One of the more astonishing things about the market is how something that should matter doesn’t for the longest time . . . and then it suddenly does.
I find it incredible that suddenly, the denial we have been living with for so long gets removed. The robust inflation has been denied, ignored for so long. Despite all the evidence, the price increases on ordinary goods, medical services, housing, insurance, all the while commodity prices run amuck has been overlooked, as if its irrelevant.
Then suddenly, it matters.
Meanwhile, we see Housing, the prime (domestic) driver of the economy for the past 4 years, rapidly cool — and the market has yet to discover this as an issue. If the Housing slowdown continues, expect Consumer spending in Q3 to be very soft. Target showed revenue growth of 12%, but missed earnings estimates due to increased costs — (but there’s no inflation). Hey, we still have a full 6 months before we have to start thinking about Xmas spending yet — that could be way off also, if present trends accelerate.
It may be too early to "officially" say the end of this cyclical Bull market is upon us, but the past few days is certainly a warning shot across the market’s bow. As noted, I sold my QQQQ puts yesterday to lock in some games gains; This is an expiration week, and that often sees option trader hedge by going long common against thier puts. I am still long SPY puts for June and September, and actually bought some Qs for a bounce trade.
My first half targets for the year (and you know I think all forecasts are nonsense) were looking pretty good for a while: Dow 11,800, Nasdaq 2600, SPX 1350. The past few days makes them increasingly unlikely by June 30.
I do, however, suspect the next move up is shortable.
By year’s end, I still expect a correction of at least 25%. I believe we are very parallel to late 1972/73 right here.
Meanwhile, here are a few Real Estate headlines that I believe Mr. Market is in the process of discounting:
• Homebuilder sentiment lowest since 1995
• Growth in U.S. Home Prices Slows
UPDATE May 16, 2006 10:42am
Lots of good comments, so I wanted to address them sooner rather than later:
-A 25% sell off in the SPX or Dow is actually a modest correction historically; Consider the 1966-1982 period (which I believe is parallel to this, following as they both do a multi decade bull), there were five selloffs of 24% or greater;
-Consider this: There was a 10% SPX selloff every year from 1995 – 2000; We havent had one of those since March 2003;
-Inflation is quite simply a measure of the purchasing power of the dollar. That has been going down — domestically for some time now, and internationally more recently; "Real interest rates" are less relelvant to my analysis than the calculus of "What is your money worth?"
-As to things going down in price, I have to ask what? The only items I see dropping in price have nothing to do with deflation, and everything to do with manufacturing technologies, consumer adoption curves, and economies of scale.
http://biz.yahoo.com/usat/060515/13552840.html
For those of us who vehemently agree with your assessment of the underlying economic founcations there are a couple or three key questions:
1) what is denial based on and how is it sustained ?
2) why 25% ? That seems rather large ?
3) any comments on timing and structure, i.e. when, triggers, etc.
One could argue that the market has in actuality been relatively flat since Jan but each jump up has been triggered on some fantasy of no further Fed rate increases. Aside from it’s intrinsic merits the problem that puzzles me is that s.t. rates aren’t the issue – it’s what happens in the l.t. rates. Which are more market determined.
Fascinating, as Mr. Spock would say.
Dave Livingston
Barry:
One of the factors that seems to be left out of the bulls argument about the market seems to be the reality of spending as a function of living. The market “expects” spending, but for Americans who are living a $30 and hour livestyle on a $10 and hour paycheck the most likely scenario for the economy is that the consumer will spend and spend until all sources of money are exhausted, then fall off the cliff into utter destruction.
Smart people live in a fairyland of disbelief that this could happen given that they would never make this mistake, but if you look at the burden on the under $50,000 per year wage earner, it’s obvious that this process is occuring and will soon be very evident in spending patterns.
While I reckon that most of what Barry says is very reasonable and ”open eyed”, I want to take exception here to object to the seemingly small but important generalization in:
«I find it incredible that suddenly, the denial we have been living with for so long gets removed. The robust inflation has been denied, ignored for so long.»
While I agree that inflation has been going up a lot (and how otherwise, given ultra-loose money policy of the Federal Reserve, with real interest rates negligible or negative) it is vital to always say: ”the inflation of what?”
Because some prices are going up as Barry points out, but some are going down.
The prices that are going down, so far, are those of labour and things where labour is a large input, and things consumed by labourers; the prices that are going up are those of assets and the things that are bought by those that derive their income, directly or indirectly, from assets.
Eventually sure the rising prices of assets will feed through, actually they are feeding through right now; while asset owners have gained so much political leverage in the past decade that they have been the major beneficiary of the ultra-loose money policy, eventually the flood of liquidity is starting to bring up other prices.
But it is important to remember that ”inflation” is a very ambiguous term, especially in non technical discourse, and one should always qualify it with ”of what?”.
