SORRY EUROPE, BUT WE HAVE A BIGGER PROBLEM HERE AT HOME
The negative news in the housing market is beginning to pile up even faster than I suspected. After calling the housing bubble in 2006, followed by government induced stability in 2009 I said the housing market would begin its next leg down once the government stepped aside in April and removed the home buyers tax credit. Since then, fundamentals in the housing market have deteriorated rapidly.
In addition to the very weak mortgage application data in recent weeks, we are seeing some very disturbing data across the board in real estate. Lumber prices are absolutely tanking – now down an astounding 40% from their peak just 6 weeks ago:
Case Shiller data is turning negative again, housing starts are declining and the latest NAHB data was substantially weaker than expected. Bondsquawk elaborates on the weakness in the NAHB data:
“While all attention was made on the gain in the Euro and equity markets yesterday, the National Association of Home Builders released its monthly market index. The NAHB Index data release disappointed by posting a reading of 17 versus market surveys of 21. From the prior month, the index declined 5 points or 22.7 percent from a reading of 22. As points of reference, the index reached a high of 72 in mid 2005 during the housing boom and sunk to a low of 8 in January 2009.
David Rosenberg, economist of Gluskin Sheff looked behind the numbers to paint a more gloomy picture.”
There is no denying the renewed decline in the U.S. residential market, and this transcends the end of the tax credits — the sector is fundamentally weak. Moreover, demand has not reacted to the latest downdraft in mortgage rates and homebuying intentions are, in a word, moribund. The National Association of Home Builders (NAHB) housing market index sagged from 22 in May to 17 in June — a three-month low. Buyer traffic receded from 14 to 16 but the real story was the four point collapse in the “future sales outlook,” to 23 from 27 — it hasn’t been this low since the depths of the recession back in March 2009.
We ran some regressions and found that the “future” component does indeed have the best “fit” with both housing starts and new home sales — the latter is set for a renewed 10% in coming months, to a 600k annual unit rate, and the latter by 30% to the 350k level, which would very close to the all-time low of 338k hit in February 2010. Ouch!
Adding insult to injury are recent comments out of Toll Brothers who is seeing very weak trends in their markets just a few months after calling for a robust recovery in housing (not surprisingly, Robert Toll has not been an active buyer of his own shares despite dumping massive quantities on the market at just about every short-term peak). Joel H. Rassman, chief financial officer of Toll elaborates:
“In the three weeks following our earnings conference call on May 26, 2010, our per-community deposits have been running about 20% behind the comparable period in last year’s third quarter and our per-community traffic has been running about 3% behind. Thus, for the first six weeks of our FY 2010 third quarter beginning May 1, 2010, we are slightly ahead of last year’s third-quarter pace of contracts signed on a per community basis. However, we have 21% fewer communities than one year ago.
“Typically, the strongest selling season for new homes begins at the end of January and ends in late April. Our third fiscal quarter, which encompasses the period from May 1 through July 31, is typically slower. For the 20 years between 1990 and 2009, we signed contracts for approximately 8.23 homes per community on average in our second quarter compared to 6.21 homes per community on average in our third quarter. We signed 4.32 contracts per community in FY 2010′s second quarter. Although better than FY 2009′s second quarter, this was approximately half our historical average. Because we typically sign fewer contracts per community in our third fiscal quarter than in our second fiscal quarter, we currently anticipate that our total net signed contracts in FY 2010′s third quarter will be less than those signed in our FY 2010 second quarter.
“Although demand in recent weeks has been quite choppy, in general, we continue to believe that the housing market has emerged from its darkest period of late 2008 through early 2009. Interest rates remain near historic lows, affordability is near historic highs and there are positive signs of growth in the economy. We believe pent-up demand exists. At the moment, consumers view the economic glass as half empty: volatile financial markets, global deficit concerns and the oil spill in the Gulf are all contributing to this gloom. We believe that once the employment picture begins to brighten and the economy stabilizes, consumer confidence will improve and the housing market should begin a steadier recovery.”
