Yes Virginia...It's a Bubble...

[don]

California Bubbly: Riding the Wave

One thing to understand about California housing is that boom and busts are central to the market. It is fascinating from a psychological standpoint that today, many think that California housing is a simple and safe bet. Casually, they forget the massive destruction that occurred only a few years ago and the echoes of the impact are still around: low inventory, massive Federal Reserve intervention, and a shift to investors buying homes. Looking to buy? Gear up for a sizable down payment and maximum leverage on a low interest rate. Also, it is easy to forget that 1,000,000+ Californians lost their homes via foreclosure and many today are still underwater even with the recent boom in home prices. Even with the trend to higher prices, people have the choice to buy or rent. Unlike stocks, most households have to make the analysis of buying or renting. In spite of rising prices and the meme that home values will only go up, the homeownership rate in California has plummeted. The state is seeing a wave of households opting to rent. This trend started in 2005, while home prices held a plateau up until 2007.

In housing, trends reverse slowly. Take a look at 30 years of housing data for the LA/OC markets.30 years of trends in the LA/OC marketThe boom and bust cycle is simply part of the California market. We’ve had a nice boom driven by investors and low inventory recently. But investors (those with big wallets) have pulled out dramatically early in 2014. Yet momentum is shifting but the question is, what will come about this change? People also forget that the stock market is on a six-year tear and California, especially the Bay Area has a deep connection between the two. Stocks are up and real estate follows. It is interesting to see that the stock market this year is also unsure of what it wants to do.It might be helpful to look at the Case-Shiller Index for the L.A. market. The index also pulls in OC data so it is a nice overview of a very big market. Here is data going back 30 years:



The blue line is the Case-Shiller Index with no adjustments. You can see the recent big bounce up. The red line shows momentum changes in the form of year-over-year changes. You can see that the trend is definitely heading lower. Of course, these changes happen over years. For those in the market looking at a $700,000 crap shack, you are really betting against the above chart. It is interesting that many in California will look at the stock market as some kind of risky proposition, even when placing a $50,000 bet. Yet some see no problem buying a $700,000 home requiring a $140,000 down payment to get down to a modest monthly mortgage payment. A small 10 percent correction (see chart above) would wipe out a nice chunk of change. Those going in with low down payments might be in a position where equity is at par (or below given selling costs).More to the point, price-to-income ratios are incredibly out of whack. It is interesting to see the justifications today for why prices are high. There is a reason why the LA/OC market is the most overpriced in terms of housing. Not New York. Not San Francisco. Not Chicago. It is the LA/OC region and you know why? Because relative to the other areas, incomes here are simply not that high. This is also a reason why we see more booms and busts here. Take New York City:


You notice how prices didn’t take a massive hit like the LA/OC area. You know why? Because unlike New York City, the LA/OC market is one giant urban sprawl that isn’t land locked. That is a massively important point to note. Also, incomes in NYC are simply better than in L.A. and Orange County. Forget about population density:



And that is merely for L.A. the city. L.A. County has 10,000,000 people and many are looking to buy in L.A. County cities, not L.A. With that said, the homeownership trend for California has been moving lower over the last decade:



Simply put, this means more renting households and fewer buyers. This young group of future buyers is unlikely to materialize, at least with current incomes. We’ve already highlighted that 2.3 million adult Californians are living at home with their parents. Wages are simply not keeping up with price gains or even rent increases. The last boom was driven by low Fed rates, hot investor money, and a lack of inventory (you notice how higher incomes or booming sales are not driving prices up).But if you want to buy, here is a nice and bright home in Highland Park:



6071 Roy St,Los Angeles, CA 900423 beds, 1 bath 1,231 square feetThis place sold for $90,000 in 1986 (the current tax assessment is $165,228). The current list price is $599,000 (in other words, $600,000). Just think, you’ll enjoy this bright colored home and you’ll have the privilege of paying property taxes 3.5 times higher than the current Prop 13 rate. This is a perfect hipster/Taco Tuesday home (make sure you get $120,000 for a nice down payment).

In 2011 the Zestimate on this place was $366,000. Now you “need” to pay $240,000 more but for what? So how do you justify a $240,000 (a 65% jump) price move in a mere 3 years. For the privilege of living in Highland Park. And they say real estate isn’t a speculative market. Look at the historical data here and you will find out that California is all about boom and bust. The LA/OC market is the epitome of this.

