U.S. Housing, Real Estate, Credit Bubble Deflation, 5 More Years of Financial HellHousing-Market / Deflation Jun 01, 2010 - 09:17 AM GMT
"...and it is in such twilight that we must be aware of change in the air, however slight, lest we become unwitting victims of the darkness." ~William Orville Douglas
First of all, please allow me to apologize for the infrequency of my Safehaven posts, as obviously I have become a fellow more inclined to write at market turns than one who chimes in on an ongoing basis. I appreciate to no end the number of emails I receive requesting updates, but my fingers are in a few more pies now (including the penning of a second screenplay with writing partner Tim Wells and the pursuit of my investment advisory representative license).
I guess what they say is true: There are only so many hours in the day. Then again, our most significant call hasn't changed one iota: The global economy is still caught in the eddy of real estate, asset and credit deflation and there is nothing anyone can do of any consequence other than to delay the inevitable (and, ultimately, make things worse). Suffice to say you'll be hearing the "D" word on an ever-increasing basis over the next five years.
For those reading my pap for the first time, our claim to Safehaven "fame" is based on giving heed to investors before the storms hit. May, 2005: "The relentless drag of deflation is coming soon to a theater near you. A contraction in credit will change the rules of the asset game for at least a decade"; June, 2006: "Real estate deflation has begun and will persist for a longer period than almost anyone can imagine. Our call is for an astonishing percentage decline in real estate values over the next ten years"; September, 2006: "It's time to deleverage -- now!"; March, 200: "Stocks will crash. Time to sell all real estate"; January, 2008: "Values have a long way to go (down), both in terms of price and timeframe"; February, 2008: "ALL U.S. property values are poised to take an increasingly substantial dive in the next 24 months. No property type will be spared"; May, 2008: "Stock markets around the globe will face ever-more downward pressure"; and April, 2009: "The current stock market rally will have legs, and will run longer than most expect" (more below).
Anyway, I write today's update because the worst of it is dead ahead and we care greatly about the finances of our readership. Scores of you have written to tell us how much you've saved selling important assets before their respective markets tanked (or by waiting to buy until prices were lower), and believe me when I say we have taken those stories to heart. That's the main reason you'll continue to get trusty asset and credit deflation updates from us from time to time. Meanwhile, it pains me greatly to write this one, but I suppose every cancer patient needs a guy wearing a stethoscope -- hopefully with proper bedside manner -- to offer that victim the sobering news.
Onward. Last April, we steered clear of the dreaded permabear label by calling for an extended stock market rally, to wit:
The current stock market rally will have legs, and will run longer than most expect, confounding the short-sellers. The mother of all bear markets is in session right now, so it stands to reason that bear market rallies have the same potential to impress. The sell-off that took place from October of 2007 to March of 2009 was so relentless and steep, we could be in the midst of a fairly impressive countertrend rally despite utterly atrocious economic prospects worldwide.
...There will probably be a fake-out or three (or not!) as the market climbs the "wall of worry" investment veterans speak of. Before this rally is done, idiotic CNBC cheerleaders will chorus that the worst is over and shell-shocked short-sellers will be the ones using sleep aids. I wouldn't be at all surprised if, as the next monstrous leg down begins, bears are hiding in the forest and the shorts aren't in place to shore up the downdraft.
Check, check and check. Despite the coming, inevitable deflationary depression, the market rallied correctively to the tune of 70% in 13 months and any semblance of fear just up and left the dance hall. By most measures (start with the VIX), investor sentiment became hysterically bullish, as GE, I mean CNBC cheerleaders (like lead idiot Dennis Kneale) talked about things like Dow 100,000. Alas, this relief rally was just that, nothing more. It merely set the stage for the "Credit Bubble Implosion, Stage II -- This Time It's Personal" phase of deflation. We remain in the secular bear market of all secular bear markets.
Of course, the talking heads did their usual sis-boom-bah; they told you that the relief rally was the start of a new bull market and a six-month leading indicator of economic things to come. At the same time, policymakers like the delusional Ben Bernanke tried to sell you a bill of goods by declaring victory over the credit crisis because, you know, everything's now rosy as far as the eye can see. But seriously, folks, do you still really trust these people?
Back on point, we did close out last April's market rally prediction with this longer term view:
Make no bones about it, once this countertrend stock rally is over, the next leg down will make the October, 2007 to March, 2009 decline look like child's play. The washout will go down in history as the greatest stock market collapse of all-time, bar none, and it will take real estate and commodity values down right along with it, to an almost shocking degree. Few will be ready for the devastation.
Cue the storm windows.
I wonder if the CNBC crew will trumpet that "six month leading indicator" thingy if the market falls hard the rest of the year? Is it proper to write "LOL" in an economics forum?
