“Everyone has a plan 'till they get punched in the mouth.”
- Mike Tyson
There have been a lot of interesting Mike Tyson quotes over the years, some fit for print, others less so, but this one seems apropos for the times. The Fed tells us they have a plan, and they’re implementing it. So far, the markets seem to like it. Let’s see how their plan fares once they get punched in the mouth.
This summer we introduced our bearish thesis on housing with our 100-page report entitled: “How Low Will Housing Go in 2H10 and 2011”. In that report we laid out our three separate home price models: our supply model, our demand model, and our combination supply & demand model. The output of those models forecast home price declines ranging from high single digits to 20%+ over the next 12-18 months. How have we fared so far? As the chart at the end of this note shows, the four major home price series that we track (Case-Shiller 20 City, Corelogic, FHFA, and Existing Home Sales Median Home Price) are all heading south. After peaking in the April/May timeframe on the strength of the tax credit, three out of four home price series are now solidly in negative year-over-year territory. The lone holdout, Case-Shiller, is a 3-month rolling average, which is why it lags the other series in reflecting the degree of slowdown. The next few months of Case-Shiller data will show a comparable negative trend.
For reference, the Corelogic series is the series now used by the Federal Reserve. How has the Fed’s preferred series fared? According to Corelogic, home prices have rolled from being up +4.3% YoY in May 2010 to being down -2.8% YoY in September 2010, a negative -7.1% swing in four months. Looking month-over-month, the Corelogic series was down -1.8% sequentially in September (the most recent data available), which translates to the fastest rate of decline since February 2009.
The supply and demand imbalances were at the root of our housing call this past summer and nothing has changed on that front. The market is more dislocated today than it was when we made the call in the summer. At the time we made our call in June there were 3.99 million homes on the market for sale and existing home sales were running at a rate of 5.37 million, which equated to 8.9 months of supply. Today, there are 3.86 million home on the market for sale (October), while existing home sales are running at a rate of 4.43 million, which equates to 10.5 months of supply. Existing home inventory peaked at 12.5 months of supply in July. Based on our conclusion that home prices take one year to fully respond to supply and demand imbalances, we would expect to see July 2011 be the low watermark for year-over-year price trends in housing. The more important takeaway, however, is that between now and July 2011 the trends should continue to get worse. While it is possible that the market’s “bad news is good news” mentality will persist and ongoing weakening in home prices will simply translate into greater and greater expectations for further quantitative easing, we continue to think that bad news is simply bad.
Another point to consider is the impact QE2 is having on the housing market. While recent demand statistics have been modestly upbeat (i.e. October pending home sales up 10.4% month-over-month), the reality is that mortgage rates have backed up sharply in November. The Bankrate 30-year conforming mortgage index has ballooned from 4.20% a month ago to 4.70% yesterday. For reference, a 50 bp backup in 30-year rates has a 5% negative effect on affordability.
It’s also worth pointing out that no amount of stimulus or quantitative easing seems to increase banks’ willingness to underwrite residential mortgage loans. In the most recent Senior Loan Officer Survey released November 8, the net percentage of lenders tightening access to prime mortgage credit rose to +9.3% from -5.5% quarter over quarter meaning that the average American is now finding it more difficult to get a mortgage than they were over the summer. The trend was similar for access to nontraditional mortgage credit: +9.5% of respondents reported tightening standards, up from +4.5% last quarter. This isn’t helped by the fact that banks are currently engaged in trench warfare with Fannie & Freddie as well as the entire private-label MBS universe over mortgage putbacks. Further, there are 8.5 million borrowers who have either been foreclosed or are currently non-performing on their loan. This is a large slice of the overall homeownership pie that has been semi-permanently eliminated from the buyer pool (7 years for most lenders to look past a mortgage default). All of this has cast a pall over banks’ willingness to underwrite new mortgages.
