Economic Recovery only with Housing Recovery?

After a long respite, I've had a few things bother me enough to consider them in long form. The first is the continuous drumbeat that the economy will not recover without a housing recovery. I want to challenge that hypothesis.

I agree that as a function of addition in GDP figures that if fixed residential investment does not stop plummeting, GDP will have a hard time going up. Housing has been the anchor. Will it continue to be? Do we need a rapid recovery in housing to have a rapid recovery in the economy? My opinion: only if we want the next economy to look like the last economy. Of course it's easy to see what was and wish for it to be so again. That thinking is short sided and will miss whatever eventual recovery will eventually unveil itself.

I decided to use the new FRED excel add-in to pull fixed residential investment (FRI) and GDP numbers since 1947 to find out how large of a role fixed residential investment plays in our economy and in economic recoveries. I tracked change in FRI over change in GDP to find the mean contribution to GDP of 5.7% with a standard deviation of .547. At first glance, I surmised that housing, although relevant, was not THE driver of our economy pundits often make it out to be. With 258 observations, however, the 95% confidence interval for the entire period is 0.11%-11.35%; a bit of excess kurtosis if you will. Here's the chart for the whole period.

During the 2000s, the mean contribution to GDP from FRI was 7.7%. The main damage was done shortly after Greenspan lit the match lowering rates from 6.5% to 1% to cushion the blow from the internet bubble bursting. An initial explosion of FRI in Q3 2001 notwithstanding, FRI contributed on average 12% to GDP growth for the next four years; that uninterrupted growth compounded to trade one misallocation in our economy (internet stocks) for another (housing). But has housing always been the driver of our economy? That lead me to think about FRI as a proportion of GDP. It has oscillated between 3-6% except after the bursting of the housing bubble and is now at 2.22%.

Amazingly, even with a bubble, housing, our Savior that has since passed whose Resurrection we eagerly await, only retraced its range from decades earlier and didn't even make a new high! That lead me to define exactly what the BEA measures as FRI (pg8):

Residential fixed investment consists of all private

residential structures and of residential equipment that

is owned by landlords and rented to tenants. Residen­

tial structures consists of new construction of perma­

nent-site single family and multifamily units,

improvements (additions, alterations, and major

structural replacements) to housing units, expendi­

tures on manufactured homes, brokers’ commissions

on the sale of residential property, and net purchases of

used structures from government agencies. Residential

structures includes some types of equipment that are

built into the structure, such as heating and air condi­

tioning equipment.

Did you catch it? 'New construction, ...improvements,.. and net purchases of used structures from government agencies.' FRI does not include purchasing existing property or any refinancing. That helps explain why during the bubble FRI/GDP did not reach new all time highs. All existing home sales are not captured in FRI investment. What proportion of home sales were existing?

Consistently over 83% of all home sales during the housing build up were existing and were overlooked when counting FRI. The stretched valuation of housing was not considered when calculating GDP and overlooked by many as a result. Those high prices were paid for on credit as rates moved lower and lending standards eased. It's fair to say, the housing picture and its impact on the economy has been convoluted with what was the most recent bubble: credit.

-Insert growth in personal credit

-Slump in savings rate

As we all know (I hope), what we experienced the last few years was the popping of a credit bubble with an impact on all assets, real and financial. The reason housing is now the topic of conversation, and the hoped for Savior, is because house prices were the biggest manifestation of credit expansion on the balance sheet of average Americans. To expect a housing recovery to power the economy is to expect a recovery in credit. Remember, the action of expanding credit causes debt to appear on the balance sheet of the actor. How did that work out last time for most people. Fool me once, shame on you..

It's also important to remember those passed transgressions and their poor prints on the balance sheet of consumers and the opposite reaction to the balance sheet of banks. Irving Fisher and debt deflation would encourage us to boost house prices to ease the overhang but if that's the case, lets not get all excited when home builders catch a bid in the stock market and housing starts increase; it's only adding to supply.

So will the recovery be led by housing? Highly unlikely. It could easily be health care or productivity advancements, or a range of other things but most likely not housing or anything else credit related.