The good news is that you've still got your health. The bad news is absolutely everything else. We are on the threshold of five years of pure economic hell, featuring 1) a worsening of credit bubble deflation as it proceeds domino by domino ever closer to credit system collapse; 2) a series of stunning, stair-step down, stock market "crashes"; 3) continued real estate deflation featuring a relentless "grind-down," followed by an additional, sudden 30-40% value smackdown at some point; 4) a resumptive pimp-smacking of commodities prices (and pretty much anything else one might consider an asset); 5) a coming "crisis of liquidity" (little savings, lost equity, wage deflation) which for most will translate to "we have no money"; 6) progressively eroding economic indicators including another doubling of the unemployment rate; and 7) an inevitable bond crisis that will translate to rapidly ascending interest rates and sudden and severe asset value loss, thereby providing the appropriate coup de grace for Greenspan/Bernanke's 20 year "Drunken Stupor Bubble Policy and Attempt-To-Reflate-The-World-Forever" debacle.
Before we get to the oft-requested crystal ball stuff, please take a look at the chart that seals the deal for our deflation call. It's an 18 month Reuters/Jefferies CRB (Commodities) Index chart:
What we have here, people, is the picture of post-bubble-bubble-bubble asset deflation, for given the amount of central bank money pumped globally in an attempt to resuscitate all markets since the initial and smelly credit bubble fart, the performance of this chart is spectacularly bad. It serves as a general proxy for other asset classes, as well. The CRB quantifies the fact that ill-conceived money printing and socialization of "too big to fail" investment losses generated almost zero economic traction, and that the "coordinated" monetary effort can only be characterized as a failure of historic proportions. The stock market did jump that 70%, true, but the CRB is generally reflective of real estate's performance, and the performance of most other asset classes since the first (temporary) bottom was reached in March of 2009. Don't worry; stocks will catch up soon enough, and of course by up I mean down in a major league way.
Why did this central bank effort fail so spectacularly? Why not one hint of hyperinflation? Simple. The credit bubble was imploding (and continues to implode) and credit losses sustained worldwide faster than the sum total of all additional artificial money created. Picture a sputtering vehicle stuck in the mud -- engine smoking, wheels spinning, mud flying -- as torrential rains bring further flooding and add to the mess. That's what it feels like to be a money-pumping monetarist right now. They can't figure out why they've got the pedal to the metal, yet remain stuck in one place.
Coming soon: Sputtering vehicle stuck in mud runs out of gas. Eventually the folks printing the currency and attempting to borrow even more money as a means of getting out of debt will figure out the jig is up and they'll have no choice but to let the final credit bubble implosion do what comes naturally. The financial system will collapse accordingly, yes, but that's probably a good thing, as from those ashes a Phoenix can arise. The 70 year cycle will being anew. It's the way nature intends.
Add to it the fact "there is no free lunch" (thanks, daily dose of reality "Mish" Shedlock), and it's only a matter of time before the bill for this borrowing comes due. Market participants will determine that declining tax revenue can't service each respective nation's debt and they'll demand significantly higher returns in exchange for keeping their money at risk. Interest rates will take off as helpless central bankers look on. Look to Europe right now for a foreshadowing of events to come here in the U.S.; their sovereign debt issues will become our own cross to bear within a few short years.
So what can we expect to see in the U.S. over the next half-decade?
First off, get ready for a paradigm shift. Cycles take 70 years or so to run their course, so you really can't blame anyone for believing that real estate values and stock market indices will "always go up in the long run." Well, since 1932 (the beginning of this long-term cycle) they have, with occasional dips along the way. But when the 70-year cycle ends and investment bubbles mark the climax, a deflationary period ensues, knocking values back to levels we'll all find almost impossible to fathom. Our generation will be the one to discover that not only can post-bubble-bubble-bubble values head the other way; they can decline by upwards of 90%. Printing money or not, it'll be no different this time around.
Stocks will fall out of favor. Remaining rallies are nothing more than selling opportunities; any lasting reward is not worth the risk. The coming downside should be breathtaking. The good news is that if you keep what stock market value you have right now, you'll come out the winner, as the buying power of that money will be factors greater come 2015-2016 when we start fishing around for a market bottom (below Dow 1500).
Another unforeseen, massive decline in the U.S. stock market (and worldwide) will devastate market psychology, and that will quickly affect pretty much everything economic -- from consumer confidence to consumer spending to corporate earnings to employment, clear through to the housing market. Lenders will pull in their horns even further and few will be in the mood to borrow. Deflationary forces will be fully in play and those forces will continue to feed on each other as the value of virtually every asset class heads down yet again. Those not ready for this reversal will wonder how in heaven's name we went from placid waters to perfect storm in such a short period of time.
