To Buy Or Not To Buy

October 28, 2018

by Steve Stofka

In ten years, the number of households that own their homes has grown by only 2-1/2%. Renting households have grown by 20%.

Should you buy a home? Home prices are sky high in some cities. Mortgage rates are rising. Is 2018 a repeat of 2006? Many bought homes at high prices only to see the price fall by a third or half over the following years.

Time to discover your inner owner investor who is going to buy the house. You are going to rent the home from your owner investor. Let’s compare the annual Net Operating Income (NOI) to the purchase price of the home. To keep the math simple, let’s say the owner investor can charge the renter $2000 a month in rent for the home. Let’s say that you, the renter, are going to bear the monthly cost of utilities. You, the investor, must pay $2000 in property taxes and other city charges like garbage collection. Your annual net income from the property is $2000 x 12 = $24,000 – $2000 taxes and costs = $22,000. Let’s say that the all-in cost of the home is $360,000. $22,000/$360,000 = 6.1%. That is the cap rate of the property.

Home pricing, like many assets, behaves in a cyclic manner, as the graph below shows. In the past thirty years, the average annual growth of the Case-Shiller home price index in Los Angeles is 5.6%. The rate of the past three years is slightly above that thirty-year average, meaning that prices in the L.A. area have stabilized relative to the long-term growth average.

HPILA

Rents have risen almost 5% so the two growth rates are fairly close. Let’s subtract an inflation rate of 2.6% from that to get a real capital gains rate of 3%. Add the two rates together to get a combined rate of 9.1%. For an average home in the L.A. area, this is a pretty good total rate of return.

Let’s look at another area: Denver. The thirty-year average of annual growth in home prices is 4.9%. During the past five years, population growth in the Denver area has been robust. Home prices have risen more than 7.5% during each of the past five years, topping 10% in 2015. In 2017, rents rose an average of 5.33%, not enough to keep pace with the growth in prices. An investor would be buying at an above average price.

In a hot market like Denver, a family might think “I am saving 8% a year by buying now.” They assume that above average price growth will continue. The law of averages indicates the opposite – that price growth is more likely to fall below average, and even turn negative.

In making a decision, understand where current prices are in the cycle (Note #1).  Understand where current rental growth is in the cycle and compare the two (Note #2). Here is a graph comparing the two series in Denver. Note the large divergence between home prices and rents in the late 1980s, 1990s and again in the 2000s. Rental prices were much more stable.

HPIvsRentDenver

Imagine that the home purchase is a cash investment and estimate a total return on that investment, as I showed above. Some familes pick a home in a price range based on the leverage of their income and down payment. A real estate agent may present home buying choices based on the amount of house a family can qualify for. But – is the house a good deal? These rates of return are an important factor to consider in making a wise decision.

////////////////////////////////

Notes:

  1. You can search for “FRED home prices [large city name here]” to get the Case-Shiller Home Price Index for that city. Click Edit Graph button in upper right and change the units to “Percent Change From Year Ago”. To get an average, click the Download button above the Edit Graph button to download an Excel spreadsheet.
  2. You can search for “FRED cpi rent residence [large city name here]” to get the index of rental prices for that city. As above, click Edit Graph button and change units to “Percent Change From Year Ago

/////////////////////////////////

Stocks

The recent downturn in the market was overdue. Since the election almost two years ago, the year over year total return of the SP500 has been above the 10% historical average.

SP500TRYOY

The longest above average streak under Obama’s Presidency was almost three years. In the dot-com boom under Clinton, the market had above average returns for almost 3-1/2 years. After a two-month stumble in 1998 due to the Asian Financial Crisis, the streak continued for another twenty months. Such a long period of exuberance was sure to fall hard. During the following three years, the market lost half its value. Reagan and Eisenhower enjoyed the next longest streaks of almost 2-1/2 years. The 1987 crash ended the streak under Reagan.

Trade Wind Turbulence

April 8, 2018

Remember the clip of Jack Nicholson In the 1980 movie The Shining? Jack hacks his way through a door with an axe, then presses his face to the jagged hole and announces, “It’s Johnny!” Substitute “Trade Wars” and we get a dramatic portrayal of the stock market this past week. On several days, the Dow swung 700+ points, or more than 2%, in response to fears of a tariff feud between the U.S. and China.

The share of global commodities that China consumes far exceeds its share of the world’s population (1/5) or the global economy (1/6). Here’s a chart from Visual Capitalist.

On Thursday, the market opened almost 2% down in response to comments from the chief Tweety Bird in the White House. Later that morning, Larry Kudlow, Trump’s new NEC Director, did a quite effective job of easing market jitters. Kudlow has been a host of CNBC and his own radio program for many years and is savvy to shifting sentiments. No, he said, Trump is a free trader in disguise. This is just a bargaining tactic. The market started the day 500 points down and finished up 240 points.

