US Economic Outlook--3 Possible Scenarios

   Market participants and economists have noted that the macro outlook for the US economy is particularly uncertain. There seems to be so many contradicting variables that lead to differing conclusions. On one hand you have strong corporate profits, easy monetary policy, and growth from emerging markets. On the other hand the US has high structural unemployment, egregious levels of government debt, and a housing depression. I believe the US economy faces 3 possible economic scenarios:  Economic Stagnation (1-2% GDP growth), Economic Depression (severe economic contraction), and Hyperinflation. You will notice that there is no V-Shape economic recovery with strong growth (4-5%) option. Anyone who has studied economic history will tell you that economic and financial conditions simply do not support this outcome as a realistic possibility. The main reasons for this include de-leveraging, an insolvent banking system, collapse of housing market, record levels of government and private sector debt, and high unemployment. Under these conditions it is impossible to have a strong and healthy economy. Lets review 3 possible economic scenarios:

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US Economic Outlook--3 Possible Scenarios

"Nothing Down" Makes a Comeback: So Much For Increased Lending Standards

  While I never trust statistics from the National Association of Realtors, I do enjoy reading their realtor surveys. One important question from the June survey was "If the buyer obtained a loan, what percent was the down payment?" Here are the results:

Buyer did not make a down payment                  14%

Buyer made a down payment of 1% to 2%           3%

Buyer made a down payment of 3% to 6%          38%

Buyer made a down payment of 7% to 10%          9%

Buyer made a down payment of 11% to 20%       21%

Buyer made a down payment of 21% to 99%       16%


   That's right :14% of home buyers purchased a home without a down payment (and you thought banks had raised their lending standards). More importantly, 55% of home buyers put less than 7% down. The reason there is a large number in the 3-6% area is because FHA usually requires a 3% down payment. You would have thought that banks and mortgage lenders would have learned by now that it is important for home buyers to put up at least 10% down. This way they have some skin in the game and are less likely to default on a loan. Evidently, financial institutions have learned nothing from the whole real estate market collapse and subsequent financial crisis. I tried to confirm these results from a realtor I know in the Chatsworth, California area, and was told that it is possible to  purchase a home without a down payment, but you have to have good credit. In my opinion, these kind of stats how  vulnerable the US housing market is to any further decline in home prices. How many home buyers in the no down payment category are willing to endure negative equity? My guess is not many, and the same can be said for people in the 3-6% category. Talk about weak hands! These people will simply walk away and contribute to the bloated housing inventory.

Black Swan Insights    

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"Nothing Down" Makes a Comeback: So Much For Increased Lending Standards

How Low can Home Prices go?

   














    With the expiration of the home tax credit we can now expect home prices to roll over and continue their downward trend. The question is: How much lower can they go before the market finally clears? As you can see from the chart above. nationwide home prices are currently hovering around $166,000, but this is very misleading because of the large fluctuations in regional home prices (West expensive, South and Midwest cheap). But it does show that in aggregate, home prices could fall to around $150,000 to get back within the historical norm. This would represent at least another 10% decline. This is likely a conservative estimate because post bubble prices usually overreact to the downside which could send nationwide prices into the $125,000-135,000 region.  However, there is one key variable in the housing market, and that is interest rates. If rates increase even 100 bps, this could have a very negative effect on prices. Currently, rates are at historical lows of around 4.7% which is allowing people to afford more house than they would normally be able to purchase. If you look at a longer term chart of mortgage rates, you will see that they usually average between 6-8%. Since  it is hard to see rates moving any lower (unless the Federal Reserve steps in), one would have to conclude that rates will eventually find their way back to the historical range.  This should keep prices capped for an extended period of time as the market establishes an equilibrium.

   One last thing to remember about the housing market is that there is no need to try to time the bottom. The housing market, unlike stocks or other asset classes, moves incredibly slowly. If you look at other boom/bust cycles in the housing market, you will see that once prices hit bottom, they usually stay there for a while and tread water (3-5 years). So don't believe the liars at the National Association of Realtors who claim that you have to "get in now" to get the best price. When it comes the housing market, patience is a virtue.    

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How Low can Home Prices go?

