A Brick By Brick Housing Recovery

The dust has finally settled down
The sun is shining on these pieces that are scattered all around
This house was everything we knew …

Brick by brick, we can build it from the floor
If we hold onto each other, we'll be better than before.
And brick by brick,
we will get back to yesterday …. (Train)

Last December I described the housing market as being “constipated” and said the market would continue to “skid” on the bottom before finally starting to recover around March 2012.

This forecast was very accurate.  Usually a correct prediction made just four months out is not impressive, but few people were forecasting this.  Back then, people were panicking because the market hadn’t “bottomed out”.  Now people are panicking because the market isn’t recovering fast enough.

The problem is that people are using charts, graphs, and models based on historic data to compare and forecast the current economic and housing recovery.  You can’t do this because many traditional indicators are still malfunctioning.

This was a very damaging recession.  There is no quick bounce back.  There is only a slow, sometimes excruciating painful, and climb out.   Imagine a long distance runner who falls down the side of a hill. He gets up, brushes himself off, climbs back up the hill and rejoins the race.  He bounces back and is able to finish the race, albeit at a much slower time than if he had not fallen.  Contrast this to a runner who falls and breaks his arm.  There is no bounce back.  And he won’t be finishing this race or any race until his arm is healed.

When will the housing market start to race again?  We may not have the old models to help forecast, but we have a new one.  Many industries crashed during the recession and have since started recoveries.  Housing was the last to hit bottom because it had the furthest to fall.  If you look at what happened in the capital equipment, transportation equipment, and recreational vehicle markets, there is a sequence to the recovery process:

1.     Crash – the industry suffers a severe, unprecedented, drop in sales.

2.     Skid – the industry hits the bottom, but does not begin a recovery.  It slides on the bottom for almost a year.

3.     Walk – the industry begins to show increased sales, but at a very modest rate.

4.     Run – the industry gains momentum and sales return to healthy (but not peak levels)

The housing market stopped skidding around March and started walking in April.  We will be walking for a while before we run (forecast at end of post).

The Current Housing Market

Housing Starts, New Home Sales, and Existing Home Sales are all up 15-30% over last year, but this sounds better than it actually is.  Remember 15% over a very low number is still a weak number.  And there has not been consistent growth from month to month in some of the statistics.  This causes “panic” from some people, but it is characteristic of the “walking stage” of this recovery.   

Another hopeful sign is that housing prices actually increased on average in the March-April time frame for the first time in many months.  This was not expected to happen until later this year. 

But there are factors holding back the market.  Listings are very low, down around 20% from a year ago. People cannot sell their homes easily if their mortgage is underwater. Unemployment is still high so people are not getting jobs and buying a house.  People are not changing jobs so they are not moving to new locations.  Prices are still much lower than peak so many people are waiting for a stronger market before putting their house up for sale.  And banks are still holding back on some repossessions because prices are too low.

Sales are also being slowed by tight credit.  Mortgage rates are low but it is one giant teaser rate.  It looks very appealing, like a swimsuit model, but you are not getting any of that unless you have a “super fine” credit score.

There are some positive factors.  There is less slack in the market than was previously thought.  The shadow inventory (repossessions or future repossessions) is smaller than expected.  This is because it is not in the banks’ interest to repossess too many houses and people are not “walking away” from underwater mortgages as much as feared because they still need a place to live.  Bankers and customers continue to work together to prevent foreclosures.  This is an example of the free market at work.

Basic economics is the key to housing recovery.  Low inventories (supply) lead to higher prices.  Higher prices lead to less people being “underwater”.  Higher prices also lead to higher inventories and this will ultimately lead to a strong housing recovery.  But this process takes time.

The Forecast

The “walk” phase will last through 2012, but each quarter should be stronger than the preceding one.  Based on what has happened in other industries, look for the housing market to start “running” around March of next year.

