Predictions Or Simply History Repeating Once Again

At the risk of sounding like Goldilocks crying wolf repeatedly, I thought it might be more bold of me to simply say when the wolf is coming so everyone can be on guard.  No further shout-outs are necessary.  Oh, if you're not aware of what is so disconcerting to me, then note it is the perilous economic position of this country and the world at present.  My fear is the wolf that appeared during the Great Recession will surely morph into something even more unsettling before this situation finally corrects for good. 

So, let me set forth my timeline for calamity in this country and let the masses draw their own conclusions over the coming years  At least with concrete dates and notable events, one can easily measure my win-loss record. 

Just to be clear, I'm not talking about college basketball bracketology here (although I finished in the top 97th percentile of Yahoo sports this past March Madness!).  I'm talking about the direction of our country, the world and how things might be coming at us that throw "normalcy" out the window like a feather on the dash of my buddy's convertible Porsche 911.  Keep in mind that we are creatures of habit so things not being normal might seem...well, a bit chaotic. 

As you might guess, there are many famous quotes about "predictions" especially how inaccurate they mostly are. Oh, and how those that do predict should hide in shame as they try to explain why their predictions fell short of their futuristic expectations. Hey, at least I didn't have to explain why Louisville mens team didn't win the championship! 

As one of the foundation builders of chaos theory once remarked: "It is far better to foresee even without certainty than not to foresee at all." So with that, I'll foresee here so I can blog down the road on my own wall of shame like so many before me.  I do believe everyone should be thinking of the future and being prepared differently from what we're accustom to.  It might make sense especially when the future has an eerie historical step-child like The Great Depression!

Many Wall street stockbrokers are aware we're in what is deemed a Secular Bear stock market which is just past 13 years in duration since the dot-com bust in 2000.  They also tend to know that historically these markets end badly.  We've had three Secular Bear markets since 1925.  The first being 1929 to 1942 and the second 1966 to 1982.  The first being approx. 13 years in duration, the second approx. 16 years in duration.

We are now reaching the topping phase for what I believe is the third down wave in many aspects of what is just starting to feel good.  The third down wave is sure to be the most painful and it will effect stocks, hard assets like real estate, commodities and peoples lives like nothing before we've ever experienced.  Without further ado:

1. Economic indicators turn bearishly negative by the end of summer 2014 (August 2014).
2. An official depression is declared beginning the fall of 2015 (October 2015).
3. The depression is officially declared over by the end of 2019 (December 2019).
4. A true leader of this country will take office and restore the dignity this once mighty nation has with the American people (January 2020).

Keep in mind that economists conveniently take a look back in time to "officially" declare the start and stop of economic periods such as these.  So, when the depression finally ends it won't be until much later in the year 2020 that everyone is informed.  And, it won't be until much later after that where the majority of us really start to feel better about our personal financial situations once again.  Mostly because we will be so thankful for what we have as little as what is left.  The end of this current Secular Bear market will be the longest on record of 19 years.

Next time we have a bull market in this country, I want everyone to simply accept the economic pain dictated by the following bear market as a normal consequence.  Don't let government do things to try to lessen the counter balancing payback.  I'll take my pain in small dozes rather than huge financial amputations like the one we'll be getting soon hereafter!

Housing Bubble In The Making - Take 2!

So much is being written about how housing is rebounding and real estate markets are appreciating once again across the nation that it warrants another serious look with a longer-term time horizon in mind.  Seems nearly everyone is believing we hit bottom and it's time to buy...that we are on a historical time-proven path of another real estate appreciation boom that could last for years to come.  Better climb on board now or you'll miss out is the feeling!

Yikes!  I would have to differ from the masses on this one.  To me, this seems like the perfect time to sell, IF A) you don't have a long-term time horizon to live in your home (like after year 2020), B) you can't secure a 5% or less fixed rate mortgage, and C) you can't make your mortgage payments should your household income be cut in half at some point in the future (or rental income is substantially reduced if holding investment property).  That's about the only scenario I would agree with pundits touting homeownership as a safe and sound investment. 

Even those owning real estate outright with no mortgage debt will face some serious future headwinds that will make such ownership very suspect in light of the U.S. economy of the future.  Let me explain.  First off, it's hard to NOT follow the crowd and to go against the grain.  But, that is generally the precise time to capitalize on others poor timing or herd mentality.  We all know it's not location, location, location that makes you money but timing, timing, timing that really counts these days.