[Polish_Silver]

Re: Yes Virginia...It's a Bubble...

The dollar has gone up more than 10% against almost all currencies in the last year or so. But the fall in imports is surprisingly large. This doesn't bode well for commodities exporting economies.

For those who are well traveled in China will know that China has a large consumer economy (the largest consumer of iron ore, cement, cellphones, television, etc) - although relatively small as compared to exports - so the steep fall in commodity prices more than offsets the fall in exports.

Except for oil, what is the US importing less of ?

[gwynedd1]

Re: California Bubbly: Riding the Wave

For a house with 900423 beds that isn't too bad, but with only one bath I'd shower at the gym.

I know. Shame on me...

Though I would not make the same mistake Keynes made about WWI. He said the combatants would run out of money . He wasn't considering a foreign source like the US. China is propping up the California real estate market as we speak.

[don]

Re: California Bubbly: Riding the Wave

For a house with 900423 beds that isn't too bad

zippy-do-dah bunking . . . .

[touchring]

Re: Yes Virginia...It's a Bubble...

Except for oil, what is the US importing less of ?

You could import the same quantity but the value will fall if unit price falls.

[lektrode]

Re: California Bubbly: Riding the Wave

dlt the dbl...

[lektrode]

Re: California Bubbly: Riding the Wave

zippy-do-dah bunking . . . .

talk about yer couch-surfing potential...

One thing to understand about California housing is that boom and busts are central to the market. It is fascinating from a psychological standpoint that today, many think that California housing is a simple and safe bet. ....

But if you want to buy, here is a nice and bright home in Highland Park:



.....
In 2011 the Zestimate on this place was $366,000. Now you “need” to pay $240,000 more but for what? .

well.. 600grand is still cheaper than anything over in santa monica or the south bay...

kinda chump change, eh - unless one is into soul surfin - never mind if yer lookin for the Real Deal, aka THE Banzai Pipeline

The ventures - PIPELINE

nice one! - but this is a MUCH BETTER version (of one of my faves):



even if ole dicky boy is/was no match - even in his best days - for stevie ray, IMHO

[GRG55]

Re: Kaisa on Brink of Dollar Default Spooks World’s Money Managers

Yes indeed. That is why I prefer to try to track these themes on a single thread or I will sometime resurrect an old, dormant thread and update. Whether it is China, the crisis in Europe, housing in California or, now, Canada, or most other macro economic situations, they all tend to last longer and inflate much larger than any of us could have imagined. It's useful to be able to look back at the discussions and see what we can learn that will help us profit from greater understanding and investing appropriately.

As for China growing >7% at this moment...I have my doubts, and there is some evidence that number too is now inflated.

7%. Really??

Hands up anyone who can spot the difference between the PBOC and The Fed.


PBOC cuts Chinese interest rates again

Sat 27 Jun 2015 11:02:45 GMT

The People's Bank of China has today again lowered its interest rates in a bid to stimulate the economy

• 1 year benchmark lending rate cut by 25 bps to 4.85%
• 1 year benchmark deposit rate cut by 25 bps to 2.0%
• reserve requirement ratio (RRR) for banks lending to farm sector and SMEs lowered by 50 bps

PBOC said

"The interest rate and RRR cuts, will help stabilise growth, adjust structures and lower social financing costs", the central bank said. Going forward, the central bank will continue to implement prudent monetary policy, use various policy tools to strengthen and improve marco-prudential management, optimise policy combinations and create neutral and appropriate monetary and financial environments for economic adjustments and upgrading."

The PBOC last cut rates, also by 25 bps on May 10...


China central bank eases policy again to support economy

BEIJING |
REUTERS/

Sat Jun 27, 2015 9:00am EDT

China's central bank cut lending rates for the fourth time since November and trimmed the amount of cash that some banks must hold as reserves, stepping up efforts to support an economy that is headed for its poorest performance in a quarter century.

Saturday's combined easing highlights Beijing's concerns that money isn't flowing to some of the most-needed sectors in the economy and that stubbornly high borrowing costs that could fuel bankruptcies and job losses. The last time the central bank simultaneously cut interest rates and reserve requirements was at the height of the global financial crisis in late 2008.