Meanwhile, there's substantially more pain to come in real estate. As the Realtors proclaim on their TV commercials, "Every market's different," which is their slimy way of saying, "Sure, prices are falling everywhere else; just not in your neighborhood!"
Oh, those wacky Realtors.
On the housing front -- and despite the fact we've seen positive price activity in scattered markets in the U.S. in recent months -- values are about to begin another descent as the global credit crisis/implosion enters its hair-raising stage, the stock market gets bludgeoned and another fifteen million foreclosures (including the existing, massive shadow inventory and what will become a growing wave of "strategic defaults") are brought to market over the next few years. When home values are cut in half after a 75 year run, is it possible they can be cut in half again? With ever-greater numbers of foreclosures, an even more intense economic recession and what will no doubt be eroding demand feeding the deflationary monster, bank on that rate of decline and more.
Real estate's own relief rally has been built on historically low interest rates, massive government subsidy including socialization of mortgage losses, socialized refinance giveaways and buyer tax incentives, the banking industry's wink-nod holding off on foreclosures ("extend and pretend"), and the corporate media's daily hypnotic suggestion ("you're getting sleeeepy") that the bottom is in. But take a moment to ponder this: What if mortgage interest rates stood at even 8 or 9%, Federal and state real estate tax incentives never existed, the Fed and Treasury left mortgage debt issues to the market to contend with and foreclosures were brought to market without delay? The answer is that values would probably have sustained another 50% haircut right off the top. But governments can only prop up markets temporarily; in the end, it's all about gravity. Finding a true free-market bottom will be a slow and painful process, and history will show that everything the government and policymakers attempted to do to keep the bubbles afloat ended up making everything that much worse.
"But if the real estate bottom isn't in, Steve, how low will it go?" Since my residential and commercial real estate predictions have been on point for five years now, I receive numerous emails asking me if the real estate bottom is in. The answer is an emphatic "no". Unfortunately, we are still several years away. The likely bottom will occur once the mother of all bursting bubbles (the inevitable U.S. bond crisis) forces interest rates up to at least 18-20% and brings real estate transactions to a virtual standstill. Ultimately, I expect values to decline to 1974-1982 levels, so anyone with considerable liquidity will find buying property at the nadir to be like shooting fish in a barrel. Of course you'll need cash.
Other signs the bottom will be near: Rural and some suburban ghost towns, scores of bankrupt and abandoned high-rise condominium developments worldwide, and government bulldozers leveling entire neighborhoods in an attempt to lessen the effects of rampant oversupply and blight.
Meanwhile, what would your home be worth right now if buyers had to pay all cash? As the credit bubble does a Hindenburg, the credit system will at some point lock down and the spigot will get shut completely off. Lenders will not want to lend (or won't be in position to), government will have no choice but to give up the "print money/socialize losses" ghost, borrowers will have little to borrow against and interest rates will be prohibitive anyway. When the whole thing goes kaphlooey, many with assets will choose to sell some for whatever cash they can get their hands on -- at least for a time. It will be a phenomenal time to buy the good stuff.
Care to join me? I'll no doubt be putting together a vulture fund when the time is right.
Commercial real estate will continue to experience declining values for much of the decade. Already hit to the tune of 40% nationwide, overbuilding in all commercial real estate sectors and ever-slackening demand will result in increasing tenant bankruptcies and consolidation, persistent vacancy and rapidly declining rents, not to mention higher mortgage interest rates. Spaces will sit empty for years to come. Absent massive discounts, the category will gradually fall out of favor with investors (and lenders) and capitalization rates will steadily rise. When interest rates eventually jump to 18-20%, real estate cap rates will be dragged along with them, at least for a time, for there will be no reason to deal with property headaches, vacancies and bankruptcies when higher passive yields are available elsewhere. Expect to see a lot of boarded-up windows and 16% capitalization rates -- even on "desirable" property -- at the nadir.
(Note: One real estate sector I do expect to perform relatively well: Senior affordable housing. As baby boomers approach retirement age and an extraordinarily high percentage of them stand to lose what remains of their net worth, governments will be forced to encourage and subsidize affordable housing for the demographic most vulnerable to the devastation of the Greater Depression).
Residential investment real estate will bring nothing but heartache. Apartment property values are already falling rapidly, vacancy is rising, tenants are losing their jobs and declaring bankruptcy, and late rents are commonplace. Add to it what's sure to be an intensifying trend of single folks doubling or tripling up and grown children moving in with mom and dad and, well, suffice to say this is an investment category heading absolutely nowhere. Add in all other coming macroeconomic effects and the downside to this sector is considerable. Get remaining equity out before it disappears.
