What is the last shoe to fall in a housing downturn? According to Stephen Roach, that would be construction activity. Once we see its demise, we should expect the "downside of the building cycle could be both deep and prolonged."
Abelson has all the details:
WITH ALL ITS FOIBLES and an incurable tendency to occasionally go berserk, the market has an enviable record as an economic forecaster. No surprise, really, for it can be a pretty good diviner of the economy’s currents and even better at spotting its incipient tides. On this score, it certainly boasts some palpable advantages over economists. For one thing, it doesn’t talk gibberish. For another, you don’t have to take it to lunch to find out what it thinks.
At the end of the day, of course, what’s happening to the economy and what’s likely to happen to it determine what the market does or fails to do. But as anyone knows who has dipped as much as a small toe in it, the blamed thing can be quite quixotic, responding to emotion and kindred unreasonable influences rather than solid data or definable prospects.
Which, in part, anyway, we suspect, accounts for its rather doughty performance of late in the face of daunting fundamentals, most particularly an already wobbling economy slated to get who knows how much worse as housing collapses, as it surely will, like a house of cards. On this score, as the latest dispatches from the home front make clear, the drop in demand, the rise in unsold houses and the beginning of what we believe will be a dramatic fall in prices, all are coming sooner and with greater velocity than even growling old bears like us expected.
What’s more, as Morgan Stanley’s Steve Roach points out in an especially perceptive commentary that popped up on our screen Friday, "construction activity is the last shoe to fall in a housing downturn. Due to sunk fixed costs of land and property acquisition by developers, homebuilding typically continues into the inventory overhang phase of the cycle. Such is the case today — with residential construction activity still holding at relatively high levels…."
However, Steve sternly warns, "once this last gasp of project completions runs its course, the construction downturn should gather force. Given the magnitude of the current inventory overhang, the downside of the building cycle could be both deep and prolonged…."
For quite a spell now, we’ve been preaching a similar sermon. The logic seems inescapable: The greatest housing boom this fair land has ever seen is over and is due to be followed by one big bust. All by itself, housing has been a mighty prop to the economy, and its crumbling can’t help but have widespread and unmitigatedly ugly repercussions.
Forgive us for repeating this gloomy screed. But we think it’s critical that nice, smart folks like you not be sucked in by recent signs of life in the stock market. What has buoyed the market have been sentiment — investors have grown increasingly wary — and, relatedly, a towering short interest. On the latter score, shorts may be wrong but they’re no dopes. They’re the quintessential short-term traders and they tend to rush for cover when the trend runs against them. And they’ve been doing some of that in recent sessions.
The sentiment figures speak for themselves. Investors Intelligence surveys show a consistently thin plurality of bulls over bears — the difference was a scant 3% in one recent canvass. In like vein, the American Association of Individual Investors’ latest poll of its members, who tend to be small plungers and nervous, showed 39.4% bullish and 37.4% bearish. While soundings of pros by the Consensus Index and Market Vane exhibit similarly subdued enthusiasm for stocks. And ISI’s survey of hedge funds showed those flighty birds pulling in their wings a bit, trimming their net exposure to equities to about 50%.
None of these contrary indicators are at levels where you could go out and buy the market blind. But they all express sufficient caution to explain the action of the market and the possibility, if not likelihood, of a further rise. However, these are strictly ephemera and most emphatically hardly the stuff to shake our conviction that a serious bear market is out there waiting to happen.
What more needs to be added?