This is a trader’s market. Much of the price action is taking place in the last hour of the trading day. Each price recovery since mid-March has failed, so the overall sentiment is negative and Friday’s trading was near the 200-day average. For an investor who has not yet made their 2017 IRA contribution, buying now is somewhat equivalent to dollar cost averaging over the past nine months. For those with shorter time horizons, cash looks good till the market finds its head.

The Labor Report for March showed job gains of just 103,000. This was below the 175,000 anticipated gains and far below ADP’s 240,000 estimate of job gains. Mid-March weather on the east coast may have had a negative effect on this month’s survey. The average of the BLS and ADP surveys is 172K, and I find that average to be a more accurate long-term estimate.

The BLS recently released a report on unemployment rates and weekly earnings classified by degree. This chart is a dramatic picture of the advantages of higher education.

UnemplEarnByDegreeBLS
VividMaps released a map showing the income needed to buy an average home in each state. Because the data uses average house prices, the map overstates the affordability problem for many families but does reveal the underlying trend. Why do I say overstates? The average home price is far above the median price because extremely expensive homes raise the average.

First quarter earnings to be released in the next two weeks are expected to show strong annual growth. Will the confirmation of rosy expectations overcome the darker fears of a global trade war? Stay tuned.

Taxes, Bitcoin, and Housing

December 24, 2017

by Steve Stofka

Merry Christmas! Because of the holidays, I’ll keep it short. A few notes on the tax bill passed this week and some odds and ends I’ve collected.

In the final version of the tax bill, the state and local tax (SALT) deduction was limited to $10,000.  This limitation will hurt those in the coastal “blue” states.  As a group, these states already pay more in Federal taxes than they receive in various Federal programs.  The limit on the SALT deduction will take even more money from blue states and give it to red states. There is a second transfer taking place intra-state.

There are several components to SALT: income, sales and property taxes. According to the Census Bureau’s American Community Survey, almost 50 million households own a home with a mortgage.  Under current tax law, they get to deduct whatever mortgage interest they pay. Rich homeowners take the bulk of the mortgage interest deduction on their million-dollar homes.  50 million households rent. They get to deduct zilch.

For decades, homeowners have been in a protected class and able to deduct their property taxes. Renters have enjoyed no such deduction.  The owner of the building gets the deduction.  Think the owner is sharing that tax largesse by lowering rents?  No. For years, renters have effectively subsidized the tax deduction for their homeowning neighbors. The new tax bill transfers some of that tax burden from renters back to homeowners, putting both types of households on a more even level.

The density of coastal populations requires more infrastructure supplied by states, cities and towns.  Unless there is a natural resource like oil that can be taxed, local jurisdictions need higher taxes to pay for the added infrastructure. Secondly, the population density leads to more competition for land and housing, which causes higher property prices.  Even if New Jersey and Colorado charged the same property tax rate, the higher home prices in New Jersey would result in higher taxes.  But the two states don’t charge the same rate.  New Jersey averages almost twice the property tax rate charged by counties and towns in Colorado.

If you would like to compare property taxes in your state, county, or zip code with others, you can click here (https://smartasset.com/taxes/new-jersey-property-tax-calculator)

Democrats have long championed a graduated income tax, and the more graduated the better. The limit on the SALT deduction effectively levies more tax on those with higher incomes. That is the core principle of a graduated tax. Isn’t that what Democrats want?

//////////////////////////

Bitcoin Bumps

After surging more than 2000% this year, bitcoin has fallen 40% this week, but is still up more than 1400% for the year. 80% of the trading volume this year has come from Asia. Japanese men have turned from leveraged forex trading to bitcoin and other digital currencies. (WSJ article)

As an exchange of value, currencies should be stable. When they are not, they have failed, and it is invariably due to a failure of government policy. Venezuela is a current example. From 2007-2009 Zimbabwe’s currency failed, and even today, they use the U.S. dollar. Germany in the 1920s is probably the most egregious example of a failed currency.

Bitcoin is not a currency. Bitcoin is an asset but barely that. Buyers of bitcoin and other digital “currencies” are buying a share in the “greater fool” theory. Yes, the concept is brilliant. Ledger transaction chains solve many problems in international exchange. But digital transactions take too much energy to serve as a currency. In the time that it takes to validate the transfer of one bitcoin, hundreds of credit card transactions take place.

Bitcoin is not secure. A South Korean bitcoin exchange went bankrupt this month when it was hacked, and its reserves stolen. (CNN article) . Mt. Gox is the most well-known bitcoin hack victim, but there are others (Top 5 Bitcoin Hacks ).