Finally, I want to ask Barry and the other people here a very (deceptively) simple question: do you think that real interest rates right now are negative, close to zero, or positive?
Considering that a certain gunny guy thinks that the real inflation rate is 8% and the real unemployment rate is 12% (”real” as in: measured as it was in the 70s)…
«do you think that real interest rates right now are negative, close to zero, or positive?»
Even better: since 1996 (the year of «irrational exhuberance, when stock prices were a lot lower than now), in how many years do you think real interest rates (whatever that means) were positive?
Barry do you have any thoughts on the Iranian oil bourse and what that could potentially do to the markets if it were to really get off the ground and see a lot of foreign interest. Also why is the financial mass media in the U.S. ignoring the risk of euro/oil exchange possibly signaling the end of the world dominance of the U.S. dollar? Maybe I am giving the rumors too much credit, so what is your take on this. Wouldn’t this also mean that war with Iran is a lock before the elections in November?
You meant to say “to lock in some gains” but you typed “to lock in some games.”
Actually, I like the “games” version better.
Things consumed by labourers are not all going down in price. The necessities of life (food and energy) are going up, while the cool toys are dropping in price. With wages staying flat, a larger percentage of income needs to be spent on staying alive, which leaves less money for the toys. Nobody is going to starve so that they can buy a 30 inch television. Anybody that bought a house with an ARM is going to have their mortgage payments increase dramatically sometime in the next few years. Most people will pay the mortgage before they buy more things.
There is inflation in the non-optional part of people’s spending. That leaves very little money for buying the optional things that drive the economy. A recession is the most likely outcome.
good point, jkw…. there is inflation in all the things we NEED, yet little to no inflation in the crap we don’t need.
to me it’s not about goods inflation per se but rather about the devaluation of the dollar which is driving some actual inflation (commodities) but more importantly it is driving inflation expectations and a potentially larger inflation premium in long term interest rates. stocks got whipsawed last Thurs because they initially interpreted soft economic data as bullish because it would keep the Fed out of the picture, but as the dollar sold off on the same premise, bond yields, the yield curve and commodity prices all rose which was ultimately unsettling for stocks.
i believe this is what Barry is referring to by saying that it doesn’t matter until it does.. stocks will continue to get whipsawed as economic data will either be dollar bullish/higher FF rate or dollar bearish/higher bond yields/yield curve/inflation premium
«Things consumed by labourers are not all going down in price. The necessities of life (food and energy) are going up, while the cool toys are dropping in price. With wages staying flat, a larger percentage of income needs to be spent on staying alive, which leaves less money for the toys.»
This just reinforces broadly my point that one must ask ”inflation of what?”…
However, broadly speaking, I think that most stuff that workers buy has been dropping in price: after all there is a large labour component in the cost of even basic stuff like clothes and food, and Wal*Mart is one of the few stores that tries to pass on the savings.
Then though there are commodities like petrol for which the labour component is small; also the rising prices of property is getting rents, and commercial rents, higher.
But so far the main story is no so much that CPI («inflation ex-inflation» :->) has been stable, because the fall in labour costs has largely compensated for the rise in the price of raw materials and of profits (which are a cost too, and an ever rising one for the past few years).
The main story is that real compensation for workers (at least in much of the western world) has been falling faster than the prices of goods workers consume. By real compensation I mean the total package, including benefits like pensions and health care (whose value has been collapsing).
While the prices of things asset owner consume have been growing but not as fast as the profits and capital gains from those assets.
WSJ article cites Y-O-Y house price change for the current Q. That’s not the relevant measure. This lead sentence in the WSJ may actually be false:
“Home prices were higher in many U.S. markets in the first quarter of 2006”
If prior Q’s YOY was 13.6% and the latest Q’s YOY is 10.3%, it’s possible that prices actually decreased (from latest Q to prior Q).
“I believe we are very parallel to late 1972/73 right here.”
Along with Latin American governments taking over gas and oil fields, that’s just another remninder of the 70’s and something that emerging markets investors are oblivious to. What me worry?!
same questions I have, DBLWYO. But as Larry pointed out very rightly…economics doesn’t play out in just linear cause-effect thinking way. Suddenly something matters that many (?) saw coming (inflation, etc.). If you can catch those moments correctly you are mastering the markets. Keynes paraphrased that once in saying: the markets can remain irrational much longer than you can stay solvent…
Real estate will not collapse because it is part of the same hard-asset phenomenon responsible for the commodity boom. Anything you can hold in your hand will retain its value relative to financial assets.
Stocks will not drop 25% (which would have the major averages at inflation-adjusted post-2000 nadirs). Remember that we in the midst of a global economic boom unique in human history. What’s more, the triumph of free-market capitalism (Larry Kudlow) in all put a few isolated pockets makes this environment far different from what prevailed in 1972.
