This
past January, I wrote an article titled "Real Estate Burst, Upcoming
Recession, and Soaring Commodity Prices". At the time of the article,
most people thought that a recession prediction was outrageous and that a
burst in the real estate market was hopelessly pessimistic. Since then, we
have seen clear signs of an upcoming recession as well as a slowdown in
housing that is only set to accelerate. Recently, I have had a number of
inquiries from readers that wanted some updated information on the above
mentioned article. If you have not read it, I urge you to read it here:
While
the Federal Reserve and most Wall Street economists continue to predict a
soft landing scenario in housing, the increasingly worrisome economic data
tell another story. In fact, if one were to compare shopping for a house
today with shopping for a house in January, one would see some noticeable
differences.
Are you worried about
having someone outbid you? Don't worry. Houses are on the market a lot longer (approximately 6
months) and inventory is at a multi-year high. The National Association of
Realtors reported this past week that the number of homes for sale is at
their highest point since 1997. The Commerce Department also reported today
that new home sales dropped by 3% last month.
Is your Real Estate
agent telling you that you better buy now before prices go even higher? Don't believe it. Housing prices
have already started their decline. Take a look at the recent decline in San
Diego County Media Home Prices.
Source: http://piggington.com
The sharp
decline over the last couple of months does not look anything like a soft
landing scenario.
Did you plan on
paying for your closing costs? No need. Sellers are paying for closing
costs and even offering new washer and dryers to boot! Home builders are even
offering incentives for upgrades and even leases on luxury cars.
It is
clear to me that we are well on our way towards the housing burst that I
predicted in January. Anecdotes about housing incentives will only multiply;
supply of homes on the markets will increase, and prices will continue
falling.
Foreclosures
According
to Foreclosure.com, foreclosures are up 2.6% throughout the country. While
this number does not seem staggering, it does reaffirm a change in the trend.
In fact, some areas of the country are already showing a dramatic increase in
foreclosures. In Dallas,
for example, foreclosure rates are up 26%. As interest rates continue rising
and the overextended homeowner is faced with the reality of higher mortgage
payments, I expect that we will see these numbers exponentially rise.
Going Forward
At the
center of the housing burst, is the continual and
inevitable rise in interest rates. While most Wall Street economists firmly
believe that the interest rate hike is over, I contend that this outlook is
undeniably shortsighted. In fact, most of these
economists that are predicting a pause or a stop in rates have had this
outlook for the last several rate hikes. Generally speaking, their argument
is centered on the fact that they feel that inflation
is not a problem.
Inflation,
however, is a problem. Over the last several years we have seen the price of
oil triple and raw material costs reach multiyear highs. While manufacturers
and producers have been eating up these costs for the last several years,
this trend is not likely to continue. In fact, we are already starting to see
companies pass through the high energy costs to the consumers. Companies like
FedEx have raised their prices due to higher energy costs. Even some
restaurants are beginning to pass through the higher transportation costs to
the consumer. The end result of the pass through of costs is a higher core
CPI number.
The
significance of higher core inflation is that the Fed will finally be forced
to acknowledge inflation. Ben Bernanke has clearly
stated that they will rely on data to determine their actions. Rising
inflation would force the Fed to continue moving rates higher. The last
several months have resulted in higher than anticipated core CPI numbers. In
March, the core CPI jumped up 0.3%. Wall Street economists had expected a
0.2% increase. In April, the core CPI jumped up another 0.3%. This number
again came in above Wall Street expectations of 0.2%. May once again showed
another 0.3% increase in the core CPI numbers. Not surprisingly, Wall Street
had expected an increase of .2%. Finally, the June CPI numbers also came in
at a 0.3% increase, higher than the expected 0.2% increase. The Fed continues
to argue that inflation is contained, yet I believe that the cat is already
out of the bag. Going forward, I expect further spikes in the core CPI
numbers to translate into higher interest rates.
The
rising interest rate environment will have a negative impact on homeowners
who have interest only or adjustable rate mortgages. In the next 18 months,
there will be approximately 2 trillion dollars worth of adjustable rate
mortgages that will have to adjust to a fixed rate. Overextended homeowners
who were paying a certain amount on their mortgage will be forced to pay a
higher rate. Unfortunately, a good number of these homeowners do not have the
means (see negative savings article) to afford the higher mortgage payments.
With rising interest rates, we will see a rise in foreclosures, which lead to
additional supply of homes on the market. The additional homes on the markets
coupled with slowing demand will translate into a continued burst in the Real
Estate Market.