So why is this the time to sell if points A through C are not in play for you?  Well, first off, let's look at what is driving this housing frenzy:

1. The U.S. Federal Reserve has a mandate to keep interest rates low and to buy mortgage backed-securities and long-term treasuries at unprecedented levels for the foreseeable future to stimulate the economy.  MY TAKE ("MT"): This can't last much longer especially at the clip of $85 billion per month.  Stealing a line from many others: "The Fed is leaving the punchbowl out and they want people to get sloppy drunk before pulling it back in."  When has being sloppy drunk ever been good for anyone!
2. 98% of home mortgages are purchased/supported/backed by Federal agencies like Freddie Mac, Fannie Mae, FHA, USDA, VA and others.  MT: Huge government intervention that supports low down payment loans, inflated prices to cover buyer closing costs and the re-sale of most mortgage debt by the nation's financial institutions (note: they sell the debt to the government to recognize quick shareholder profits rather than hold the low-rate paper knowing they need to protect their asset base from rising rates in the future).  This real estate market is way too dependent on future government support when in fact our government by many standards is financially insolvent therefore so are the enterprises and branches of government that rely upon it to support housing.
3. The Obama Administration is once again pushing for financial institutions to underwrite mortgage loans to low-income, weaker credit borrowers in an effort to further stimulate the housing market and expand homeownership for most.  MT: Been there done that!  We've seen the sub-prime mortgage debacle and it's not pretty.  Why do that again and hurt the very same folks that are believed to be help by this.
4. Foreclosures have been heavily restricted by new regulations and government pressure on "too big to fail" financial institutions to work with troubled homeowners in lieu of foreclosure.  MT: This keeps "available" housing inventory off the market and otherwise inflates values of such properties generally associated with higher deferred maintenance costs.  Remember, rising tides raise all boats!  It also gives rise to humans "acting in a manner" typically detrimental to long-term housing security.  Gee, if we get in this predicament once again - why would the government (now the owner of most mortgage debt) foreclose on me when they pressured the banks not to so this last time! 
5. Cash buyers represent 32% of home buying for the 3rd year in a row according to the National Association of Realtors.  As investors lose ground to taxes and inflation on their money sitting in CDs, money market and other low interest bearing investments they take on much more downside risk for not much more return by jumping ship to housing.  MT: That's a lot of eggs in one basket!  Owning real estate outright in 2006 was not good as we all know now.  It's not the banks or government taking the financial hit should this be another bubble it will be dollar for dollar the investors loss...OUCH!
6. Many buyers are taking money out of 401K's, IRAs and other retirement plans or otherwise using tax-deferred dollars with self-directed options to acquire real estate as investment properties.  MT: Less investment diversification is the result with huge expense implications down the road.  Often ill timed investment withdrawals hurt the most especially if paying taxes and penalties on such decisions.  Don't chase returns, anticipate opportunities!
7. Large hedge funds like the Blackstone Group and other institutional fast-money players have jumped into housing creating "artificial" demand.  MT:  There will be added housing inventory later as the opportunity to turn a quick profit peaks for them. Isn't their timing always the best...watch when they decide to sell their portfolio likely in bulk to some unsuspecting foreign institutional buyer and most never take heed of the moment.  Guess what happens when this foreign buyer decides to unwind its portfolio at the worse possible time!
8. Inventories are incredibly low in most markets thereby fueling impulse or overzealous emotional behavior that results in over asking price offers and buyer approved purchase price/appraisal value differential guarantees.  MT:  This has to be the definition for every asset bubble - just wait for the euphoria to wear off and values to deflate.
9. Contractors, real estate professionals, investors and many others that are unemployed or under-employed (or with less income earning options) have individually or systematically teamed up to buy fixer-uppers, repair them and then flip them for profit.  MT: Creating huge housing demand not otherwise present as well as inflated property values on resale to account for the "profit" needed by the flippers is detrimental to housing stability.  Assets need to appreciate from a "healthy" supply of homes not from an "unhealthy" demand by buyers.
10. First-time home buyers and trade-up buyers are conspicuously absent from this market.  MT: The market is not being driven by two of the bigger influences that drive housing stability.  In fact, there are more downsizing and rightsizing buyers than the aforementioned in light of this "suspicious" economy.  And of course, many more of the aging Baby Boomer generation will be considering the opportunity this market creates for them to do the same.

By all measures, what is happening is not "normal", let alone sustainable, and in many ways can be characterized once again as "irrational."  The hope of the Federal Reserve and the government is to "trick" us into thinking things are getting better and that you'll miss out if you don't get on board.  Fundamentally, things are slightly improving on the surface but undermining all of this is something deeper and less obvious to the general observer (most everyone!). So, buyer beware.

Heck, the stock market is also in bubble-mania once again as it feeds off the easy monetary stimulus of the Fed having already ascended quite substantially since the bottom in March 2009.  Coincidentally, the stock market is just now luring money back in from the small investors after hitting record highs.  An eerie parallel to how big investors lured small investors into the stock market just before the 3rd down wave during the Great Depression era.  We've had two down stock markets since 2000 with a 3rd yet to be realized? 