Many investors forget just how slippery the slope of negative home prices can be. Falling prices don’t happen in a vacuum: they have two insidious offshoots. First, they generate a tangible negative wealth effect. For reference, for all the excitement resulting from the upward move in equities recently, consider that as a rough rule of thumb, every 100 points of upside in the S&P is roughly equivalent to a 5-6% rise in home prices based on there being total direct equity wealth of $10.8 trillion and total residential housing wealth of $17.1 trillion. That said, the wealth associated with housing is much more broadly felt as 65% of American families are homeowners, a far higher proportion than those with material equity wealth. Second, negative home price trends increase pools of underwater borrowers. We have shown that there are presently 11.3 million borrowers (20% of all borrowers) who are underwater. 4.9 million of whom are underwater by more than 25%. A 20% decline in home prices from here would increase those who are underwater to 21.9 million (46% of all borrowers) and those underwater by 25% or more would rise to 9.4 million (20% of all borrowers). Laurie Goodman, a Senior Managing Director with Amherst Securities, one of the leading providers of mortgage data analytics, has shown that loans with LTVs greater than 120% are currently defaulting at an annualized rate of 19.1%, while those with LTVs between 100-120% are defaulting at an annualized rate of 11.3%. Those are scary statistics when one considers that there could be 22 million borrowers in a negative equity position with a 20% drop in home prices from here.
The real question is, what will a 20% drop in home prices feel like for the markets and for the consumer? Our guess is that it will feel a lot like getting punched in the face by Mike Tyson.
This note was originally published at 8am this morning, December 06, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“If the government owns all of the printing presses, it will determine what is to be printed and what is not to be printed.”
-Ludwig von Mises
On a flight to Calgary, Alberta yesterday I was reviewing “Economic Policy – Thoughts For Today and Tomorrow” by Austrian economist, historian, and philosopher Ludwig von Mises. His book, published by The Liberty Fund, compiles the following 6 lectures that von Mises gave in Argentina in 1959:
- “Foreign Investment”
- “Politics and Ideas”
This book is only 75 pages long and sits amongst the classics in my library. The deep simplicity that von Mises achieves in explaining complex macro-economic issues is unrivalled. I highly recommend it to anyone looking for the opposing argument to Big Government Intervention.
In the coming weeks I’ll refer to these lectures, quoting one of the founding fathers of libertarian free-market thinking whenever the opportunity presents itself. After watching a completely politicized head of the US Federal Reserve telling stories on 60 Minutes last night, one of those opportunities is now.
Post Ben Bernanke’s interview, the #1 headline on Bloomberg this morning should shock anyone considering this country’s constitutional underpinnings: “Bernanke Says Fed May Take More Action To Curb Joblessness”… One man, one ideology, one power to print money…
Before I get into what The Ber-nank’s professional politicking for additional Quantitative Guessing (otherwise known as printing moneys) entailed, let’s take a step back and re-read what the US Federal Reserve said most recently about its go forward QG2 strategy:
“The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability."
In English, sans le Greenspan-esque obscurity, this means that the Bernanke Fed’s goals are:
- Fostering maximum employment
- Fostering price stability
Sounds nice, in theory… but last week’s US Unemployment rate hitting a new high of 9.8% was an unmitigated train-wreck on point #1 and on point #2, never mind “price stability”… Ben Bernanke is fostering some of the highest levels of price volatility that modern markets have ever seen. How about fostering some accountability, dude.
Look at last week’s week-over-week percentage moves:
- SP500 = +2.9%
- CRB Commodities Index = +5.0%
- Oil = +6.5%
- Gold = +3.1%
- Copper = +6.1%
- VIX = -18.9%
Bernanke must be kidding himself, because he certainly isn’t kidding me. That VIX (Volatility) decline of -18.9% week-over-week came the week after the VIX rocketed +23.2% higher. At this point, he’s Printing Price Volatility in volatility itself!