Well, with government austerity on the table, Census lay-offs on the way, the end of government stimulus and a still very cautious private sector (thank you European debt crisis!) it’s unlikely that employment is jumping to the necessary 250K+ level any time soon. Therefore, what Toll is essentially telling us is that they’ve just experienced their strongest portion of the year (which wasn’t that great) and things are starting to deteriorate rapidly. Not good signs.
This looks like classic deflation mentality to me. The similarities with Japan are becoming more and more frightening by the day. Remember, real estate was the epicenter of the entire credit crisis yet the market appears so fixated on Europe that it’s missing this enormously important domestic story. The deterioration in consumer balance sheets via real estate set-off the longest recession in the last 75 years. Although Ben & Co. believe this is a bank driven crisis (something which I believe he has now been proven entirely wrong about) this was actually a consumer driven balance sheet recession. The deterioration of the consumer’s largest asset is a very bad sign of things to come.
This is a central bank’s worst nightmare. You can’t solve a problem that is largely driven by psyche by applying traditional monetary policy. And don’t be fooled – deflation is as much a psychological event as it is a monetary event. To anyone who has done their homework in housing it’s clear that home prices are still bloated on a national level (as much as 30% according to historical levels), supply remains high, and that means there is no great rush to buy. This is the classic deflationary trap – “why buy now if prices might drop?” Anyone who has lived in Japan in the last 20 years is well aware of this psychological phenomenon. And just like Japan, every time fiscal stimulus stopped the economy retrenched as fiscal austerity exposed a fundamentally weak and psychologically fragile private sector. Now that the government incentive is out of the way and we’ve stopped what was essentially a price fixing scheme at the government level, the market is showing its true colors and they are not pretty.
Move over Europe. We have bigger problems to deal with here at home over the next 18 months….
TPC,
I know I’ve thanked you before, but again, thanks. The ease and readability with which you put these pieces together is so so helpful to an investor like me. Thanks and please don’t ever stop writing!
Dan in Ohio
well said
The market appears to be taking all of this in stride dont you think? I know you don’t believe in the markets long-term discounting abilities, but we’re not far from the recent highs and investors seem to be ignoring what now looks like some very real risks in the next 12 months. Is the market waiting for them all to materialize before acting? Any thoughts?
Yep. This is either a “Teflon” market where seemingly harsh news/facts are taken in stride or so brainwashed drunk in their invincibility that we’re off near the blow off peak.
Duh!.. whoever thought that the housing mkt will not have another dip.. but the trillion dollar question is what are u trading ? The Dow or the housing market.. trade the market not the funky correlation about which no one has the faintest idea.. the market is now in a confirmed uptrend albiet fragile…but chances are 1500 S&P sometime this year.. 100 eps 1yr fwd 15 times earning…stay invested
Keep up the good work. Another great balanced piece of analysis – that’s why we read this blog. Bloody well done!
The rise in U.S. home prices over the last few decades was so massive and persistent that there is no way this can be corrected in a mere three or four years.
Heads up Canada and Australia!
Hi John,
A friend and I have been discussing the housing bubble in Ontario, Canada for about a year now. A neighbour down the street has been trying to sell their house for about a year now with no luck. Sales are down everywhere even at the local Walmart. I see signs posted on real estate signs with “reduced” or “new price”. People have their heads stuck in the sand, they do not believe that it will happen to them, I think.
A girlfriend of mine lives in the interior of British Colombia. She has been trying to sell her house for two months. She reduced the price two weeks ago by 40,000 and still no offers.
I think the bubble is breaking but it may take until the end of the summer for people to believe it.
This is what’s so puzzling to me about the bulls case. I’m no economist but most of what I’ve read states that no recovery has ever been sustained without a rebound in housing, which clearly is not happening. No rebound in housing means the consumer is for the most part remaining retrenched. No consumer, then where is the 2/3 of GDP he represents. Yes, we seem to be seeing a rebound in industrial and manufacturing activity, but is that enough to base a bull market on?