    

I’m Voting For Ross Perot (just 20 years too late)

The main arguments against the President of the United States needing corporate business experience are:

1.     It’s not really needed since presidents have functioned fine without it.

2.     The last time we tried it (Herbert Hoover), it was a disaster.

 

In response the second argument: People are still trying to figure out what caused the Great Depression and while Hoover made mistakes, I don’t think his business background caused him to make bad decisions.  And I don’t think the notion “we tried that once 83 years ago and it didn’t work” holds much validity in 2012.

The first argument merits more discussion.  In the past we have elected many successful military generals as presidents.  This is logical because the men proved themselves leaders on the battlefield.  More importantly if the biggest threat facing the country was another war, who better to lead the country than a former general?  In times of peace, we go for politicians but we still tend to favor those with executive government experience (governors and mayors).

There have been successful presidents who have not had much first-hand business knowledge.  So it is true that corporate business experience was not needed in the to be an effective president. 

However the world has changed greatly in the last 25 years.  The United States has gained more military superiority which reduces the chances of fighting a defensive war.  But we also lost much of our economic superiority as the “world economy” blossomed.  In addition many industries were deregulated which fostered competition, but it also increased the complexity and variability of our economy.  The biggest challenge we face today is worldwide economic competition.  What do you fear most: China’s military or China’s manufacturing?

A President of the United States may not have needed business acumen in the past, but will definitely need it in the future.  If you are expected to manage an economy, it helps to understand one.  And we know what the alternative is: Career politicians produce more politics and less action.

We have not had a “Business-President” in a long time.  The last business-presidential candidate we had was Ross Perot in 1992. 

Perot’s main message was:

1.     Government spending was out of control and we shouldn’t borrow money to pay for our reckless spending.

2.     Government programs, including Social Security and Medicare, were very poorly managed and in need of major reforms.

3.     Both political parties were irresponsible and lacked the backbone to stop the spending and fix the problems.

And now 20 years later it is obvious that Perot was correct and a visionary.  Visionaries are mocked because they see the truth long before other people do.  Perot described the situation in 1992 by using an array of charts and graphs (precursor to a PowerPoint presentation) and the expression “giant sucking sound” (to describe jobs leaving America).  Many people dismissed Perot because he looked funny, he talked funny and he sounded like a crazy man.   But knowing what you know now if you could go back in time, who would you vote for president in 1992?

 

Provided Perot could accomplish his goals in eight years as president and turn the reins over to a like-minded leader in 2000, how much better off would we be today?  Sure we still would have had recessions due to the business cycle, but we would be so much better off economically that we are now. And it doesn’t matter who you blame for the current mess. Clinton, Bush and Obama have all contributed.  

So the last time we had an opportunity to elect a candidate with strong business experience, we did not do it.  This was a mistake the country (myself included) made and we have paid enormously for this choice for the last 20 years. The problems are now much worse and we are running out of time.  Elections matter and corporate business experience is vitally important.  Where will we be 20 years from now if we don’t get our financial house in order soon?

Taking Care of Business (Experience)

Taking care of business every day
Taking care of business every way

I discussed the need for political leaders to have corporate business experience in the post “California Dreaming” (April 2010).  At that time Meg Whitman (former CEO of E-Bay) and Carly Fiorina (former CEO of Hewlett-Packard) were running for governor and senator respectively in California.  My argument was that to solve the country’s economic (business) problems, you need people with real business experience.  Unfortunately both the women lost. Now California is depending on Gov. Jerry Brown to fix its fiscal mess and it is not going so well.

It appears that once again I was ahead of the curve.  Now the main issue in the presidential campaign is the value of business experience.  Several commentators are claiming that corporate business experience does not qualify you to be President of the United States and that this experience is irrelevant when evaluating presidential candidates.  Obviously I disagree.

This argument is ludicrous.  It’s referred to as the executive branch of government.  Hello! Do you think someone who has been a business executive might have learned something relevant to serving in the executive branch?  The President is also referred to as the Chief Executive of the United States.  Chief executive of a large corporation, chief executive of a large country: can you maybe see how experience in one might be useful in the other?