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Sources:
The Medicare Scam
UP AND DOWN WALL STREET
ALAN ABELSON
Barron’s MONDAY, AUGUST 28, 2006
http://online.barrons.com/article/SB115654804252746089.html
US: Another Post-Bubble Shakeout
Stephen Roach (New York)
Morgans Stanley, Aug 25, 2006
http://www.morganstanley.com/GEFdata/digests/20060825-fri.html#anchor0
Mauldin runs his “Fingers of Instability” again today. It bears re-reading because I think that it speaks to the dynamics the “unfolding” of the economic story and the frustration of those on the “fringe” as to why more folks just “don’t get it.” H&R Block heads to the front of the line in it’s announcing increasing its loss reserves. Bravo to them for taking this action though they took the ceremonial shellacking that comes with such announcements. We will see more of these announcements, I think and additional revisions downward. Why the market is surprised is surprising. I have to feel for the auditors of these mortgage entities. Grappling with issue of negative amortization in a suspect housing market with the end result of having to opine on the adequacy of loan loss reserves has to sleep depriving.
So far as I’m concerned, he’s preaching to the converted. Hallelujah!
Stephen Roach is one of the best articulators of potential economic pratfalls. But I think he’s missing the third element of the coming post-bubble mess, i.e., the damage to financial markets from things like the underpricing of all the financial instruments used to finance the housing boom. All those mortgage-backed bonds given ratings based on suspect LTV and income levels, then the credit default swaps based on them… Even bonds based on soft-second mortgages…
The people carrying the ultimate risk have interests almost diametrically opposed to the appraisers and mortgage brokers who actually see the house and the buyers financial situation, but have reasons to fudge both.
This isn’t going to just hit the California S&Ls peddling option ARMs, but all the holders and guarantors of that debt, big and small banks, hedge funds, pension funds, insurance companies, etc.
Which all begs the question;
How does an economy that stays afloat almost completely on housing, remain above water when housing sinks?
Abelson at his poetic best, the optimists reasons for hope and the pessimists preaching doom and gloom. The clues are all there to be found, Roach has his and I have my mine. It is the calm before the storm. For years we have been borrowing against our future. When peace broke out with the collapse of the cold war it marked the beginning of an extended period of optimism, ever lower interest rates and the technology of the day, whilst armies of new workers wanting to share in the growth of living standards. These factors are not going to disappear, but they are priced in as profits from will not grow any faster than now. The return of inflation has reminded central bankers of their day job. They are undoubtedly hitting the vulnerable first, but as they hit more of us the tide will turn as bears ran rampant over the bulls. Of course next week the market will rise, far too many of us pesky bears around, but we won’t be denied.
One of the indicators, unemployment, may be suspect in the coming months. In the area where I live I would suspect 20 to 30% of employment in the construction industry are illegal immigrants. Even though construction will slow down, and many workers will be without jobs, a large percentage will not show up in the unemployment figures due to their illegal status.
credit spreads still tight, ISM indices above 50… why worry?
“The return of inflation has reminded central bankers of their day job.”
Speaking of inflation… this is from Doug Noland’s China watch this week:
“August 24 – International Herald Tribune (Carter Dougherty): “During 20 years in the toy business, Anthony Temple has reveled in the bounty of inexpensive stuffed animals, coffee mugs and resin figurines on sale in China. But a buying trip this year for his company, Rainbow Designs…was a rude awakening. Traveling through the Pearl River Delta north of Hong Kong, Temple found that cost increases – for raw materials, but above all, for labor – dominated every discussion he had with suppliers. Far from being eager to underbid each other, Chinese companies talked about marking up their prices from 5 percent to 10 percent so consistently that Temple…became convinced that these were not simply negotiating gambits. ‘When I went over there, I was under the belief that China is a bottomless pit of cheap product,’ Temple said. ‘When I left, I was not.”
As China has been the world’s inflation killer for the past few years, stories like this are troubling. Import Inflation, anyone?
Though on the flip side, a Clinton Admin official claims that “employment parcipitation” may actually go up or stay steady during the downphase of housing because of all the people who couldn’t find a “decent” job post dot.com bust actually just lived off their house keeping unemployment lower than it actually was by the model’s the BLS uses to caculate unemployment. Last month’s figures sorta confirmed this while employment/population fell as well, so that could make unemployment look worse in the short term while the economy unwinds. Just a thought.
