Sunday, December 10, 2006

The U.S. Dollar and Housing Market: RIPPLES, MOMENTUM, FEEDBACK

December 8, 2006
By Jim Willie CB
Holder of a Ph.D. in Statistics at Carnegie Mellon University
Publisher, The Golden Jackass website
http://www.freemarketnews.com

For specific detailed analysis of the Gold, USDollar, Treasury bonds, and inter-market dynamics with the US Economy and Fed monetary policy, see instructions for subscription to my newsletter research reports, which include stock recommendations positioned to rise in the commodity bull market. Articles in this series are promotional.

A steady, relentless, and nearly perpetual force pushing the USDollar down in the next two years will be the housing bear market. Most economists seem woefully inept and insufferably weighed down by optimism, as they issue silly pronouncements couched as analysis but teeming with nothing but hope and badly disguised promotion.

As policy shifts toward relieving the pressure exerted from the housing decline, slightly lower interest rates will matter little. Closely behind comes the Weimar-like push on monetary expansion, an accelerated effort to inflate. Housing will not respond much at all, but our world reserve currency will from severe debasement, as its exchange rate tumbles into the basement of shame. The USDollar will undergo major damage while gold and silver make new highs. The most painful twist will be the rise in energy costs (crude oil, natural gas, diesel, gasoline, heating oil) mainly from the US$ effect, despite somewhat lower domestic demand as the USEconomy slows. China & India will chug along.

The biggest housing bull market (12 years since 1993) will be followed by the greatest housing bear market in the modern era. It has been launched in descent. Economists miss three critically important and powerful factors since they choose to act like banker apologists, promotional pitchmen, corporate marketing agents, brokerage harlots, bogged down by wishful thinking, inhibited by preservation of their own continued paycheck.

1) Ripple effects slam business niches operating closely to housing, which is unavoidable since such a large supporting cast assists in the acquisition, construction, selling, and financing of homes. How can a large object like housing fall without affecting neighboring objects in its proximity? It cannot.

2) Momentum effects are very difficult to gauge in the financial world, where physics plays a valid role in a somewhat hidden nature. See my “Financial Market Physics” from June 2005 for a broad list of relevant phenomena. How can a large object like housing reverse course without a tendency to remain in backward motion? It cannot.

3) Feedback effects guarantee that each quantum step down ensures a reaction from observers and passive participants who are pressed to respond. How can a large object like housing take a jump down in price appreciation, a jump down in sales volume, a jump up in inventory, and a jump out of the lax lending room altogether without inviting a secondary reaction? It cannot. These three effects are analyzed more fully in the November issue of the Hat Trick Letter, where members can read.

The housing decline, with a 10% annualized decline in the last six months, will drag the USEconomy, and worsen the current recession. We in the United States have been in a recession for five years, if you wish to live in the world of reality. The CPI is under-stated, as the GDP is over-stated. Use 1990 statistical reporting methods, and one sees that at least 4% and probably 5% must be subtracted from official GDP doctored growth statistics. This doctor chooses to remove the nonsense and live in the world of reality. As an official negative GDP is announced reluctantly in early 2007, that will mean the GDP decline is actually a 5% recession, if again, you wish to live in the world of reality.

It is clear to all but the most blind mavens that the USFed is finished with interest rate hikes. Inflation fears are cited only by goofy Fed Governors, paid to speak stupidly. The USFed will, just like in 2001, suddenly act to stimulate the USEconomy in a matter of a few months, with interest rate cuts.

Gold will love it. Unless Europe and Japan stop hiking rates and join with rate cuts themselves, the USDollar will register multi-decade lows. It is really just a matter of time before the Western World (with adopted son Japan) follows monetary policy directed by Dr Weimar, whose directives will be as desperate as they will be simple. Damn the market torpedos! Full speed ahead on money printing! We must prevent a global recession! Real money like gold & silver will shine! Hedges like energy deposits will soar!

