Fin/Inv

Many of you have been asking me about housing lately via e-mail and in the comments section. I thought today was a perfect day to discuss it because I believe we are now seeing the makings of a Perfect Storm for whats left of the housing market at the end of the year.

It all starts in the bond market.

Lets take a look at some stats. First of all, lets take a look at the treasury auction today:

Quick Take:

The bid to cover wasn't bad but look at the lack of participation by the inderects(China and the other FCB's)! Only $5 billion of the $35 billion auction was bought be the world. This is pathetic and very frightening. It tells you that they are running for the hills when it comes to buying our treasury debt!

China has been warning for weeks that they planned on diversifying out of treasuries. Folks, if we lose the indirect bidders we are going to start seeing failed bond auctions. At that point the economy will be toast.

You gotta wonder if the pullback we saw today and after hours is a result of the banks backing off on buying equities because they needed the liquidity to sell the auction. Things are getting dicey!

Fed Announces Record Treasury Sales Next Week

We also got this pleasant piece of news from the Treasury today:

"Aug. 5 (Bloomberg) -- The U.S. Treasury plans to sell a record $75 billion in its quarterly auctions of debt next week and also indicated plans to expand inflation-indexed securities next year as it finances unprecedented budget deficits.

The Treasury plans to auction $37 billion in three-year notes on Aug. 11, $23 billion in 10-year notes Aug. 12 and $15 billion in 30-year bonds Aug. 13. The amounts matched the median forecast of analysts surveyed by Bloomberg News."

So how did bonds like all of this news? As you can see not very much. Treasuries sold off hard late in the day:

My Take:

The credit markets look absolutely horrifying folks. It appears the world is quietly backing away from our treasuries as we continue to issue ridiculous amounts of debt. there is not enough money in the world to soak up $75 billion a week unless we start printing. BTW, the dollar was down once again today.

This is going to force lending rates to soar which will result in further pressure on housing prices.

Even the banks are finally starting to catch up on how bad this crisis is. Take a look at Deutsche Bank's gloomy housing report:

"Aug. 5 (Bloomberg) -- Almost half of U.S. homeowners with a mortgage are likely to owe more than their properties are worth before the housing recession ends, Deutsche Bank AG said.

The percentage of “underwater” loans may rise to 48 percent, or 25 million homes, as prices drop through the first quarter of 2011, Karen Weaver and Ying Shen, analysts in New York at Deutsche Bank, wrote in a report today.

“Borrowers may also ‘ruthlessly’ or strategically default even without such life events,” they wrote.

Seven markets in states with the fastest appreciation during the five-year housing boom -- including Fort Lauderdale and Miami, Florida; Merced and Modesto, California; and Las Vegas -- may find 90 percent of borrowers underwater, according to the report.

Home prices will decline another 14 percent on average, the analysts wrote."

Final Take:

What can I say folks I am speechless. If you bought at the top you might as well just walk away now. Save yourself the grief and pressure of trying to come up with that $4000 every month to pay the mortgage on your McMansion.

It will most likely be worth 50% of what it was when you bought at the peak when this is all said and done. It will be even worse in the bubble areas mentioned above.

The Bottom Line:

Trying to chase down a foreclosure at this point is still a fools game. The speculators are once again flying into the stock market thinking the recession is over(yeah riiiight). This is probably carrying over into the housing market to a point.

Whats further threatening the housing market is the fact that the first time buyer home credit expires at the end of the year.

I spoke to a mortgage analyst at a large financial firm and he explained to me that in some areas, 90% of the deals they are doing are first time home buyers who are taking advantage of the $8000 tax credit.

He also explained to me that jumbo loans now require 20-30% down payments because no one wants to touch the paper. Minimum credit scores for all mortgages are also rising. Fannie/Freddie now want a 700 credit score. FHA now wants 620 up from 580. This sharply shrinks the potential pool of buyers.

The real estate market according to this analyst is absolutely petrified as to what happens to the housing market when this tax credit disappears.

That's the problem with stimulus folks. Its a one time high similar to what a crack head experiences after he shoots up. The problem is the high wears off and the fundamentals once again appear.

Whats frightening here as this "high" wears off at the end of the year, the fundementals will be significantly worse. IMO, we will be heading straight into The Perfect Storm which is:

Higher lending rates as a result of our Ponzi style deficits

Elimination of the Tax Credit at the end of 2009

Millions of current homeowners begin walking away

Rapidly Rising Defaults leading to further foreclosures on current loans

Even tighter lending standards requiring higher down payments and better credit scores.

