Since you were asking, here's the complete unabridged version about where my noggin is at the moment -- I see no reason for me to not publicly post my thoughts on this IMO, so that's what I'm doing.
As you know, I have been somewhat perplexed as to why this 'credit crunch and its effects' stuff seems to be happening in slow motion, but I think I'm starting to get my head around that. The best way to sum up my view of where we are now is to start by revisiting some of my older experiences.
I was in San Diego for a week or so a few springs back with my wife (a convention for her, a quasi-vacation for me). At night we would have a bit of fun wandering around downtown looking at the condo construction activity during our comings and goings between our hotel (the Marriott marriott.com ) and whatever restaurant we were hitting that evening. Note from the Marriott's location that this was/is in the heart of condo-land in San Diego. I also took a lot of photography (a hobby of mine) during the day while I was wandering around and generally watching what was happening, in addition to reading all the local RE rags for something to do. I remember at the time frequently wondering aloud who was going to live in all these lovely new buildings.
What was particularly interesting (astounding? enlightening?) to both of us was that, at night, you could see that most of even the finished condo buildings didn't have any lights on indoors to speak of. We also noticed by sneaking and peeking into the underground garages at street level that there weren't very many cars parked inside these buildings either -- the obvious conclusion being that no one was actually living in any of these units. Yet multiple additional towers were springing up around us all over the place on neighboiuring streets with prices like $900K+ for a 1-bedroom = it was clearly an unsustainable, non-occupying, flipping speculator frenzy, and it was going to end very badly at some point.
Although the delayed reaction to the deflating RE bubble as exemplified to me by San Diego was quite remarkable IMO (SD RE topped out long before it showed up much in the stock prices of most related companies), eventually some stock groups got around to a generalized collapse -- first in the home builder shares, then the mortgage lenders, and now we're in the process of catching up to the money centre banks/brokers as well as a lot of non-listed financial entitities (e.g. hedge funds, including those offshore). Yet we have not really seen much of significant decline in the SPX generally (a mere 10% at the current correction low, which curiously made a lot of people freak out as if it were 80%, and over 1/2 of which has already been retraced by so-called 'bargain hunters'). Thus, overall stock prices still seem to suggest this will all be 'contained', or have the bizarre notion that what can devastate the financials somehow doesn't or won't affect anything else.
As we all know, the sub-prime blow-up that I peg as starting with New Century's collapse early in 2007 as later confirmed by BSC in June has finally been happening in public rather than merely in the minds of financial bloggers and message board posters. These public admissions have engendered the onset of a major recognition phase outside WS that, while upon us, IMO may only be just getting started. Whereas I was formerly scratching my head at what still to me looks like an obvious disconnect in stock valuations vis-a-vis reality even after the recent 'correction' (making me question my own analysis BTW), I have now come to attribute this strangely inefficient slow-mo process of reducing stock prices to how WS sell-side traditions work (as described 6 paragraphs further down the page). Bottom line is that I'm now thinking that we probably don't have very long to wait for that next big SPX drop -- here's how I see things playing out from here going forward, and how I came to form my opinions.
This last April I was back in SoCal again and also Vegas and parts of Arizona, allowing me an opportunity to take another dipstick reading with my own two eyes -- needless to say, things weren't very pretty, but everyone seemed to still be in denial about it in some way or another (it's just a lull, etc., etc.). This is where the San Diego thing comes back into the equation for me -- read this following article from July entitled Neverending Stories pcasd.com -- it's not particularly brilliant or prescient in itself, but it chronicles the SD market and how RE has played out rather badly there despite all predictions to the contrary that things wouldn't work out this way because employment was strong. Well, in the end, RE prices still collapsed, strong employment or not. Now if you look at the new Shiller data just released 8/30/2007 here seattlebubble.com; you can see that SD, LV and LA pretty much led the nation in this RE bubble insanity -- therefore, you can probably apply what has subsequently happened in SD since the top as a model for what will more or less happen to the US as a whole, and probably also when it will happen too.