Recession
Recessionary
concerns have also intensified over the last six months. Whereas several
months ago few people were arguing the recession scenario, there are now more
people that are at least acknowledging a slight probability of an upcoming
recession. In truth, there is more than just a slight probability of an
upcoming recession. If you subscribe to a burst (or even slowdown) in
housing, you should expect a recession to unfold.
As
real estate prices have climbed in the last several years, we have seen
consumer spending go through the roof. In turn, this has led to strong
corporate profits and a false sense that we have a strong economy. However,
borrowed money does not translate into a strong economy. It only translates
into an eventual recession. Take a look at the below chart. It tracks consumer spending versus housing.
As you
can see when housing slows, the consumer stops spending. Of course, this
makes sense. Consumers will no longer be able to tap into their home equity
and withdraw cash for frivolous expenditures. In addition, those that will be
able to remain in their homes will be forced to pay more on their home
mortgage. It is important to note, that if we were a manufacturing economy,
this would not hold as great of significance. However, we are a consumer led
economy. As a result, a slowdown in consumer spending will be put a
screeching halt to this pseudo-economic growth we have experienced in the
last several years. A housing burst will also contribute to a higher
unemployment rate. While it is true that the current unemployment rate is
pretty low, I do not expect this trend to continue. Mortgage companies, real
estate firms, construction companies, and other real estate driven industries
will be forced to lay off workers as the real estate bubble comes to an end.
Additionally, industries that rely heavily on discretionary consumer spending
will also lay off workers. Already, we are starting to see signs of a
slowdown in consumer confidence and spending.
Are We Watching
Re-runs of That 70's Show?
While
the upcoming real estate and economic outlooks are far from rosy, you can
position yourself to weather out this storm. Fortunately, we can look at the
past as a point of reference of what might happen in the future. During the
1970's, Americans experienced high inflation, a recession, and rising interest
rates. Sound familiar? The 1970's also provided investors with an opportunity
to profit in commodity markets.
Gold, for example,
moved up 19.5 times in value. At the end of 1971, Gold prices were trading at
just about $43/ounce. Before the bull market was over, Gold prices had
reached a high of $850 an ounce. In comparison, the present bull market in
gold has only appreciated 2.5 times in value. Although there were some
1970-specific factors (such as the end of the gold standard and the oil
embargo) that are absent from today's market, the main factors that were
present during the 1970's are clearly present today. One can also argue that
there could potentially be a greater demand for gold during this bull market.
Population growth and wealth creation in Asia, central bank buying, and a
declining interest in fiat currencies are just a few reasons why this could
be the case.
Besides
gold, there were other commodities that experienced appreciation during the
1970's. Sugar went up 9 times in value. Coffee went up approximately 6 times
in value. All in all, commodities were in a bull market.
At the
present, there is speculation that a rising rate environment could put an end
to rising commodity markets. Some pundits argue that higher interest rates
will slow down economies, which will in turn slowdown demand for commodities.
This logic, however, is flawed. First, we have had 17 consecutive rate hikes.
During the rate hikes we have seen commodity prices continue to soar. Second,
the 1970's clearly showed us that commodity prices can still rise as interest
rates rise. Take a look at
the below chart:
Source: www.vardeni.com
Courtesy - Puru Saxena's
Money Matters, www.purusaxena.com
There
are clearly investment opportunities during the upcoming recession and
housing burst. You can either continue to believe that the economy is strong
and that we will only have a soft landing in housing, or you can start
positioning yourself to deal with the upcoming recession and housing burst.
Other Strategies
While
many investors are well informed on stocks and bonds, few have diversified
with portfolios with managed futures. Managed futures may provide above
average returns in both bull and bear markets. Having a buy and hold stock
portfolio might not necessarily make sense for all investors. If you are
interested in learning more about managed futures or would like to sign up
for my free commodity newsletter, please sign up here:
The
risk of loss in trading commodity futures contracts can be substantial. You
should therefore carefully consider whether such trading is suitable for you
in light of your financial condition.
If you are interested
in learning more about the commodity bull market, I urge to pre-order my
forthcoming book, "Commodities for Every
Portfolio: How To Profit from the Long-Term Commodity Boom".
Emanuel Balarie
Senior Market Strategist
Wisdom Financial, Inc.
Direct toll free: 866-465-0017
International: 949-548-2021
Emanuel Balarie is the Senior Market Strategist at Wisdom
Financial. As an expert on foreign markets, foreign currencies, and the
precious metals industry, Mr. Balarie often speaks
at public engagements and his research is regularly published in investment
newsletters. You can find out more about Mr. Balarie
and his services at www.wisdomfinancilinc.com
The risk of
loss in trading commodity futures contracts can be substantial. You should
therefore carefully consider whether such trading is suitable for you in
light of your financial condition.
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