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Saturday, September 13, 2008

The outlook for the US market

The following commentary comes from a Japanese forum I have contributed to.

I don't dismiss the fact that the US is going through pain, and I certainly appreciate that the world is looking at higher interest rates and inflation, but that does not spell depression, nor is the credit bubble going to unwind just yet. The sad reality is that people will recover from this thinking there will be no depression in future because people called 'wolf' on this occasion. That cannot be helped.
So why is the credit bubble not going to unwind? Because the mechanisms for expansion are still in place. China, India and other countries still have a lot of capacity to expand their output. Developing markets aside from China and a few Eastern European countries are not overvalued. So there is more scope for asset inflation, cost of living deflation, as we have become accustomed to. For this reason, I say there is another leg to this bull, and I would expect the Fed to support it. The evidence is they are doing just that.
I do agree with your comments on the Fed, just disagree on your premature diagnosis of mayhem.
Pachipro: "The reason why the world and the US did not go into recession in 2000 during the dot.com bubble bust was the implementation, by the Fed, of low cost housing loans to anyone who breathed and could sign their name at very low teaser rates of 2-3%. Thus, the US did not go into recession and housing prices went through the roof as many people hoped to make a huge profit flipping houses. Also, it enabled many people to buy more house than they could afford. This is the sole reason why the US did not go into recession in 2000 when it most definitely should have".
This is all true, but you have to make a case for why inflation should persist as a problem. It is rising because asset prices are falling. So I'm saying they will fall to a point, but they will turn around. Europe is already lowering its interest rates, Japan's are low, Australia is falling, NZ will. Just America is raising its rates. The US needs to attract savings, so US rates will be relatively high, but I don't think too excessive. The lack of returns in the US will cause an Asian property boom. China and India will be investing in global commodity projects.
Pachipro: "Now they are all broke and way in debt and the world back then was also duped into believing that the US economy was sound when the truth is, it was far from sound. The result today is the sad fact that the average American is upside down in their home and car and have more than, on average, more than $8,000 in credit card debt and 7 out of 10 households are 1 - 2 paychecks away from bankruptcy".
Those statements make for a great human interest story but actually they do not constitute statistics that support your argument. The reason the global economy will turn around is because of the critical issue you have missed - there is no big or significant capacity shortage. On the contrary, a lot of markets are tight. I'm focused on commodities, but notice how the prices for iron ore, coal, alumina and copper are still quite high. Even your precious housing stock will be absorbed within 2-3 years. Mass migration will bail the world out, and the credit tap will keep flowing. Sure few Americans will jump in at first, but they will.
Pachipro: "Sadly, Shouganai, you need to do a little more research as the majority of homeowners today are upside down in their mortgages and have no equity whatsoever; have not only a mortgage, but also a HELOC (Home Equity Line of Credit) and cannot afford to pay two mortgages today".
More sensational headlines. Where is the statistics showing that its so bad that we need to worry about depression. The depression was marked by a period of mass over-supply. Where is it - other than US housing stock? This was just an asset price correction causing a spike in inflation. It will recede.
Pachipro: "The simple fact is that real income for the average American DOES NOT support housing prices even at their currently depressed levels. 9% of US mortgages are either in default or foreclosure and the economy is worsening on a daily basis. Therefore, the government had no choice but to take over Fannie and Freddie".
Well I wouldn't be surprised if real income is falling at the moment, but unemployment is 6.1%, and I doubt it will breach 9%, which is a recession number, but it will be absorbed in 2-3 years tops. This boom will continue. Oil prices have already cooled, so those people in default or foreclosed (you say 9%, but have not sourced it and you dont even seem to differentiate. So let me cite Bloomberg's numbers are a lot lower than yours. See Bloomberg.
Bloomberg says "new foreclosures increased to 1.19%, rising above 1% for the first time in the survey's 29 years, the Mortgage Bankers Association said in a report today. The total inventory of homes in foreclosure reached 2.75 percent, almost tripling since the five-year housing boom ended in 2005. The share of loans with one or more payments overdue rose to a seasonally adjusted 6.41 percent of all mortgages, an all-time high, from 6.35 percent in the first quarter".
Now those figures will not take into account the falling oil prices and broader fall in some commodity prices, eg. zinc, lead, nickel. Some good new don't you think. Notice that foreclosures only marginally increased. The reason is that people are in default not because of failure to pay debt but because of falling asset values. So they are being forced to sell 2nd homes, knowing full well they have fully paid off one home. We are talking 2.75% of homes - not your 'scary 9%'.
Pachipro: "This amounts to bankruptcy and nationalization".
Actually there is a world of difference between foreclosure, debt delinquency and bankruptcy. You ignore the assets they hold. There is also a world of difference between absorbing a private banks debts and your presumption that they would be redeeming the housing stock.
Pachipro: "According to recent Treasury figures, foreign holdings of US Agency debt, that is debt of Fannie Mae and Freddie Mac, rose from $107 billion in 1994 to $1.304 billion as of June 30, 2008. Foreigners own about $800 billion of that debt. Thus, you can see why bondholders were bailed out. In addition, Fannie and Freddie are responsible for $5.3 trillion in mortgages, that impact, by comparison, is 13 times greater than the Bear Stearns failure".
I guess you are quite impressed by those numbers. I think you mean $1.3 trillion. The twin [quasi-government) underwriting agencies for the bulk of US housing debt, so of course their liabilities have grown considerably. Yes, the US government has over-stretched. Its just not going to cause more than 2-3 years of recessed US market, and the US will resume its growth.
Pachipro: "Now that the majority of homeowners have no equity, are "upside down in their mortgages, and many are being foreclosed upon, including the "flippers", they are just walking away and, if the US government did not step in to help Fannie and Freddie, foreigners would be very upset and may have sold their treasuries to make up for their losses. This would bankrupt the US".
Well I've established that 2.75% are in foreclosure, so I don't know how you get 'majority' have no equity. I assure you banks foreclose before they have no equity, so the implication is that less than 2.75% have no equity. We have to remember that some of these are 2nd home owners. A bit too early to hit the panic button don't you think.
Pachipro: Maybe you should think about investing in US foreclosures as anyone with cash is most welcomed today by banking institutions. However, the end is not in sight yet and may not be for at least two more years as now ALT-A mortgages are beginning to default.
Well I wouldn't invest in US foreclosures unless I was living there because the economy is going sideways for 2-3 years. I prefer the Philippines because it has far better dynamics. I guess all the US foreclosed you are talking about can afford to retire there.
Pachipro: "You don't have to believe me or call me names like "Pachipronomics". The partial story is here on Bloomberg "US Foreclosurers Hit Record in August As Housing Prices Fell".
Actually this article does not support your point, they say 11% increase, not 11% foreclosures I didn't call you any names.
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Andrew Sheldon www.sheldonthinks.com
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