So what is particularly worth noting on that graph is that some 3 years after the top in SD, LV and LA, house prices are still falling, and at progressively faster rates too. Even more ominous IMO is that the freefall is continuing as RE market seasonality worsens, suggesting that the numbers will further deteriorate even on a normalized basis, much less in the new risk-averse environment where nobody wants to touch RE with a 10-foot pole -- e.g., many a recent blog entry entails the logic, "Why should I buy something now that is still falling in value? I'm going to keep waiting before I even think about buying a house." IOW the appetite for RE speculation has dropped to almost zilch, which logically means we only need enough homes for people to actually live in, and the rest are surplus -- unfortunately the supply of homes in a lot of expensive places is another 3 or more year's worth of currently unoccupied units, with still more being constructed as I type that were already in the pipeline, so we're talking about the market needing a lonnnnnnnng time to absorb the oversupply.
I also continue to read blog anecdotes about would-be RE sellers who have stubbornly refused to lower their asking prices (i.e. the market will come back, we are not panicking.... yet), but some of these stalwarts are now beginning to get that nasty feeling in the pit of their stomachs about continuing falling prices as autumn approaches without having seen any action (i.e. no bid) on their house, upside-down mortgage or not. There is also the dilemna of the lenders, who are faced with disintegrating collateral against a raft of non-performing loans, yet have no way to arrest their losses by seizing and selling the collateral (if they could a find a decent bid either) without driving the market even lower and exacerbating their own bad situation -- so we have a great deal of pent-up selling in the mix now rather than pent-up demand, all of which suggests that we are still not even close to what I will call the vulture stage of this collapse, where sellers truly panic and/or elect to sell at such ruinous deep discount prices that one might expect a bottom to form.
So, if one looks at the Shiller graph and sees that the leading housing debacles are still raging on after 3 years of degradation in a cyclical downturn that is only seeing its nuclear fallout impact up the food chain here in the present some 2 or 2 1/2 years later, then if you even only loosely overlay that 2 or 2 1/2 year time frame onto the country as a whole (using as a starting point the early 2007 collapse of New Century as the start of a broad recognition phase that "it's over"), then US RE valuations appear to be in for a massive world of hurt of being discounted back to reality looking forward for another few years at least. Furthermore, the unavoidable collateral damage that will occur in all other asset classes as a result of the wealth destruction in RE is likely going to rival if not exceed the decline in residential RE itself, i.e. expect to see nominal 50% haircuts or more in asset valuations, and maybe more when priced in something that has constant purchasing power such as gold.
And at the risk of sounding like I'm piling on here, there's also the matter of the future impacts of property tax defaults that are all tied into the mortgage mess -- think anybody not making their house payments is paying their realty taxes? And what will happen when the municipalities don't get the revenues they thought they would get -- they'll have to cut services, go into debt themselves, raise taxes for the honest people remaining in their homes, or do all three -- and that's just going to make a bad situation even worse.
So what's up with the stock market pretending that none of this is happening? IMO it's because, quite amazingly, we haven't advanced very far from the Y2K days of bullshit earnings estimates and WS buy/sell recommendations -- not many people with significant net worth manage their own money even in this day and age, which is another way of saying that far too much money is being passively managed by mufus that are ignoring the facts in front of them, and who are just collecting their MERs and still following the dollar-cost-averaging script -- but just watch what happens when the script revisions finally feed through the system in their usual 'after the fact' manner by the sell-side system of lowering earnings forecasts and stock downgrades.
So looking forward near term, quite aside from possibly hearing about a calamity like some big bank going bust (which BTW I expect will or perhaps already has happened, although I'm not so sure we're going to be told about it publicly in a timely manner), IMO the next logical shoe to drop will be conventional WS warnings and/or disclosures about the magnitude of reportable earnings losses in the financials due to the vaporization of their MBS/CDO/CLO/LBO fee income streams as well as their hedge fund losses. Hell, business has positively sucked lately, so they can't possibly be doing as well as they thought they would be when they last gave guidance. As of last Friday, Q3 is 2/3 over, and by now it should be as plain as day to any banker that they are not going to make their Q3 numbers -- some will fess up sooner than others, but they will all have to do it eventually, so I expect to start reading these types of announcements real soon. As an added reaction, these earnings warnings will (should?) also be accompanied by sharply reduced forecasts for the financial group's earnings going forward as well. And since financials make up the largest part of the SPX, we are talking about taking a lot of the E out of both the trailing and forward P/E -- and the buoyancy of E has been one of the two principal arguments cited by bulls that SPX 1500 is 'not overvalued' (the other being strong employment, but I'll come to that).