Two comments on housing/mortgages:
I think the data points to a real bifurcation of homeowners. 60% or so either own their homes outright or have a very manageable mortgage. Those with mortgages probably refinanced in the last few years, but did so for very sound reasons. The other 40%, maybe closer to 30%, is in a much more precarious position. They have often refinanced 2-3 times, each time taking out cash, many have sub-prime mortgages (some of whom have seen their rates jump to 8-9%) many are paying the minimum on an option ARM.
I think this dichotomy has given the illusion that things are OK, because the well-off group are so well-off all the aggregates don’t look so bad. Many in the second group are very likely to get hurt in the next couple of years.
One other point, check out the table on page 7 of the OFHEO report for 4Q05((http://www.ofheo.gov/media/pdf/4q05hpi.pdf). The appraised value of homes refinanced has fallen out of sync with that for sales. I think this is a symptom of the fact that even banks writing risky mortgages are now able to offload their risk to the bond market. The bond market rates bonds based ultimately on the values appraisers have set on houses. These appraisers have a vested interest in satisfying homeowners, mortgage brokers and banks, and carry no risk if the bonds have under-rated risk.
Bob – maybe houses with larger increases in price are more likely to be refinanced, and therefore included in the survey?
The market is overbought and hasn’t really significantly corrected in awhile. Plus, summer is upon us and we all know how robust trading is then. I suspect some market fallback over the summer with a larger correction in early fall. Then there’ll be a rally going into the end of the year followed by the end of the cyclical bull in early 2007.
I’m out of the market right now. A 5% cd will return better than the best market projections that I’m seeing …..
Barry, great comments, but a writer as good as you should eschew the obvious, cheap, wrong strawman such as ‘but there’s no inflation’ re Target.
There is inflation. I’ve never seen any professional dispute that.
You can use PPI or CPI or price deflator.
It is ‘your side’ of the fence that is saying that one’s ad hoc, personal view of inflation is that it is much higher than the gov’ts official measure, normally offering nothing other than gas/oil, or new home prices, or SBUX prices went up to justify this POV. They confuse the ‘base rate’ with the ‘case rate.’ A typical error. They pretend that there are no prices that have dropped.
On the housing front, I find it interesting that even with the slowdown, the YoY increase in median housing price was still 2.9% for April, iirc. My projection still remains that will not go negative, as it has not since the great Depression in 1932.
Do you still believe the opposite?
curious,
Miami
Bob, pls cite the source for your ’30-40%’ of homeowners that have refi’d 2-3 times, taking out cash each time. Because it’s clearly untrue.
According to the Fed, the FOR [disposable income/ debt service] for mortgages has risen from 9.37 in Sept 1985 to 10.76 as of latest figures for homeowner mortgages, meaning homeowners have higher amounts of debt service coverage [11x!] at their disposal.
Mortgages comprise 73-75% of US Debt, around $7.5 trillion today.
According to the OFHEO, home equity rose 56% in the 5 years ending June 2004, so surely much higher today.
Btw 1985-2005, RE values net of mortgage has gone from 27% of Household Net Worth, down to 24.6%. Debt has gone from 4.30% to 4.31% of HNW.
Home ownership is at a record high, so it is no surprise some new owners are not as ‘paid up’ as people in their homes for 30 years, I totally agree. Used to be that less than 50% of the US households owned a home, now it is 70%!
Home equity as a % of net worth has risen from 21% to 17% over the past 30 years – all data from 3Q05 Fed FoF report.
Finally, using the Constant Quality Index for housing prices, last quarter showed a 4.8% YoY increase. Not very exciting, at least imho.
miami
last month’s CPI report:
Items up less than 1% –
household insurance -2.4%
apparel -1.2%
furnishings -0.4%
new vehicles -0.2%
telephone services – 0.0%
meats, fish 0.9%
dairy prods 0.9%.
I guess nobody buys clothes, or furniture, or cars, or insurance, or meat, or…
> There is inflation. I’ve never seen any professional dispute that.
The Fed disputes it. They are in total denial. The Fed’s dual mission is to cover up inflation and create bubbles.
They admit that some statistics show inflation, but always downplay that inflation with an endless set of excuses:
Inflation outside “core” doesn’t matter, so food and gas inflation doesn’t count
Asset inflation doesn’t count so the Fed doesn’t care if the cost of raw materials goes parabolic or the cost of houses increase by double digits for five years
Inflation is ok if it is within their target zone (or a little over as they expand the zone to meet the data)
Globalization makes it impossible to have severe, persistent inflation
Any inflation which isn’t explained away by the above excuses is downplayed by saying it is “temporary”
… or inflation which is covered by the previous excuses is ignored by saying [it exists but] “inflation expectations are contained”
One way or another the Fed always finds a way to avoid admitting that inflation is a problem, and to avoid hiking rates to the point where they might fix something.
