To paraphrase the highly regarded fund manager and notable
bear, John Hussman, you can look like an idiot before a Bubble pops or
after it’s popped.
I guess I’m squarely in the camp of looking like an idiot before the
bubble pops. I might watch “The Big Short Again” for some “moral
fortitude.” With history’s stamp of approval on my side, all I can do is
shake my head and chuckle. As soon as the Dow crossed over 23,000 on
Wednesday, the “experts” on bubblevision began speculating how long it
would take for the Dow to hit 24k. I was actively trading and shorting
dot.com stocks in late 1999 and the curent environment feels almost
exactly like it felt then. Wake up everyday and wait for Maria Bartiromo
to breath the name of a dot.com stock you were short and watch it spike
up 10-20% on her signal. The Nasdaq ran from 2,966 to 4,698 – 1,700 pts
or 58% – in 4 months. It was painful holding shorts but very rewarding
after the brief period of “suffocation.”
It feels like the market could go into a final parabolic lift-off to
its final peak before the inevitable. The non-commericial (i.e. retail)
short-interest in the VIX – meaning retail investors are “selling”
volatility – hit another all-time high this past week. This a massive
and reckless bet against any possibility of any abrupt downside in the
market. It reflects unbridled hubris. Don’t forget, smart money and
banks are taking the other side of this bet.
To think that any Trump tax reform bill that might get passed will
improve the fundamentals of the economy and lead to higher corporate
earnings is absurd. The tax bill proposal is nothing more than a huge
windfall for the wealthy (as in, 8-figure net worth and above) and
Corporate America. The plan is, on balance neutral to negative for the
average middle class household. Although it doubles the standard
deduction, it eliminates the deduction for state and local taxes, which
means you’ll lose the deduction for property taxes. It also will steer a
large portion of middle class homeowners away from itemizing
deductions, which means it will marginalize or eliminate the ability to
use mortgage interest as a deduction. Corporations of course will
benefit the most – as the tax rate would be lowered from 35% to 20% –
because they throw the most money at Congress.
It’s estimated that the tax plan would cost the Government $6
trillion in revenues over the next 10 years. At $600 billion per year,
this would have doubled the “official” spending deficit for FY 2017
(Note: if you include the debt issuance that was deferred until the debt
limit ceiling was suspended – a little more than $300 billion – the
amount debt that would have been issued by the Government in FY 2017
would have been about $1 trillion. This number is the actual spending
deficit).
In short, even if some sort of “compromise” legislation is passed,
the tax “reform” would do little more than shift trillions from revenue
going to the Government to cash flow going into the pockets of Corporate
America and the upper 1% (and really the upper 0.5%).
That
said, any notion that the stock market melt-up this past week is
connected to the tax reform effort is idiotic. This is because it will
add $100’s of billions per year in Government debt issuance requirements
and will do little, if anything, to stimulate economic activity.
On the contrary, the stock market behavior is attributable to the
last-gasp capitulation that characterized the coup de grace phase of any
previous stock market bubble. This includes the re-surfacing of phrases
like, “it’s different this time,” “it’s a new economic paradigm,”
“stocks have reached a permanent plateau,” etc. CNBC even featured a
graphic last week which showed Bitcoin as having a P/E ratio. Sheer
madness.
It’s different this time? – As much as I hate to
listen to radio ads when I’m driving (I listen to the local sports
talk-radio programming and normally switch to music during the 5 min ad
breaks), in the past several weeks I’ve been listening to the commercial
breaks. The reason for this is that radio ads often reflect the current
local trends in demand for services /products. Starting in late summer,
frequent ad spots have been occupied by: 1) a service that offers IRS
back-tax settlement services; 2) numerous mortgage brokers pitching “use
your house as an ATM and take-out home equity loans to pay-down credit
card debt and have money for the holidays;” 3) “make fast money”
home-flipping seminars.
In terms of middle-class demographic trends, Colorado has always been
regarded as a leading indicator for most of the country between the
coasts. The IRS tax settlement service ads tell me that the middle class
has run out of disposable income: can’t pay taxes owed, credit card
debt is too high, and is worried about holidays. I’ve been discussing
this development for quite some time. The tax thing is self-explanatory.
There’s likely similar companies/law firms all over the country running
ads pitching tax settlement services. Wage-earners will under-withhold
their paycheck taxes to help cover current spending and hope that
year-end bonuses, or whatever luck fate might have in store, will enable
them to pay what they owe when they file.
