August 2006


The consumer spending rose by 0.8% in July and personal savings are -0.9%, which means the average consumer is spending 0.9% more than his salary is.

As noted here, the 16-months period of negative savings is the longest since the Great Depression.

Do you like the news that certain economic indicator is the worst since the Great Depression? So do I, my friends, so do I.

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I want to add a little bit more to the earnings analysis made by Barry @ Big Picture’s. He’s saying that though earnings of U.S. companies are growing at double digits, they are more concentrated in financials and energy.Bernanke

But let dig a little bit more on why earnings are so good. The problem is, the big concern of any corporation are the taxes. From any liability the corporation has to pay the tax is just waisted money. So the corporation has to balance between having to much earnings and waist money on taxes and have less earnings and see the share price to drop.

Now, the good way to decrease earnings is capital spending, i.e. investment into business growth. So, how strange it sounds, the taxes are actually promoting the growth.

As you know, the principal Bush agenda was to cut prices on riches to let the ruling class to monetize its political victory over American people on 2000 elections. And, as we found that taxes are promoting growth, the Bush’ low taxes are hurting the growth, making corporation to profitize the earnings, i.e. pay dividends and perform share buybacks instead of investing into the future.

You need more proof? Sure, there no need to go far. This article from Bloomberg is titled “Business Spending May Languish, Raising Risk of U.S. Recession”. Should I enlist Bloomberg into anti-Bush campaign?

The latest data on housing starts shows that there is an (well expected and even overdue) slump in housing starts. While the total number of new housing permits fell by 6.5%, the West is hit hard – the decrease of 12.4%.

12% less of new homes that are going to be build means that 12% of construction workers, and good % of associated folks like real estate agents, mortgage brokers and related industries factory workers will be laid off.

According to calculated risk there are 3.3 million residential construction workers. My careful and educated guess will be that 20% will be let go in the next 3 months, or about 25k people per week. Last new claims figure was at 315k lost jobs per week. Expect the number to bounce to 340k by mid-September. Just mark my words and see if I’m right.

And this is the vicious circle, as laid-off people will have to sell their houses and depress prices, which, in its turn, will decrease housing starts even further. Our checkpoint is September 1st, when the unemployment rate and construction spending will be released.

Thanks Greenspan and Republicans for our tax cuts!

This surprisingly bearish post is suggesting that we are in the credit bubble rather than housing bubble, which is just a side-effect.

Traditionally, Mortgages have been low risk lending, as the loan is securitized by the underlying property. When banks were lending less than the value of the property (LTV), to people with good credit, who also were invested in the property (substantial down payments) you had the makings of a very good business: low risk, moderate, predictable returns, minimal defaults.

That model seems to have been forgotten. THIS IS REMINSCENT OF THE S&L CRISIS — where lenders did not have any repercussions for their bad loans!

By the release of the August housing numbers, it should become clear that the housing market is beginning a significant decline. When this realization hits home, investors will finally have to confront the fact that they are gambling on people who took out no-money-down, interest-only, adjustable-rate mortgages at the top of the market and the financial institutions that made those loans. The stock market should then begin a 25%-30% decline. If the market ignores the warning signs until fall, the decline could occur in a single week

It doesn’t take far to go for the example of mortgage originators troubles:

H&R Block Inc., the largest U.S. tax preparer, on Thursday said it expects to take a $61.3 million charge, or 19 cents per share, for losses related to rising delinquencies by subprime mortgage customers.

The losses total $102.1 million before taxes, and relate to H&R Block’s Option One Mortgage Corp. subprime lending unit

The bubble trouble, indeed.

July new home sales posted a spectacular decline of 4.3% and inventories are at 11-year record level. But what about prices? So far the median prices are holding at national level in nominal (non-inflation adjusted) values.

But once hot markets are not feeling as good as average. In Massachusetts median home prices declined by huge 3.5% in just one month. At the same time condominiums got cheaper by a stunning 4.1%.

Despite the current housing slowdown is about 9-months old, the actual decline in nominal prices is something new. It will take another month for weak spots to drag the national price average down, but once it happens four weeks from now, the markets will have to respond with taking a possible recession into account. I wish the citizens will digest the new reality of falling real estate into account just before November elections.

Thanks Greenspan.

The data released today are horrible as never before.

First, the association of realtors is posting a huge 4.1% seasonally adjusted decline in existing home sales for July. Never, never since 9/11 we had such a huge decline in just a month. And the North-east posted its first y/y decline of -2.1% in, as far as I can tell, 15 years.

The inventory of unsold homes climbed to 7.3 months, which is the record since the spring 1993. If something, whatever it is, is at 13-years record you must pay very close attention.
Second, the seasonally adjusted Mortgage Application index for new purchases fell by 1% in just 1 week and by 7% in 6 weeks.

How to short real estate, that’s the question 🙂

Recently Barry Ritholtz almost changed his opinion about bond traders being adult supervisors over the markets to the one that bonds do not predict inflation expectations well enough. He’s referencing the article of Peter Schiff where it’s claimed that bond traders:

  • they no longer focus very intently on CPI reports
  • they “admit” current signs of rising inflation are backward looking
  • Yields are below Fed funds rate, despite inflation running at its fastest pace since the 1980’s

Let look closer into details. What is inflation, anyway? Getting away from scientific definition I will better say that inflation is the willingness and ability of consumers to purchase things rather sooner than later on perception that things are getting more expensive.

Looking at the negative savings rate I rather rephrase this into inflation is a consumer perception that it is more practical to borrow and purchase things now rather then save and purchase things later.

And here we have the whole spectrum of people consciousness from, on one end, the habit to borrow as much as possible and declare bankruptcy when the credit is denied to, on the other hand, a cold blood decision to borrow below expected inflation rate and buy mostly items with very low deprecation rate, like real estate and furniture. But in essence, it’s all based on borrowed money, from Uncle Sam to uncle Joe. The good economist will easily show than the abrupt reduction in borrowing rate will immediately kill any consumer inflation.

So the current inflation is based on:

  • Reckless lending practices. That allows flocks of people who never owned the house before and have no idea how to manage finances or even read fine print to borrow horrible amount of money and purchase a house no matter what the price is as long as their negative-amortisation ARM is paying for it
  • Real estate and commodity bubbles. The wealth effect is filling the confidence to borrow and spend
  • Very low unemployment. People just have money to spend

Let see how those sources of inflation will be gone soon.

  • Lending practices are based solely on the bond markets accepting the Mortgage-backed securities (MBS) with quite low interest. Any increase in delinquency rate combined with Bank of Japan tightening will deteriorate MBS market. We are probably another 6 months from that
  • Real estate bubble already popped. It just takes time until consumers will realise that home prices are appreciating well below inflation and mortgage rates
  • Commodity bubble is fueled by the monetary inflation, i.e. the dollar losing its confidence on the world markets. That’s a function of Bush’ reckless borrow-and-spend budget. This bubble is not going anywhere, but I don’t see the producers to be able to pass the cost of materials along the pipeline. We rather see declining profits, i.e. job losses and less consumer spending, not more
  • Very low unemployment. Indeed, with 504,000 of real estate brokers in California alone the employment is quite low. Just in few months we will see a lot of new jobless people coming from the ranks of former real estate agents, mortgage brokers, construction workers, plumbers and painters, factory workers making anything related to construction, piping and wiring, anything that is put in or outside new homes

So the current inflation is based solely on inflation expectations but has no fundamentals. I expect February to be a turnaround, when Holiday shopping will not materialize, the unemployment will jump, real estate slump and any price pressure evaporate. Will it be a recession? Maybe not yet, but definitely not inflation.

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