//////////////////////////

Housing Prices to Income Ratio

New home sales in October were 10% above estimates. The average price of a new home hit an all-time high of $400K. The median price is $316K, more than five times the median household income. Here’s a graph of that housing price/income ratio for the past thirty years.

HomePriceIncomeRatio

The ratio first broke above 4 in 1987 and steadied for the next 13 years. During the housing bubble in the 2000s, the ratio rose swiftly and crossed above 5. As the bubble popped in 2007 and millions of people defaulted on their loans, the ratio fell as fast as it rose. Since the Financial Crisis, low interest rates have helped fuel another bubble.

The recent Case-Shiller housing index was higher than expected. Home prices are going up 6% per year, twice the rate of increase in incomes.

/////////////////////////

I’ll have more next week on long-term trends in income and inflation. Have a merry and take care of year ending stuff this week! Those with high SALT deductions might consider paying 2018 property taxes in 2017 but there is some question whether the IRS will allow the deduction. See this L.A. Times article.

Storage Costs

August 6th, 2017

Last week I discussed the concepts of present and future money. This week I’ll look at the costs involved in storing our money for future use. When I store my fishing boat over the winter, I pay storage costs. When I store money for the future I also pay storage costs. Some of these costs are outright fees. If I have a financial advisor, I may pay them a percentage based on the amount of money they manage for me. All mutual funds charge a fee which is clearly stated in the fund’s prospectus. Pension funds charge fees as well and that is not always as clearly stated.

In addition to fees, there are implied costs. My bank lowers the interest rate they pay me for savings and CD accounts to take care of their operating costs and profits. I could put my future money under my pillow but inflation eats away at my store of future money like rats in a granary bin.

Let’s turn to another cost that is more of a packaging cost– income taxes. But wait, taxes come out of my present money, my income. How can that be a cost of my future money? In the progressive income system that we have in this country, my income is taxed. If I make more money than my neighbor, I will pay a higher rate. My neighbor may pay an effective tax rate of 5% and I pay 15%.

We pay taxes on our leftover income – what we could put away into our store of future money. Let’s say that the median household income is $50K and my family makes $70K. The difference is $20K more than the median. It’s money that I could put into my store of future money. On the other hand, my neighbor’s household makes $40K, or $10K less than the median. Part of my family’s income that I could have put away for the future is going to be taken by the government in taxes.  Some of it will be used as a fee to pay for today’s common expenses like defense, police and courts, research, and infrastructure. Part of it will be given to my neighbor as a transfer payment. My future money becomes my neighbor’s present money.

How did I get my present money, my income? Invariably, it came from someone else’s future money which was previously saved and invested in a business that either hired me or contracted with me. All this money is on a merry go round of time.

Now let’s turn to the prospects for my future money. This article lists 22 reasons for not investing more money in equities at current valuations. I have mentioned several points covered in this article. One is the percentage of household wealth that is invested in the stock market. This past month, that percentage surpassed the level at the peak of the housing boom in 2006-2007.

StocksPctFinAssets201706

Maybe this time is different but I won’t count on it. The heady peaks of the dot-com boom in the late 1990s shows that this can go on for some time before the whoosh! comes.

Housing prices continue to grow above a sustainable trend line. I’ve marked out a 3% annualized growth rate on the chart below. This housing index is for home purchases only and does not reflect refinances.

PurchaseOnlyHPI201706

Check out the growth in commercial real estate loans.  The 10% annual growth of 2015 and 2016 has cooled somewhat in the first two quarters of 2017 but is still a torrid 7.6%.  (Source)

CommlRELoans

Several years ago, I thought that real estate pricing would not get frothy again for several decades. We had all learned our lesson, hadn’t we? Maybe I was wrong. The worth of an asset is what the next buyer will pay for it.  Zillow tells me I am growing richer by the day but there’s a problem.  If I did sell my home, what would I buy?  Everywhere I look, housing prices are so expensive.  Now I come back full circle to another storage cost – storing the future me.

Merry Christmas

December 21, 2014

In preparation for today’s solstice, the market partied on in a week long saturnalia.  The week started off on a positive note.  Industrial production increased 1.3% in November, gaining more than 5% over November of 2013.

Capacity utilization of factories broke above 80%, a sign of strong production.  Production takes energy.  I’ll come to the energy part in a bit.

The Housing Market Index remained strong at 57, indicating that builders remain confident.  Tuesday’s report of Housing Starts was a bit of a head scratcher.  After a strong October, single family starts fell almost 6%.  Multi-family starts fell almost 10% in October, then rebounded almost 7% in November.  Combined housing starts fell 7% from November 2013.