Another thing with housing, we talk about stuff like sales, we are still looking at early/mid summer numbers. It won’t be to October we get the late summer/early fall figures, which IMO will show a unhealthy picture……..of the housing industry “right now” August 25 2006.
I’m all for a good recession, myself. perhaps durable goods will become truly durable again. Bought a dishwasher and had it installed this week, and it DOES NOT WORK. Out of the damn box, it doesn’t work. That is the first time I’ve ever had a major appliance simply be broken from the get-go. I am so sick of the cheap crap and bad labor practices and shoddy workmanship in this country. We need to get back to doing things right, and I thought the lesson of Japan had taught us that, but I guess not. Sigh. I watched the entire software industry go through the whole producing crap thing, now it’s into everything. It really sucks.
My QA rant for the day, sorry. I’m just sick of everything being about money and marketing instead of doing thins right and making them work, from the things we produce to the companies we run to the government here. It’s all a mess, and it needs fixing.
Barry thanks for the piece, fascinating reading. As for transporting building materials just got off the phone with an in-law who drives for an independent trucking firm. Evidently much has changed in the space the last 12 months as larger corporate firms like Hunt have reduced prices in competing for less freight. Needless to say the only pay raise he has received the last few years is via his DRIP’s in the likes of “GE” and “C.”
Even though I agree with your thesis that inflationary pressures are building, at the end of the day the game of “chicken” being played between speculative money driving-up commodity prices and the lack of willingness for the captains to pick-up the tab will be decided by a trend already well under way. While textbook defensive plays like JNJ remain grossly overbought first-class energy firms maintain a single-digit handle per valuation. Now that petrol is below $ 3.00 a gallon here in Napa Valley, I’m going to take the profits from my winning bet (my wife may not be the sharpest knife in the drawer but T.G. she is hot) and role them over into a $ 2.75 strike by Thanksgiving :)
Cherry sorry to here about your chatski, note my 9 volt trans. radio works great 30 years later!
ooops Donna-pardon me!
Barry thanks for the piece, fascinating reading. As for transporting building materials just got off the phone with an in-law who drives for an independent trucking firm. Evidently much has changed in the space the last 12 months as larger corporate firms like Hunt have reduced prices in competing for less freight. Needless to say the only pay raise he has received the last few years is via his DRIP’s in the likes of “GE” and “C.”
Even though I agree with your thesis that inflationary pressures are building, at the end of the day the game of “chicken” being played between speculative money driving-up commodity prices and the lack of willingness for the captains to pick-up the tab will be decided by a trend already well under way. While textbook defensive plays like JNJ remain grossly overbought first-class energy firms maintain a single-digit handle per valuation. Now that petrol is below $ 3.00 a gallon here in Napa Valley, I’m going to take the profits from my winning bet (my wife may not be the sharpest knife in the drawer but T.G. she is hot) and role them over into a $ 2.75 strike by Thanksgiving :)
hey Donna
what are the lessons of Japan ???
15 years of recession are OK ?!?!?!?
btw , nice blog you have there
Stephen Roach has been so consistently wrong on everything over so many years, it is hard to believe his shamelessness in continuing to publish his economic writings.
Frankly, I feel embarassed for him. There is a stealth revolution going on with alternative energy (solar, wind, perhaps even shale oil, biofuels) thats going to trigger a trillion dollar impetus to the economy, end the trade deficit, create millions of jobs and bring back a bull market within a couple of years and poor Stephen Roach will be proven wrong again.
per Nomen Nescio:
“There is a stealth revolution going on with alternative energy (solar, wind, perhaps even shale oil, biofuels) thats going to trigger a trillion dollar impetus to the economy, end the trade deficit, create millions of jobs and bring back a bull market within a couple of years”
solar- that’s been going on for 30 years and is a failure
wind- maybe, but it would require an infrastructure that does not exist and will not unless GE decides to get serious about it
shale oil- only practical with oil at $60+ and the dirtiest solution possible; if implemented, oil would drop and it would no longer be feasibile, so…
biofuels- ha! takes 10% more energy to produce than you get back and also only practical with high oil.