THE RIPPLE EFFECT

One third of job creation has come from the housing industry in the last five years, well documented. A recent McGraw Hill study estimated that $1200 billion in construction spending occurred within the national economy in the 12 months ended August 2006. In connection with that study, their conclusion was that the decline in housing sales and prices has occurred more quickly and less orderly than anticipated.

The McGraw Hill study forecasts a 1% decline in 2007 construction spending after a 12% rise in 2005. Key details behind the current decline are tied to a 5% drop in single family home building and a 3% drop in the construction of stores and shopping centers. Therein lies an important ripple.

As a whole, the construction industry accounts for about 9.5% of the USEconomy. James Haughey of Reed Construction Data sums up the linkage. “When there is a new neighborhood, there is a new grocery store and pizza parlor in a small shopping center… It will be a delayed impact because the pipeline of shopping centers is so full.” He expects a falloff in retail spending very soon.

My forecast is that retail spending will be the last piece to fall into place. Ironically, that is precisely what financial market observers are looking for in order to conclude an economic slowdown.


THEY AWAIT THE LAGGING INDICATOR, NOT ANY LEADING INDICATOR LIKE RANK AMATEURS.

Cut in half, home equity extraction no longer comes to the economic rescue. The peak annualized cash jerked out of homes was $732 billion in 3Q2005. The latest recorded figure is $327 billion in 2Q2006, down by over half. Retail consumption and the ability to sustain households are at great risk.

This home equity dependence is a recent phenomenon, having emerged onto the scene in the 1990 decade. Home equity extraction has rendered the overall economy like a sick patient lying prone on a gurney with a line of credit acting like an intravenous flow in near total dependence. The patient does not rise to go build in factories, because the factories are largely gone. To think the economy will be spared, held immune from the housing damage, is mindless and naïve and absurd. Housing will deliver monstrous ripples, much like a motorboat does to a small canoe on a lake in summertime. Been there, done that, not fun!

Beware that the US tendency to devote the majority of construction outside the sectors known for productive capacity is a defect of the USEconomy. Houses do not generate ongoing income like a factory. This is precisely where the ripple effects will be felt, the initial damage. Building of homes, shopping malls, and retail shops is not a viable foundation for any economy, since no productive output. Instead they are severe misallocation of resources, labor, materials, and equipment.

We are a nation avidly building bubbles, whether financial or residential. Approximately 90% of US economic growth in recent years is derived from the housing bubble and consumer spending, a dire signal. Meanwhile in the last year, consumer spending growth has outpaced income growth by a 3:1 factor. The most surprising element of the housing bear market underway is its widely recognized genuine nature on Main Street, beyond the fluffy specter of Wall Street.

Realtor agents, mortgage brokers, commercial agents, small and large real estate tycoons and barons, community business leaders, almost everyone realizes we next must deal with a housing bust. Official statistics cannot lie on this one. This current bust is in our faces, all around us, with visible signs for sale and stories of loss, if not heartache.

Job layoffs are only beginning in the housing sector. The list of home builders under deep stress actually covers almost all its members. In fact, my forecast is for a major home builder to declare bankruptcy sometime next year in a major shock announcement. KB Home is the prime candidate. The HGX home builder stock index is likely to lose over 75% of its peak value.

Expect a bounce occasionally as prices come down, but each bounce will be followed by yet another painful crushing decline. The current rise in the HGX index has gone too far, spitting in the face of deteriorating statistics which are nowhere in recovery. In fact, expect five or six bounces, much like a victim would experience falling down a staircase. This will turn ugly.

Home suppliers have disclosed their early stage pain. Fallout is hitting sellers of diverse building supplies (like plumbing, hardware, carpentry, wiring, lumber, landscaping), but also faucets, fixtures, carpets, cabinets, appliances, and furniture.

Home Depot has warned already a couple times, with more coming. These are the ripple effects in related industry groups. Job losses already announced on the finance sector, such as by mortgage lenders. This is only the beginning, to be followed by jobs tied to the exhausted consumer in retail chains. More layoffs will follow in the lending institutions. See recent Washington Mutual and Countrywide announcements.