The market continued to react to the change in oil prices.  For the big picture, let’s go back a few years and compare the SP500 (SPY) to an oil commodity index (USO).  For the past five years, USO has traded in a range of $30 to $40, a cyclical pattern typical of a commodity.  In October, the oil index broke below the lower point of that trading range.

On Tuesday, oil seemed to have found a bottom in the high $50 range.  USO found a floor at $21, about a third below its five year trading range.  Beaten down for the past three weeks, energy stocks began to show some life (see note below).

Encouraging economic news helped lift investor sentiment on Tuesday morning. Some bearish investors who had shorted the market went long to close out their short positions. Growth in China was slowing down, Japan was in recession, much of Europe was at stall speed if not recession and the continued strength of the U.S. dollar was making emerging markets more frail.  While the rest of the world was going to hell in a hand basket, the U.S. economy was getting stronger.  Thee Open Market Committee at the Federal Reserve, FOMC, began its two day meeting and traders began to worry that the committee might react to the strengthening U.S. economy with the hint at an interest rate increase in the spring of 2015.  This helped sent the market down about 2% by Tuesday’s close.

Wednesday’s report on the Consumer Price Index (CPI) was heartening.  Falling gas prices were responsible for a .3% fall in the index in November, lowering inflation pressures on the Fed’s decision making about the timing of interest rate hikes.  The core CPI, which excludes the more volatile energy and food prices, had risen 1.7% over the past year, slightly below the Fed’s 2% target inflation rate.  Traders piled back into the market on Wednesday ahead of the Fed announcement Wednesday afternoon.  Back and forth, up and down, is the typical behavior when investors are uncertain about the short term direction of both interest rates and economic growth.

The Fed’s announcement that they would almost certainly leave interest rates alone till mid-2015 gave a further 1% boost upwards on Wednesday afternoon.  Twelve hours later, the German market opened  up at 3 A.M. New York time.  Early Thursday morning, the price of SP500 futures began to climb, indicating that European investors were reacting to the Fed’s decision by putting their money in the U.S. stock market.  Those of you living in the mountain and pacific time zones of the U.S. might have caught the news on Bloomberg TV before going to bed.  Maybe you got your buy orders in before brushing your teeth and putting your nightgown on. Very difficult for an individual to compete in a global market on a 24 hour time frame.  On Thursday, the market rose up as high as 5% above Wednesday’s close, before falling back to a 2.5% gain.

Still, a word of caution.  Both long term Treasuries, TLT, and the SP500, SPY, have been rising since October 2013.

As long as inflation remains low and the Fed continues its zero interest rate policy (ZIRP), long term Treasuries and stocks will remain attractive.   Something has to break eventually.  ZIRP  helps recovery from the aftermath of the last crisis but helps create the next crisis.  Abnormally low interest rates over an extended period are bad for the long term stability of both the markets and the economy.

**********************
Sale – Energy Stocks – Limited Time Only

(Note: this was sent out to a reader this past Tuesday.  Energy stocks popped up 4 – 5% the following day, a bit more of rebound than I expected. The week’s gain was almost 9% and the ETF closed above its 200 week average.)

As oil continues its downward slide, the prices of energy stocks sink.  XLE, a widely traded ETF that tracks energy stocks,  has dropped below the 200 week (four years!) average.  (A Vanguard ETF equivalent is VDE).  Historically, this has been a good buying opportunity. In the market meltdown of October 2008, this ETF crashed through the 200 week average.  A year later, the stock was up 38% and paid an additional 2% dividend to boot.  Let’s go further back in time to highlight the uncertainty in any strategy. The 2000 – 2003 downturn in the market was particularly notable because it took almost three years for the market to hit bottom before rising up again.  The 2007 – 2009 decline was more severe but took only 18 months. In June 2002, XLE sank below its 200 week average.  A year later, the stock had neither gained nor lost value. While this is not a sure fire strategy – nothing is – an investor  is more likely to enjoy some gains by buying at these lows.

****************************

Emerging Markets Stocks

Also selling below the 200 week average are emerging market (EM) stocks.  These include the BRICs (Brazil, Russia, India, China) as well as other countries like Mexico, Vietnam, Turkey, Indonesia and the Philipines. When a basket of stocks is trading below its four year average, there are usually a number of good reasons. Several money managers note the negatives  for EM.   Also included are a few voices of cautious optimism.  Sometimes the best time to buy is when everyone is pretty sure that this is not the right time to buy.  Another blog author recounts two strategies for emerging markets: a long term ten year horizon and a short term watchful stance.  The long term investor would take advantage of the low price and the prospect for higher growth rates in emerging economies.  The short term investor should be cognizant of the fickleness of capital flows into and out of these countries and be ready to pull the sell trigger if those flows reverse in the coming months.

