, the U.S. Claims Court has held that having a reasonable chance to make a profit, apart from tax considerations, will suffice.

The test is subjective: Was your intent to earn a profit? The IRS looks at the following factors to decide if your intentions are honorable:

-The manner in which you carry on the activity.
-Your expertise and the expertise of your advisers.
-The time and effort you expend in carrying out this activity.
-The expectation that the assets used in your business may appreciate in value.
-Your success in carrying on similar or dissimilar activities.
-Your history of income and losses with respect to the activity.
-The amount of occasional profits, if any, that are earned.
-Your financial status.
-The elements of personal pleasure and recreation.

That doesn’t mean that just because you enjoy doing your “job” that the expenses aren’t tax-deductible. The Tax Court has ruled that “suffering has never been made a prerequisite for deductibility.”Moreover, even if you’re employed full time elsewhere, that doesn’t prevent you from having another vocation on the side. I spent many years as a full-time college professor while running a legal and accounting practice on the side. This technique works whether your business is your primary source of income or it’s a sideline.

Your hobby can be a businessThat means your hobby could qualify as a business. In the process, you’ll cut your tax bill.

How to qualify as a business deduction-
To qualify as business deductions, your expenses must be:

-Ordinary and necessary -- defined by the courts and the IRS as “reasonable and customary.”
-Paid or incurred during the taxable year.
-Connected with the conduct of a trade or business.The term “reasonable and customary” depends on your specific business and the business customs in your locale. The expenses don’t have to necessarily be reasonable and customary to you, but simply to your particular trade or industry. There are innumerable cases of “hobbies” converted into “businesses” with expenses allowed.

Focus on your profit-making motive. Remember that it’s not what you pay in taxes that counts, it’s what you keep.

Tuesday, April 11, 2006

Housing Supply and Demand

Inman News reports a NAR Press release..

"Existing-home sales are projected to drop 6 percent to 6.65 million this year from a record 7.08 million in 2005, according to the latest annual forecast by the National Association of Realtors trade group."

"New-home sales, meanwhile, are projected to fall 10.9 percent to 1.14 million from the record 1.28 million last year – both sectors would see the third best year following 2005 and 2004. Housing starts are forecast at 2 million in 2006, which is 3.2 percent below the 2.07 million in total starts last year, according to the forecast."

So in 2005 there were 2.07 million housing starts, and 1.28 million houses/housing units sold. In 2006 the estimate is 2.0 million housing starts and 1.14 million sales. Wait a minute. Isn't this a huge imbalance? New house inventory will have increased by 1.65 million housing units in 2005/2006 if these figures are correct. In 2004 the average existing home inventory was around 2.5M units. (I'm not sure what the new home inventory was in 2004). Any way you look at is, 1.65 million additional units is a huge inventory increase! This is based on the NAR's (read house price appreciation cheerleaders) own figures and does not evenconsider any possible flipper flops, Boomer drops, bankrupt no-docs pushing additional supply back onto the market.

Analyzing these figures is so straightforward, yet few seem to do it. I guess people look for, and believe what they want, until it's too late and they loose their shirt. Of course it doesn't help that the NAR reports these figures and then make statements such as:

"Home sales will move up and down somewhat over the remainder of the year but stay at a high plateau..."
- David Lereah, NAR, 1929, er I mean 2006.