Friday, May 10, 2013

The Third & Final Bubble: Enjoy The World Around You Before It Pops

After last week's performance on CNBC, this week we get another dose of reality from Peter Schiff on Fox News discussing the Fed induced bubble in stocks, bonds, and real estate.

If a small portion of the trillion+ of dollars currently printed every year should begin to enter back into the energy or agriculture market (it is already spiking the cost of rents), then you will have the trifecta that ends this charade: rising inflation in the goods people need to survive every month. When this occur the Fed must decide to either stop printing or ignore it and just hope for the best. Either scenario will lead to total disaster (for the real value of asset prices) and the world will once again see that the emperor has no clothes.

This process will most likely occur first in Japan and provide a blue print for what is coming for the U.S.

In the meantime, and I say this with all honestly, enjoy the world around you today where people are more happy in general because they think this is a real recovery. Most people have no understanding about what is currently happening and therefore have no understanding about the consequences today's actions will induce.

This bubble will be the last bubble because when it begins to collapse central banks and the governments will already both be "all in." There will be no bailout that comes from Mars or Jupiter. The bill will finally come due for the 70 year debt super cycle that has now bankrupted every layer of the economy.

For a complete discussion on the most likely first domino to fall during the next collapse see:

Japan Steps Into The Abyss: Begins Largest Money Printing Experiment In History

2013 Outlook: Japan's Government Debt Bomb Goes Off

Wednesday, May 8, 2013

The Economic Strength Behind The Housing Recovery

The following should hopefully provide a very brief and updated recap (for those standing in line outside a Realtor's office waiting to cash in on the current mania), on the long term economic strength behind the current real estate "recovery."

We know that pockets of the United States are back in a residential real estate bubble, euphoria, mania, hysteria, or whatever you like to call it when people's decisions become almost solely based on emotion and greed. The fear of losing a dream home, or the thought process that someone will "miss out" on lower interest rates or these low prices has the country, in a few select markets, back in full madness mode.

A strong, healthy, real estate market would be composed mainly of growing middle class families (having kids - need more space). They have a job that is going great, they have low debt, and they have a high amount of savings which allows them to put down a large down payment on the American dream. We have the benefit of economic data statistics to see if this is what is actually occurring across the United States and driving these real estate prices higher.

We'll begin first with income growth. The chart below shows the US median income through the end of March. It collapsed after the current depression began in December 2007 and has not yet recovered.

How could I possibly and irrationally use the a country with a stock market that not only goes up every day, but goes up every hour?

If you strip away the artificial government life support, and look at personal income excluding transfer payments, you get the very scary chart below showing a free fall back down to 2008 levels.

If Americans are not earning, at the very least we know that they are not piling on more unpayable debt, right? Didn't we finally learn that lesson back in 2008? 

Nope. US consumer debt levels have now crossed back above previous record highs thanks in most part to the explosion in student loan debt (good luck for that generation getting a down payment on a home with hundreds of thousands in student loan debt and no job) and subprime auto lending.

If you are good at math you can probably guess how the final component of healthy growth will look, but we will review it anyway. With income collapsing and debt soaring that obviously leaves little room available to save. You can see the steady trend in America beginning in the early 1980's where the country moved from one of savings to one of borrowing. With no savings, it makes down payments on a home difficult. The chart below is a mirror image of the chart above. Savings were replaced with debt.

During the previous housing boom it was the average American pushing home prices higher, seen in the rising homeownership rate below. Housing prices bottomed in many areas in early 2012, but the homeownership rate has continued to fall, last month hitting a new post bubble low. This shows it is not the average middle class family working family that is buying homes and pushing prices higher.

Another tool we can use to see that the average working family has not been involved with this recovery is the number of mortgage applications. When a family goes to purchase a home they take out a loan. This is not occuring.

The actual cause of the recent price surge we have discussed in the past, but will review a piece of the story again briefly. The number of homes being foreclosed on collapsed in September 2010 after the robo-signing scandal. This inventory has been held off the market now for close to three years creating an artificial shortage.