Based on my observations of many years of business experience, here is a list of skills business executives must learn and display to be successful:

  

-        How to take responsibility for your decisions (and not blame others)

-        How to lead a diverse group of people to achieve corporate goals (leadership skills)

-        How to make good decisions, how to make unpopular decisions, how to recover from bad decisions. (decision making skills)

-        How to allocate and utilize assets wisely

-        How to evaluate and hire outstanding talent

-        How to develop and execute strategic plans

-        Understand how a “sub-macro” economy works and how to generate profit under constantly changing conditions

-        How to build and motivate teams

-        How to develop strong leaders to serve under and after you

-        How to influence others one-on-one (how to create “buy-in”)

-        How to listen to the opinions of others and use the information to choose the best course of action

-        Understand the importance of strategic alliances and loyalty

-        How to compete against strong rivals

-        How to unite opposing factions without “taking sides” 

Now let’s make a list of the skills that have been lacking in our government leaders the past several years. Well, um, eh, I guess we don’t need to make another list.  We can just use the one above.  Well isn’t that interesting.  Maybe you don’t need business skills to be President; but you may need them to do the job well. 

And those commentators arguing otherwise still don’t get it.  I’m guessing that they never worked in an organization other than journalism or government.  After generating much criticism after writing their initial articles, a couple of them tried to defend their positions by claiming that it is not being “Socialist” to criticize someone’s business success.  I happen to agree with this.  When you make this type of inane argument, you don’t sound like a Socialist.  No, you sound like a freakin’ Communist.  

Bankers Gone Wild! – Watch Them Flash Your Cash!

Cue some wild party music …..

Host 1:  Welcome to another exciting episode of “Bankers Gone Wild”.  Today we are going to follow the wild hijinks of J.P. and her two banking buddies Morgan and Jamie as they party in the exotic Derivative Islands.

Host 2: Yes, the Derivatives are a dangerous, yet exciting, place for wild bankers to frolic.  There are shark infested waters and many places for naughty financiers to get into trouble.

Host 1:  Looks like the girls are getting very drunk on a combination of cheap money and greed.

Host 2: Wow, that’s a lot of loose cash.  I just hope they are able to control it!

Host 1:  Oh no!  They’ve started buying!  Whoa, look at them buy.  It’s like they are just buying anything.  Buy, Buy, Buy! 

Host 2:  Those girls are really moving that cash! They are awesome!  They are totally out of control!

Host 1: Oh no! They have started to really lose it.

Host 2: Yeah, they are really wasted. Isn’t it great?

Host 1: No, I mean the cash.  They are losing it. They are wasting it big time. This often happens when investing in the Derivatives.

Host 2:  Wow, they are losing every time!  Lose, lose, lose.  Those loses are really racking up!

Host 1:  They’ve just blown through a billion dollars!  Maybe we should say something.

Host 2:  Girls, you’ve lost a lot. Maybe you should slow down a bit.

Host 1:  Oh no!  They don’t care. Now their flashing us their assets!

CENSORED --  CENSORED  -- CENSORED

Host 2: Hey, they’re right back at it.

Host 1:  Look at all that cash. It’s flowing right down that rat hole! Lucky rats!

Host 2:  Here we go again. Lose, lose, lose!

Host 1: These bankers have gone super wild!

Host 2: Look, they just blew through their second billion and now they are lying exhausted on the beach.

Host 1:  Hey, girls.  You just lost two billion dollars in the Derivatives. Aren’t you even a little embarrassed?  What do you have to say for yourselves?

Host 2: What’s that? You say it doesn’t matter because you still have plenty of cash.  Oh great, here we go again.  Now they are flashing us their balance sheets!  Look at that bottom line!  Look at those TIPS! (Treasury Inflation-Protected Securities)

CENSORED --  CENSORED  -- CENSORED

The Solution

The simple solution is to revert back to how the banks were structured in the past. Banking operations were separate from investment firms.  This set-up worked fine until it was changed and it has not worked well ever since.

