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The Economy in the Plastic Bubble

March 21, 2013 9 comments

We’re going to leave behind the topic of Cyprus for a day. It does seem as if events are coming to a head, but with banks there closed until Tuesday (and the ECB lifeline in place until Monday), there will be lots of news over the next few days but most of it will be heat without light.

So, speaking of heat and light, let’s look at today’s data. Specifically, let’s look at Existing Home Sales.

While the total sales number fell just shy of the 5mm-unit level, the 4.98mm print still represented the highest number (aside from the home-buyer-tax-credit induced surge in 2009) since 2007 (see chart, source Bloomberg).

etsl

The inventory of homes available for sale bounced off of 14-year lows, but remains at levels lower than any we’ve seen in over a decade.

And, near and dear to my heart, the median price of existing homes accelerated from last month (although, due to historical revisions, last month’s y/y was revised down to 10.67%) and stands at 11.34%. The January Home Price Index from FHA also came out; the 6.46% year-on-year rate of increase in that index is also the highest post-2007.

There are long lags between both of these indices and the appearance of price pressures in the Consumer Price Index, but at the moment all indicators of housing point the same direction: Owner’s Equivalent Rent should be in the 2.75% neighborhood by year-end, and could be as high as 3%. This is a key part of our forecast that core CPI should reach 2.6%-3.0% by year-end, and accelerate further in 2014.

The amazing recent run in home prices – which I suspect is driven in part by institutional investor interest in real estate – has caused existing home prices as a multiple of household income to move above levels that prevailed for the last quarter-century of the 20th century. The housing industry likes to present charts of housing affordability, which takes into account the current level of interest rates, because currently those interest rates make even the relatively high home prices look more affordable.

Yes, I said “relatively high home prices.” The median sales price of existing homes averaged 3.36x median household income from 1975 to 2000, with a relatively small range of values around that average. Even including the bubble, when the multiples reached 4.8x, the average through 2011 only rose to 3.54. As of year-end 2012, the multiple was back to approximately 3.48 and if median prices rise “only” 8% this year (remember, the current pace is 11.3% and rising) the multiple will be around 3.6x by the end of the year (see chart, source U.S. Census Bureau, National Association of Realtors, Enduring Investments).

medpricevsincome

Notice that even at the depths of the crisis, home prices were only slightly cheap by pre-2000 standards. Similarly, equity prices at the lows only reached approximately fair value by pre-2000 standards. There are two interpretations of this fact set. It could mean that the pre-2000 era valuations were too low, and that modern financial markets and structures make higher valuation multiples permanently viable. Or it could mean that the Federal Reserve continues to artificially support markets at multiples that are not likely to be sustainable in the long run. I suspect the latter point is more accurate, although I am open-minded about whether the former point might have some validity.

This isn’t necessarily a bad strategy, if the idea is to let the market stair-step down to equilibrium rather than letting it crash there all at once. But I don’t see anything that suggests the Federal Reserve has the slightest idea how to value assets. I understand that they don’t want to substitute their own analysis for the market’s judgment (at least, that would be the counterargument), but that’s what they’re doing anyway – with no indication that they plan to back off anytime soon. The Fed is just more comfortable in the bubble, and afraid to leave it entirely. But don’t we have to, eventually?

The VIX returned to 14 today, which makes a bit more sense to me than the 12.7 level of yesterday. It still seems low to me, but at least there is a way for long-vol positions to actually lose.

Real Estate – A Good Investment Again?

May 22, 2012 2 comments

After the comparatively high-volume selloff on Friday, the stock market responded with a low-volume rebound on Monday (except for new IPO FacePlant, which is now 18.4% below the IPO price) and a low-volume, water-treading session today. Monday’s rebound was punctuated by chirps of “oversold!” from certain financial news networks, but unfortunately nothing fundamental has changed other than the price.

Existing Home Sales were reported today as-expected. Inventories of existing homes rose, but this was strictly in line with the normal seasonal pattern (see Chart, which I mainly show to illustrate a neat new Bloomberg function I discovered).

Using the same style chart, though, consider what happened to the median sales price of Existing Homes. Ordinarily, the non-seasonally-adjusted price in April is down 0-5% from year-end prices. This year, though, NSA prices are up about 10%.