Besides the many contributing factors noted previously for driving housing back to inflated levels, let's look at why things might be different from past housing cycles in this country.  After all, how could this be in bubble territory already when we're just now seeing price appreciation after five long years of decline?  Well, generally because the underlying trend doesn't always surface until more time passes. Just ask Michael Dell or even Bill Gates about computer hardware and software trends. Here's a look at other possible reasons for housing to be on a downward descent not otherwise being propagated by real estate pundits and industry associations:

1. The U.S. is crippled with an alarming debt bill currently at $148,000 per taxpayer.  We are bankrupt! Way more government belt tightening and higher taxation will be needed meaning much slower growth and less employment in the future.  Fewer jobs = fewer potential buyers.
2. There is no better path to increased tax revenues then to eliminate or significantly reduce beneficial tax provisions...especially surrounding housing.  We've already seen a recent change on capital gains tax rates having been increased to 20% from 15% (which impacts investment properties).  The capital gain personal residence sale tax break of $250K for singles and $500K for married couples will surely be eliminated.  And, despite the greatest lobbying power in Washington by the National Association of Realtors, the mortgage interest deduction will also eventually fall victim to the principal and interest payment demands of U.S. debt.
3. Interest rates will rise and with increasing rates comes decrease affordability unless values start to decline.  Creditors demand higher returns on "troubled debtors" and that will be the case for the U.S.  Cheap money will go away and house prices will need to deflate to compensate.  A doubling of interest rates from 3.5% to 7% requires a 32% reduction in value to maintain the same affordability ratio.
4. The GDP of this country is 70% consumption based.  Meaning we consume way more than we invest.  The GDP formula returns the same result whether we spend $40 on gas to go shopping, buy a new shirt to go out to eat or purchase a power tool to make a living.  Unfortunately though, only the tool would be considered an investment that can lead to wealth creation.  Too much consumption leads to wealth destruction and boy have we been a downward spiral here!
5. The Baby Boom generation is aging, downsizing and rightsizing their housing expenses for decreased employment income or retirement. Immigration and the current birth rate will not offset the downward influence this group's exodus will have on housing let alone the financial wherewithal to keep it elevated. 
6. China has been exporting their deflation through a constant exchange rate (although recently allowed to "float") thereby keeping a tight control on living standards across their population.  Inflation will eventually take hold there through increased domestic demand thereby driving prices higher to importing countries like us. Basics like food and clothing will cost so much more leaving Americans with much less for living expenses.
7. The U.S. standard of living is declining faster than you might think. With little manufacturing base, massive offshore job bias by our own corporations, huge entitlement programs and many other factors are negatively impacting wealth for the middle-class (forget wealth generation except for the super rich and powerful!). Why is the fed trying to create inflation so badly with their current monetary policies? To combat deflation. Both negatively impact true wealth protection!
8. Employment in the U.S. is service oriented and not manufacturing based.  We are a country of servants...not producers.  Further many of our higher-end paying service and technical jobs are going overseas which follows our domestic manufacturing employment base.  We are becoming a society of Starbucks, Subways, McDonald's and the like.  Hardly a fortitude of high wage earner skilled positions that support housing and can drive prices higher further.
9. The Fed is creating future inflation with its "dollar printing presses" working overtime.  However, it's not likely to benefit housing like it did in the 70's.  I believe it will result in the inflation of most everything else but not housing as real wages will not follow suit.  The most significant factors that create inflation are wages and energy prices.  However, due to a currently high unemployment rate (and potentially even much higher unemployment/under-employment in the future) and low paying service related jobs, we will not see a corresponding increase in real wages.  Higher energy prices alone are not sufficient to drive housing inflation especially in rural and suburban areas as more disposable income is used to pay for job commuting and other necessities.  Further, higher interest rates will be due to systemic/default risk which will be different than higher rates due to inflationary pressures or a combination of both.  Either way, housing affordability in an inflationary environment with deflationary wage pressures will decline as so would prices to keep the market from a complete collapse.

I'm reminded of something the president of a prominent local real estate firm stated recently in some local newspapers, blogs and the Sacramento Business Journal that bears mentioning here.  Not that what he said was so revelating but more indicative of selfishness or ignorance and I believe it to be the former.  The quote: “This (real estate boom) will last for the foreseeable future. Ignore the naysayers touting another bubble. Low interest rates and monthly payments will keep current buyers, investors and refinancers in the homes they’ve purchased for a long time.”  The last sentence is true.  However, that is not much of a supporting argument for this not to be a bubble once again.  Remember, it only takes those that are NOT locked in to the payment security he boasts about that can tank the market when there are fewer or no buyers willing to accept the interest rates and monthly payment terms of the future!

Let's also keep in mind that history does have a tendency of repeating itself especially when so many generations tend to separate us from the past and we try to dismiss basic human behavior as being different this time.  The great American Industrial Revolution started in 1790 and later led to the Great Depression beginning in 1929 and not ending until the start of World War II.  There is an eerie parallel to the great Internet Revolution that began in the early 1990's or if we go back to the great Computer Revolution that began in the early 1980's then we seem to be in lock-step with our ancestors nearly 200 years ago.  We all know how that ended.  Nearly all asset classes found another bottom one more time and those being roped in at this point paid the price the most!