Massive state and municipal budget cuts and layoffs are upon us; fat union contracts and unsupportable pension obligations just add to the problem. With tax revenues already in deflationary decline, intense budget pressure continues to build for the vast majority of state and local governments. Coming, additional waves of foreclosures will further erode the tax base. The "easy" cuts have already been made, band-aid solutions have been applied, borrowing from Peter to pay Paul is falling out of favor and credit ratings from coast to coast are about to get kicked in the groin. Not only will painful budget cuts increase unemployment further and take even more revenue out of circulation, in time many state and municipal entities will have no choice but to go the bankruptcy route. It's not only inevitable but necessary.
Bankruptcies will beget more bankruptcies. Once even a few high-profile "receiverships" take place, others are sure to see the benefit and follow suit. Union contracts and absurd pension obligations will be cast asunder or trimmed back to bare bones, adding yet more fuel to the deflationary fire.
Hold onto that job, gents. Given the amount of so-called "liquidity" (that's a good one) pumped into the system and socialist, slapdick government "stimulus" thrown wantonly about, the 9.9% unemployment rate (17% real rate) is a stunning policy failure at this point. Beyond that, the Bureau of Labor Statistics' "birth/death model" makes the statistic a relative farce anyway. Expect greater than 20% unemployment (35% real) five years from now. If you have a job, treat it like gold; be the first to show up, the last to go home, polish your boss's apple and try to make yourself indispensable in every way. Find a job in the foreclosure/bankruptcy industries or working for what will surely become a confiscatory I.R.S. Better still, invest in a bulldozer and a dump truck. I suppose I'm kidding, but at some point demolition companies will be in pretty high demand.
Gold/silver aren't slamdunks -- yet. I take a lot of ribbing from readers because my record on calling gold and silver for the last five years has been pretty terrible. And other than the big silver correction in 2008 (which tellingly took place within the first phase of the credit deflation collapse), I have for the most part been "early" on my call for the PM's to get caught in deflation's grip. But I believe the coming market slapdown will affect the metals yet again and to a greater degree. Non-confirmations on a grand scale (look at 30 and 3 year charts) point to a coming 60% silver sell-off, likely as the next leg down intensifies the liquidity crisis.
Gold has performed admirably early on in the unfolding crisis and will continue to outperform most other asset classes on a relative basis, but I see no reason to buy it before what is sure to be a major correction ahead. I'd rather make bigger money shorting the market with put options than nurse along a slogging investment, particularly when sentiment is overwhelmingly one-sided. A reversal looms.
But when the time is right, I will load up on silver bullion. I'd buy the yellow metal, too, but I think the U.S. government will ultimately decide to tax the bejesus out of gold "for the common good", if not confiscate it altogether. (Whereas, as an industrial metal, silver MIGHT fly under the radar). History does have a way of repeating itself and desperate government times will probably call for desperate government measures. Don't quote me on it, but silver might be the safer bet when the time comes.
Continue to live lean and mean and pay down debt. With things headed where they are, this is no time to loosen the purse strings. Continue to conserve wherever you can and pay down any remaining debt. Set aside cash safely to the extent that you can. The buying power of meaningful cash will be something to behold five years from now, and possibly sooner.
And before we say goodnight, a cool story: A few years ago, one of my readers -- J.D. Rosendahl -- contacted me via email which led to a couple of phone conversations and then to an enjoyable lunch. Given the fact he's a damn smart commercial banker, a long-term trend seer who definitely "gets it" and one helluva nice guy, a friendship quickly formed. Soon J.D. began writing Safehaven articles of his own, and the whole process interested him enough that he's now a full-blown daily blogger. I encourage you to bookmark his new site: www.roseysoutlook.blogspot.com along with Mish's outstanding blog: www.globaleconomicanalysis.blogspot.com and anything Mike Whitney writes: www.marketoracle.co.uk/UserInfo-Mike_Whitney.html. As a group, these fellows cover this developing story on a daily basis and from different angles, but always with insight and aplomb. If you want to survive the coming firestorm, proper and objective market analysis is paramount. I'll try to throw in my two cents from time to time, too. As always, thanks for the support.
NOTE: We'd like to hear about your recent real estate stories, experiences and anecdotes -- good or bad. We may feature some of them in upcoming columns. Feel free to send them to me at StephenLMoyer@aol.com or log on to our website ( www.ponderthis.net ) and post your comments for further discussion. Thanks.
Copyright © 2005-2008 Steve Moyer
He has been an investment real estate broker since 1982. He is a columnist and the assistant editor of the monthly newsletter, Ponder This .... www.ponderthis.net .
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