There isn’t going to be a tech miracle on the supply side, nor is any of this going to create millions of jobs, fix the trade imbalance, etc. We’re going to have to settle for Devolution and quit buying so much petroleum based crap. How about a 10% duty on any import that is made of plastic that could have been made of wood? How about a 10% tax on any vehicle that gets less than 30 mph city that was not bought for commercial use (as opposed to business use- you had to buy the truck to make a living in other words).
If demand is not stanched, you might as well be talking about ranching whales for their blubber. Dynamite the plastic imports and make buying a piggie vehicle more painful and you make some headway even in a global oil market.
Builders know that prices are dropping so they’re actually hiring more people now than near the peak. Every month lost means another 1-2% reduction in price here in San Diego. Watch building permits for an idea of where employment is headed.
From Florida “LAKELAND — Polk County records show only 409 building permits were applied for in July, a 56 percent drop from the 932 permits pulled in July 2005.”
http://www.theledger.com/apps/pbcs.dll/article?AID=/20060817/NEWS/608170511/1004
per KirkH:
“Builders know that prices are dropping so they’re actually hiring more people now than near the peak.”
Sorry, you lost me, why would they hire more people now? Are building permits going to expire or what?
Judging from the article you linked, I’d say that there are some people in FL who are completely detached from reality, but they’ll get a visit from The Assassin soon enough.
Nomen:
I agree Roach has a bad track record.
This isn’t the best forum to share contrarian opinions I’m afraid. Too bad the debate of ideas is frowned upon here.
“This isn’t the best forum to share contrarian opinions I’m afraid. Too bad the debate of ideas is frowned upon here.”…
This is a GREAT forum for contrarian opinions and ideas….
Not so good for the few neo-con trolls who’ve come flailing in here so far, but having said that, rouse yourself from your diffident hopelessness and speak up Miss!
“Anna S” apparently likes Happy Days posts without any substantive arguments to back them up. Cheaper then just to buy a pack of Hallmark cards or an inspirational calendar. Related to “S” in any way? He/she has on the same blinding rose-colored glasses. (See syncophantic defense of Sherman screed.)
Dear Whipsaw,
The private sector (not counting status-quo behemoths like Exxon) has started looking at the upcoming energy crisis as an opportunity. These guys have shareholders to answer to and they don’t sit around wringing their hands worrying about the collapse of energy-dependent civilization.
As recently as the late 1990s wind-energy was a non-starter in the U.S. and now its growing by leaps and bounds. They are making tremendous strides with Solar (concentrating solar, thin films, even storable solar ) and we could start seeing cost-competitive solar deployed on a decent scale within a couple of years.
As far as biofuels are concerned, there is a controversy as to the energy returned on energy invested. There is a lot of research going on for using non-food plants ( using corn seems criminal) for diesel or ethanol. Brazil is already known to get 8:1 return on energy invested with sugarcane based ethanol. We have a colder climate here but I wouldn’t rule out a technological breakthrough that would allow economical conversion of biomass into fuel.
Shale oil is another long shot that might pay off. The bottom line is that Peak Oil has suddenly given a huge impetus to researching our own energy resources. Don’t get me wrong – I am all for conservation also – but if energy prices settle down at a permanently high plateau it woud turn out to be a blessing – we can produce a lot of our own energy at those high prices and cut out massive hydrocarbon imports.
We have had a multi generational bull market with interruptions by the mire of the 70’s and the bust of 2000. What we are facing is a multigenerationally generated bear market that will play out in one generation.
U.S. economic supremacy coming puy of WW2; renewal in the 80’s with decreasing interest rates, ebbing wage pressure, the first of Greenspan’s rescues in1987; the fall of the Soviet Union with its disgorging of raw materials; multiple Greenspan liquidity infusions; the tech revolution ans bust.
All this time costs have been pushed ouy into the future.