******************************

Welfare

What are the characteristics of TANF families?  When the traditional welfare program was revised in the 1990s, lawmakers coined a new name, Temporary Assistance to Needy Families, to more accurately describe the program.  The old term carried a lot of negative connotations as well. Two years ago Health and Human Services (HHS) published their analysis of a sample of 300,000 recipients of TANF income in 2010.  Although the recession had officially ended in 2009, the unemployment rate in 2010 was still very high, above 9%.  It is less than 6% today.

There were 4.3 million recipients, three-quarters of them children, about 1.4% of the population. By household, the percentage was also the same 1.4% (1.8 million families out of 132 million households).  In 2013, the number of recipients had dropped to 4.0 million, the number of families to 1.7 million (Congressional Research Service)

In 2010, average non-TANF income was $720 per month, or about $170 a week.  To put this in perspective, this was about the average daily wage at that time The average monthly income from TANF averaged $392. Recipients were split evenly across race or ethnic background: 32% were white, 32% black, and 30% Hispanic. For adult recipients only, 37% were white, 33% black, and 24% Hispanic.

Rather surprising was how concentrated the recipients were. 31% of all TANF recipients in 2010 lived in California.  43.3% of all recipients lived in either New York, California or Ohio.  The three states have 22% of the U.S. population and almost 44% of TANF cases.

HHS data refutes the notion that welfare families are big.  50% of TANF families had only one child.  Less than 8% of TANF families had more than 3 children.  82% of TANF families also receive SNAP benefits averaging $378 per month.

In 2014, Federal and State spending on the TANF program was less than $30 billion, about 1/2% of the $6 trillion dollars in total government spending.  The Federal government spends a greater percentage on foreign aid (1%) than the TANF program. Yet people consistently overestimate the percentage of spending on both programs (Washington Post article).  The average estimate for foreign aid? A whopping 28%.  Cynical politicians take advantage of these public misperceptions.

**********************

Omnibus

Aiming to overhaul the health care insurance programs throughout the country, the Affordable Care Act (ACA) was a big bill.  No, it wasn’t 2700 pages as often quoted by those who didn’t like it.  The final, or Reconciled, version of the bill was “only” 900 pages.  The House and Senate versions were also about 900 pages each; hence, the 2700 pages.

At 1600 pages in its final form, the recently passed Omnibus Spending bill makes the ACA look like a pamphlet.  As  specified in the Constitution, all spending bills originate in the House.  Past procedure has been to pass a series of 12 spending bills.  Majority leader John Boehner has found it difficult to get his fractious members to agree on anything in this Congress so all 12 bills were crammed into this behemoth bill just in time to avoid a government shutdown.  Just as with the ACA, most members of the House and Senate did not have adequate time to digest the details of the bill.  The bill is sure to hold many surprises for those who signed it and we, the people, who must live under the farcical law-making of this Congress.  Here is a primer on the budget and spending process.

**********************

Home Appraisals

They’re back!  A review of 200,000 mortgages between 2011 and 2014 showed that 14% of homes had “generous” appraisals, inflating the value of the home by 20% or more.  Loan officers and real estate agents are putting increasing pressure on appraisers to adjust values upwards.

**********************

Personal Income

You may have read that household income has been rather stagnant for the past ten years or more.  In the past fifty years household formation has increased 78%, far more than the 50% increase in population.  The nation’s total income is thus divided by more households, skewing the per household figure lower.  During the past thirty years, per person income has actually grown 1.7% above inflation each year.  Inflation adjusted income is now 66% higher than what it was in 1985.

In 2013, the Bureau of Economic Analysis released median income data for the past two decades. Median is the middle; half were higher; half were lower.  This is the actual dollars not adjusted for inflation.  Except for the recession around the time of 9-11 and the great recession of 2008 – 2009, incomes have risen steadily.

The 3.7% yearly growth in median incomes has outpaced inflation by almost 25%.

Why then does household income get more attention?  A superficial review of household data paints a negative picture of the American economy. Negative news in general tugs at our eyeballs, gets our attention.  The majority of the evening news is devoted to negative news for a reason. News providers sell advertising in some form or another.  They are in the business of capturing our attention, not providing a balanced summary of the news.  In addition, a story of stagnating incomes helps promote the agenda of some political groups.

***********************

Merry Christmas and Happy Chanukah!

A Busy Week

October 5, 2014

On Monday George and Mabel flew to Portland, Oregon so Mabel could attend a teacher conference in Eugene on the development of strategies and practices for online learning.  “How’d you get invited?  You’re retired,” George had asked a few months earlier.  Mabel had spent many years both as a teacher and high school principal.