The “use your house as an ATM” ad is disturbing. This was an idea
originally proposed by Greenspan in 2002 and put aggressively into
action from 2004 to 2008. In 2004 Greenspan advocated using adjustable
rate mortgages. How did that end up? The reason it won’t go on for
another four years is that households are stretched on their
Debt-To-Income profile (pretax income to debt service ratio) relative to
the 2004-2008 period. Household debt – auto/credit card/student loan +
mortgage – already exceeds the 2008 peak. Back then, home values were
rising right up until late 2007/early 2008. Currently, in most markets
home prices are starting to drop (this was occurring by late summer, so
it’s not just “seasonal,” which is an argument you might hear). I’m
starting to get email notices of homes listed in every price segment
that are dropping their offer price up to and over 10%. This includes
apartments in the under $400k price-segment (according to the NAR, the
average price of existing home sales declined 2.7% from August to
September – more on existing home sales below).
As enough home sales are closed with price drops greater than 10%,
the fun begins. As I’ve detailed in previous issues, an increasing
percentage of buyers right now are flippers (those radio ads are
occurring for a reason). Enough people have decided that they “don’t
want to miss out” on the “easy money” being made flipping homes. Guess
what? They’ve missed out. The majority of flippers who have purchased in
the last 3-6 months that have not been listed or are listed but just
sitting are soon going to be looking for buyer bids to sell into. The
problems will start when the flippers who used debt to buy their
“day-trade” discover that the current “bid side” for their home is below
the amount of debt used to buy the house.
Just like upward momentum in stock and home prices induces daytraders
and flippers respectively to chase prices up in anticipation that
someone will readily be willing to pay them even more, falling prices in
stocks and homes generates motivated selling and scares away buyers.
With homes it’s slightly different. Falling stock prices tend to
generate selling volume that “forces” the market lower quickly. With
stocks, there will be short-sellers who provide some liquidity to
sellers as the shorts cover on the way down.
Housing, on the other hand, goes from a “liquid market” in rising
markets to an ‘illiquid market” in falling markets. A home is a “chunky,
high-ticket” item that takes time to close. In falling markets, the
value of a home declines measurably before the buyer closes. Because of
this, buyers will disappear until the market appears to have stabilized.
Unlike stocks, homes can’t be shorted, which means there are no buyers
looking to take a profit on a bet the market would fall. Often price
falls in a “step function.” By this I mean there will be price-gaps to
downside in the market as buyer “bids” disappear completely (i.e.
bid-side volume vanishes).
I’m seeing this dynamic in the over $1,000,000 market in Denver. I
have friend who lives in a high-priced neighborhood in south Denver
(Heritage Hills). He had his house on the market for close to a year and
couldn’t move it at a price that was in-line with comps (he’s a
licensed real estate agent). The problem is that homes were not selling
in his ‘hood. I told him if he marked it down $100k he could probably
move it. He said he would wait for the market to improve and took it off
the market. That was in July. It’s too late. Homes over $1mm are being
reduced in price in $100,000 “chunks” now. I’ve gotten several “price
change alerts” for homes around Denver listed during the summer that are
lowering their offer in $100k steps. Some of them have been lowered
already 15-20% from their original listing price. It gets worse.
One of the Short Seller Journal
subscribers who lives in the south Denver metro area sent me a note
about a home he has been watching in Castle Rock, which is about 35
minutes south of downtown Denver in a very pretty area along the
foothills. The area ranges from cookie cutter middle class neighborhoods
to a high-end, exclusive country club community. It was one of the
hottest bubble areas in the mid-2000s bubble. He showed me a home that
was listed in May for $1.39 million. Since then it’s been taken down
$400k in four price changes. The last price cut was $200k.
This is an example of extreme “step function” price drops. Maybe the
house was over-priced to begin with, but not by nearly 30%. The original
offer price has to be based loosely on comps or no listing broker would
touch it. It’s on its fourth listing agent. Last summer (2016) it’s
quite likely this house would have moved somewhere near the offer price.
He also told me that he’s seeing more pre-foreclosure and foreclosure
activity in the homes around $1,000,000 in that area. This is how it
starts and I’m certain this is not the only area around the country
where this is starting to occur.
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Dave Kranzler spent many years working in various Wall Street jobs. After business school, he traded junk bonds for a large bank. He has an MBA from the University of Chicago, with a concentration in accounting and finance, and graduated Oberlin College with majors in Economics and English. Dave has nearly thirty years of experience in studying, researching, analyzing and investing in the financial markets. Currently he co-manages a precious metals and mining stock investment fund in Denver and publishes the Mining Stock and Short Seller Journals. Contact Dave at dkranzler62@gmail.com.
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The author is not affiliated with, endorsed or sponsored by Sprott Money Ltd. The views and opinions expressed in this material are those of the author or guest speaker, are subject to change and may not necessarily reflect the opinions of Sprott Money Ltd. Sprott Money does not guarantee the accuracy, completeness, timeliness and reliability of the information or any results from its use.