Our current bubble addicted economy is a wave of increasing costs heading toward the future; while there is a wave of multigenerational costs headed from the future to the present. We will have the pleasure of observing this collision in the next few years.
Nomen,
What I said was, “Stephen Roach is one of the best articulators of potential economic pratfalls.” And he has been. If you simplistically used his opinions as investment advice, you would do badly. But then, that isn’t the point of them. I’m sure he makes most of his money being long too. He just worries about things, and since most investors don’t worry enough, they’d be wise to listen to him. He has warned there are big potential hazards in our huge trade imbalance, China’s over-heated economy, etc. What he wants is for action to be taken so these problems can be avoided. Not to be “right.”
You might be right about alternative energy development. Although, I remember people being as sure as you are now being horribly wrong before.
But if I were to take your position, that energy technology is going to explode, I would be inclined to look for it happening in other, mostly emerging market, economies. In China, there are companies actually making money from solar heating. Our subsidized biofuels program is mainly a way to use our excess and highly subsidized corn production and protect Archer Daniels Midland’s profit margins. Brazil’s system actually makes economic sense.
I think the center of dynamic creativity is moving elsewhere. The U.S. has been overly encumbered by vested interests and rising debt levels. The savings rate in China is greater than 40%, our’s is the lowest of any major country.
If we had spent the several trillion dollars we borrowed from the rest of the world over the last decade doing something useful like developing the things you speak of, we might be sitting pretty right now. But we didn’t. We used them to fuel equity and housing bubbles, and to finance tax cuts and a war in Iraq.
Bob
you write:
If we had spent the several trillion dollars we borrowed from the rest of the world over the last decade doing something useful like developing the things you speak of, we might be sitting pretty right now. But we didn’t. We used them to fuel equity and housing bubbles, and to finance tax cuts and a war in Iraq.
end quote.
I see the standard liberal/left-wing critique of American Capitalism lurking behind your comment.
The following I think is true –
The U.S. has done and continues to do horrible things all over the world – but
It is the best country on earth.
It is true that short-sighted,ruthless corporate moguls call the shots here – but its much much worse in the rest of the world (You could say some Scandinavian countries are better than us, but they are ultimately under our protection and cannot survive the way they are without us).
American capitalism is like Alchemy (turning base to gold) – now that they can smell profit in alternate energy – the same greedy short-sighted entrepreneurs who got us into this mess will now find solutions driven by the profit motive.
Environmentalists can also help by increasing awareness among the public, but the actual solutions will come from profit-making corporations.
As far as the rest of the world is concerned only Europe and Japan seem to be forward-looking with respect to the energy crisis – I don;t see a lot of innovation fron China, India etc. They seem to be following the old paradigm of cozying up to present owners of hydrocarbons such as Iran and Venzuela.
Brion ,
bit of a misogynist are you ?
What infuriates me is people who attack liberals by saying that they are anti-capitalistic. Those same people go on to gloat about the merits of capitalism by comparing America’s story vs. that of the rest of the world.
I could go on and write an essay but I’ll stick to say that comparing America to Europe is like comparing a young man to an old man. And America is getting older.
One of the most important variables – if not the most important – in capitalism is a free market determined interest rate. America’s interest rate is set by the Fed so I could easily argue that America is far from being capitalistic.
As inflation goes, my bet is that we’ve only seen the tip of the iceberg.
If Japan’s debt is over 100% debt/gdp why can’t other countries go to that level? The USA has been doing a good job increasing its debt and if its economy slows government will increase its spending to prop it up.
Debt is a relative game. If the USA increases its debt it gives all the other countries the opportunity to increase theirs also.
Russia’s debt has just dropped to 6% of GDP giving them a new slate. My forecast is that they’ll rebuild themselves and bring the ratio back up.
Usually, when government spending increases so does inflation. I think the world is ready for a new bout of inflation.
Danielle,
who sets the 2-year , 5-year , 10-year , 30-year debt ?
The Fed, by inference.
If the Fed funds had not been at 1% for a considerable length of time and if the market was not so confident that Greenspan would leave it there, do you really think spreads would have gotten so low?