Once the adjustment to the earnings capabilities of the banks starts being discounted, it will be a very short walk to knocking down the retailers for the same reasons, including lowering the autos even further, and eventually just about everything else quite frankly -- let's face it, even good old steady reliable MMM will sell less Post-It notes and Scotch transparent tape in a consumer-led recession. These slowdowns will all eventually lead to a rise in reported unemployment, they have to, even with government number-fudging. Remember that previously referenced strong employment argument that was supposed to protect San Diego RE valuations but didn't? Can you imagine what's going to happen to housing (and everything else for that matter) when the employment numbers genuinely go into reverse from a starting point on the debt curve like we have now? A market realization of a worsening unemployment eventuality will kick the last legs out from under the bull case, and as TJ likes to say, it will be 'Game Over Player One'.
So will next Friday's employment report be the day of the 'big epiphany' when investors collectively click in to what it means when US consumers start losing their jobs or even if large numbers don't get laid off right away, they simply go AWOL for lack of credit? Maybe yes, maybe no on this month's reporting occasion, although I am expecting to see at least some front-running of what I anticipate to be bad employment figures (see references to government fudging possibilities). But however the epiphany occurs, as soon as it starts to become apparent that JSP and his maxed-out credit cards have gone AWOL, those who have been asleep these past few months who wake up and quickly join the dots will head for the door ASAP, and we will get our big SPX sell-off sooner rather than later -- although IMO we WILL get it anyway eventually.
Meanwhile, if I haven't already appeared to have buried the US consumer by now, there's also food prices inexorably ramping up -- stockcharts.com -- food represents a largely inelastic and unavoidable claim on JSP's disposable income, so it's very difficult to make a rational case for how the consumer holds up here in the face of all these obstacles converging on him at the same time, especially now that so many have been cut off from their access to credit. And any actions by the Fed to significantly lower interest rates that also drop the dollar are going to be somewhat muted by correspondingly increasing the cost of certain key imports (e.g. crude oil and therefore gasoline -- JSP is already broke and can't afford $4 unleaded anymore than he can afford his increased ARM payment). And I know that many before me have declared the US consumer dead, only to have him magically keep getting out his wallet, one more time -- but given the keystone change to the 'no liquidity' world of today from what has been available to keep the game going for many years (access to more and more credit), this time I really believe that JSP is finally toast.
Now, will the government fudge next week's employment data and borrow from future stats to buy another month of policy maneuverability? That's certainly possible, but lying about these things month after month has to catch up to them eventually. I just can't see how the SPX escapes all these realities forever, even in the presence of government massaging and manipulating the data. The government might do a lot of things, but they can't invent the sale of a refrigerator and its positive economic effects simply by inventing a statistic that a bankrupt citizen bought a new refrigerator when in fact he didn't -- that's too Orwellian for even me to accept. Some things have to have an actual basis in fact, e.g. the food you consume has to actually be on your plate to eat, not just conceptually there or hedonically counted as theoretically being present. IMO they cannot successfully lie about everything indefinitely.
So I expect stocks to be dramatically lower in the coming months as the sad truth about what IMO has already been lost leaks out and spreads. I also cynically expect this dire circumstance to be used and exploited by the Dems to advance their own cause rather than do anything constructive about it before they take office. China? The US being broke and in a 'state of national economic emergency' would be an interesting excuse to invoke to not go to the Olympics and try to spoil their party, would it not? Some irony in there? As to whether we could alternatively see a "Zimbabwe-rally" scenario occur attributable to interest-rate driven inflation (i.e. one where SPX rises, but SPX:GOLD does not), I would submit to you that in trying to predict which route the Fed et al are going to take in dealing with this current mess, one needs to look to how the Brotherhood of the Bell crowd is positioning themselves if you hope to gain any insight -- at the moment, the lagging gold price is signalling that the 'men behind the curtain' are currently inclined away from inflating, which infers that perhaps they have taken steps or believe that their wealth will be better protected in a deflation.
Another consideration is that all of the bad things I've described above that seem to lie ahead for the US economy because of the death of the US consumer might happen so fast statistically that there won't be much of an opportunity to inflate quickly enough to cover it up. That would also snare and catch a lot of complacent longs off-guard here who think the Fed is on the case and will therefore be able to handle whatever comes its way. However, since we could debate the inflation/deflation thing for months if not years to no avail, I'd rather not get into it, if that's all the same to you -- too much time and energy required that I would rather apply to analyzing more likely outcomes than a near-term Zimbabwe-ization of the USA
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