To the man who has a hammer, everything looks like a nail, it’s true. But to me, this is a remarkable chart that smacks of asset price inflation in housing. Consider that Existing Home Sales, at a 4.62mm seasonally-adjusted pace, are running at about 65% of 2005’s pace, and only 88% of 2000’s pace. The pace of sales is still quite a bit depressed, in other words, yet the year-on-year rise in prices is about 10.4% (see the chart below, which is a more-normal time series). Prices in other words rose much more-rapidly in April than they typically do at this time of year, despite the level of unemployment and other, various measures of economic softening.

Don’t read too much into one month’s data, even if it is entirely consistent with what should be happening given the accelerating rise in bank lending and the persistent rise in money supply. But be wary.

Housing is, as I’ve been writing for a while, near fair-value or even slightly cheap after a long period where it was overvalued compared to traditional relationships to income and rents. (The same people who today tell me I am too bearish on stocks are the ones who told me I was too bearish on housing back in the mid-2000s.  But I’m not even that bearish on stocks – I’m just not bullish enough for some people!) It is, as commodities are, a classic “real asset” that doesn’t return very much, but tends to keep up with inflation over long periods of time. It ought to respond to money growth, now that the bubble seems to have run its course. However, I’m as surprised as you are that it seems to be happening – I thought, as did many of you, that housing prices would fall straight through fair value and become cheap. And they probably would have, had central banks not printed so much money.

Ironically, the other classic “real assets” are commodities, and they continue to get pummeled. The DJ-UBS index lost another 1% today, with grains and softs losing 3.4% and 2.4% respectively. I think that what is happening is that since commodities are traded and consumed internationally, it is easier to get confused about the role that the global growth dynamic should play. Case in point is cotton, which was -3.9% today and now sits 68% off the highs from March 2011. Someone in China mentioned that yarn production may drop below 20 million metric tons this year, from 20.5 million last year, due to weak global growth. -0.5 million tons translates into -68% on the price? That’s one inelastic supply curve! But weak global growth clearly shouldn’t really affect the price of a house in Idaho, so this error doesn’t translate as easily to housing as a real asset. Therefore, housing prices are now rising (maybe) while commodity prices trade incredibly cheap (although gasoline futures prices rose 5 cents on Monday).

It has been a long time since it was worthwhile to watch the housing numbers, but today’s pricing data raises my interest in the New Home Sales figures tomorrow (Consensus: 335k vs 328k). It isn’t the number of new sales that interests me; that number is low and even with a high-side surprise will continue to be low compared to old standards for a long time. But since the inventory of new homes is at a life-of-series low (see Chart) I will be looking for signs that the bids are starting to reach up for the offers.[1]

The median price series for New Home Sales isn’t as smooth as the one for Existing Home Sales, simply because the absolute number of sales is much smaller. But if there really is something going on in home prices, I’ll expect to see it in New Home Sales in the next month or two as well.

In any event, with 1-year CPI swaps ending today at 1.44% and 2-year swaps at 1.69% – let’s just say I wouldn’t want to be caught shorting that market at these levels! Core inflation is at 2.3%, so you’d better be expecting either a sharp fall in core or a huge drop in gasoline prices. Neither appears to me to be in the cards – there’s a better chance of gasoline prices falling in the near-term if there’s an economic train wreck in Europe, but in that case go out another year: the 2-year at 1.69% implies 1y, 1y forward inflation of only 1.94%.


[1] As an aside, a reader in Phoenix told me recently that bids there and in Vegas have been getting jumpy recently, all of a sudden starting a few months ago. “Pull up Redfin and try to call an agent about a property in Mesa, Tempe or Scottsdale.  If a house is out on MLS more than a day they likely have 10 bids stacked with an agreement above the ask. This just started ~60-90 days ago and has accelerated.  Crazy, like no one remembers 2008-2010.” It was an interesting anecdote – but now the data are reinforcing that observation.

Son Of “Risk Off”

March 22, 2012 5 comments

Although the last few days’ worth of trading is consistent with the type of trade we have periodically seen over the last year or two, referred to with the hackneyed description “the risk-off trade,” it isn’t much risk and it isn’t far off.

After a 21% rally in the S&P since November, prices now stand a whopping 1.2% off the highs. Wow, time to get in!

After 10-year note yields rose 45bps in two weeks, they have now fallen 10bps. Be still, my heart!