Yes, very nice article. Thanks. Now, shall we talk about a solution? I’ve come to the conclusion from general moral principles alone that the US Treasury should just create some legal tender fiat and send it to every adult in the US. This would:
1. Bailout the underwater homeowners.
2. Compensate savers for years of suppressed interest rates.
3. Fix the banks in nominal terms.
4. Fix state tax revenues.
Oh, yes. I remember. I did suggest this but TPC said it might cause hyperinflation. So then let’s raise reserve requirements but someone else said that would cause severe deflation. Don’t you see? The combination of replacing credit money with actual legal tender plus raising reserve ratios might be a stable solution?
Oh, and many would scream “You’re printing money!” as if that could not possibly be a real solution to our problems. Yet, I don’t see why not. A gold bug could never see this solution, I’d bet.
I am not a “gold bug” but I think you make a “keynesian mistake”: a flow of wealth is not equal to a flow of “paper currency”. To create wealth you need work,know-how and capital. To create paper currency all you need is a printer press.
“I am not a “gold bug” but I think you make a “keynesian mistake”: a flow of wealth is not equal to a flow of “paper currency”. ” domingo
No, I am not talking about creating wealth; I’m talking about preventing the DESTRUCTION of wealth in a deflationary spiral.
To actually generate wealth will require monetary reform, IMO, unless we are willing to wait out a depression which I think would be unjust, unnecessary and very dangerous.
Two negs? Interesting. Neg away but if there is any other solution, I’ll be surprised.
Thanks TPC. Great macro view! I’m retired and have children, and grandchildren, living with me. I’m also still close to my ex-co-workers. I feel very connected to multiple generations. In addition to all you’ve said, most people are either paying off debt or saving everything they can. I don’t see it as a short term trend. These generations have much regret over past behavior. I think we’re in for a long run of self imposed austerity.
Europe was just the story of the day and tried to use that to convince the bulls that things weren’t as great as they seemed. I’ve been bearish through this whole rally because is was all manipulated thanks to Uncle Sam. Now that he’s just about exhausted, we can continue the decline. But, like Japan, we are still sick because we refuse to face our problems and deal with them like adults. Until we do, we will continue to be like Japan and eventually will see our markets trade a great deal lower. Some people forget that the Nikkei traded near 30,000 20yrs ago – just over 10k today. That amounts to 4800ish on the Dow.
“In addition to all you’ve said, most people are either paying off debt or saving everything they can. I don’t see it as a short term trend. These generations have much regret over past behavior. ” Tom in Michigan
Don’t be so hard on them. What choices did they have? The choices they had were:
1) Parked their money in a savings account and watch it get eaten away by negative real interest rates.
OR
2) Speculate in the stock market or housing.
As for consumption itself, it’s not bad.
The villain is the government backed banking cartel not the population. We need a bailout of the population with debt-free legal tender followed by genuine reform.
@Angry MBA,
I might look into alternative money exchanges. I suspect the sticking point is taxes. If one could only avoid dealing in FRNs altogether! But I doubt that is possible. After all, if victims could escape how could they be victimized? Or is this just an IQ test that I have heretofore failed?
But you are right. If I actually started an exchange I would probably learn the pitfalls. Well, I don’t have the capital to risk but I could read about other attempts. Any recommendations?
“the market is now in a confirmed uptrend albiet fragile…but chances are 1500 S&P sometime this year.. 100 eps 1yr fwd 15 times earning…stay invested”
That’s laughable. First, a prudent P/E multiple is driven by the expected growth rate of earnings (below trend) and the equity risk premium which should incorporate market volatility. My measures suggest a multiple of 13 to 14 is more appropriate.
More importantly, the bottom’s up estimates for 2011 are a joke. My research suggests that $80 is the new peak earnings due to the topping out of operating profit margins (expense/job cuts are a done deal) and stagnating revenues.
So a “fair” value based on current circumstances is likely 1040 to 1120. If we slip back into a recession, I expect the overreaction to the down side to be significant as investors run for cover based on the fear of another 2008.