The latest move could also be aimed at comforting investors following a 20 percent plunge in the country's stock markets over the last two weeks, some analysts said.

"The simultaneous cuts in interest rates and reserve requirement is a forceful move, indicating the downward pressure on the economy is very big,” said Xu Hongcai, senior economist at the China Centre for International Economic Exchanges (CCIEE), a Beijing-based think-tank.

"The monetary policy adjustment will also help curb sharp fluctuations in the stock market."...

[ProdigyofZen]

Re: Kaisa on Brink of Dollar Default Spooks World’s Money Managers

"The interest rate and RRR cuts, will help stabilise growth, adjust structures and lower social financing costs", the central bank said. Going forward, the central bank will continue to implement prudent monetary policy, use various policy tools to strengthen and improve marco-prudential management, optimise policy combinations and create neutral and appropriate monetary and financial environments for economic adjustments and upgrading."

Macro-prudential, there is that phrase again. I fear the translation of said phrase is "micro management of the economy by the central bank"

At least the PBoC has 485 bps to go before it hits ZIRP. Lots of room to inflate asset prices unlike Western central banks.

What do they say, the rise and fall of civilizations can be observed in it's rate of interest?

[WDCRob]

Re: Kaisa on Brink of Dollar Default Spooks World’s Money Managers

Hola all...long time...

Are there any boil the ocean pieces from EJ subsequent to the 2013 review and 2014 forecast on the front page? I can't tell if that's the last article, or if there are some hidden behind the pay wall that aren't referenced in the public spaces. TIA

[WDCRob]

Re: Yes Virginia...It's a Bubble...

Hola all...long time...

Are there any boil the ocean pieces from EJ subsequent to the 2013 review and 2014 forecast on the front page? I can't tell if that's the last article, or if there are some hidden behind the pay wall that aren't referenced in the public spaces. TIA

[shiny!]

Re: Yes Virginia...It's a Bubble...

Hola all...long time...

Are there any boil the ocean pieces from EJ subsequent to the 2013 review and 2014 forecast on the front page? I can't tell if that's the last article, or if there are some hidden behind the pay wall that aren't referenced in the public spaces. TIA

No big articles, but EJ participates in conversations behind the paywall when he has something to say.

[GRG55]

Re: Yes Virginia...It's a Bubble...

Thank gawd China still has 7% official growth in the economy as a whole. Where would the world be otherwise

Seems to me the PBOC should call Janet and inquire how to promote the origination and bundling of subprime auto loans. I Yuan.na new car.

China Slashes Vehicle Sales Forecast to 3% Amid Stocks Rout

July 10, 2015 — 12:32 AM MDT

[Bloomberg] China slashed its forecast for vehicle sales in the world’s largest market, projecting deliveries to expand at the slowest pace in four years amid a stock-market rout that threatens to dent consumer sentiment.

Total vehicle deliveries including trucks and buses will probably rise by 3 percent this year, down from the 7 percent projected in January, the China Association of Automobile Manufacturers said Friday. That would be the smallest increase since 2011, when the government unwound stimulus measures unleashed in the wake of the global financial crisis.

Global automakers such as Volkswagen AG and General Motors Co. are now growing slower in China, where they have spent billions to build factories, than in their home markets. With the recent stock market rout wiping out $3.9 trillion of value and economic growth continuing to moderate, concerns are rising that demand will slow further even as more auto factories are completed...

...The revised forecast comes as Volkswagen, the biggest foreign carmaker by sales in China, became the latest company to extend financial assistance to its dealers...

...China will see more manufacturing capacity added even with sales slowing. Hyundai Motor Co. is building two more plants in China by next year, while Renault SA has a factory set to open in the first half of next year. Fiat SpA is set to start making Jeeps in China later this year.

Earlier this week, Cui Dongshu, secretary-general of the Passenger Car Association, a separate trade group, described the stock-market rout that turned a world-beating boom into a bust as a “meat grinder” that destroyed wealth that might otherwise be spent on new cars...

...Price cuts by both foreign and local brands in the past months have done little to spur demand. A survey by MNI Indicators showing the proportion of consumers who planned to buy a car shrinking last month, while inventory was at levels that indicate low market demand for nine consecutive months.