Spanish 10-year yields, down from 7% in November to 4.8% earlier this month, have reversed the February rally from 5.41% to 4.80% to return to 5.47% – only 153bps below the high yields. Calamity!

Ten-year inflation swaps, which began the year at 2.25% and closed at a high of 2.75% two days ago, drooped all the way to 2.68% today. Tantamount to deflation!

Hey folks, cool it. Nothing much has changed, yet. Initial Claims today was 348k when 350k was expected. Housing Starts on Tuesday recorded 698k rather than 700k. Existing Home Sales showed 4.59mm rather than 4.61mm. There are disappointments, and then there are disappointments. This is the disappointment that sends a stock lower if the company doesn’t beat the “whisper number,” even if the earnings are still great.

Markets will, though, probably get a boost from the comments of Chicago Fed President Evans, who commented in a speech after the markets closed that “clearly more accommodation would be appropriate.” I assume he is speaking about monetary policy and not the size of his hotel room, and if so then it’s a remarkable statement to be made about an economy that’s growing at or above a 2% rate of growth. Dallas Fed President Fisher, on the hawkish side of the spectrum, says on the contrary that he won’t support further quantitative easing, but that’s not really a surprise. In any event, there’s clearly disagreement at the Fed about further QE. That’s almost mind-blowing to me given that we are not in a state of crisis, most policymakers tell us we shouldn’t worry about a resumption of financial crisis, and economic growth is doing fine (although it’s not booming!) with the exception of some clear signs of inflationary pressures. If they can’t get fair unanimity about holding off on QE3 now, then either they know the chances of further disaster are not as remote as they say, or QE3 will be on the table forever.

This was, in any case, roughly the right place for the bond selloff to take a pause. The chart below gives the very-long-term monthly closing chart of the secular bull market in bonds. As with any long-term chart of a series bounded by zero, as nominal yields are, the chart makes the most sense logarithmically. The very regular decline in yields had a false breakout in 2008, a re-test of the lower line (which I took at the time as the turning point of the whole bull market, incorrectly), and then a more-durable breakout over the last year.

The selloff so far has taken us slightly inside the lower trendline, which is an unstable position. Either yields should move somewhat higher from here, exiting the area of the trendline, or this should represent just a re-test of the breakout and lower yields are to persist for a while. My view is that the selloff we are currently experiencing, which is in line with normal seasonal patterns, should result in no less than a return to the channel and a migration back slowly towards 3% 10-year yields. However, we have to keep in mind that the breakout from the natural, secular decline corresponds to the Fed’s direct and almost unprecedented manipulation of long-term interest rates (I say “almost” because the Fed back in the 1940s pegged long-term interest rates, but the market was much smaller then).

This chart, as much as any other, shows how unnatural the intervention has been, in disturbing the market’s natural rhythms. That also means that the Federal Reserve is rowing against the tide, but so far they have been successful. I can’t rule out the possibility that a QE3 might hold rates near 2% (although it is hard to see them much lower than that, in any case, while there are massive deficits and rising inflation), but I take the bearish view.

Although TIPS remain expensive, they are nonetheless still cheap to nominal bonds. Now that breakevens are 35bps wider they aren’t as cheap as they were, but I still vastly prefer to own TIPS at a -0.10% real yield than nominal Treasuries at 2.28%: what could well end up being a much worse real yield.

Neither Trumpets Nor Bomb Blasts

February 22, 2012 Leave a comment

Today, finally, we can focus on the domestic situation. While the matters in Greece are far from resolved, and are generating the usual amount of chaotic-looking discussion about what exactly the “deal” is supposed to mean, and for who, and whether everyone who needs to be a party to the deal actually has in fact signed off on the deal. So far the early returns are not promising, but there were neither trumpets nor bomb blasts today and we will therefore leave it behind for a day.

It seems odd to actually think about the economic data for a change. Today’s Existing Home Sales data, though, are worth thinking about. With good weather providing a boost, January Existing Home Sales ran at only a 4.57mm seasonally-adjusted pace, below expectations and with a hefty downward revision to last month’s data. Unless the seasonal adjustments are being made based on the previously-misreported-by-NAR data…and I can’t imagine that mistake being made…this is simply a weak number. Bloomberg’s initial take was “Sales of Previously Owned U.S. Homes Increase in Sign Recovery Taking Hold,” but then they realized that the 4.57mm was below the previously-reported pace of December. That is, the only reason there was an “increase” is that last month’s data were revised lower. (Bloomberg later dampened down the headline).

