2014: Seeing Some Bubble-Like Comments
The segments below from a recent CNN
Money article have a familiar 2002-2006 housing bubble ring to them:
The competition for the homes that are available is so intense that buyers
need to bring plenty of cash to the table. In fact, all-cash deals hit
a record 43% of home sales in the first quarter of this year, according
to RealtyTrac...Demand is so high that real estate agents are actively
seeking people who are willing to sell. "You get letters in the mail asking
if you're interested in selling," said Jackson. "People knock on your doors."
Setting The Debate Table
Prior to considering the basic question of is the Fed making the same "keeping
rates too low for too long" mistake, it is important to set the table from
a historical perspective. The slope of the home price curve below began to
steepen in 2003 before cresting in late 2006.
Since interest rates impact affordability, they also impact demand for housing.
If you think in extreme terms, if mortgage rates were currently sitting at
10%, how many first time home buyers would be able to even consider home ownership?
The graph of interest rates below shows an extended period during which Fed
policy was very helpful to the housing industry.
Many Factors Contributed To The Housing Bubble
Regular readers know we believe that our firm's opinion has very little impact
on asset prices, a concept that was described in detail under the What Determines
The Value Of Our Investments? subheading in a May
14 article. What does matter is the general investing public's opinion;
something we can gauge from the readers of this article. Therefore, the purpose
of this article is not to make a case on the "low rates too long" question,
but rather to spark a debate among readers. The excerpts below relate to the
original 2002-2006 housing bubble and may help readers tap back into their
housing bubble memories, perspectives, and experiences. From the Economists
View by Mark Thoma, Professor of Economics, University of Oregon:
I feel compelled to rebut this Fed love fest since there are compelling
reasons to believe the Fed did play an important role in creating the housing
boom. To be clear, I do not see the Fed as the only contributor-far from
it-but it does appear to be one of the more important ones. Here is my
list of reasons why:
- The Fed kept its policy interest rate, the federal funds rate, below
the natural or neutral interest rate for an extended period.
- Given the excessive monetary easing shown above, the Fed helped create
a credit boom that found its way-via financial innovation, lax governance
(both private and public), and misaligned incentives-into the housing
market.
- Given the Fed's monetary superpower status, its loose monetary policy
got exported across the globe. As a result, the Fed helped create a global
liquidity glut that in turn helped fuel a global housing boom.
For these reasons I believe the Fed played a major role in the credit
and housing boom during the early-to-mid 2000s.
Fed Policy: 2002-2006 vs. 2009-2014
If we assume low interest rates played a role in the 2002-2006 housing bubble,
a fair question is:
How does recent Fed policy compare to the 2002-2006 period?
The answer is provided via the graph below. If the orange box contributed
to the housing bubble, then at a minimum it is reasonable to ask if the Fed
making the same mistakes again?
Housing Prices Are Rising Again
We opened the article with 2014 anecdotal stories of "intense" competition
for homes. Nationally, as shown in the graph below, prices are rising at a
fairly steep rate (again).
Fed Policy Aligns With Economy
Is it fair to compare Fed policy in 2004 head-to-head with policy in 2014?
No it is not fair; the economic landscape is a part of Fed policy. However,
the graphs of interest rates above do sound some alarm bells from the potential "bubble
blowing" perspective.
Respecting The Law Of Supply And Demand
Before we open the debate on how Fed policy impacted the inflating of the
housing bubble and its current impact on housing prices, it is important to
respect that prices are governed by both supply and demand. According to Investopedia:
The law of supply and demand defines the effect that the availability
of a particular product and the desire (or demand) for that product has
on price. Generally, if there is a low supply and a high demand, the price
will be high. In contrast, the greater the supply and the lower the demand,
the lower the price will be.
Supply Has Been Impacted By Fed
If we keep simple economics in the picture, the low supply of homes in 2014
bubble-like areas, such as Boston, cannot be ignored. However, low supply is
due in part to the post-bubble world. Imagine if a homebuilder approached a
bank in 2010 and said:
"I want to begin development on hundreds of new homes in the greater
Boston area to meet what we believe will be a supply shortage in the years
ahead."
That developer would have been kindly told by potential creditors:
"We are not interested in lending to anyone for the development of single
family homes. We wish you nothing but success in terms of finding credit."
When markets get skewed as housing did between 2002 and 2006, it alters the
pricing mechanism from both a supply and demand perspective.
Investment Implications - Not Much Has Changed, But...
Do low interest rates and the potential for new asset bubbles impact our approach
to the stock market? Yes, if stock prices have been inflated in part due to
the Fed's asset-friendly policies, then it means the market has a higher than
normal speculative bent to it. Downside risks are higher in speculative markets,
meaning it is important to have specific capital
preservation plans in place, with an emphasis on specific.
Staying with the specific theme, having something firm to manage against is
always a good idea, but even more so in an indecisive market environment (see
last five months). The tactical tweets below speak to an ongoing trading range,
and the need to have defensive contingency plans within reach ($SPX is the
S&P 500 Index):
We will enter Wednesday's session ready to play defense. The S&P is down
5 points so far this week. Since not much has changed (yet), we continue to
hold a mix of stocks (SPY) and bonds (TLT). Let the debate on housing and the
Fed begin.