I know some people planning on eventually moving to Florida that visited an enormous community called The Villages in 2010 which was completely flooded with foreclosures and vacant homes. The median home price in this area fell from a high of $248,000 down to about $175,000 (about 30 percent decline), and has trended up to about $200,000 and held steady over the past few years.

They are back visiting The Villages this week and it is a complete mania (see the recent surge in pricing on the chart above on the far right). A Realtor they spoke with told them that there is now only 1 foreclosure in the entire community (the residential area is the size of a small city). The Realtor said that home would probably be sold in minutes and that there are bidding wars on the limited supply of homes available. Where did this inventory go?

The red line on the graph below shows the collapse in foreclosures in Florida after the robo-signing scandal. These foreclosures never returned to the market.

I have no idea what the number of bank homes currently in default are that are being held off the market in this specific retirement community. It could very well be zero as these Realtors are telling people. A retirement community is also a different type of market than your typical single family neighborhood (there is currently strong demand from retiring baby boomers). I was in a conversation about this particular neighborhood earlier in the week, which is why I use it as an example. Every market is different.

The purpose of this disucssion is to think about the fundamental factors that would strengthen the real estate market as a whole and create a long term sustainable recovery against the actual factors taking place in the market today.

For a further discussion on who the new big buyer is in the real estate market (if it is not working families as just discussed) see:

Wall Street Becomes The Housing Market: Why This Is A Good Thing

For those that do not remember the Robo-Signing scandal or its recent conclusion, here is John Stewart with a nice summary:

Jeremy Grantham On Debt Fueled Growth & The Fed Killing The Donkey

The following is just a small piece of an excellent conversation with legendary money manager Jeremy Grantham on Charlie Rose. The chart he discusses on the debt growth which began in the early 1980's is here:

For the complete interview click here.

Sunday, May 5, 2013

Charlie Munger On Bankers & High Frequency Trading

On high frequency trading: "It is legalized front running." Very simple, and correct. For an example of how they front run (your stock purchases) see:

Dark Pools: Understanding The World Of High Frequency Trading

Some of the greatest quotes from Warren Buffett over the years, list courtesy of Barry Ritholtz at The Big Picture.

“The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities ¾ that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future ¾ will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.

     - Source: Letter to shareholders, 2000

“Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.

     - Source: Letter to shareholders, 2004

“Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.”

     - Source: Letters to shareholders, 2005

“After all, you only find out who is swimming naked when the tide goes out.”

     - Source: Letter to shareholders, 2001

“SUPPOSE that an investor you admire and trust comes to you with an investment idea. “This is a good one,” he says enthusiastically. “I’m in it, and I think you should be, too.”
Would your reply possibly be this? “Well, it all depends on what my tax rate will be on the gain you’re saying we’re going to make. If the taxes are too high, I would rather leave the money in my savings account, earning a quarter of 1 percent.” Only in Grover Norquist’s imagination does such a response exist.”

     - Source: New York Times

“You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.”
     - Source: Warren Buffet Speaks, via msnbc.msn

Buffett comments on some of Charlie's comments and discusses other market ideas from the weekend:

Wall Street Becomes The Housing Market: Why This Is A Good Thing

It is no secret now that the major driving force behind the current floor or temporary recovery in the U.S. residential home market is the enormous money entering through the investment funds. These funds are entering cities and purchasing home after home after home for cash with the anticipation of renting them out.

Before we go on I find it fascinating that many writers feel that this is just another "evil banker move," saying that "we will all become serfs to these new landlords." I feel the exact opposite. This is exactly how a healthy free market heals itself, something I have been talking about for years now. 

What will this do to the average cost of living for every American? It will lower it! That is how free market capitalism works. These buyers will continue to buy homes and rent them out, and rent prices will continue to fall as more supply enters the market. This is already happening. Economics 101. For more on this see:

Behind The Curtain Of The Artificial U.S. Residential Home Market

Unfortunately, this is only a portion of the story and if it were to end there it would have been a happy one. When looking at the complete residential housing picture you find that it is still quite unhealthy, creating a bottoming foundation made of sand.