Facebook and Social Media Reach Fever Pitch

I wasn't planning on commenting about FB and social media, I prefer to stick to market action and economic views, but a fever pitch has been reached and can no longer be ignored. The frenzy that is Facebook, Twitter, and the contents of 'social media' are reaching a fever pitch that will turn quickly when the shift arrives. If you believe society is a living, breathing organism then the implications of any shift are large and wide ranging.

In a recent Hitwise Intelligence report it was determined that Facebook surpassed Google as the most visited site on the internet with 7.1% of web traffic vs. 7% for Google. To start, the logic of comparing total clicks could be fraught with errors but it is difficult to tell. Does the study just compare 'total clicks?' If so, I guess it makes sense that FB would have more clicks as people sit around and look at pictures of each other while Google is only utilized once to reach a new destination and then we might bookmark that destination and never search again (I admit, I'm a Google over-user). To use an analogy though, it is telling that one store in town is utilized more than all the stoplights combined! What does that tell you about society and where we are headed? We have more information available at our fingertips than we could possibly consume yet would rather scroll through Jennifer's 23rd birthday album.

Facebook has always been somewhat of an enigma to me anyways. I was reluctant to open an account but did so only after studying abroad a few years ago and thought it a prudent vehicle to stay in touch with others I met along the way. The logic is air tight but it has not happened as such. My account is basically sitting idle with a three year old picture of myself that I (very occasionally) sign into. I never thought others would be very interested in my current 'status' or random thoughts I felt like making available for mass consumption. If you're that interested in someone else, you should probably call them up and share some time together.

The awful part is marketers are now attempting to get in on the act. Although some have come to their senses, others think it's a powerful avenue that should be used to grow your business. I'm truly trying to keep an open mind but I just can't imagine having my consumption patterns altered by reading the latest Tweet about P&G products or the hottest new organic food. Any revealing stories for honest discourse would be welcome.

Even though I have always had a distaste for these productivity killers, there has been a shift recently from those around me. A colleague recently shut down his account because he realized it was a waste of time. Why now though? Is Jennifer no longer posting pictures? Don't you care that Jimmy is doing laundry because it's raining outside? Even a marketer friend of mine has reached the conclusion that 'social media' is an excuse to call a meeting but has little consequence to the bottom line. It's as if they do it for themselves more than other stakeholders. Now there's a way to grow a business.

Kevin Depew of Minyanville has been all over this topic for over a year. His latest update weaves together how social mood drives social action and ultimately the market. The topic might help us discern whether we are in a new bull market or only a counter trend rally in a bear market. If social mood is tightening with a larger focus on small groups and quality time, as observed, those feelings are more consistent with bear markets than bull markets.

The transition, though, will not happen smoothly. Remember, the debt markets were still interested in PIK toggle loans into the fall of 2007 when the writing was clearly on the wall that a debt crises was on the horizon. Similarly if you're in a herd headed towards a cliff, any chance to save yourself goes unnoticed until it's too late and in a free fall. If I were long social media, I would enjoy the bubble but set a quick trailing stop. Any attempt to value these businesses is blindsided by hopeful perspective reminiscent of the tech bubble.

RBA Raises Again

In line with the majority of market soothsayers, the RBA continued its campaign of raising interest rates last night. I had a change of heart concerning whether a long side try was viable after the morning data and initiated around .8990. Trading isn't easy though and the news was sold down 40 pips or so while the crowded trade had some running for the exits when a move higher didn't take place. The downside scenario didn't play out over night and AUD rallied back above .9000 to peak around .9050 around 745am this morning. I cleared my book on a pullback around .9040 and look to enter another trade when/if a high probability opportunity presents itself.

The RBA telegraphed to expect more rate hikes this year saying ''The (RBA) Board judges that with growth likely to be close to trend and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average. Today's decision is a further step in that process.'' Many expect to see rates around 5% a year from now. From where I sit, most of risk is to the downside unless Asia is going to continue to pull Australia around regardless of what happens to the rest of the G20. You won't see me making any bets on that though. That economy has been know to put some out for a stroll.

