11/05/09 Gaithersburg, Maryland – I was in New York earlier in the week for the Value Investing Congress. Among the more valuable presentations were those of Sean Dobson at Amherst Securities and Whitney Tilson and Glenn Tongue of T2 Partners.
They were valuable because they helped frame where we are in the mortgage crisis, which has been the main shark in the water over the past couple of years. You should know where that shark is and whether or not it is hungry. The chart below shows you the ferocious fish may still have an appetite.
It shows you that we are past the viscous subprime crisis, when that shark chewed through the balance sheets of a number of banks and financial institutions, in some cases devouring them whole. However, it is not yet safe to get back in the water:
There are these other slices of mortgages that are not quite as risky as subprime that reset in the next couple of years. Years 2010 and 2011 face big resets in so-called Alt-A and Option ARM loans. What this means is more write-downs and more losses for banks and others who hold these mortgages.
Making all this worse is the fact that the housing has not yet recovered. The T2 duo made the case that the current “stabilization” of the housing market is a head fake. Mostly, it’s due to huge government support of the housing market. But there is still a large inventory of homes out there. And with these resets coming due, we’ve still got a large amount of foreclosures on the horizon.
All the while, the unemployment numbers are still poor. The T2 duo calls the unemployment situation the “most severe since the Great Depression.” The US economy has shed over 8 million jobs in this recession and unemployment – officially – is nearly 10%.
Plus, it’s not like the average US consumer is in a good position to sail through this crisis. Household liabilities are still high, as this next chart shows:
US consumers need to save and rebuild their financial strength. This is why the savings rate is on the rise. This is why, for the first time since the 1950s, household credit debt declined.
As investors, it seems clear that any idea that depends on discretionary consumer spending – say, buying trendy new sweaters or watches or expensive shoes – faces some big head winds. Better to the stick with the necessities, I say.
Also, it looks like the bounce in the stock prices of overleveraged banks and financial institutions is premature. Most bank stocks should be sold, not bought. The bounce in home building stocks looks ridiculous in light of what they have to look forward to. The T2 duo actually recommended shorting the home building stocks through the iShares Dow Jones US Home Construction ETF (ITB). By shorting it, you make money when the stock prices of the home builders go down.
They made a compelling case, of which I will highlight a few things. Exhibit A would be the fact that the average new home has been on the market for 12.9 months. Exhibit B is that we have about 2-3 years of existing home sales just to absorb the vacancies that exist. According to T2, about 6% of all homes built this decade are vacant.
Exhibit C is that the home builders themselves have too much debt and too much inventory relative to their thin equity cushions. The home builders are in the position of trying to hold up a bowling ball with a sheet of paper…in the rain.
Lastly, the home builder stocks are almost universally expensive on a price-to-book basis, as this chart shows:
Stocks with lots of debt, too much inventory and an awful market don’t deserve premiums over book value. Discounts are more like it.
So there you go. I like the idea of shorting the home builders. At the very least, I wouldn’t buy one. I’d also stay away from banks and financial institutions that hold mortgage assets. American real estate is not worth zero, as Dobson said, but it can be worth a lot less than today’s price.
I recommend staying with the sorts of companies that own essential assets and/or sell essential items. As I like to say, stick with what keeps civilization a going concern. And avoid any stock that is dependent on regular access to the credit markets. As we saw in 2008, a mortgage crisis can shut down the credit markets. We don’t want to be held hostage by lenders in that situation, so stick with excellent financial conditions.
Regards,
Chris Mayer,
for The Daily Reckoning
Sign Up for The Daily Reckoning e-letter and receive a copy of Bill Bonner's The Trade of The Decade report… at NO CHARGE.
We Value Your Privacy.
Dont think this analysis is factoring in that fed funds and related benchmarks are close to historical lows and that the fed funds rate is unlikely to be raised substantially (ie >300 basis pts) in the near future so the resets on arm’s entered into at mostly higher interest rates should not be that significant to new carrying costs limiting any new wave of defaults despite their sheer volumes. The bigger problem of subprime and mispriced securities on books appear mostly behind and a different pyschology towards home ownership by consumers-investors along with tighter financial regulation and more conservative lending standards should seemingly prevent a repeat of overleveraging in real estate over the this coming decade. Not expecting any RE boom with a sluggish recovery looming over the immediate horizon but rather housing stabilty and resumed growth later especially in areas with increasing population as repaired balance sheets lower inventories and demographics help demand and prices. See the lift occuring generally in the lower to mid points of entry as sq footage desires devrease which could result in much higher share prices for some national homebuilders despite today’s ratios. Mc Mansions will be hard pressed to be in wide fashion given recent lessons and a generation that is more environmentally conscious generation and less geared towards materialism. (At least until they hit their 40″s lol)
It is likely that the FED and the politicians forseeing the next ‘housing bust cycle’ will keep the interest rates low for a some time till at least the elections are over in the near future, I dont think they will risk their political position allowing this ‘bubble’ to bust.
Low interest rate is irrelevant if banks won’t lend money on property that is under water.
A Question:
Either way housing and/or the general economy heads, the US $ over time is absolutely headed down to zero & that seems to be the stance held by Mr. Buffett isn’t it?
Therefore, how do we figure the “value” of housing, regardless of price, as the purchasing power of the housing prices continues to be re-evaluated against a downward trending US $?
For example, if we look at the American Institute For Economic Researches’ “Chart Book” graph of the US $ sense the 1800′ds, we can see where the purdhasing power of the US $ was as high as around 140 pennies; while today the US $ is stuggling to maintain 4 pennies in buying power ea. and so how do we correlate that against future home price values?
In other words let’s say for sake of our question here a house is selling for $1,000 when the US $ was @ 140 pennies each which would equate into premium $1400 in purchasing power; while that same $1,000 home today equates into a mere $40 in purchasing power. We certainly know the difference between $1,400 of purchasing power vs. $40 vs. todays’ higher prices that translate our general purchasing power against the inflated $ for all nationally available goods and/or services. Not even fluctuations in interest rates or the supply/demand pictures have thwarted the decades long trend of the downward trend of the US $’s purchasing power and so now back to my question above please.
Russ, Calif.
resmith@wcisp.com
I think you’re all full of merda