Making this change would:

1. Reduce the size of the major banks in a logical, non-disruptive, way.  To reduce the size of the banks in other ways would require wise government choices and that of course is an oxymoron.

2. Really eliminate “too big to fail”.  First, the banks would naturally be much smaller.  Second, and more importantly, the banks would not be able to make the risky investments that could cause them to fail.  The banks would again be safer and depositors could be confident that their banks would not take major risks with their money.

3. Allow the investment firms to invest in whatever risky investments they choose with the money they are able to receive from investors (their customers).   Investors would be well aware of the risks.  If the firms make bad investments, they lose all their money and go bankrupt.  No government bailouts, no congressional meetings, no hand wringing, just turn out the lights and close up shop.  This is the way it is supposed to work.  

This would be so simple but the Democrats don’t understand the financial markets so they are intent in punishing the banks.  And the Republicans understand the financial markets too well and want to write the rules with enough loopholes so that nothing really changes.

The French Connection

Those stupid Frenchmen.  They are in the middle of an economic crisis and they just elected a socialist to lead them out of it!  Who do they think they are, California?  Ha Ha Ha Ha Ha!  That is just totally ridiculous.  A socialist!  How dumb.  The only thing worse than electing a socialist in that situation, would be to reelect a socialist during a time of economic calamity. That would be insanely idiotic. Bwahaha, Bwahaha, Bwahaha, hey wait a minute …..

The Stock Market Will Fall In February 2014! (Yes, I am serious)

Smells Like 2.2%, Not 3%
 

The initial Q1 GDP growth estimate was lower than my forecast.  It smells like 2.2% rather than 3%, but to the Obama administration it just plain smells.  My estimate was high, not because of inventory, but because of a reduction in government spending. If this component had stayed constant, GDP would have been 2.8%.

Proponents of smaller government believe it is worth limiting economic growth in the short-term to free up more money for the private-sector in the long-term.  Fans of big government will complain that you are limiting important spending when the economy needs it most.  But that means you should spend more money when the economy is bad because you need to and you should spend more money when things are good because you have more money to spend.  That philosophy is how government got so bloated in the first place.

However the worst news of the GDP report is that the growth of non-residential business investment is continuing to slow.  This should be increasing in a healthy, growing, recovering, economy.  A reduction in business investment is how most recessions start.  Business investment is still increasing, but the trend is ominous.   If you looked at this statistic alone, you would expect a recession to start by the end of the year.

The weak GDP combined with very disappointing April jobs numbers and weaker retail sales means that Q2 GDP will be lower than Q1. This is consistent with my Kentucky windage reading last month.  The problem is growth is decreasing from 2.2%, not 3%.  This means GDP of 1 point something, you fill in the blank because it really doesn’t matter.  I’ll say 1.8 just for reference (or a .4 drop from wherever the revised Q1 ends up).

2012 Model T Forecast 

Last year the Model T predicted an S&P 500 Index high of 1400 for 2011.  The Index peaked in April at 1370 (around 2% lower than the target).  This year the model forecasts the 2012 peak at 1435.  The index hit 1422 (within 1% of the target) in March.

 

The Model T forecast would indicate that there is a good chance that the stock market has already hit its peak for the year or that it will do so soon, provided the current rally has one more surge.  The economy is mirroring last year, so it is logical that the stock market will do the same.  If this is true, look for the market to dip to around 1245 later in this year. 

In calculating the bottom, I am assuming there will not be a “Greek Tragedy” this summer.  I know there could be a “Spanish Disposition” or some “Italian Ice” but I have to inject some degree of optimism into this ugly post.

I do not advocate timing the market with your entire portfolio.  However, if you are thinking about buying stocks, I would wait.  If you are considering harvesting some profits, you should consider doing it now.  It may be a good time to reduce the risk in your mutual funds, IRAs and 401-Ks.