On the other side of the demand dynamic you have supply. Banks continue to hold properties off the market and this I certainly do not believe is part of a healthy free market housing recovery. Accounting changes in early 2009, discussed relentlessly here since their inception, have allowed banks to hold assets as mark to myth. After the robo-signing scandal in late 2010 the number of foreclosures declined precipitously and that supply never returned. The banks found that if they artificially hold supply of the market they could create a short squeeze and increase the value of the assets they are holding on their books.

The red portion in the graph below shows the foreclosure filings in the state of Florida. You can see the cliff drop in foreclosure filings when the robo-signing scandal hit in October 2010. Then when a settlement was reached last year something strange happened; the inventory (foreclosure filings) did not pick back up.

You would believe that there would be a pent up level of homes building during the two year settlement period. By then the banks could see what was taking place. With that supply off the market it was already creating the artificial squeeze. Their hope is to trickle the supply back onto the market and keep the artificially low "supply" data in the brochures of every Realtor in the country. Why sell and take a loss if they can just hold homes at "full value" on their balance sheet?

This is creating an artificial rise in the price of homes and there is nothing healthy or free market about it. Buyers entering the market today that have little understanding of what is occurring enter a bidding war with Wall Street (cash buyers) over the limited supply available and they think there is some sort of new mania in the market which is causing them to get caught up in a frantic buying mind set. This of course is tremendous news for anyone looking to offload a property.

Las Vegas has become the perfect case study of this dynamic in place and I highly recommend you read the following article:

Special Report: Cheap Money Bankrolls Wall Street's Bet On Housing

The third part of the real estate analysis that I believe is both unhealthy and will slow the inevitable bottoming process is the artificial lowering of interest rates by the Federal Reserve which is allowing home buyers, in their new manic state, the ability to over pay for homes as the temporarily low interest rates bring down the monthly mortgage payments. For a complete discussion on mortgage rates impact on home prices see:

Residential Home Prices Have Not Bottomed

If banks were forced to put the real supply of homes on the market and mortgage interest rates were not artificially held down then the prices of homes would fall much further. This would allow investors and those capable of purchasing a home to do so at much lower levels. The monthly cost of living for everyone in the country would be significantly reduced allowing more money every month to be used for spending (boosting the economy) or saving/investing (boosting the economy). Real growth.

Instead we continue to lurch forward in this zombie housing market and people with little understanding of what is actually taking place and getting caught up in the short term frenzy of markets will be once again be hurt badly, just as they were the last time.

Peter Schiff Visits CNBC's DOW Celebration Studio

The people on CNBC, and their guests, have once again completely lost their mind. The show has become a  24 hour a day live streaming celebration of new DOW highs, which at times feels more like a Saturday Night Live skit. Unfortunately, someone accidentally booked Peter Schiff to come speak with Maria for a few minutes on Friday afternoon, and the studio was hit with something they have not heard in a while and had no answer for: reality.

Maria, who appears to be literally drunk off the DOW highs, continues brushing off every real economic data point Schiff provides and counters with "there is no other option for stocks" and "the Fed has this market going higher." The other guest is even more laughable as he provides a real time look at what the network's market analysis has become.

For a helpful visual on the economic data Schiff is discussing you can see its strength below in the US Macro economic data (red line). The green line is the S&P 500. We now live in a world where what takes place in the actual economy has no relevance. Good economic data makes stocks go higher, and bad economic data makes stocks go much higher.

Why? Terrible economic news just means more Fed printing, which can then be re-invested by the banks back into the stock market in a perfectly healthy loop that is now the American economy. Pass the bubbly, and watch that ticker roar to 16,000 and beyond because when this madness ends as Schiff points out; it will make 2008 look like a Sunday picnic.

Fore more on the strength of Maria's main argument, "there is no other alternative," see:

Why Buy Stocks? There Is No Other Alternative

 h/t Zero Hedge