The market is just chasing whatever momentum is left (Cramer’s C.A.N.D.I.E.S). Looks at the QQQ’s just 4.5% off the April 23rd highs. This won’t end well…
I wonder what the foreclosure situation was like in Japan. I’ve heard from Japanophiles, that it wold be a disgrace to walk away from homes and that they would rather burden their children and grandchildren with multi-generational mortgages then default. This psychology crushes the consumer and frees up investor capital for forex speculation. I think the japanese government has it all wrong. They should restructure like Korea did; investors’ equity has to bite the bullet. I think the only thing the US has in common is changing demographics. US home owners will either default or ignore their house price. Of course the precarious situation is if there is a “housing run”, but I think that is low probability since the government already owns the homes that will default anyways (through the backstop of the banks), so that translates into a run on the USD.
In the U.S., housing bottomed in 1932 or 1933 after a 90% decline in home prices and sales activity. It was only four or fives years from top to bottom; painful but quick. Homeowners that bought in 1928 did not break even until 1952 (national average, but they didn’t have to face decades of declining prices that reduced demand.
In Japan, because of efforts to support prices the decline in housing has been painfully slow. I believe there is only one year since housing peaked in 1992? that prices have been up. That was a fractional % rise.
It’s unfortunate that politicians believe spending money to artificially support prices is better for their pol’s and political life. If it were not for the artificial life support, we could get this economic turmoil behind us and start working on a real recovery.
Sales activity may have declined 90% in the 1930s, but home prices only declined a little over 30% during the Great Depression. The decline was actually mcuh less than today relative to other consumer prices. We have had inflation in consumer prices since 2006, but there was significant consumer price deflation in the 1930s on the order of 20%. Home prices were overvalued in the late 1920s but that was no housing bubble like in 2004-2007.
I would be interested to know what data you use to indicate only a 30% decline in real estate prices from their peak to 1933 low. According to my Feb 1939 Farm Economics it was significantly more than 30%. What I have even discusses how fair pricing was not often established because neighbors refused to bid on foreclosed properties in order to thwart the banks.
It also states “When, after 1933, a certain degree of stabilization in the situation had been established, the renewal in building activity …was launched largely on government funds…. Whether or not such a renewal of building enterprise would have begun withut the aid of government is a subject only for academic speculation.”
Real estate prices did rise from their trough to the end of the depression. As did equities. Perhaps that is the difference in our data.
Unfortunately, full data, like we have today, was not widely available.
> The rise in U.S. home prices over the last few decades was so massive and persistent that there is no way this can be corrected in a mere three or four years.
Heads up Canada and Australia!
I actually wnder about this too. Now in the US we keep hearing that people should’ve know better than too buy houses that were too expensive and they couldn’t afford, blah, balh, blah and how many other people recognized overpriced housing and rented instead and shouldn’t be now penalized. BTW, it was one of the reasons I never considered moviong to California even though I work in IT.
But now we areseeing the same maddness in Australia and Canada and UK and nobody says anything . All we hear about is how wonderful canadian banks are.
The bottom line, hindsight is 20/20.
Australia, Canada, Russia, the middle east are ALL in for a rude awakening. Brazil wont fair great. Australia and Canada in particular are going to get it from all side, housing, banking and resource collapses, it’s going to be messy. The gulf states wont be able to turn their debt on $30 oil and Russia, well they wont stand a chance.
@ TPC:
Good post.
Why are we facing something Japanese-style?
In the 1st of the lost decades, private sector balance sheets were cleaner than white sheets, weren’t they? Savings rate was through the roof? Or is that incorrect? I thought it was public sector “debt” that was the issue in the early `90′s?
I think we are in for something way worse than Japan…
I think the big drop in lumber prices (and copper for that matter) has more to do with China than US housing market. Like Toll said we are entering the weak season for construction. The numbers will rebound again in the fall.
You’re 100% correct, it’s a freight trains rumbling that most choose not to hear. For that reason the recovery team and buy on dip followers are going to push this market sharply higher in the coming weeks. The announcements were significantly bearish this week but the market just wants to shrug them off. I say we at least form a right shoulder at around 1050 before any downside. It’s not entirely unreasonable to see us bump up against the previous yearly highs also.
then prepare for the cliff-dive………….