Long-Term Model T Forecast 

The original purpose of the Model T was to predict long-term peaks and valleys of the S&P 500 Index.  For the first time since I began writing this blog, the Model T is predicting the next “major” peak. The model forecasts the S&P 500 will reach 1480 in January of 2014 before the start of the next bear market.  Of course this forecast will change as the inputs to the model change, but you are getting this forecast 20 months in advance.  I’m sure that you will consider this the “Most Interesting Stock Market Prediction In The World”, so plan wisely my friends.   

 

Dr. Hope and Joe Economy

The Setting: A few years ago Joe Economy was very sick.  He had ingested toxic assets and suffered a painful bubble burst.  His physician Dr. Bushwack had not done a very good job attending to Joe but now Joe had a new doctor, Dr. Hope, who promised Joe’s family that he would soon return Joe to good health.

Nurse: Doctor, the patient doesn’t look so good.

Dr. Hope:  That’s not a problem.  I am Dr. Hope and I am here to change things!

Nurse:  So you’ve treated many patients like Joe before?

Dr. Hope: Actually Joe is the first patient I’ve ever dealt with, but how difficult can it be? In addition, I did sleep in a big, white, mansion last night.

Joe: Help me, Dr. Hope

Dr. Hope:  The problem is that you are just laying there, Joe.  We need to get you up off the bed and get you stimulated!  Now get over here and grab this shovel and look as if you are about to dig a hole.

Joe: How is this going to help?

Dr. Hope:  If people see you digging holes, then they will start digging holes and then they will load and dump dirt all over the place and you will get better.  That is my aspiration!

Joe: I don’t think you know your aspiration from a hole in the ground, but I will give it a try.

Dr. Hope: See, it’s good being stimulated. Isn’t it?

Joe: I still don’t feel so good. I think I better lie back down. Oh no.

Nurse: The patient has just dumped a load in his britches. What should I do now?

Dr. Hope: Change!

Nurse: Dr. Hope, your patient isn’t getting better.

Dr. Hope: Oh no, he’s not my patient; he is Dr. Bushwack’s patient. And it’s DR. Bushwack’s fault that Joe’s not getting any better.  Dr. Bushwack was a terrible doctor and the failure of any of my actions will be and will ever continue to be, Dr. Bushwack’s fault.

Joe: Help me Dr. Hope.

Dr. Hope:  What you need to do now Joe is to go get your clunker of a car, drive it to the car dealership and trade it in for a brand-new.

Joe:  But my car isn’t a clunker and I don’t have the money for a new one. I don’t think this is going to work.

Dr. Hope: No problem Joe, here’s a stack of cash to help buy the new car. When people see everybody buying cars, this will motivate them to buy more stuff. And when they buy more stuff, you are going to start to feel great.

Joe:  Okay I bought the car and that was fun, but I don’t feel so good now. Oh no.

Nurse: Joe just cashed some clunkers in his shorts.  What should I do?

Dr. Hope: Change!

Nurse: Your patient, I mean Dr. Bushwack’s patient, still looks very weak.  What now doctor?

Dr. Hope: Joe, get up over here and hold this solar panel.

Joe: Why?

Dr. Hope:  It will show people that you are working in a green job.  Green jobs are great because they put people to work and stop global warming.

Joe:  Okay, I’ll hold this thing, but you do realize it’s cloudy today and this thing isn’t going to provide much energy.

Dr. Hope: Nurse, shine some lights on Joe so it looks like it’s sunny.

Joe:  This seems a bit like an artificial stimulus.

Dr. Hope: Just keep smiling and go green Joe.  Here’s another truckload of greenbacks to create even more green jobs.

Joe: I still not feeling so hot. Oh no.

Nurse: Your patient, I mean the patient, has just created some global warming in his pants and it looks like he’s gone green! What now?

Dr. Hope: Change!