“The conference is focused on post-secondary education, but Lorraine thought I would be interested and wangled me a spot.” Her friend Lorraine was a department chair at a local community college. “I might be able to give her some perspective from the high school level as these kids make the transition to college courses.”

They had to get up early to make the morning flight.  Retired people should only get up this early when they are having a colonoscopy, George thought.  After the conference, they planned to spend a few days on the Oregon coast, which they were both looking forward to.  They sat in the Denver airline terminal awaiting the boarding call.  George couldn’t understand most of what they said.  Millions of dollars to build an airport and the contractors seemed to have bought the cheapest speakers through somebody’s Uncle Harry who knows a guy who’s got a connection with some exporter in Malaysia. Airline service had become little more than a subway in the sky.  In fact, the speakers sounded just as bad as the ones used in New York subway cars.  “Gate 23, now pre-boarding …” came out of the speakers as “Ateleeteehoweeornayhinienegetcrispbeergoremekeens.” Passengers, please get in the metal tube, sit down and be quiet.  The metal tube will go up in the air and deposit you at your destination.  Transportation for the masses.  The future has turned out slightly different than the one imagined at the New York World’s Fair in 1964.

In Portland they rented a car and drove down to Eugene.  Settling down in their hotel room, George was pleasantly surprised to find they had good wi-fi reception.  The market had been up but had closed below Friday’s close, indicating that there was still more negative sentiment to come.  Personal income in August had gained 4.3% above the level of August 2013.

That bit of good news was offset somewhat by a report from the National Assn. of Realtors that year-over-year pending home sales were down a little bit more than 2% in August.  This confirmed last week’s housing reports and made it unlikely that tomorrow’s Case-Shiller report on home sales would have any positive surprises.

Tuesday morning, George slept in while Mabel got up early to go to the nearby conference at the University of Oregon.    He missed the free breakfast at the hotel but the woman at the reception desk pointed him to a nearby coffee shop that served egg croissants and a good cup of coffee. The sun broke out on the short walk to the coffee shop, brightening George’s mood.  Despite the mid-morning hour, a number of people sat in the coffee shop working on their laptops.  West coast time was three hours behind New York so half of the day’s trading had occurred before many Oregonians had started work.

The Case-Shiller home index showed that home prices in 20 metropolitan areas had declined for the third month in a row.  Year over year gains were still positive at 6.7% but the pace of growth was slowing. Last Friday’s Consumer Confidence survey from the U. of Michigan had been positive and rising.  A separate Confidence survey by the Conference Board was positive but showed a declining sentiment on worries about employment and income.

In the afternoon, he drove near the campus to meet Mabel.  The campus was an artist’s rendition of what a college was supposed to look like.  Shade trees dotted the grounds between the grand buildings of gray stone.  Lawns and bushes were clipped but didn’t look overly manicured.  The concrete walkways that led from one building to another were well maintained but showed the typical wear of traffic and a wet climate.  The ghosts of mankind’s great minds and talents would feel comfortable on these grounds and in these halls.

Mabel introduced George to several colleagues attending the conference.  Most attendees were teachers and administrators in their forties and fifties.  For 300 years, teachers and students had gathered in  a classroom in what was called face-to-face education.  Students prepared for class at home at various times outside of the classroom but the daily routine of classes centered the educational activity of the students.  Online learning was a new phase in distance learning, attempting to blend the broader educational training of traditional colleges and universities with the asynchronous methods of the correspondence schools of the past century.

On Wednesday came further confirmation that the growth in housing sales and construction was slowing.  Year-over-year construction spending had increased 5% but the growth had declined for 9 months.  George thought this was a fairly normal cycle but the market reacted negatively, dropping more than 1% by the end of the day.

European Central Bank head Mario Draghi announced that they would continue to keep interest rates low to help spur the non-existent growth or decline in many European countries.  The private payroll processor ADP reported job gains of 215,000, slightly above expectations.  The Institute for Supply Management (ISM) showed a slight decline from the robust growth of the previous month but overall a very positive report.

Wednesday evening after the conference had concluded, George and Mabel had dinner at a restaurant with two women who had attended the conference.  The conversation was lively, the food a bit pricey for the quality but George enjoyed the evening.  For the past two days he had encountered many young people, reminding him of his college days decades before.

“I’ve decided I want to be 20 years old again, only not as dumb and inexperienced,” George quipped. He remembered sagely pronouncing that Fitzgerald’s novel, The Great Gatsby, was about social classes that no longer existed in America and was irrelevant. Somehow he had survived his own poor judgment.  He did want to jump high in the air once again, twisting toward the basket and snapping a 3-point shot at the basketball net.  The losses in physical vitality were offset by the gains in sagacity, George hoped.