TPC,
Welcome to the party, I had to wait a long time for you to get to this juncture. And yes I am in the Austrian camp, and I do not believe that there is much that we can do to “solve” this situation except allow the bad investments to go broke. Then we can quit trying to tax and regulate businesses out of existence, and allow them to slowly start to grow us out of the problem. Bailouts and such other tricks just prolong the time we will be in a depression. Of course we are not going to do that because the liberals think that they are smart enough to use bailouts and financials tricks to get us out. Anyone with a good backgroung in mathematics could easily tell you that that will never happen. This financial crisis is what you call in math a problem with too many unknown variables and too few known variables, thus making it unsolvable.
@ Bill W:
Acually (slight smile), we applied mathematicians call this a case when there are too few equations (constraints) and too many variables in order to simultaneously solve the (matrix) equation Ax=b (for x, the variables). When this happens, we call the “system” under-determined. But you have it “wright” in spirit!
But here is where I am very much in agreement. We must do an orderly and procedural “wind-down” of the debt issues. And folks ARE gonna take some losses.
And Big Bank (and Big Gov) are 1 of them.
It is very much like war; you lose the majority of wealth you could not physically hide. And then you start anew – hopefully w/ some controls in place that prevent that disasters that caused this in the first place.
As an Austrian, you probably are going to hate hearing this, but regulation of financial markets is a necessity, I believe. Why?
1) they are actually not “free”, they are cartels
2) Steve Keen’s debtwatch #31 points out how the credit markets are the tail that wags the dog! That money created does not lead to credit but that the reverse is actually true (pointed out to me by Mish Shedlock). Now this, all in itself is a daunting proposition that defies Austrian models (I don’t even think Murray Rothbard had this down other than to want a design against it!).
I can not claim to be a Libertarian (and certainly an Austrian in economical view), but I do want my liberties, and I do want to be free – it is perhaps my views in religion/philosophy that guide me most. Political/economic structures are only a beginning study for me.
But, as an engineer/applied mathematician (and I get tickled by Mish’s comment (or someone else recently) that Austrian’s would be well served by using math?), when confronted w/ a problem, my next motivation is to fix it.
Now here is where I play the “blame game”:
1) Big Bank cartel and never allowing them to take responsibility (moral hazard), as a matter of fact, cartels of all sorts that distort a “free” market,
2) Socialistic policies from FDR in `34 on and the impact to our country’s population (who don’t undertand rights from entitlements and wants). Dude, a “Great Society” is built from the ground up by good societies – 1 community at a time – NOT from the top down through wealth transfers – which is tantamount to a loss of property rights
3) A review and thorough understanding of not only currency systems but also new credit-led systemic thoughts (Keen, Mitchell, Mosler) and the understanding of the cross-dynamics to fiscal policies which are poorly understood, especially the actions of Fed through easy-money policies and Gov Agencies (Fannie/Freddie) that enforced policies that have caused major destruction and horrendous malinvestments.
4) A population that is in the HRE decline, a loss of their moral compass and the values that led to prosperity in the first place – not only for their generation, but for their future generation as well. Of promoting savings and fiscal conservatism in the home’s budget. Of living (well) within your means.
Don’t think so? Then why was this phrase recently invented: “word/life” balance (referring to texting)?
5) A Federal Gov that continues its power play dynamics while continuing to violate the Constitution at will – they are a bloated stinking mess of guck – kinda like the oil spill in the Gulf. 90% of the Fed Gov is actually ILLEGAL!! It is why I no longer have a dilemma w/ the phrase: “illegal law”!
I think if we took a 5-pronged attack on these issues, we’d get it done w/in 5-10 years. And we would still have the currency system we have today, and the banking system we have today (w/ modifications under regulation that mebbe, just mebbe, took a hard look at their Capital rqmts (which goes against assets == loans) rather than their reserve rqmts (which goes against their debits == deposits). Sorry, for banks a balance sheet is upside down to a normal company or household, it is what it is. B/c, Big Bank right now is Capital constrained (in the sense that they have NONE!!!), they are not reserve constrained.