Rising foreclosure inventories as banks continue to flood the market with their "Shadow Inventory"

Still want to buy after reading all this? I hope not but good luck if you do! If you MUST buy, stay on the lower end (under300k) because the inventories aren't that bad.

WARNING: I suspect inventories in this price range will rise sharply once again at the end of '09. I say this because the tax credit focused on this end of the market because first time buyers usually buy the lower end.

Stay on the sidelines folks. The housing time bomb is about to explode, and my guess is the fireworks start to go off when the tax credit disappears at the end of the year.

I think you will see a very different housing market down the road with much lower prices even several years from now.

"Frequently, I do try to find things that are cheap. Normally if something is cheap, it is because it is in the dustbin; people are not looking at it. If everybody is looking at something or if everybody is investing in something, you know as well as I do, it is not cheap." in Bloomberg TV, July

I see that Jeremy Siegel replied to Jason Zweig’s criticism that Siegel’s studies of stock returns contain sample size biases. One of Zweig's criticisms is that for the early periods, e.g. 1815 and 1834, Siegel’s data is composed of only a few stocks. The results biased the returns upward.

Siegel responded that while there are problems with the early data, he pointed to Goetzmann and Ibbotson’s work, A New Historical Database for the NYSE 1815 to 1925: Performance and Predictability, as being free from survivorship bias and supportive of his conclusions about long-term stock returns of about 7% per annum.


But there is survivorship bias in the data!
All this bickering about the data still doesn’t make sense to me. Let’s do a sanity check, as I did in my post What actually happens in the long run:

What if your family had managed to save the equivalent of $100 at the time of Augustus Caesar (give or take 2,000 years ago) and put it into equities or an equivalent investment? At 7% a year, the value of your family’s $100 original investment would now have 60 zeros behind it. Your family could finance TARP and the bailout by the world’s central banks from the chump change derived one day’s interest.

What happened?

What happened was in the intervening 2,000 years, there were many upheavals that destroyed wealth. Empires fell, starting with the Roman Empire, barbarians sacked cities and a lot of people died in very unpleasant ways.

Quantitative analysis without context
Children draw pictures by coloring the numbers. This is an example of quantitative analysis by coloring the numbers. Proper analysis needs proper context. Many of these quants are far smarter than me, but sometimes they need to step back and really, really think about the assumptions behind their models.

Here is an example from David Halberstam’s The Best and the Brightest about Robert McNamara, who I consider to exemplify the greatest quant failure of our time:

[His] mind was mathematical, bringing order and reason out of chaos. Always reason. And reason supported by facts, by statistics — he could prove his rationality with facts, intimidate others. He was marvelous with charts and statistics.

Once, sitting a CINCPAC for 8 hours watching hundreds and hundreds of slides flashed across the screen showing what was in the pipe line to Vietnam and what was already there, he finally said, after 7 hours, “Stop the projector. This slide, number 869, contradicts slide 11.”" Slide 11 was flashed back and he was right, they did contradict each other.

Everyone was impressed, and many a little frightened. No wonder his reputation grew; others were in awe. For it was a mind that could continue to summon its own mathematical kind of sanity into bureaucratic battle, long after the others, the good liberal social scientists who had never gone beyond their original logarithms, had trailed off into the dust.

Though finally, when the mathematical version of sanity did not work out, when it turned out that the computer had not fed back the right answers and had underestimated those funny little far-off men in their raggedy pajamas, he would be stricken with a profound sense of failure, and he would be, at least briefly, a shattered man.

Figure 1 is a concept that I have put forward before, and it is gold's performance relative to a basket of 8 currencies.Those currencies are: 1) Australian Dollar; 2) Canadian Dollar; 3) Swiss Franc; 4) Eurodollar; 5) British Pound; 6) Singaporean Dollar; 7) Japanese Yen; 8) US Dollar. This is a weekly chart. Relative to other currencies, gold is starting to outperform, and the indicator has turned positive after about 10 months of underperformance.

I don't want to be a day trading service, and I don't want to spoil the bull party. So let's just consider this a public service announcement: looking at the Rydex asset data, bullish sentiment is becoming rather extreme.

Sears Holdings (SHLD) looks poised to breakout. Once above $70, the next stop is likely $100. Now the market seems do for a pullback according to most analysts and media outlets, but not much of that happened when the market fell off the cliff last fall.Its currently solidly above the 20EMA which is above the 50EMA which is above the 200EMA. Its a beautiful chart once it breaks $70. Its also will