[don]

Re: Yes Virginia...It's a Bubble...

by Peter Schiff via Euro Pacific Capital,

The past four years or so have been extremely frustrating for investors like me who have structured their portfolios around the belief that the current experiments in central bank stimulus, the anti-business drift in Washington, and America's mediocre economy and unresolved debt issues would push down the value of the dollar, push up commodity prices, and favor assets in economies with relatively low debt levels and higher GDP growth. But since the beginning of 2011, the Dow Jones Industrial Average has rallied 67% while the rest of the world has been largely stuck in the mud. This dominance is reminiscent of the four years from the end of 1996 to the end of 2000, when the Dow rallied 54% while overseas markets languished. Although past performance is no guarantee of future results, a casual look back at how the U.S. out-performance trend played out the last time it had occurred should give investors much to think about.

The late 1990s was the original "Goldilocks" era of U.S. economic history, one in which all the inputs seemed to offer investors the best of all possible worlds. The Clinton Administration and the first Republican-controlled Congress in a generation had implemented policies that lowered taxes, eased business conditions, and encouraged business investment. But, more importantly, the Federal Reserve was led by Alan Greenspan, whose efforts to orchestrate smooth sailing on Wall Street led many to dub Mr. Greenspan "The Maestro."

Towards the end of the 1990's, Greenspan worked hard to insulate the markets from some of the more negative developments in global finance. These included the Asian Debt Crisis of 1997 and the Russian debt default of 1998. But the most telling policy move of the Greenspan Fed in the late 1990's was its response to the rapid demise of hedge fund Long term Capital Management (LTCM), whose strategy of heavily leveraged arbitrage backfired spectacularly in 1998. Greenspan engineered a $3.6 billion bailout and forced sale of LTCM to a consortium of Wall Street firms. The intervention was an enormous relief to LTCM shareholders but, more importantly, it provided a precedent that the Fed had Wall Street's back.

Not surprisingly, the 1990s became one of the longest sustained bull markets on record. But in the latter part of the decade the markets really started to climb in an unprecedented trajectory. As the bubble began inflating in earnest Greenspan was reluctant to follow the dictum that the Fed's job was to remove the punch bowl before the party got out of hand. Instead he argued that the Fed shouldn't prevent bubbles from forming, but simply to clean up the mess after they burst.

But while U.S. markets were taking off, the rest of the world was languishing, or worse:



Created by EPC using data from Bloomberg
All returns are currency-adjusted

But then a very funny thing happened. In March 2000, the music stopped and the dotcom bubble finally burst, sending the Nasdaq down nearly 50% by the end of the year, and a staggering 70% by September 2001. When investors got back into the market their values had changed. They now favored low valuations, real revenue growth, understandable business models, high dividends, and low debt. They came to find those features in the non-dollar investments that they had been avoiding.

Over the seven years that began at the end of 2000 and lasted until the end of 2007 the S&P 500 inched upwards by just 11%, for an average annual return of only 1.6%. But over that time frame the world index (which includes everything except the U.S.) was up 72%. The emerging markets, which had suffered the most during the four prior years, were up a staggering 273%. See table below:



Created by EPC using data from Bloomberg
All returns are currency-adjusted

Not surprisingly, the markets and asset classes that had been decimated by the Asian debt and currency crises, delivered stunning results. South Korea, which was only up 10% in the four years prior, was up 312% from 2001-2007. Brazil, which had fallen by 4%, notched a 407% return, and Indonesia, which had fallen by 50%, skyrocketed by 745%.

The period was also a great time for gold and gold stocks. The earlier four years had offered nothing but misery for investors like me who had been convinced that the Greenspan policies would undermine the dollar, shake confidence in fiat currency, and drive investors into gold. Instead, gold fell 26% (to a 20-year low), and shares of gold mining companies fell a stunning 65%.

But when the gold market turned in 2001, it turned hard. From 2001 - 2007, the dollar retreated by nearly 18% (FRED, FRB St. Louis), while gold shot up by 206%, and shares of gold miners surged 512%. As it turned out, we weren't wrong about the impact of the Fed's easy money, just too early.

2010 - 2014

In recent years, investors who have looked to avoid the dollar and the high-debt developed economies have encountered many of the same frustrations that they encountered in the late 1990s. Foreign markets, energy, commodities and gold have gone nowhere while the dollar and U.S. markets have surged as they did in 1997-2000.



