Norther Trust weekly report
Paul Kasriel
[A few snips but one can not appreciate the snips alone.
Lots of interesting charts in the attached link.
Read it
Mish]
Relative to our after-tax income, the value of houses, and the ground under them, reached a new record high at 192% in the third quarter (see Chart 1). This escalation in home prices relative to household income finally appears to be having a negative effect on housing affordability. In the two quarters ended Q3:2004, the 30-year mortgage rate increased a minuscule net 29 basis points (based on quarterly averages of interest rates). But in that same period, an index of housing affordability declined by 9.44% (not annualized). Maybe this is why adjustable-rate interest-only mortgages are becoming so popular. Even with relatively low 30-year mortgage rates, many folks are not finding homes affordable given the sharp rise in the value of residential real estate. If the Fed keeps pushing up short-term interest rates, home-price bids might start to soften as housing gets less affordable even if financed with adjustable-rate interest-only mortgages.
Back in the late 1990s, when the P/E ratios on corporate equities were climbing to the sky and some of us Chicken Littles were warning that the sky would be falling, we were told that “it’s different this time.” Currently, the P/E ratio on owner-occupied housing is also climbing to the sky, hitting a record high 18.2 in the third quarter. But the “it’s-different-this-time” crowd will point out that a high P/E ratio on housing is to be expected because interest rates are low. But some of us Chicken Littles would point out that in 1965 the 10-year Treasury was trading around its third quarter average of 4.30 and the P/E ratio on housing was only 13.3 vs. today’s 18.2 (see Chart 2). It very well may be different this time – much worse for housing when interest rates climb more.
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Households continue to put a lot of their nest eggs in one basket – their houses. Chart 4 shows that residential real estate represents a record-high 29% of the value of total household assets. Sure hope it pays off for all of us rapidly-aging baby boomers. But as I said a number of commentaries ago, if it doesn’t work out, we will become a nation of bed-and-breakfast proprietors, renting rooms to Chinese and Indian tourists.
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Now let’s turn to Corporate America. We have some role reversal here. As mentioned above, after decades of being net providers of funds to the rest of the economy, households have now become net demanders of funds. Curiously enough, after decades of being net demanders of funds, nonfinancial corporations have become net providers of funds to the economy. That is, corporations are not spending all of their after-tax after-dividend cash flow on capital equipment and inventories. Although the amount of funds nonfinancial corporations are providing to the economy is small – only $20.3 billion on average in the four quarters ended Q3:2004 – as shown in Chart 8, any positive net financial investment by these corporations is very unusual. What makes it especially unusual is that the cost of capital – be it equity or debt capital – is so low now. This suggests that the expected return on capital in the U.S. might be unusually low now.
And enjoy these stocking stuffers over your Christmas and New Year’s holidays. To cheer you up over the holidays, I am going to take a couple of weeks off from writing these dreary commentaries. Aren’t you feeling cheery already?
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This is a mandatory read
Read the rest here:
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