On Thursday, George and Mabel woke up early (again! two times in one week!) to drive out from Eugene to the Oregon Coast.  At the Oregon Dunes they walked through coastal rain forest, then dunes, then a less dense strip of rain forest, then beach and ocean. “I get smaller the more I walk,” he told Mabel.  “What do you mean?” she asked.  “We walk through places like this, they’re like landscapes, I guess you could call it, shaped by this wind around us, the ocean out there,  and underneath our feet the earth is shifting about.  It’s like we’re teeny tiny bacteria walking on the ridges of paint left by some artist’s brush.”

Mabel smiled, “Well put.”  She paused.  “With the physical classroom, students and teachers can have field trips out to the Oregon dunes.  How do we take that and put it in an online environment?” she wondered.  George glanced at her.  “Someone has brought the conference to the beach, I think.” Later, they stopped off for a coffee in the old town of Florence before ending the day in Yachats where they stayed at the Overleaf Inn.

I could get used to this, George thought, checking the market news from his balcony while the last streaks of sunset and orange turned to purple and gray out over the ocean.  The BLS reported that the 4-week average of new unemployment claims had fallen below 295,000.

Levels lower than this had occurred rarely – in early 2006, 2000 and the winter of 1987-88. Yet there was no dancing in the streets.

Instead, investors focused on the 10% drop in factory orders for August.  Most of the decline was due to volatile aircraft orders, which had surged in July followed by an equal drop in August. The market remained flat.

On Friday, George and Mabel walked several miles on the 804 trail, a sometimes dirt, sometimes asphalt path that ran for many miles along the Oregon cliffs.  They ate at the Drift Inn that evening.  Good food.  “You think there’s much work for younger folks around here other than the tourist industry?” he asked Mabel.  “I doubt it,” she replied. “We’ve seen a lot of twenty-somethings working at hotel reception desks, waiters, waitresses, the coffee shop in Florence.  They can’t be making a lot of money.  Still it is lovely here”, she mused.  “Could be more sun, ya know?”  George nodded.  “We’re kinda spoiled in Colorado,” he said.

When they returned to their hotel room later that night, a stiff wind blew off the ocean, bringing with it a bit more chill than either of them had packed for on this trip.  George checked the monthly employment data released that morning by the BLS.  Job gains had surprised to the upside at almost 250K but the market had still closed below Wednesday’s opening price and was still below the 10-day average. He pulled up some FRED data to get a snapshot of the relative health of the labor force seven years after the start of the recession.   The results were rather chilling – or maybe it was the dampness of the Oregon coast that he was unaccustomed to.  In seven years the number of employed people had grown just 1% – not 1% annually but 1% total for the entire time.

2.6 million more people were working part time because they could not find full time work. The number of underemployed had grown almost twice the 1.4 million new jobs created in seven years.

The unemployment rate had dropped below 6% in September but even that bit of positive news did not look so good when George pulled up the historical snapshot of unemployment since the recession began.

The rate had risen more than 1% in those seven years.  Despite all the talk of recovery, the surge of stock prices from the lows of 2009 and the rise in home values, the labor market was still wounded.

“Why don’t you help me figure out where we’re going to stay tomorrow in Newport?”, Mabel asked.  “One of my friends suggested the Elizabeth St. Inn.”
“Fine with me.  I want to see the Aquarium if it’s open,” George replied.  “Hey, check out the moon.”  Then he put on his windbreaker, pulled a blanket off the bed and went to sit out on the balcony.  Through the shifting clouds, moonlight shone softly on the water below.  Mabel, taking a cue from her husband, tugged a blanket from the second bed, wrapped it around her and sat with him.

Shoot Out At the OK Corral

October 20th, 2013

This coming Saturday is the 132nd anniversary of the gunfight at the OK corral.  We got our own OK corral in Washington and there was a whuppin’ this week – a Washington style whuppin’, which means that no one got whupped but everyone agreed on an appointment date for a  future whuppin’.

Congress passes a continuing budget resolution with the same frequency that many of us get our teeth and gums cleaned.  Many government reports were not released this past week but the National Assoc of Homebuilders (NAHB) released a very positive monthly report of the national housing market, showing a slight decline over the past few months last month but still a strong index reading of 55.  Two years ago this October, that index stood at 15.  In fact since the latter part of 2007, the index oscillated in the range of 15 – 20, so this has been a strong and sustained growth surge.