RBA Decision Imminent

Considering the data of late, I think it's prudent to enter a long AUD position. As a trader, I think the market position is unfavorable (either rally to .9070 on a hike or break to .8800 on a pause...quoted .8890....risk 90pips to make 80) but considering recent data, I am willing to take a shot. The important part of the article isn't in the headline, though cumulatively it is enticing. The meat of my decision comes towards the bottom under Government spending gains. I know it's normally the boring crap at the bottom of the ticker no one reads but we should recall Mr. Stevens making comments about the balancing act central banks will play between monetary and fiscal stimulus. Total general government final consumption expenditure grew 1.8% in Q4 vs growth of 1.4% in Q3 and .89% in Q2. Expect Stevens and others to turn the faucet down a bit in an hours time.

Some Disagree with Price

In a show of how some disagree with the price, many are noticing the prices of CDSs. Consider the Guardians story, Calls to curb CDS gamblers as Greek crisis continues (http://www.guardian.co.uk/business/2010/feb/15/credit-default-swaps-regulation).

I agree that illiquid markets do not render accurate market data all the time but is it possible the odds of default are greater than most believe? If hedge funds are over-paying for CDSs, don't you think Goldman or JP Morgan would offer them as many as they want?

I do agree that this crap should be regulated. As a clearing member at a futures exchange, I can only think of one legitimate reason it isn't: those making all the money set the rules. It's similar to corporate bond trading before the TRACE was put in place. Markets with informational disadvantages assure those in the know will pick off someone on the other side for a tidy profit. It's time regulators clean this up.

As we get started, it's necessary to recognize where we are on the chess board. There are many issues vying for our attention each day and it's important to narrow them down to something manageable. We want to create a conceptual understanding of the topic that can slowly be managed over time. A change in perspective should come from a cumulative change in market data or news flow. I try to manage my understanding of a topic cumulatively, without letting one piece of data scare me out of the pocket. Decisions are made at the margin however, once cumulative imbalances are enough to change your judgment of the environment. That said, below is a list of investment themes that should be researched each day.

1. Debt. The debt problem has evolved from a household issue into a sovereign issue. As governments around the world stepped up spending to avoid the next Great Depression, they have accumulated more debt in the face of declining tax receipts. This is evolving at a fast pace with Greece at the forefront of any news report. How the EU deals with the Greeks could set the tone for how/when the debt problem will manifest. This war is also waging in State finances but fortunately, the spotlight is elsewhere.

2. Public Servants/Unions. The compensation and benefits of public servants and unions is out of line with the private work force. Budgets will have to be tempered to make ends meet. Some will bargain. Some will not. http://www.projo.com/education/content/central_falls_teachers.1_02-13-10_A8HEI7Q_v61.3a65218.html.

3. Unemployment. There is not a clear driver for jobs outside of government work. Even as the economy stops hemorrhaging jobs, an increase of 150,000 a month is necessary to reduce unemployment (all other things equal).

4. Emerging market growth story. China is racing after Japan to be the second biggest economy in the world. Even with 10.7% GDP growth in Q4 and 8.7% for all of 2009, China has problems of its own. It has recently raised reserve requirements and interest rates and clamped down on lending to prevent its economy from overheating. If China downshifts, the repercussions will be felt from Australia to the US as many are looking for emerging markets to pull the US out of recession.

5. Politicization of markets/market participants. The finance industry will stay under pressure as society places blame. Talking heads will disagree with the price to serve their ideological bias. Those successful in the markets will be viewed as taking advantage of others. Providing liquidity will no longer be viewed as a benefit to society.

That's a good starting point to define the major issues confronting the market and the economy. I'm sure other issues will come to the forefront as some slip away. We will change our judgments accordingly.....and slowly.

In the beginning...

“In the beginning was the Market, and the Market was with People, and the Market was People. People were in the Market in the beginning.” Trading 1:1

That sums it up. The market is only the collective consciousness of society. It is always telling a tale whether or not you agree with the price. Ben Graham once said the market in the short term is a voting machine but in the long term it’s a weighing machine. The market never lies over the long term. In the short term, it's almost always being pushed and pulled by different forces whether they be the psychological blind spots of market participants or an intervening hand. The goal of this blog is to be aware of those different forces over varying time horizons. We will rise above the chess board and study the implications of political and market news on different asset classes from commodities and currencies to stocks and bonds. Let the games begin.