Posted by: Dwight Johnston | June 3, 2012

Mini- Housing Boom/Bust?

I haven’t posted anything on this blog in a while what with writing for, the California and Nevada Credit Union Leagues, and Callahan, but I thought I would post a few thoughts on housing. The next few weeks will be very interesting. The crisis point in Europe I have been expecting could be in the early stages. All bets are off then on everything, including housing.

Last week we wrapped up the months various housing reports with Existing and New Home Sales numbers. Both of those continued the trend of modestly more positive news in housing. As I’ve written in the past, I believe this is the year we can finally say the housing market bottomed and began a slow, gradual turn. But the challenges ahead aren’t insignificant. Incomes are not growing and most mortgages require substantial down payments. Additionally we don’t know how much supply will hit the markets from foreclosures this year and the next. The landscape for housing in indisputably better, but I fear that some of the articles appearing now might be misleading and encourage people to leap into the housing without weighing all the pros and cons.

I had to check my calendar recently to make sure I didn’t travel back in time after seeming some stories on housing. Over the past couple of weeks several leading newspapers have written stories about bidding wars breaking out over houses. The stories divide into two camps. On one side, the wars are over the shrinking supply of distressed homes as investors try to top each other to buy these properties. While it’s a good thing to see inventory leave the market, more is coming and we don’t know for sure if the investor crowd will remain so ravenous. But, more importantly, these articles often leave a false impression of what is really going on. They fail to report that the wars are mostly all cash bidders, but more importantly they fail to point on the reality of the sale prices. Some articles cited gains of 20% or more in areas in Florida and Arizona. That sounds fantastic until you look at reality. As an example, one county in Florida reported the median home price rose from $90,000 to $111,000 in just one month! Fantastic, right? But the records show that the median home price in that same area was $294,000 in 2006. The articles fail to point that out. So beware the hype about percentage price gains. It’s easy to make the gains look good when they are coming off such a low base number. Don’t get caught up in the hype.

The second type of battleground for bidding wars is occurring in some the priciest areas of the country. In the Silicon Valley homes are bringing multiple offers as the latest round of high tech bubble money is flooding the area. Other areas, such as Beverly Hills, are also seeing the bidding war phenomenon return. These areas are still crazy expensive, but the current prices are considered bargains. Homes that might have sold in 2006 and 2007 for $5 million or so are going for $3.5 million. Get ‘em while they’re hot! Here is what got my attention. One very happy realtor said he had not seen this sort of frenzied investor activity for homes since 2006 and 2007! Hmm. Are bubble signs already popping up?

The point of this discussion is that we’re beginning to read articles that make it sound like there is a new housing boom going on, and you’re about to miss out. The articles read as if they have been written by realtors. The accounts do make good headline fodder after years of relentless negativity on housing, but don’t let these sunshine reports influence your personal decisions. Rates are very low, which is a huge plus, and if you need and can afford a home in your preferred area it’s not a bad time to consider it. But do not get caught up in the hype and live to regret it. That happened to a few million people just five or six years ago. The housing market is far from fully healed. Investor activity is disguising what is really still a market in a nascent recovery. The frenzy will run out of energy long before the market runs out of houses.

Posted by: Dwight Johnston | February 13, 2011

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Posted by: Dwight Johnston | August 19, 2012

Computer takeover confirmed

I wrote this article about a week ago for a publication and thought I would post it here on the blog. This is something to think about. The theme of the article begins about five paragraphs in.

Computer Takeover Confirmed

Traders and market-watchers kept waiting all week for something to happen – anything. But, something never came, and anything was nowhere to be seen. The market is usually good for one or more days of big swings and volatility, but there was none of that last week. A very late rally in Friday’s trading took the Dow up 40 points from a low of -70 points; this created the only 100 point trading range for the entire week. The primary reason for the lack of action in the stock market was the lack of action in euro trading as the currency moved little last week. There were several weak economic indicators from Europe, but it’s obvious that stock traders want to wait to see what the European Central Bank President Draghi has in store for them. As you recall he is promising to “save the euro.” His first lifesaver for the euro will not be thrown until September. This could keep stocks on an even keel until then regardless of the news.

The only market that was active last week was the bond market. For the second week in a row, the bond market showed noticeable signs of fatigue. This was apparent when the U.S. Treasury came with its monthly sales of longer-term debt. Demand for the issues was the weakest in about two years. It appeared that the 10-year note might break above 1.75%, and speculative traders were talking about a move to 2% was in the cards. But the selling stopped suddenly for no apparent reason, and yields rose only slightly on the week. Mortgage rates are roughly a quarter percent off the very lowest rate of this cycle. A move to 2%, should it develop, would boost mortgage rates at least another quarter percent. This is something to keep in mind if you’re shopping for a home or looking to refinance your home.

The lack of economic news last week will be made up for this week as several important numbers hit the tapes. Retail Sales will be released on Tuesday, and this is the biggest number of the week. After three consecutive months of declining sales (the first time this has happened since 2008), economists are expecting sales to turn higher. Most reports from major retailers for July indicated better sales as back-to-school buying kicked in. This is the report to watch.