Created by EPC using data from Bloomberg
All returns are currency-adjusted

It is said history may not repeat, but it often rhymes. If so, there may be a financial sonnet brewing. There are reasons to believe that relative returns globally will turn around now much as they did back in 2000. Perhaps even more decisively.

Just as they had back in the late 1990's, investors appear to be ignoring flashing red flags. In its Business and Finance Outlook 2015, the Organization for Economic Cooperation and Development (OECD), a body that could not be characterized as a harbinger of doom, highlighted some of the issues that should be concerning the markets. Reuters provides this summary of the report's conclusions:

• Encouraged by years of central bank easing, investors are plowing too much cash into unproductive and increasingly speculative investments while shunning businesses building economic growth.

• There is a growing divergence between investors rushing into ever riskier assets while companies remain too risk-averse to make investments.

• Investors are rewarding corporate managers focused on share-buybacks, dividends, mergers and acquisitions rather than those CEOS betting on long-term investment in research and development.

While these trends have been occurring around the world, they have become most pronounced in the U.S., making valuations disproportionately high relative to other markets. As we mentioned in a prior newsletter, looking at current valuations through a long term lens provides needed perspective. One of the best ways to do that is with the Cyclically-Adjusted-Price-to-Earnings (CAPE) ratio, which is also known as the Shiller Ratio (named after its developer, the Nobel prize-winning economist Robert Shiller).Using 2014 year-end CAPE ratios that average earnings over a trailing 10-year period, the global valuation imbalances become evident:



As of the end of 2014, the S&P 500 had a CAPE ratio of well over 27, at least 75% higher than the MSCI World Index of around 15. (High valuations are also on evidence in Japan, where similar monetary stimulus programs are underway). On a country by country basis, the U.S. has a CAPE that is at least 40% higher than Canada, 58% higher than Germany, 68% higher than Australia, 90% higher than New Zealand, Finland and Singapore, and well over 100% higher than South Korea and Norway. Yet these markets, despite the strong domestic economic fundamentals that we feel exist, are rarely mentioned as priority investment targets by the mainstream asset management firms.
In addition, U.S. stocks currently offer some of the lowest dividend yields to compensate investors for the higher valuations (see chart above). The current estimated 1.87% annual dividend yield for the S&P 500 is far below the current annual dividend yields of Australia, New Zealand, Finland and Norway.

If a dramatic shock occurs as it did in 2000, will investors again turn away from high leverage and high valuations to seek more modestly valued investments? Then, as now, we believe those types of assets can more readily be found in non-dollar markets.

Another similarity between then and now is the propensity to confuse an asset bubble for genuine economic growth.The dotcom craze of the 1990s painted a false picture of prosperity that was doomed to end badly once market forces corrected for the mal-investments. When that did occur, and stock prices fell sharply, the Fed responded by blowing up an even bigger bubble in real estate. When that larger bubble burst in 2008, the result was not just recession, but the largest financial crisis since the Great Depression.

But once again investors have mistaken a bubble for a recovery, only this time the bubble is much larger and the "recovery" much smaller. The middling 2% GDP growth we are currently experiencing is approximately half of what we saw in the late 1990s. In reality, the Fed has prevented market forces from solving acute structural problems while producing the mother of all bubbles in stocks, bonds, and real estate. A return to monetary normalcy is impossible without pricking those bubbles. Soon the markets will be faced with the unpleasant reality that the U.S. economy may now be so addicted to monetary heroine that another round of quantitative easing will be necessary to keep the bubble from deflating.

The current rally in U.S. stocks has gone on for nearly four full years without a 10% correction. Given that high asset prices are one of the pillars that support this weak economy, it is likely that the Fed will unleash another round of QE as soon as the market starts to fall in earnest. The realization that the markets are dependent on Fed life support should seal the dollar's fate. Once the dollar turns, a process that in my opinion began in April of this year, so too should the fortunes of U.S. markets relative to foreign markets. If I am right, we may be about to embark on what could become the single most substantial period of out-performance of foreign verses domestic markets.

While the party in the 1990s ended badly, the festivities currently underway may end in outright disaster. The party-goers may not just awaken with hangovers, but with missing teeth, no memories, and Mike Tyson's tiger in their hotel room.

[Thailandnotes]

Re: Yes Virginia...It's a Bubble...

I have a hard time keeping Schiff and Trump straight.