As ripples slam the US Economy, the US Federal Reserve will be forced to abandon its tightening bias. Let’s be clear. That nutty bias is designed to placate foreign US Treasury Bond holders, who want assurance of higher bond yields and more protection for their vast TBond assets, both in bond principal value and currency exchange rate.

Many authors, including me, have warned of diametrically opposite forces pulling at the USFed. Domestic housing pain will force the US Fed to cut interest rates, as economic and political forces prevail. The USDollar smells it, or one should say FOREX currency traders smell it.

They have delivered a serious blow in the last three weeks to the clownish US Dollar whose fundamentals resemble a Third World currency. More US Dollar declines lie directly ahead. Gold, silver, oil, and natural gas will love it, and jump for joy in a higher price.

THE MOMENTUM EFFECT

An object in motion tends to remain in motion, until a new force acts upon it. This is a basic law of physics. It applies to the USEconomy, and in particular to the housing market. Evidence lies in a 10% annualized price decline in existing houses. When taken against the $20 to $22 trillion housing base, we have monumental MOMENTUM.

Imagine a 20 ton boulder rolling 10 meters in six minutes, and the associated momentum. Imagine a 20-foot sailboat which moves at the mooring dock by 10 meters in 6 seconds, and the associated momentum. Each is extremely difficult, if not impossible, to stop in place. The object continues to move. It crushes everything in its path and does not stabilize quickly, coming to a stop. The same is true of the housing market.

The mere concept of a Soft Landing is as nonsensical as a jet aircraft losing its engine power and landing comfortably. It falls quickly to earth, just like a brick, and crashes. In fact, NASA pilots refer to the space shuttle as a “flying brick” affectionately. If anybody can identify a true soft landing example in the last 30 years of US Economic history, please check into the nearest clinic for your anti-psychotic medication. If not, then you firmly stand in reality.

In the housing market, momentum has a strong psychological component. In the upward course seen from 1994 to 2005, the mere belief that home prices would continue to rise tended to keep demand strong. Now on the other side of the mountain, the belief that home prices would continue to soften will tend to keep buyers at bay, watching from the sidelines, awaiting more favorable and attractive prices.

The concept of momentum was clear on the upside, but nowhere yet mentioned on the downside. Evidence of momentum comes after all the internal forces work their destructive magic, like ripples and feedback. Momentum in the marketplace cannot be proven, only observed. To expect the housing market to step down in price structure, without a continuation, is mindless. The internal forces must do the job of the marketplace, namely find a price which clears current inventory, and find a price which attracts new supply. Right now, inventory is large, growing, and nowhere near the norm. Right now, buyers are not only standing aside, but lenders are restricting mortgage lending, except for truly insane outfits which have a cruel lesson ahead.

Greenlight Financial advertises a low 6.95% fixed mortgage rate with no requirements for income verification, tax returns, bank statements, or property appraisal. Such insane offers will vanish altogether very soon. The target audience is the subprime group of borrowers with miserable credit.

Fast forward two years and this batch will show very high defaults. And yet another mortgage lender has gone kaput in the same putrid arena. Ownit has appealed to the subprime borrowers, even offering 45-year mortgages. The firm has been shuttered, despite its well-heeled partner, 20% owned by Merrill Lynch. Subprime borrower delinquencies, defined as 60 days late, have doubled in the last year to 3.9% of outstanding contracts.

Greenspan is on record as justifying the asset bubbles as positive. Home equity is counted as bonafide wealth in his perverse equations. He boasts of the “impetus to spending” and “virtuous cycle“ that bailed out the nation after the stock bubble & bust with his signature in 1999-2000. His styled rescue to avert a prolonged statistical recession in 2001 was derived from an economic dependence upon asset bubble wealth, much like a garden variety drug addiction.