And lastly, I would like the Austrians and Post-Keynesians to stop talking by each other. (For Pete’s sake! You can’t even agree on the frickin’ definition of inflation/deflation – would y’all please get real!!) It is really making me mad. LISTEN to each other and get w/ the program will ya’? Austrians, figure out that we have the currency system that we have b/c it was flexible enough to handle a global economy. From there develop a currency stewardship policy that can help us.
Doesn’t mean it’s “correct”; just understand that it is what it is (i.e., reality, man) and let’s move on. If I have to read another article on why the gold-standard was so cool, I am gonna pull out my baseball bat – no joke. Get w/ the reality of our times – today. Get functional please.
It is what it is – stop bemoaning the fact we are not on a gold-standard and help us rather than just sitting on the fence and saying: “Nope, sorry, the gold standard is the ONLY WAY”. This is pontification – it is not productive.
And you post-Keynesians? Can you please productively draw from the rigors of Austrian thought – we need not be wild dogs baying at the moon – right?
I would like to see an integrative melding of thought to help move us forward. The thingie you had on G Soros 1-2 days ago actually lit me up (I did a lot of systems analysis as an undergrad – “those poles in the S-plane BETTER be in the left half part of that plane o/w you have positive feedback!!”).
Mebbe financial systems are NOT stable?? Mebbe, they can go non-linear on you? Hey? If we don’t pull our heads out of the sand and start working together, we will just waste time non-productively arguing; whilst things continue to take a tumble.
Knock it OFF!
I apologize to the respected readership here. Normatively, politics is not a part of the on-going excellent dialogue of this site.
But, in order to provide solutions to our ills, it will require a systemic approach, which involves the politics/fiscals as well. I don’t know how to keep it separated.
Won’t happen again, promise (small smile)!
2 cents…
“Mebbe financial systems are NOT stable?? Mebbe, they can go non-linear on you? Hey? If we don’t pull our heads out of the sand and start working together, we will just waste time non-productively arguing; whilst things continue to take a tumble.
Knock it OFF!” Illuvatar
@Illuvatar,
Way to go man! If you were only redheaded, female and available!
I am an engineer myself though not a good one but good enough to recognize a good one when I see one. Not to give you the big head, though. I do have disagreements with you but as the Beatles said “We can work it out”, I think.
Now if Angry MBA would stop hating my guts…
If the housing market drops by another 50% and all the banks go bust, the Fed could buy all the collateral from the FDIC, effectively monetizing it, and lease all those forclosed houses out as rentals for the next 50 years. The FDIC would need enough money to pay insured depositors, so a few trillion should do it. Houses built today will probably deteriorate so much in 50 years that they will have to be torn down anyway, and then the Fed could sell the land. This is probably the best way to reset the system.
” This is probably the best way to reset the system.” Andrew P
Ugh! I hope not. So the Fed ends up controlling everything? Heavens, no. May the counterfeiter-in-chief be humbled, may it please the Lord.
@ Matthew Claassen “fair pricing was not often established because neighbors refused to bid on foreclosed properties in order to thwart the banks”
Public education about the depression was about as useful as Moa’s Little Red Book, but one uncle was willing to talk about how farmers would come to auctions with pitchforks and dare anyone to bid on anything. The farmers lost their cash when the local bank closed and its president, a lifelong friend, committed suicide or disappeared in the middle of the night. The combination of drought and low prices eliminated income, and the option to defer paying RE taxes didn’t exist, which forced immediate foreclosures and resulted in the insurance and finance industry owning much of the farmland. Later, political action resulted in legislation that prohibited corporations owning farmland and inspired the insurance companies to sell to farmers and to provide loans to support the prices.
The too-big-to-fail and their political friends believe the public is to be harvested. Most of the public may now think a pitchfork has something to do with baseball, but a politician could be distracted from the TBTF lobbyists if the public were to properly apply the sharp end of a desert fork in an appropriate place. How many stabs it will take to find the appropriate place is an open question. Is a teaspoon a fork?