The good news in the report is that housing inventory dropped to the lowest level since 2005. This provides a bit of support for home prices, but it also suggests that bank REO property isn’t yet coming to the market in any quantity. If that is the case, then one interpretation of the low sales figures could be that homebuyers are waiting for the foreclosed inventory to begin to hit the market. It’s not a bad strategy, if you see shadow supply that is suddenly freed, to let the supply be listed before negotiating on your dream home.

But perhaps I am reaching. European PMI data, out this morning, fell unexpectedly into contraction territory. It would not be a difficult stretch to imagine the economy stumbling over the next quarter or two; in fact, many observers have predicted just that. I suspect the U.S. will withstand a Greek default and potential Euro exit, but I also don’t expect strong growth. Weak growth, rising inflation is what I expect.

Consistent with that theme, for the second day in a row, equities struggled (today -0.3%) while commodities rallied (DJ-UBS +0.4%). Industrial metals led with a 2% gain while Energy commodities rose 0.6%. Front gasoline is now up 25% since mid-December.

The 10y Treasury note rallied a surprising 6bps to 2.00%; TIPS rallied more, so that 10-year breakevens (or inflation swaps) rose about 1bp. Again, this is somewhat interesting in the context of weaker housing and European PMI data, stronger bonds, and weaker equities. It is consistent with the notion that the underlying inflation process has some momentum. I want to share a chart here of one component of CPI, the Apparel major subgroup. Many of the economists who are calling for core inflation to moderate point to housing supply (as do I), but many of them also point to Apparel as a component that has recently been rising but which they expect to correct because everyone knows that Apparel prices never go anywhere. Or at least, they haven’t gone anywhere for a long time. The chart below (Source: BLS) illustrates the point.

From 2003 to 2011, Apparel prices were unchanged to lower. And from 1999-2003, they trended lower. Indeed, since 1994 or so Apparel prices have gone sideways or down. So it’s not an unreasonable supposition that a rise in Apparel prices ought to mean-revert, so any effect on core CPI ought to be ignored. Except for one thing, and that is that you can see from the chart Apparel prices haven’t always trended lower. It isn’t somehow a law of nature that Apparel prices decline all the time. Over the last two decades, as more and more clothing was produced and exported from developing Asia, there was a constant downward competitive pressure. But that may no longer be the case. The recent rise in the Apparel subcomponent looks to me a lot more like the pre-1993 period than it does the post-1993 period.

By the way, I picked from 1987 just because it was enough data to make the point. But so you don’t think 1987-1993 was the unusual part, here’s the whole chart back to 1960.

Rising apparel prices are much more normal than declining apparel prices, in the grand sweep of history.

Here’s another inflation-related story. The Atlanta Fed’s “macroblog” posted an item today entitled “Weighing the risks to the inflation outlook: Two views.” Since any hint that there might actually be two views among the one thousand economists at the Federal Reserve gets my attention, I read this story. It’s interesting for a couple of reasons. The humorous reason is that the authors seem to see nothing curious about their first chart, which shows that the respondent firms to their survey have had incredibly stable expectations for short-term inflation. Unreasonably stable. Suspiciously stable. As an econometrician, I’m tempted to throw out such obviously useless data, unless I first investigate and find there is a good reason that, with oil prices gyrating wildly and Europe imploding, business owners don’t change their opinions about year-ahead inflation.

But that’s not the main point here. The main point is the authors’ observation about the reason for the fact that longer-term expectations are higher, by a full percentage point, than the shorter-term expectations. They conclude that while they agree on the central tendency for inflation over the short and long term being in the 1-3% range, in the short-run the respondents give a slightly higher chance for a lower outcome than they do for a higher outcome…but in the long-run, the respondents give a much higher chance for a higher outcome (more than 3%) than for a lower outcome.