To fully appreciate the insanity of the foundation for the USEconomy, consider this. From 2001 through 2005, outstanding mortgage debt rose 68% from $5293 billion to $8888 billion. One author joked that housing has not merely been the icing on the cake, but rather “housing has been the cake.” In the summer of 2005, Greenspan (still USFed Chairman) was clear in his statements that he was targeting the housing asset prices. Such recklessness is irresponsible beyond description.

We will see the momentum soon unstoppable. One cannot reduce a bubble, but only prick and burst it. Alan G. Magoo is a poor student of both finance and physics.

The momentum effect will gradually dishearten US policy makers in the banking community. The soft landings in both the USEconomy and the US housing market are fairy tales. As the tale is let go in favor of more reality, the US Federal Reserve will be forced to lower interest rates. However, momentum in such a large body as a national economy is powerful. A minimal 25 basis point interest rate cut will accomplish almost nothing. Only a full 1% rate cut would have a mitigating relief effect on housing and consequently the USEconomy. The USDollar will surely respond to the gradual chipping away of nonsensical forecasts, stubborn monetary policy, and economic fundamentals. More USDollar declines lie directly ahead. Gold, silver, oil, and natural gas will love it, and jump for joy in a higher price.


THE FEEDBACK EFFECT

We have not even begun to hear about the vicious nature of the feedback loops. By this is meant the effect on retailers, job layoffs at the shopping malls and retail chains, fresh rounds of homes put up for sale, foreclosure auctions, bankruptcies (both private and corporate), reversal of monetary policy, eroded consumer confidence, and shattered confidence in the US Federal Reserve. Job losses already announced by mortgage lenders are only the beginning, to be followed by jobs tied to the exhausted consumer. More layoffs will follow from related sectors.

Few attach a linkage between the housing market decline and the car sector job layoffs marred by plant closures. They should, since a link exists. Detroit foreclosures lead the nation. My joke to some friends is that the housing bear market will be finished after numerous mortgage firms and home builders go bankrupt, but with a final exclamation point of real estate agents selling their own homes. A case in point comes from a story this week from Washington state. Former Univ of Washington Huskie football player Scott Greenlaw has been forced into bankruptcy.

The state’s largest mortgage brokerages has left a trail of angry employees, expensive lawsuits, unpaid taxes, and government investigations. Greenlaw is trying to avoid bankruptcy by selling his own $4 million waterfront home to pay his debts, in sharp contrast to financing homes for others. What a nasty turn of events for a former college football star who cobbled together $225k to start a company in 2001 that grew to more than 400 employees.

His Merit Financial claimed to underwrite more than $2 billion in loans, while its head basked in its glow studded as millionaire publicity magnet. Some wonder if the firm’s ruin hinged on its practice of hiring athletes and stunning attractive but inexperienced young loan officers amidst minimal managerial oversight. Expect more such stories, just like we saw in 2000 with glitzy tech and internet millionaires whose fortunes vanished as rapidly as they were assembled.

Sheriff sales of tax delinquent properties have grown. My local newspaper used to feature one page of same, but now three or four pages are flush with such notices. We have yet to hear much of foreclosure home sales by banks, which is two stages away on the staircase of events. The final signal of the housing bust will be the sale of realtor agent homes, after they go bust.

You will hear about it in California and Denver first in a river of tears.

As distressed sales occur, the mainstream market is adversely affected. Home builders will sell also under distress, but not through local government events, since unpaid property taxes are not involved. The next step in the feedback loop process is home builders dumping houses at a loss. Another caveat on new home sales points to their price. Some builders offer financing at below 0% for a fixed period, or toss in a swimming pool, or give away a BMW, or pay the first quarter for property tax.

The 9.7% price decline among new homes seen in October might be much much worse than stated. If quality improvements can be factored into GDP statistics, then they should be factored into new home sale prices. New home prices are falling more quickly than reported. In addition to these sales at a loss, homeowners who are underwater are next to dump their homes on the market, fearful of going deeper underwater. They must produce cash at sale closings. Of course, some will hope for the best and suffer the worst. They are human after all, and might believe the press reports laced with self-serving lies. We have not even begun to see banker auctions, which might be planned for later in 2007 during the new year.

