Real Estate

Latest – Banks borrow 10.3 bln usd from discount window, largest since Sept. 2001. We all thought that $100 bln TAF would cover everything. I guess now they need $110. At the same time the outstanding banking credit just declined by $31 bln and commercial paper declined by another $5 bln. When banks are increasing lending and then run to discount window – this is bad. When banks contract lending and still run to discount window – this is panic. I hope that you are all aware that non-borrowed reserves of depository institutions stand at -$61 bln? Good.

The wise men from used to say:

Bull markets are climbing the wall of worry, bear markets slide the slope of hope

In the last couple of days I hear a lot of totally misplaced optimism from radio and TV. “Jobs are lagging indicator so bad jobs numbers mean we bottomed”. What this guy had for logic? “We are looking to buy early cycle leaders, like transports and basic materials because we are early in the next cycle”. Materials are late cycle leaders, not early. First you have to wait until late cycle leaders crash before you conclude that the cycle is restarting.

Look at the KRE – regional banking sector. This chart will bottom well before the economic cycle bottoms. Those banks are lending to main street business. Until you see the Street Corner Bank doing well it means matters will continue to get worse.

And those who claim that credit crunch is reaching the bottom are not bringing any arguments. I do. Wells Fargo is still lending mortgages with 0% down. Right now. Next week they will require to bring 3% down. In early 1990s when the last housing bubble popped nobody was lending unless you bring some serious downpayment. 5%, 10%, 20% – depending on conditions, but never 3%. Lets wait until we get there before we call the bottom.

Earlier in the morning I was listening to the parts of Bernanke Bear collapse testimony and it gave me some hope that Congressmen’s brains are located in the upper parts of the body. Specifically, they worried about:

  • Moral hazards of the bailout
  • The fact that unregulated entities are allowed to discount window, i.e. they must be regulated

But later I’ve learned something that made me think that a typical Congressman, at least in his “bipartisan” modus vivendi, has his brain located in bottom parts. They came to a deal that allows homebuilders to get a tax break.

As the housing problem worsens and builders continue to build homes just to get rid of empty land the better solution would be to bankrupt as many builders as possible. We don’t need no stinky new homes

Interesting, but it looks like the change in real estate loans is a pretty reliable indicator of recessions:

real estate loans

Well, we know that we are in recession, but there is something useful here – each bottom on this chart is leading indicator of the stock market bottom. That means whenever you have an urgent desire to jump back in for long-term position (as opposed to just trading), check this chart first. You must see a clear rebound before you even think to buy into stocks (sure, early leading sectors are the exception)

From here:

NEW YORK (AP) — Americans’ percentage of equity in their homes fell below 50 percent for the first time on record since 1945, the Federal Reserve said Thursday.

Homeowners’ portion of equity slipped to downwardly revised 49.6 percent in the second quarter of 2007, the central bank reported in its quarterly U.S. Flow of Funds Accounts, and declined further to 47.9 percent in the fourth quarter — the third straight quarter it was under 50 percent.

That marks the first time homeowners’ debt on their houses exceeds their equity since the Fed started tracking the data in 1945.

The total value of equity also fell for the third straight quarter to $9.65 trillion from a downwardly revised $9.93 trillion in the third quarter.

Leverage is biting. And forced deleveraging works as described here

Today’s inflation surprised to the upside. I see almost no bright spots, inflation rose across the board, and only one component, recreation, has a trailing 3-month annual-adjusted rate below 2% – recreation price is growing at only 1.6% annual rate. On the other side transportation cost is growing at 22% annual rate.

Do we need a better illustration that people spend money on what they need and cut on things that they want but don’t need? Recreation business has absolutely no pricing power.

Whenever we speak about inflation we need to recall what great economist David Rosenberg said:

Inflation is first and foremost a lagging indicator

It means that today inflation is echo of last year economy. Today’s state of the economy has no effect on inflation whatsoever.
Inflation is impossible without solid growth of real income and/or borrowing. Nobody has any damn interest what the producer cost is, the only thing that matters for inflation is do people have money or not.

While income growth was good but not great the borrowing was still exceptional. Look at personal consumption expenditures: growth was choking in October and December. Look at the compensation cost data: the rate of growth is getting slightly slower. Look at MEW: people continued to tap the home equity at alarming rate in Q4’07.

Based on above my prediction about inflation is following. Take this graph of MEW from CR post:


Once this graph falls into normal historic range of 2%-3%, few months later all the inflation will be gone. Completely.

Another angle to look at the inflation is like that: inflation means money get cheaper. Look at today Russ Winter blog: the main topic of this post is that price of money is going up. Mortgage rate is up, the cost to insure mortgage bonds is up, cost to finance the car is up – i.e. there will be less money in the economy once all borrowers will have to scale down on how much they can afford to borrow.

I give inflation another year, and I think I’m very generous

Of course, if our government manages to completely debase the currency the inflation will not only increase but it will turn into hyperinflation. When I see that happening I will change my mind

The rates of foreclosures in San Diego:

San Diego foreclosures

Today we’ve got the final (third) confirmation of bear market – DJ closed below intraday low made back in August. No signs of an intermediate bottom so far, which I expect 2-4 weeks from now.

We are at the point when many sectors already slided into bear, so I want to slice and dice a bit. The list will be sorted in chronological order. I take P/E from here, it doesn’t exactly matches the index I’m using for chart.

Sector Topped % from top P/E
Homebuilders $HGX July 05 58 4.5
REITs ICF Feb 07 40 34
Financials XLF June 07 30 79 for banks, 50 for services
Transports IYT July 07 23 15
Telecoms IYZ July 07 23 24
Consumer discretionary XLY July 07 25 5 to 15, no single number
Semiconductors $SOX July 07 36 10
Industrials XLI Oct 07 12 mostly low teens

As you can see the bear market is underway for a while already and some industries quite possibly already did the bulk of the decline. Try to tell this to permabull Kudlow.

What about other sectors?

  • Basic materials are in triangle and must break down soon (could be a good short)
  • Energy has no sign of topping so far, so we must assume that the trend is still up, but I suspect that upside is limited
  • Most of the various technology sectors are in the bear already
  • Biotechs are not cyclical at all, I see them flat for the last 2 years, could be a way to park money when you have no better ideas
  • Pharmaceuticals look slightly better then biotechs
  • Consumer staples are still in uptrend, could be used to hedge when you have too many shorts
  • Utilities are the only sector that is not trading according to textbooks. Classic sector rotation theory says that utilities must be early decliners together with financials, but this time they are not. Utilities hate inflation and in this cycle we had relatively low inflation and Feds already started to cut. That could be something related to our Kondratieff Winter phase. At any rate, I would not be long utilities now, just in case they start trading by the books

Any corrections are welcome and good luck with our investments!

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