Housing-proof your portfolio

Let's look at the latest information
1. Housing unit sales are down 30% and have been for several months
2. Prices are slipping (anecdotes suggest 10%~15%, actual data shows 1.5%)
3. Housing starts are waaaaay down (as low as 85% depending on location)
4. Future home comstruction will be at best 50% of current level

If #1 & #2 inform us about future prices, what do #3 & #4 tell us about construction employment?
Here are the latest employment figures
Total 145M workers in the US
* Farm workers 10M
* Service workers 113M
* Construction 8M
* Manufacturing 14M

From the US Dept of Labor September 2006 report
"Job gains in construction have averaged 6,000 per month since February of this year compared to increases of 27,000 per month during the 12-month period ending in February. Manufacturing lost 19,000 jobs in September. Within durable goods, factory job losses occurred in several industries that are related to home building--wood products, nonmetallic mineral products, and furniture. Employment continued to trend downward in a number of nondurable goods manufacturing indus-tries, including textile mills, plastics, and paper products."

So construction is almost 6% of the labor pool. Over the last 18 months, 380K construction jobs were added. But there is also evidence of a slowdown not just in the slower pace of new construction jobs but in the actual reduction in home building related manufacturing jobs.

The 380K construction workers will be without jobs in the next 6 months. Add others who were hired in 2003 & 2004 and add the accumulation of home building jobs, and it is safe to assume that 500K people will be out of work soon. Soon meaning 6~8 months. Oh, and these are the legal workers. Many more illegal workers will be forced out as well.

When 500K workers leave the employment ranks in such a short time span, it has a major impact. The average hourly wage for construction work is $25 (not including overtime) and the average hours worked are 45 hours per week. Supervisers and craftsmen earn even more. call it $60K gross and $40K net. That's $20B taken out of the direct spending pool or a 0.2% drop in GDP. Then there is the magnifier effect: those 500K workers bought stereos, TVs, cars and so on. The people selling them will be out of work very soon as well. Throw in the Home Depot employees getting laid off, the real estate agents, the loan officers, and so on.
The Fed is projecting a 1% reduction in GDP, and now you know how it gets to that figure.
Moreover, unlike the dot.com crash or the Detroit blues or Houston oil crash, the impact is nationwide. In some ways, that makes it easier to absorb.

I am mostly concerned with the rate of change. I believe that these jobs will be cut and viciously fast. Home builders will wrap things up as soon as possible. Maybe they will blame the season for the need to reduce the workforce. Whatever, happens, it will come fast after the holidays.

That's a big shock to the system. People tend to look at others getting fired and start to consider their own situation. Gradual reductions are one thing; a large and seemingly sudden drop is another. The spinmeisters will claim that this is good, that we are returning to a more normal and sustainable level of employment. But the reality is that this negative shock to the system will be accompanied by an already ongoing slowdown in the economy.

And that's when fear and panic set in. If I had to time this, I would say March/April. And the Fed will reduce rates around that time in a pre-emptive strike to keep the economy bubbling.

Now that I have painted a picture of an accelerating slowdown, lets return to the first points I raised.
1. Housing unit sales are down 30% and have been for several months
2. Prices are slipping (anecdotes suggest 10%~15%, actual data shows 1.5%)

If you want to know how much of the housing market was speculative, it's very simple: just look at the drop in the number of units sold: 30%. So when we hear that there are not quite enough houses for each buyer in the Bay Area, it begs the question: are we talking about homeowners or speculators? Remove 30% of the demand, and you will realize that there is a large oversupply of housing.

Anyone who wants to suggest that the 30% drop is tied closer to homeowners who are priced out needs to consider that prices haven't moved enough since 2005 to have that effect. That is, a $20K increase on a $650K house wasn't the straw that broke the camel's back.

Will that 30% demand return? I think not. Speculators know that the potential for price appreciation is gone, even if rates drop to 0%. But most people are holding on by a wing and a prayer. They are waiting for next season to sell, and they are taking a cash hit. (This, btw, adds to further GDP erosion.)

Like the unemployment drop that I am projecting, the disappearance of buyers/speculators is sharp and sudden. The market has yet to absorb the realities and factor it into prices. There is a period of ignorance (a lot of people just don't know what is going on and their brokers won't tell them) and outright denial.

Now consider that prices are dropping before an economic correction. There are no financial stresses in the system but housing prices are dropping and fast. This just corroborates the laws of supply and demand. I believe that as the truth works its way through the system over the next 6 months, the 2007 housing market will see accelerating price drops.

Now add in the financial stresses of foreclosures (up 300% already) and of ARMs needing to be re-set. This will shake out weak hands, which are unfortunately a lot of homebuyers. Foreclosures and falling prices re-set the comps. Appraisers will be facing a lot more scrutiny and they will look at the more recent, lower comps to set an appraisal. Anyone needing to re-finance will find that their house has lost value AND the bank won't cover their loan. Scrimping to keep their house, more cut backs on spending means less consumer buying and a further hit to the GDP.

The number of homes for sale in SF has increased almost 40% in 2 years while the number of buyers has dropped 30%. Now add the additional Fucked Homeowners (FO), and supply rockets up. Buyers will be too nervous to buy in a rapidly cooling market. And again, that is the key: it won't be gradual or a soft landing. It will be rapid. People will have to sell and speculators will panic and sell outright.

Then you add the slowdown in GDP from construction and this is a massive wave of bad financial news.
It is also a reward to people who are fiscally prudent and saved their money. Relatively new pre-owned Flat panel TVs and BMWs will flood the market, priced at a discount (watch out Detroit - drop in your sales coming up).

I am preparing by assuming a stock market correction of significance. I have set my stops to a tight range. I am building a cash position. I am also considering bonds in a few months (I do believe a rate hike is possible in a few months, but a rate cut will be happening in the Spring). As an alternative, buying a CD is a good idea - lock in the rates for 2 years - if you like that kind of thing.

I am also looking to bargain hunt. There are always companies that will grow. ILMN, for example, will grow because they are somewhat buffered from the economy. I will not chase the market down, but will wait a bit.

My message is - prepare for the worst and hope for the best.