The stream of propaganda flows freely. The most outrageous is from the National Assn of Realtors, who have embarked on a $40 million national campaign whose tagline pitch is “It is a Great Time to Buy or Sell a Home” which is the first such promotion in their history. Wow! Conjures up images of NewSpeak and the “1984” novel by George Orwell. Idiot savant Alan Greenspan somehow in late October saw “early signs of stabilization” in the housing market, a self-serving viewpoint to be sure. It is unsure what he looks at, surely not data, probably a substandard murky crystal ball bought from a pawn shop. He pointed to home purchase mortgage applications having flattened at relatively high levels. Take a look next spring, Alan.

The application index is 18% below a year ago, with no justification for any stable upcoming behavior. Baseless optimism can be found among lenders also. Countrywide Financial CEO Angelo Mozilo might be promoting his company stock. “We have already had a hard landing… In 2008 we will have one hell of a year for people who remain in the industry.” He expects the mortgage market to “tread water” in 2007. Sounds more like wishful thinking and hope than a well founded forecast upon solid analytical basis.

As feedback loops inflict untold damage, during round after round of responsive whacks to both the USEconomy and the housing market, the US Federal Reserve will be forced not only to respond, but to act in desperation. The confirmation is going to show up in the USTreasury Bond Yield curve, in the form of a steeper inversion. In the last week of November, the spread between the 2-year yield and the 10-year yield grew to 20 basis points. My forecast is for it to grow to at least 40 basis points.

To claim the USEconomy is strong when the long-term bond yield is now under 4.5% with further declines on the horizon, well, it is plain incompetent from an analytic standpoint. The feedback loops will serve to undermine the USFed credibility, especially when housing prices do not stabilize. The feedback loops will tend to produce new sellers just when the market struggles to reduce unsold inventory.

The USDollar will surely respond to the gradual erosion in confidence in not only the USFed to solve our ills, but the US capitalist leadership to maintain its reputation and prestige. The weakest industrialized economy soon will be identified as that of the United States. More USDollar declines lie directly ahead. Gold, silver, oil, and natural gas will love it, and jump for joy in a higher price.


HOMEBUILDER STOCK INDEX

The apparent recovery in the homebuilder stock index HGX is a clear bear trap. Investors who jump in will be losers, in my view. The giant downleg since April from 270 to 190, a painful 30% decline in less than four months, needed some time to resolve the imbalances, to force adjustments among the builders, and to deceive the public investors into thinking the worst is passed. It is not. This was short covering, no more.

The housing bear market will include numerous recoveries then pauses, each to offer time to fool the optimists. The rebound has recently mustered enough gusto to surpass the 50-week moving average, which surprised me given the continued horrendous home inventory data.

The stock investors for HGX component companies believe that interest rate cuts will save the builders. They might overlook the inventory problems, tied to both homes and land options. They might overlook that homes under current construction have yet to hit the market, where imbalances already persist. Expect them next March and April.

The worst will be over only after at least one and possibly two national home builder companies go bankrupt. They still are logging huge land lease losses. At the current pace, home builders continue to add 1.7 million units onto the market, almost 50% above demand, and clearly above population growth. When completed, they will add further to inventory. Some housing development locales are turning into ghost towns, with massive ripple effects assured. Even Fed Governor Janet Yellin has made public remarks about such ghost towns in California.

Charles Hugh Smith of Oftwominds has designed a criss-cross chart which depicts housing starts, housing sale prices versus inventory growth and the rise in foreclosures. He also has a pathogenesis staircase of six steps. We have only witnessed the pain of two of these clearly marked steps. Directly ahead are the feedback loop effects in action. As this housing crisis plays out, the greatest effect will come to the USDollar, precious metals, and energy. Industrial metals depend upon Asian expansion in addition to Western economies.

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