If Fed funds had been at 3-4%, do you think we would have had the real estate bubble? Do you think mortages would have been so easily securitized and MBSed out. 1% made the carry trade game hugely profitable.
The Fed sets the short term rate because it knows it can affect the long term rate. Americans must also believe that or else they would not have a Fed.
I think the Fed was created to smoothen out cycles. We thought that this would make the markets more efficient. A few decades later we’re finding out that maybe it’s not as easy as we thought it would be. It looks like mispriced rates are about to come back and bite us.
I can’t believe I allowed myself to get into a discussion with someone as simple minded as Fox news….
I’m outta here.
take Econ 101 again Daniele
must be why the 10-year yield has gone from 5.05 to 4.80% over the last 3 weeks …. its
” set by the Fed ”
Barry, maybe you could get a summary post going? Every post has great discussions and maybe a thorough summary of Fed, foreign, oil, inflation, housing, etc. (at least paraphrased) would be a good idea to get the “big picture”, heck, you could write a book by now.
I was recently in China (1 week ago). The problem I noticed in their economy is the difference between wealth and poverty. Their class gaps are tremendous. All we hear about is China’s economic growth. IMO:
1) China has grown its economy too quickly, dumb they are not, they have been trying to transition from an export economy to a self consuming economy…the self consumption is not as quick as hoped and therefore this brake on their growth is missing and that’s why its been so spectacular…
2) The real problem is the fact that the majority of Chinese do not earn much money…I like to use public transportation cost as a gauge…(the higher the median, the higher the prices) Basically their economy cannot afford inflation because of the large amount of society not being able to keep up…Imagine having to get wage increases through to most of the 1.3 BILLION people.
IMO, the Chinese economy was/is using their exports to get a jump start on their own “self sustaining” economy but it did not/has not been successful…
It’s like a steam kettle with too much pressure…If inflation hits (which it surely will), their MASSIVE economy will not adjust quickly enough. A ballet through a minefield.
Any thoughts?
Nomen
American capitalism is like Alchemy (turning base to gold) – now that they can smell profit in alternate energy – the same greedy short-sighted entrepreneurs who got us into this mess will now find solutions driven by the profit motive.
You mean the same way those ‘short-sighted entrepreneurs’ helped us in the dot-com bubble and the housing bubble…you might be right, but frankly I find that very idea that the ‘short sighted entrepeneurs’ are going to bail us out yet again totally chilling.
we should start looking at Global home sales figures , it’s not just in the U.S. that the bubble is burst
” Sales of new properties in Hong Kong — predominantly high-rise apartments — hit a record low in the second quarter of this year of just 530 units a month. Even in the second quarter of 2003, when Hong Kong was wracked by the SARS crisis, 1,900 new apartments were being sold a month … After the Asian financial crisis struck in 1997, Hong Kong property market prices fell about 60% from their peak and only began rising in late 2003. Even now, property prices would have to rise about 50% to regain their 1997 highs.” — Jon Ogden
Like Money in the Bank
What’s the icing on the bankruptcy law changes, predatory lending & eminent domain law cake? NEW YORK — Homebuilder Toll Brothers said the current slump in residential construction is unlike any it has seen in 40 years as it became…
The San Francisco Gate. “Most recent numbers suggest that the Bay Area (is) no longer a market in which sellers can set their price according to comparable properties in the neighborhood and then wait for the bidding war to send the price over the moon.”
“According to DataQuick, Bay Area home sales slowed in July to their lowest levels in 10 years, while prices increased at their slowest pace since 2003. Translation: It’s not a seller’s market anymore. The only problem? Many sellers don’t want to hear that.”
“Indeed, as the real estate market comes to a screeching halt, agents are finding themselves in the unfamiliar role of dietitians for sellers whose eyes bigger than their buildings. ‘It’s a classic dilemma in the changing dynamics of real estate,’ explains (realtor) John Asdourian.”