Let’s go back to some of The Ber-nank’s key statements on 60 Minutes:
- On Growth – “we’re not very far from the level where the economy is not self sustaining…”
- On Employment – “it takes about 2.5% growth just to keep unemployment stable…”
- On Inflation – “fears of inflation are overstated…”
In response, I guess my first question is, according to who? The man’s macro-economic conclusions are littered with ideology and inaccuracy. Maybe it’s a blessing in disguise that Ben Bernanke speaks this academic dogma out loud to the world. After all, it’s better to remain a humble looking man who knows nothing about the interconnectedness of global macro markets and says nothing, than to open one’s mouth and remove all doubt.
Rather than take my word for it on this global Fiat Experiment gone bad, I can only hope at this point that the people of the world look at real-time market prices (price instability) and the outcomes of these Greenspan and Bernanke interventions on both the sustainability of growth and employment. The records speak for themselves.
As for a solution to this mess. I’ve said this before, but I’ll say it again – the first solution is to STOP – that’s it. Stop this man from doing what he is doing in perpetuating all-time highs in the price of the #1 food staple for 3 BILLION people (rice) and anything else for that matter that’s priced in the dollars that he is on a mission to debauch.
Finally, I’d like to submit a few passages from Ludwig von Mises 3rd lecture, called “Interventionism”:
“The idea of government interference as a “solution” to economic problems leads, in every country, to conditions which, at the least, are very unsatisfactory and often quite chaotic. If the government does not stop in time, it will bring on socialism.” (“Economic Policy”, page 38)
“Is there a remedy against such happenings? I would say, yes, there is a remedy. And this remedy is the power of the citizens; they have to prevent the establishment of such an autocratic regime that arrogates to itself a higher wisdom than that of the average citizen. This is the fundamental difference between freedom and serfdom.” (“Economic Policy”, page 39)
Stop. Listen. Re-think.
My immediate term support and resistance levels for the SP500 are now 1199 and 1229, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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POSITION: Short SPY
After seeing the SP500 close higher for 3 consecutive days, my bearish position in the SP500 goes from being right to wrong. In the very immediate term, we are bumping up against significant TREND line resistance (1225 is the prior YTD closing high) and our immediate term TRADE line of resistance is just north of that up at 1229.
It’s usually easier to see macro catalysts in the rear-view mirror. The market hammering the US Dollar lower on Friday (unemployment report) helped support the bullish bid to stock and commodity markets. I personally wasn’t aware that rock star of the Fiats was going to be on national TV on Sunday night pushing his inflation book, but my lack of awareness certainly doesn’t mean Bernanke appearing on 60 Minutes was going to cease to exist.
Today, the US Dollar Index is well bid. That could change with one fell swoop of Big Government Intervention. Remember, as Ludwig von Mises said, it’s always easier for conflicted and compromised politicians to print money than impose taxes on their political careers.
Immediate term downside support is down at 1201. If that holds this week, that’s bullish in the immediate-term.
Keith R. McCullough
Chief Executive Officer
Early data indicates 60% growth for December
The following table details table revenues and market share for the first 5 days of December. Although very preliminary, based on the first 5 days of December, we project full month at HK$17.5 billion, up approximately 60% over December 2009. As always, our estimate takes into account slot revenue and the number of weekend days and weekdays. December 2009 is not exactly an easy comp as revenues in that month grew 48%.
We wouldn’t put much stock in the market share numbers since hold played a large role in the shifts and the data only represents 5 days.
Below is a real-time response from a retired Wall Street executive to America’s decision to maintain a bloated budget deficit. There are more reasons than just inflation that are driving up long term US sovereign yields.
To: Keith McCullough
Subject: Back to the Future
Good morning –
God, Keith, they make me sick. They, being the politicians.
The People spoke…..”Reduce the size of government. No tax increases to fuel more wasteful spending.”
As a response, the current Senate minority, supposedly on principle, said no to extending unemployment benefits unless there were offsets in the disgustingly bloated budget.
But, leave it to these monkeys. We now read this morning that, in order to secure a “deal” on extending the current tax regime, there will be an extension of unemployment benefits. Of course, sans offsets.
More of the same, the same, the same. It does not stop.
Yet, merrily we sing along as we get closer and closer to the precipice.
God save my grandchildren.
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