[FoRK] Mid-July, 2007, Update of “The Second Great Depression”

Eugen Leitl <eugen at leitl.org> on Thu Jul 19 06:06:46 PDT 2007


Mid-July, 2007, Update of “The Second Great Depression”

7:08 PM PDT, July 15, 2007

   In the last week, the stock market has experienced radical swings, including reaching historical highs (not including inflation) on the S&P 500.  Let’s look at the economic news that accompanied the new highs.
   Retail sales dropped 0.9%, with weakness in autos, furniture, and building supplies (the last two are consistent with what is happening to housing).  An exception seemed to be Wal-Mart, whose same-store sales climbed 2.4%.  However, looking more closely at the data, if you exclude fuel sales, the gain was only 1.6%.  And most of the remaining gain was in food, which is inflating at an annual rate over 4%.  So even Wal-Mart didn’t do as well as generally perceived.  “Consumers have been living beyond their means and they are now beginning to slow down,” said David Wyss, chief economist at Standard & Poor’s. 

   Standard & Poor’s said that it may cut credit ratings on $12 billion in bonds backed by subprime mortgages.  During 2006 they rated over $560 billion of similar bonds, some of which have already declined in price by over 50%.  If the credit ratings on these bonds are reduced, many institutions that bought these bonds (like retirement funds) may be forced to sell them, because they are required by law to hold only investment grade bonds.  This will cause a glut of such bonds on the market, causing the prices to drop dramatically.
   The dollar hit new lows against the Euro and the British pound, and slipped against the Yen.  Iran told Japan that they must buy all their oil in Yen currency rather than dollars.  Oil is rising in price, as is gasoline.  The housing issues just keep getting worse, with the four-week moving average of mortgage applications down 1.6%.  Mortgage rates are increasing.  Wages have increased 3.9% in the last year; but as reported last month, “real” inflation (including food and energy) has been running at a 7% rate.
   So, with all this seemingly bad news why did the market reach new highs?  The only explanation I can give is that mutual fund and money managers are acting as lemmings (which ultimately crowd into the sea to destruction).  At the first sign of buying or selling they all jump in.  That is how they keep their jobs.  As long as their performance matches the market, they survive.  Any attempt to read the market individually puts them at risk, because they could miss an upswing.  That is why you are seeing such dramatic swings in the market for no apparent reason.
   Gas prices at $4.00 per gallon by this fall (even though not all readers agree).  Stock market may stay high until the second quarter GDP results come out.  Shortly after, the market will begin to fall.  The S&P 500 will be below 1375 by the end of the year.  Housing prices will drop an additional 5% to 10% by the end of the year.  Also, by year end, our government will be in turmoil, with President Bush refusing to implement directives voted on by congress regards Iraq.  This will cause a lack of confidence in the US, and the dollar will drop even further versus other currencies, with the price of gold rising in response. 
   As always, the above is only my opinion.  Please, do NOT use this blindly to drive your investment choices.  Intelligent people can, and do, disagree!
Warren Brussee
Comments (13)   	 

JULY 2007 Update of The Second Great Depression
8:47 AM PDT, June 30, 2007
   In May, existing home prices, compared to a year ago, declined for the tenth straight month, the longest decline on record.  Prices, including core inflation, are down 4% from a year ago, and sales are the slowest in four years.  There is now an 8.9 month inventory of unsold homes at the current sales rate.
   New homes sales were down for the fourth month of the last five, with prices down 3%, including core inflation, from a year ago.  This is in contrast to last month, where builders cut prices dramatically to get sales.  Buyers are no longer buying homes without drastic price reductions.
   Problems related to the housing bubble are consistent with my book’s projections (pages 27 through 39).  Housing will have a much more negative effect on the economy than is generally understood.  Per the Federal Reserve Board Consumer and Community Affairs’ data, subprime or Alt-A (between prime and subprime) mortgages represent 25% of the 43 million outstanding mortgages.  So, 10.8 million mortgages are at risk.  This is a far higher number than is generally shown as a foreclosure issue, because most articles only look at subprime adjustable rate mortgages (ARMs) as being a concern.  But ALL subprime and Alt-A mortgages are at risk, given that people’s wages are increasing less than real inflation (including food and energy) and payments therefore become more of a stretch.   Many of these people will have negative home equity as home prices drop the predicted 25% (from an earlier update).
   In addition, prime ARMS are not without issue.  Per the Mortgage Foundation, foreclosure rates for prime ARMs are increasing at the same rate as those for the subprime ARMs, albeit from a lower percentage base.  Many of the people with prime ARMs have a somewhat larger cushion before they get into severe financial issues, but generally they also have much larger mortgages.  And even if they don’t get into a foreclosure situation, millions of families with prime ARMs will have to dramatically decrease their discretionary spending to make their much larger adjusted house payment, which could increase 40% or more.
   As reported in my last update, China sold more T-bonds in April than anytime in the last 7 years.  Per China Daily, they sold $5.8 billion worth, which is just a small portion of their current $414 billion holdings.  It remains to be seen if this continues, but its effect on our interest rates can be dramatic.  China has stated that they want to diversify their foreign-exchange reserves to get better returns.
   Gas inventories are very low and Americans are racking up the miles with no concern.  Even without a hurricane, gas shortages and high prices are likely.
   Consistent with the book’s projections (page 20), consumers continued to spend more than their incomes, with the May savings rate being negative 1.4%.  And of course, the whole basis of my book is that consumers can not continue this forever.  They will reach a point where this must stop; and adjustable rate mortgages, increased gas prices, and the real inflation rate of 7% will make this happen by the end of the year (or into next year at the latest).  Then the whole economy will tank.
   Gas prices will be above $4.00/gallon by this fall, but the stock market will still be reasonably high because the 2nd quarter GDP will be higher than the first quarter.  This will make investors think that the worst is over.  However, third quarter GDP will again drop.  This, coupled with higher T-bond rates, will start the stock market fall.   Per my book (pages 46 and 96), the historical stock price/dividend ratio should be below 20 before reentering the stock market.  The current price/dividend ratio is 65.  This means that with the current dividend payout, the stock market would have to drop approximately 70% before it becomes historically viable.  I believe that this drop will start by the end of the year, but it will take several years to get the full 70% drop.
   As always, the above is just my opinion.  Intelligent people can, and do, disagree!

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