Here is another thing they are missing. Pension deficits. How many times have we heard how flush with cash all these companies are, yet their pension obligations aren’t fullfilled and it will only get worse if the market crashes.
http://www.bloomberg.com/apps/news?pid=10000103&sid=a8gDLCneeLM8&refer=us
The housing numbers I’ve seen say that there are about 3 Trillion dollars of ARMs resetting in the next 3 years. Many of those are interest-only until the first rate reset, so the payments will at least double at the first reset. Even the ones that aren’t interest only will have the payments go up by at least 10%. Is any of that factored into the FED data on disposable income to mortgage service ratios? If the figure is 11x, but 1/4 of the mortgages are only being paid halfway right now, it should be adjusted downward to somewhere between 8x and 9x. It’s possible that if you ignore the introductory low payments, the actual number would be as low as 7x.
Last summer the housing market peaked in many parts of the country. YoY appreciation then was about 15%. If it has fallen to only 4.8% now, that means prices have fallen somewhat since last summer. Housing cycles are slow, so this is just the beginning of price declines. Inventory is building everywhere and mortgages are becoming harder to get. House prices will fall. They might only fall 10%, but they could fall as far as 50%. If the government does nothing to intervene, the housing bubble will correct and prices will revert to their mid-90s level (plus inflation). That would mean as much as an 80% drop in a few locations. I think there is no way the government will sit back and let that happen. My current theory is that house prices in the coastal cities will fall by 15-30% and then inflation will take over and start pushing prices up again. This will require inflation of 6%+, which will cause other problems, but homeowners have too much at stake for the government to let house prices fall as much as they would in a free market.
I think it is wishful thinking that the government can or will save the housing bubble. First of all, the injection of money would be massive and it would cause all sorts of problems. For the last 10 years or more we’ve been told that we are opposing inflation and people have acted accordingly. And now we are going to reverse that ?
In case nobody noticed, we still have deficits with no end in sight. If inflation runs 6%, our lenders will demand interest rates of 10% on their loans which means similar rates for mortgages. How how is Joe average ever going to make a mortgage payment at those rates ? On a 400K balance, he would have to make $100K a year. That is darn healthy inflation.
The last week has been very interesting and I don’t think it is over. Housing seems to becoming an issue people are starting to talk about. Larry Kudlow doesn’t buy it yet, but he is a perma bull. Others are starting to see that housing has and will drive everything for the next while and until this situation is resolved, our markets aren’t going far.
In the early 1980s mortgage rates were in the double digits. People paid those rates then (even with lower real incomes), they can pay it again – but not without a shift in prices relative to incomes.
‘YoY appreciation then was about 15%. If it has fallen to only 4.8% now, that means prices have fallen somewhat since last summer. ‘
You are very bad at math or logic or both. A 4.8% GAIN is not a drop in price, it is a slowing of increase. You fail to note this simple difference.
‘Housing cycles are slow, so this is just the beginning of price declines. Inventory is building everywhere and mortgages are becoming harder to get. House prices will fall. They might only fall 10%, but they could fall as far as 50%’
Ah, I’m sorry, you’re just ‘differently abled’.
50% fall, huh? You’ll make a lot of money with that thesis.
The national median housing price will not fall over a one-year calendar period. It hasn’t for 74 years, and it won’t this year. Or next.
‘YoY appreciation then was about 15%. If it has fallen to only 4.8% now, that means prices have fallen somewhat since last summer. ‘
You are very bad at math or logic or both. A 4.8% GAIN is not a drop in price, it is a slowing of increase. You fail to note this simple difference.
No, you’re just bad at English. Last summer, prices were up 15% from the previous summer. If they are only up by 4.8% from a year ago, then they are probably down from last summer (if there was more than a 4.8% increase from last spring to last summer, last summer’s prices would be higher than current prices). According to the NAR data, national median exiting house prices have fallen by about 1% since last summer, and about 5% from the peak. I guess they must be lying though, since house prices never fall. Or maybe you think everyone is going to rush out and start bidding wars during a buyers market so that there won’t be a YoY decline in a few months.
It seems more likely that you’re one of the idiot housing speculators that drove prices to unaffordable levels in search of profits. Miami is one of the markets that will fall hardest. I would be surprised if Miami area condo real prices fall by only 50% from their peak.
‘No, you’re just bad at English. … According to the NAR data, national median exiting house prices have fallen by about 1% since last summer, and about 5% from the peak”
Bad at English, huh? Link, please about those exiting house prices.
‘It seems more likely that you’re one of the idiot housing speculators’
I don’t own a house. I rent. Just fyi, but I can already see that facts are meaningless to you.