Lumber--a failed market

    I always get a kick out of people who say the market is a discounting mechanism that anticipates things 6-9 months ahead. My opinion is the market is nothing but a bunch of people trying to predict the future. Sometimes they are right and sometimes they are wrong. The market is not always correct as some market aficionados claim. This is evident in the recent action in the lumber market. As you can see from Nov 2009 to mid May the price of lumber surged from 190 to 320. To a casual observer this would indicate that the housing market would do well over the next 6-9 months. Some pundits even used this as evidence of an improving economy. But as we all know the housing tax credit expired in June, so the idea that we are going to see a dramatic turnaround seems unlikely. The government simply pulled demand forward which will depress home sales after the expiration of the credit. But the question is why did lumber surge in the first place? Does it mean anything? If you believe in the efficient market hypothesis this would be proof of a rebound in the lumber market. If you are like me it means almost nothing. During the price surge in 2010 the market was betting that there was a real rebound in the housing market which would be bullish for lumber.  The market was wrong and quickly corrected this mistake by sending prices down $140 in less than 2 months.

   The reason I bring this example up is because it is important to remember that the market is not always forward looking, so don't obsess about what the market is telling you. The only way to make money is follow the trend even if it goes against fundamentals.

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Lumber--a failed market

Is the housing market recovering? Should you buy?

After years of declining home prices many "experts" believe the housing market is beginning to stabilize and will recover through 2010 and into 2011. Logic, reason, and economic fundamentals suggest otherwise.

A few important facts to consider about the housing market.

Between 2000-2006 the housing market experienced the largest price bubble in US history (no kidding). US home prices rose a little more than 100%, which has never happened nationwide. This bubble was fueled by low interest rates (thanks Greenspan), fraudulent loans, and the assumption that home prices could never drop. Below is a chart, which shows the mania.


Focus your attention on the inflation-adjusted data because it is more important than simply nominal prices. Between 1970 and 1998 prices remained almost flat. Then we seek the explosion higher. This problem will eventually be corrected two ways: massive inflation or nominal home price declines by 10-20%.

The US government has desperately tried to prevent home prices from falling by handing out tax credits ($8,000) to encourage people to buy homes. Won't this support the housing market and stabilize prices? In the short term it will but eventually the market always finds a way of clearing excesses in the market. The problem with home prices is that they are still overvalued. The chart below shows existing home sales and total months of supply of homes. You will notice that the number of home sales jumped because of the government-induced stimulus. The current credit expires in June 2010. You will also notice that sales have already started to fall beginning in 2010. Why? When you give an artificial incentive to buy a product it drains future demand by pulling the demand to the present. So what we are seeing is that even with the tax credit available, people who want to buy a home have already done so. This will now be a drag on future demand.


Source http://themessthatgreenspanmade.blogspot.com/2010/03/existing-home-sales-fall-further.html

You will also notice that the supply of homes is rapidly rising again after a large drop thanks to government handouts. The supply of homes will need to fall to at least 5 months of supply before you will see any type of stabilization in the housing market.

Along with government incentives the Federal Reserve has reduced interest rates to an all-time low and purchased (with electronically created money) $1.25 trillion in mortgage backed securities to keep down mortgage rates. This program expires at the end of March 2010. If you look at a chart you will see that mortgage rates are also near all-time lows. With mortgage rates this low they have only one way to go.




When rates rise (and they will) to 7-8% this will put extreme stress on the housing market and precipitate declines in home prices. Why? Pretty simple--the higher the interest rate the lower the amount you can afford. You might be thinking that now is the right time because you can lock in low interest rates. There are two schools of thought concerning this.

1. If you intend to live in your home for the next 10-15 years and can easily afford the monthly payments, PMI, property taxes, repairs, and insurance then it might make sense. You will have to be able to withstand the possibility of home prices falling a further 10-20% in value and likely moving sideways for a few years. The best deals will be found in foreclosures or distressed sellers. Under these circumstances it might make sense to purchase a house.

2. If you are the average American who changes homes every 5 years and would be negatively impacted by falling home prices-- wait until prices fall further. Even if it means you will have to pay a higher interest rate. After all you can always refinance in the future. The worst case would be to get suckered into a low rate mortgage and watch home prices fall as interest rates rise. You will be underwater and unable to sell your home (unless you have the money to pay the bank the difference).

Conclusion

A home is not an investment--it is a place to live. Do not expect to make money (in real inflation adjusted terms) with your home. Right now there is no reason to charge ahead and purchase a home thinking that you have to get in now before prices rise. Finally, and I cannot stress this point enough NEVER LISTEN TO THE NATIONAL ASSOCIATION OF REALTORS!! This is one of the more duplicitous, deceitful, and deceptive organizations operating in the US. They lie about everything in a desperate attempt to scare you into buying a home "before it is too late." According to their propaganda the housing market never collapsed but is always on the verge of recovering. Don’t fall for this trick. Know the facts.

Black Swan Insights

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Is the housing market recovering? Should you buy?