It’s been a while since I’ve put up the charts I’m watching, and there is hence quite a virtual pile. The first pair (like many others from dshort.com) shows the breakdown in diversification benefits in the past year. Correlations tend to trend to one just when you need them to be low…
like in October 2007.
We’re in the middle of an historic bear market.
With the market all the way back to a long term trend it left 17 years ago, but not yet below. There is a reason the trend is where it is. That reason is that the market spends half of its time below it…
There are very few average years, or decades, however. The running 10 year return on the S&P 500 fell almost to -6% in March.
So is the market cheap? Should this be one of those above-trend times? PE’s – how much investors are willing to pay for current earnings – are certainly at the lower end of historic ranges, especially relative to interest rates.
But it also depends a bit on what is going on around the US and world.
Household Debt
I suppose it all began, and will all end, with debt, but it’s a tangled story I’ll try and draw out.
People just stopped paying for current expenses with current income.
Luckily, the international financial industry was there to help out (for a fee) and the home became the new ATM as mortgage equity withdrawal (MEW) added to disposable income.
House Prices
As the credit dried up, prices fell in step.
And have come back a lot.
So, how cheap are they now? Inflation adjusted, over the longer term they are still expensive.
And even worse in Australia.
Close to fair value relative to income.
Trouble is, because so many were built in the day…
…there are now an awful lot of them ready to be sold.
And so new homes are not selling, at any price.
Though there is a slight uptick in existing home sales due to record foreclosure activity – what Calculated Risk calls the “distressing” gap.
Banks
Which brings us to the banks, who enabled all this borrowing and by consolidating mortgages into securities which investors around the world bought.
I’ve been looking at this chart since July 2007. It shows us where we are in working through the fancy new mortgages underlying those mortgage backed securities. Not surprisingly, prime foreclosures now exceed sub-prime. But the storm she’s a comin’ for option teaser rate resets and Alt-A. Almost ALL the new issuance in the last year and a half are Fanny/Freddie (Agency), an arm of the US government.
Most of the liquidity of the boom years was created off-balance-sheet by non-bank actors leveraging up. This now must unwind.
The banks themselves were perhaps the first to realise the music had stopped, and ceased lending to each other.
The government flooded the markets with short-term money.
And took every bank’s deposits on to their own balance sheet with guarantees in an effort to stop the entire financial system collapsing.
The “stressing” tests assume an early recovery, and as with global warming the “worst case” is tracking actuals.
European banks not only bought US mortgage securities, but borrowed and loaned on US dollars into speculative property in Eastern Europe.
In short, the largest international banks are insolvent; not just “technically” but fundamentally as their balance sheets (and accounts) no longer reflect valuations at which their assets actively trade. 50:1 leverage is not going to get you far in this environment.
So they’ve all stopped lending as they milk their governments for credit and spreads at the cost of industry and consumers. Unfortunately, it is those customers that they’ve lent money to, and the result of cutting off credit is not looking good – particularly for jobs and world trade.
Jobs
Just when, also because, consumers decided they needed to save more, jobs have fallen badly.
Relative to other post-war episodes, this one is worse.
What jobs there are have become much shorter term, as the number of unwillingly part-time workers has risen.
Total unemployment (lhs) and weekly new claims (rhs) are both breaking new ground.
In the last month or so the rate of new unemployed has plateaued, but that rate is still very high – more than a million more lost jobs per month.
All of this has a fairly reliable effect on the market.
World Trade
Consumers in developed countries, particularly in the US, account for a large share of the economy.
When house prices stopped rising so home equity withdrawal ceased to provide spending money, and mortgage resets increased payments, and jobs began to disappear, and credit cards became harder to get, the US consumer decided to stop spending so much.
On top of this, banks stopped providing credit to facilitate trade so exporters couldn’t ship and importers couldn’t receive goods.
Trade flows took a nose dive.
Even hotels can’t sell rooms.
World trade fell dramatically, particularly for Japan, Germany and China…
Global growth is negative for the first time in decades.
Industrial production is still on a downward trend more dramatic than the previous post-war worst case.
Much productive capacity is idle, hence the idea of having the government borrow more to put it to use.
Inflation is unlikely to be a worry while so much excess capacity exists.
Commodities
Bad news is the US still has a big oil habit. Good news is that its suppliers are still accepting US dollars.
Good news is that US drivers are driving a lot less.
Bad news is that oil exports peaked in 2005, despite the rocketing prices since then.
Good news is the oil and gas prices have fallen right back with the slower economy.
Bad news is that commodity prices jump at the first sniff of growth, helping to choke it off.
Headwinds
So, is this all just a cycle, perhaps caused by the fluctuations in birth rates echoing down the years from the boomers? Who will buy the boomers’ homes (and vacation homes, and investment homes…)?
There is also a secular trend towards ageing populations world-wide. Who will buy their homes (and stocks) and pay out their pensions and healthcare?
Interesting times.