After all his actions failed to improve the health of the patient, Dr. Hope stopped trying to stimulate the patient. Joe, now with rest and the proper medication, began to heal naturally.  He started to feel better on his own, his recovery had begun.  He got up from his bed and started to slowly move forward.

Joe:  I’m feeling better now.  It’s time for me go.

Dr. Hope: Look! My patient is healed! My recovery plan worked!

Joe: Whatever. I think I’ll just be moving along now.

Dr. Hope: Let me give my patient a big hug.

Joe: Please keep your *$!% hands off of me!

And at this Joe started moving ahead even faster.

Dr. Hope: Look at him go! I’m an excellent doctor after all!

Smells Like 3% To Me

At the beginning of the year many economists said that economic growth would be weaker in Q1, 2012.  Q4, 2011 GDP came in at 3%, but much of the increase was attributed to a build-up of inventory that was not expected to be repeated the next quarter.  Few other reasons were given for the slowdown.

My expert economic panel forecast Q1 GDP to be 1.9% in January and adjusted it up slightly to 2.1 in the March forecast.  I never really bought into a lower number based on inventory changes alone.  The Q4 inventory build-up was a reaction to inventories being much too low in Q3.  They were too low because sales were much better than expected. (A good thing!).  Then businesses added to stocks in Q4 in anticipation of even higher sales (Another good thing!).  In a growing economy, I do not believe inventory increases are a bad thing, I think it is a good thing.

So if the base is 3% growth, what did the economic indicators say in the recently completed Q1? :

→ The ISM manufacturing index remained in the “growth range” each month and indicated no slowdown in production.

→ The Bloomberg Consumer Comfort Index is currently at its highest since March 2008 (very early in the Great Recession).  The Gallup survey confirms consumer confidence is growing.

→ The Chicago Fed National Activity Index (CFNAI) shows the economy growing at just above a 3% clip.

→ The ECRI Weekly Index (measures leading economic indicators on a weekly basis) is at its highest point since last August.  The government’s index of leading economic indicators also predicts continued growth.

→ Retail sales continued to grow, up 1.1% in February and preliminary March numbers are very positive.

→ Auto sales were described as “robust” by one analyst with sales much higher than last year.

→ Housing probably bottomed out in Q1 (my call).  Regardless, housing is turning from a drag on economic growth to a very small positive. This transition had to help the economy in Q1.

→ The job market keeps growing and the unemployment rate keeps falling.

→ The inventory-to-shipments ratio remained stable through the quarter which means businesses did not over-stock in Q4 and steadier growth has occurred in the last six months.

The Analysis

It is difficult to believe that the economy slowed down at all in Q1.  With all the positive news, you can make a strong argument that it improved over the previous quarter.  However you do have to factor in the negatives of high unemployment, rising gas prices and weak housing data.  Be careful when reading economic commentaries due to the political biases in an election year.  The President’s critics will make things sound worse than they really are and his proponents will spin things the other way.

I’m not an economist, so I am not going to get out my calculator and calculate Q1 inventories.  What I will do is apply what my friend Mark refers to as “Kentucky Windage” and my friend Terry calls “putting his fingers in the air”.  And if I stick my nose in the air, it smells like a Q1 GDP growth rate of 3%.  Which means the economy was somewhat stronger in Q1, with some negative inventory effect.  And while the economy could smell sweeter, it smells much better than the noxious fumes of the last few years.                                                                                      

The Forecast

It did appear that the economy was stronger in January and February than in March.  Last month job growth slowed, the stock market retreated and gas prices rose.  Gas prices will rise more in Q2 due to the switch over to the more expensive summer blends.  If the increase in price follows historical patterns, average gas prices (as reported by the government) will peak around $4.90 a gallon.  I believe this will indeed slow economic grow, but it will not stop it.  Using the same KWM (Kentucky Windage Method), let's shoot for a 2.6% GDP for Q2.

Note: “Kentucky Windage” is a term related to marksmanship, not college basketball.  It is incorrect to say: “Kentucky had much windage at the 2012 NCAA Basketball Tournament.”