We’ll also get Industrial Production, the inflation indexes, and Housing Starts along with a number of other minor indicators. After three months of generally weaker-than-expected economic data, the numbers this week will be critical. Surprises to the downside might confirm more than your garden variety seasonal respite. Of course stock traders won’t necessarily react to bad news. In addition to having the Draghi promise to look forward to, they also believe that Bernanke will kick off another round of money printing should our economic numbers continue to recede.

I’ve talked a lot in the past about how computer trading has taken over the short-term trading in stocks. News, economics, and fundamentals are irrelevant in the world of computers. Complex algorithms, seemingly currently tied to the euro, trigger trades that amount to 70-80% of the daily volume. Some of you might be skeptical of that viewpoint, but I heard someone last week in a position to know to verify that view. The CEO of one of the largest high-frequency trading firms was interviewed on CNBC last week regarding criticism of the impact on the markets by high-frequency trading. The CEO was surprisingly direct and strangely robotic in his answers, especially when the interviewer challenged his views. He reminded me of Hal in 2001 Space Odyssey, except for the fact that the CEO had a face. He mentioned but didn’t spend much time on the common claim that high-frequency trading provides liquidity to the market. That’s a farce, and everyone knows it.

To his credit, sort of, he cut to the chase and stated flatly that the individual investor has no business trying to trade this market short-term and should stop trying. He said the computers are in charge now and high frequency trading is only going to grow in its dominance. When challenged by one outraged interviewer, he said it’s okay if investors want to buy stocks for the long-run based on fundamentals. (Generous of him don’t you think?) He said the computer programs don’t recognize or factor in anything like economic or earnings data, but individuals can’t compete with computers in the short-term. Some of the questions got pretty intense as the interviewers were probably trying to shake him. After all, CNBC depends on individual investors tuning in daily in hopes of getting investment insight to make money. But there was no shaking this guy. He simply calmly restated his positions that computers are in charge now, and there is nothing you can do about it. I swear the guy was a robot or cyborg. He went on to say that the algorithmic programs “learn” as they trade and will always stay several steps ahead of human decision making. I give him an “A” for honesty but an “S” for scary.

This is not really a surprise if you’ve observed the markets over the last couple of years. It’s clear that rational human beings aren’t making these decisions. Now, if we can just get CNBC and business scribes to stop saying “investors bought today” or “investors sold today.” Investors have nothing to do with it. This is not to convince you to get out of stocks, but the cyborg trader has a point. Trading in the short-term has gone to the computers. The only reasonable way for individual investors to stay in the stock market is to invest in a diverse portfolio of funds or stocks that can stand the test of time over the long-term.

But make no mistake about it, short-term trading can impact the long-term. Big downswings in the stock market can undermine business confidence and can unnerve and drive away individual investors in stocks at just the wrong time. Big upswings in stocks for no good reason can also lure investors into the market at just the wrong time. Stock prices can also influence interest rates, even for short periods of time, which can impact your mortgage rate. The cyborg trader seemed to suggest we go about our lives and leave the stock market to them. It’s not as benign as he made it seem. Not only does the short-term influence the long-term, but as computers become even more dominant the risk of a repeat or worse of the “flash crash” of 2010. The regulators are the only ones that can fix this, but they seem unwilling to address the issue and are just hoping that nothing “bad” happens. In this regard, they remind me of the leaders of the European Union. They are just hoping nothing bad happens. Hope is good, but it’s not a solution.


Posted by: Dwight Johnston | February 13, 2012

Buffett v. Gross

In case you missed it, there was an epic smackdown last week between Warren Buffett and Bill Gross of PIMCO fame. It wasn’t actually a smackdown, but on the same day it was revealed that Bill Gross had ramped up the holdings of U.S. treasuries in his mega-bond fund to 38% of assets, Warren Buffett said that treasuries was the most “dangerous” asset class in investments. Warren has a point. At this level of rates, the price risk in longer-term treasuries is huge. Investors can buy high-quality dividend stocks at yields well above bond rates and can participate stock rallies. I am certainly not one to argue with Buffett, nor am I a huge fan of Bill Gross. But Buffet is forgetting one thing.

After the double knock-out blows of stock market and home equity meltdowns, for many investors it’s all about return of principal, not return on principal. You’ve probably heard that before. Many individuals, especially those in or near retirement, simply cannot afford to risk money on stocks. At least with bonds, you know you will get your money back on a fixed date. That’s simply not true for stocks. It’s entirely conceivable, given the European risk, that stocks could fall by 40-50% from this point. And, there is no guarantee that stocks would bounce back this time. Consider Japan. Over twenty-two years ago the double collapse of stocks and home equities struck, and today the Japanese stock market index remains at roughly 25% of its peak and the 10-year note rate in Japan has been stuck near 1% for over a decade. Bond investors are actually earning more on a deflation adjusted basis. Investors at first resisted switching to all Japanese bonds for the first ten years, but surrendered to staying in bonds after countless false starts.

It’s not just individuals who opted for return of not on principal. Global institutions and central banks also gorged on our mortgage backed bonds. Today those entities still want the safety of U.S. assets but not the risk. Those huge funds have flowed into treasuries at the sacrifice of returns. Pension funds could be next, but there will have to a revolution in re-writing pension benefits first.

We are likely in a different world in which a once in a lifetime secular event has taken place. In the Buffett/Gross smackdown it’s awfully tempting to bet on Buffett, but this could be a Gross world.    

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