Over the past hundred years, house prices have risen at about the same rate as inflation, so that the real price of homes stays about the same.  Most homeowners finance their home purchase and it is this interest cost that determines the total capital cost of the home.  That capital cost and the interest cost is divided over the life of the mortgage into monthly payments.  PITI is a familiar acronym to many home owners and buyers; the initials represent the components of a monthly house payment. The ‘P’ stands for Principal – the monthly capital cost of the home.  The ‘I’ is interest on the amount of the loan.  The ‘T’ represents the local real estate taxes which are included in the monthly house payment sent to the mortgage servicer who forwards them on to the local taxing agency. The ‘I’ represents Insurance.  This can be both house insurance and, for those with an FHA loan, the amount of the loan insurance.  The interest rate on the home loan is a key component and although there has been an increase in mortgage rates since the spring, they are near all time lows.  A 30 year mortgage is a common benchmark.

Let’s index the CPI and the house price index to 1991 and look at the divergence.

Declining interest rates have enabled many more people to qualify for a home purchase, thus driving up home prices. In 1995, Congress made some major revisons to the 1977 Community Reinvestment Act, making home loans more available in distressed urban and rural districts.  This further exacerbated the rise in home prices, creating a large divergence between the CPI and the housing price index.

As every homeowner knows, the cost of a home includes maintenance, repairs, utilities, and improvements.  As I discussed last week , real median household incomes plateaued during the 2000s.  The rise in home values and changes in banking laws enabled homeowners to tap the equity in their homes to meet these additional obligations and to augment stagnant incomes.

In the past dozen years, many people discovered that housing is not a reliable source of income.  At the turn of the century, stock traders who quit their jobs to trade stocks during the tech bubble, discovered the same truth about the stock market, whose price returns are a few percent above inflation.  A nifty calculator at  DQYDJ illustrates the average returns of the SP500 over the past 100 years.

 

At the heart of the financial follies of past centuries is that a surge in price for some asset, be it tulip bulbs, Florida real estate or tech stocks leads people to conclude that they can hop on the gravy train.  What is the gravy train?  As an asset increases in value, more people invest in the asset bubble, the valuation continues to rise and – for a time – it is possible to convert a stock, a store of value, into a flow of income by either buying and selling the asset or borrowing money against the asset.  There is always some constraint – the rise of inflation, or the rise of personal incomes, or the growth rate of profits – that eventually brings an asset valuation down to earth.  Einstein famously quipped that the most powerful force in the universe was compound interest.  He might have mentioned  what may be the most powerful force – reversion to the mean.

Home Sweet Home

March 31st, 2013

From its catatonic state the housing market continues to make headlines.  On Tuesday came a somewhat disappointing report on new home sales for February; at 411,000 it was a bit below expectations of 425,000.   A real estate saleswoman told me this week that it’s now a seller’s market in Denver.  I presume that means that buyers are now having to offer the asking price or above when submitting a sales contract to a seller.

For a long term perspective, let’s zoom out fifty years.  Home sales are at past recession bottoms BUT they are better than last year and the year before and the housing and labor markets are hoping.

Will the patient stir, starting to rise, only to fall back on the bed?  PUH-LEEZ DON’T!

Housing Starts, which include multi-family dwellings, are on an upswing but are also coming from a deep trough.

What is more telling for the labor market is the ratio of home sales to housing starts, which continues to decline as more and more multi-unit apartment buildings and condos are being built.

Construction of multi-unit dwellings takes less labor per family unit and the type of construction is often skewed to a different kind of labor force than the construction of single family homes.  There is more steel, concrete and masonry work in multi-unit construction, employing trade skills unfamiliar to some in single family residential construction.  This shifting emphasis of skills in the work force may damper growth in the construction labor market.

Let’s go up in our hot air balloons and take a gander at home valuation for the past 130 years.  The Case-Shiller Home Price index surveys home prices throughout the nation and adjusts for inflation.  The homes of today offer more than the homes of 100 years ago, both in convenience, comfort and safety.  However, the index is approaching an upper range that may be less attractive to potential buyers.

Let’s look at housing evaluations from an affordability perspective.  The National Association of Realtors offers an affordability index based on a composite of mortgages.  I prefer a different measure, one that is based on disposable income – income after taxes.  For many of us, buying a house is the biggest purchase of our lives.  Before we make such a big commitment, we need to have some savings (except during the housing boom) to make a down payment, and we need to feel some certainty about our future income.  Mortgage payments will probably take the largest bite out of our income.  

When we look at a long term history of the growth of the home price index (purchases only) and the growth of inflation adjusted disposable income, they track each other closely – until the housing boom really took off in 2000.  Below is a graph of the past 20+ years, showing the relationship between the two.

 

The upturn in home prices is still above the trend line growth of disposable income and until personal income can resume or surpass a 3% growth rate, any rise in home prices will be constrained.