This is interesting because the Fed cannot affect prices in the very short term, and the respondents seem to be saying that they believe the Fed to be asymmetrically biased to increased inflation in the long-term. Of course, this comports with history, and it is a theme I have been hammering on for a while: whatever you think the likely outcome for inflation over the next 10 years, almost all of the long tails are to higher inflation rather than lower inflation. Accordingly, you can think of long-term inflation swaps or breakevens as consisting of a forward contract plus a call option on inflation. And I think that means market prices for long-term inflation ought to be a lot higher.

Nomination For A New Villain

December 21, 2011 10 comments

It seems very strange to find myself suddenly on the more-optimistic side of opinion when it comes to the situation in Europe. That isn’t to say that I am optimistic in an absolute sense; I still think that the Euro will either fracture or dissolve, a number of banks will fail, be nationalized, or be zombied, and several nations will default or restructure debt significantly (although if the Euro disintegrates, then inflation in some countries may take the place of an overt default since countries will then control their own currencies and have that alternative). I think that still places me squarely in the long-term pessimistic camp. But I am more optimistic about the near-term trajectory of the crisis.

Maybe even “optimistic” is too strong. I suppose I just think that the huge ECB program is the best real attempt that the European policymakers have made so far to at least extend the game. Unlike all of the other measures that have been taken (or hinted at being taken, or promised and not taken), this is the first one that has at least a chance to push off the day of reckoning. Yes, as I wrote yesterday, there are lots of things that can still go wrong but there are at least incentives for the cartel to remain together for a while.

The solution so far looks to be just naked printing in everything but name. The take-up of the 3-year ECB lending facility today was an enormous €489bln, a number which will likely grow to be more enormous before it shrinks. And there is just no way that I can see that the ECB can sterilize the activity on such a scale. I could be wrong. I always could be wrong. But whatever this does for the ‘ol can, it certainly seems to represent another goose for the global reflation trade.

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The other big news on Wednesday was the National Association of Realtors revisions to past Existing Home Sales and inventories. Sales from 2007-2011 were revised down 14-15% and inventories as well. The main ‘technical issue’ was that beginning in 2007 some houses and sales were double-counted when they showed up in multiple listings, and there were several related issues of that ilk (all of which, it seems, inflated sales). Changing the data doesn’t really change the depth of the crisis, but we now have a better idea of how deep the crisis actually was. But one Wall Street economist who shall remain nameless wrote this in his/her analysis:

“…the revision does NOT imply that the NAR has deliberately been cooking the books over the past few years, trying to paint an overly rosy picture of the housing market. There were genuine data issues to be overcome.”

Sure, and interestingly all of the data issues began in 2007. Hmmm, what else was happening in 2007? Oh, I remember – existing home sales were beginning to fall alarmingly (see Chart, source Bloomberg). The white line, which represents the original release for the pace of sales, actually rose in early 2007, right when the actual sales, based on the revisions, were falling off a cliff. The NAR at the time was assuring us that the market was healthy, and somehow their estimate of sales was suddenly off by a 1mm units/year pace and no one thought anything was funny with the data. Sure.

Bloomberg chart showing original release and new, revised level for Existing Home Sales.

The fact that home sales fell more steeply and more deeply than was previously thought would have been great information for policymakers to have had in, say, 2007 when the Federal Reserve was holding the Fed funds rate steady and considering hiking further. I wonder what would have happened if, data in hand, the FOMC had started easing 9-12 months earlier than they ultimately did. It’s an interesting thought experiment. Why is it only bankers’ heads that should be hoisted on a spit?

The “new” trajectory of sales has another implication. It makes it even more amazing that core inflation never declined. The housing crisis was significantly worse than we had thought, which makes the arguments of the classical economists even less defensible than they were. By all that is good and holy and Keynesian, the core price level – nearly half of which is housing – should have declined. In only two months out of the last 48 have prices declined on a month-over-month basis, and one of those was so marginal it rounded to 0.0. The only meaningfully-negative month, January 2010, saw a -0.13% decline in core inflation. The worst recession in 80 years had almost no effect on prices. Does that evidence count for anything?

Pardon the rant, but it continues to baffle me that this even remains a debate.

Tomorrow, I plan to write my next-to-last comment of the year, and look at one or two items from the Z1 data release that the Fed put out earlier in December. Ordinarily I get to it sooner, but the story has been constant for quite a while. There is one interesting little twist this quarter, and I want to bring it up before I forget it. The last comment of the year, which will come out sometime next week, will be my year-end portfolio-allocation exercise.

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