Tuesday, February 8, 2011


In watching the market and listening to the financial media, I'm hearing two certainties these days on the part of investors:

Certainty No. 1: The bullish crowd continues to outsmart the bearish remnants -- look, stocks have hit another high this afternoon. (It's Groundhog Day all over again.)

Certainty No. 2: The investment rationale of the bullish talking heads is also constant and consistent -- a high level of uncommitted reserves by the retail investor, abundant corporate liquidity, conviction of $95/share S&P profits, contained present inflation and inflationary expectations, imminent jobs growth, monetary policy anchored at zero, interest rate advances will be muted and manageable, the budget deficit is not an immediate problem for equities ("due bills" come later), housing is on the verge of recovery, valuations are reasonable and the administration's more centrist policy is market- and business-friendly.

The question is, how much will investors pay for this optimism -- whether misplaced or properly placed?

Enormous numbers of workers are in grave danger of being left behind permanently. Businesses have figured out how to prosper without putting the unemployed back to work in jobs that pay well and offer decent benefits.

Corporate profits and the stock markets are way up. Businesses are sitting atop mountains of cash. Put people back to work? Forget about it. Has anyone bothered to notice that much of those profits are the result of aggressive payroll-cutting -- companies making do with fewer, less well-paid and harder-working employees?

For American corporations, the action is increasingly elsewhere. Their interests are not the same as those of workers, or the country as a whole. As Harold Meyerson put it in The American Prospect: "Our corporations don't need us anymore. Half their revenues come from abroad. Their products, increasingly, come from abroad as well."

The schism between the middle class (or screwees) and flush corporations is growing ever more conspicuous. This is not meant to be a statement of class warfare or a political view, rather it is meant as an accurate economic statement.

The market has clearly looked through and dismissed this issue and is ignoring its potential consequences, as it focuses on more constructive developments (corporate profit growth, an expansion in merger and acquisition activity, positive stock price momentum, etc.).

Under normal conditions, housing would be poised for a dramatic turn to the upside for the following reasons:

* Until recently, mortgage rates were at generational lows.

* New-home production has been on the descent for three years, and current levels of production are at historically low levels.

* With mortgage rates low and home prices 30% below 2006-2007 highs, affordability is at a multi-decade high, and the benefit of home ownership vs. renting is at 15-year highs.

* Continued migration into the U.S., steady population growth and normal household formations should provide meaningful pent-up demand against the aforementioned underproduction of new homes.

Unfortunately, there is nothing normal about the current (and past) housing cycle.

* Abusive mortgage lending (low-document and no-document loans) and death-at-birth mortgages (pay option ARMS, interest-only and ridiculously ballooning mortgages) coupled with the Great Decession provided a toxic cocktail and produced an unprecedented drop in home prices.

* Owners and prospective buyers were in shock, and a large shadow inventory of foreclosed and (very) delinquent began to emerge.

* As home prices began to decline, the speculation in housing subsided, and, as home prices slipped more precipitously, the speculators (and "daytraders of homes") were eliminated from the marketplace.

* Houses were dumped into the market, and the shadow inventory grew geometrically.

* In the end, the shock effect of a Black Swan-like 30% drop in home prices has soured traditional buyers away from home ownership in favor of renting (a market that is now thriving/booming).

* The tail risk of housing's last cycle emerged as abusive lending practices (and "shortcuts") surfaced, robo-signing mortgage-gate disrupted the housing market, and available credit was steadily withdrawn, among the increased confusion, in the mortgage market.

Again, it's different this time, especially in the jobs market and in the U.S. housing market.

No comments: