Housing - You can time the bottom

You are looking at the ARM re-set schedule (source: Credit Suisse).

It has 2 peaks: Dec 2007 and July 2010. Starting now, 14 months of $40B re-setting each month, and 7 months of $50B re-setting. If the average home is $500K, that's ~80K homes up per month. (BTW the median price is closer to $250K).

Now assume that some 20% are in trouble. That's 16,000 homes foreclosing per month.

The clock will really start sometime 6 months later, around May 2008. I'm assuming 6 months of a delay because of the foreclosure process and eventual dumping of properties.

The bottom will be 10 months after that or Spring 2009.

But that leaves open the door to the next wave of re-sets starting 2010. I'm less concerned about that wave because I have a feeling that those can be converted with some but minimal mortgage rate payment impact. After all, the first peak is Subprime. The 2nd peak is all other ARMs. I assuming that all ARMs are riddled with fraud and inability to pay, but folks who needed subprime were more shaky and unquaified.

The bigger concern is where housing prices will be for folks re-financing 2010-2011. Because ability to pay mortgage is one thing but ability to re-finance is harder if the underlying asset value (house) is worth less than the loan amount. I think prices will have crashed hard by then and there will continue to be problems.

Also, by then the banks will have managed their exposure and be in a position to manage the sequel better.

By 2012, the bubble pop is over.

Buying a house in 2009 means riding a 2nd wave of negative housing price pressure. The only advantage is that fire sales are more likely in 2009 - so better deals are likely.

Contained? Falling prices hit all - even homeowners with fixed rates.

If you rent, consider playing hardball with your landlord. No rent increase this year. Maybe a rent drop next year.

The bottom will be reached when housing prices drop to a point that pulls renters into buying. That will be on a cash flow basis and no equity appreciation factored in.

That is the carrying costs of owning a home (taxes, HOA dues, upkeep & maintenance, insurance, repairs, and mortgage).

An example: what is the home price equivalent for $2000.

House price: $400K

Mortgage (fixed 30 year jumbo): $2300 before taxes or ~$1400 after taxes

Taxes (assume 1.5%): $500 per month or $350 after taxes

Insurance: $100 per month

Maintenance (assume $2400 in repairs, pest control, garbage and gardening per year): $200 per month

Total running costs: $1950

In these kinds of comparisons, folks often include asset appreciation on the house and opportunity cost of renting and investing the downpayment. I'm excluding them from this analysis. Over the past few years, housing price appreciation favored the argument of owning, but in an environment where home prices are flat, the equation begins to favor the opportunity cost advantages of renting.

So I exclude them both for now.

I rent a 3 bedroom, 2 bath house for $2000. The homes in my neighborhood run $850K and up. In my example, they would have to run $400K OR LESS to bring me into owning.

That's a 50%+ drop in nominal home price. And the real home price drop is even greater when you factor in inflation

LiveRocket Week 22 Performance: Up 3.8%

How to tell if it’s a bubble: GDP goes from 5.6% to 0.6% within 1 year.
I was dead right in my prediction this week regarding the Fed. They don’t care about saving housing. They do care about inflation. They are secretly panicked about the dollar: Kuwait is another country leaving the dollar.

The implications of a weak dollar is inflation for the US on imports (oil especially).

There are several ways to spark interest in the dollar:
1. Scarcity – reduce the T-bill sales and/or buyback existing ones. This is not possible with a budget deficit AND an ongoing $100B annual Iraq war tab.
2. Boost value – The trade deficit, net oil, is a problem. The nature of global trade is that US companies are manufacturing outside of the US. So US control of the global economy is in fact strong, but the measurement of trade is limited to goods/services that cross borders. Ford is making cars outside the US and doing a decent business, but it is all offshore so it doesn’t get included. In other words, US global economic strength is bigger than ever, but the US based economy is much softer.
A cheaper dollar helps to boost exports, so that’s good. In essence, exchange rate fluctuations tend to work themselves out over time.
3. Raise interest rates – this has immediate impact. And higher rates stifle inflation. But they also tend to slow the economy.

The key issue here is that the US is no longer in charge of the global economy. China, India and the EU are players with impact. This was inevitable.
The result is that the US is in a big bind. It can no longer turn a dial or pull a lever and the US economy is managed. Global demand for oil, for example, is driving prices up and no monetary games will change that. The US is facing inflationary pressures while the economy is slowing down. Raising interest rates will stop inflation (drops import prices, throttles demand), but it will slow the economy at a time when the economy is already slowing.
It’s a trade off between growth and inflation. And there is really nothing the US can do to stop inflation. Unless the economy slows and demand slows.

This bind is called stagflation. We are going there but it will be a good 9 months before this materializes. Stagflation is the hangover to our 15 year party. What will make this version interesting will be the US ability to export to a hungry global economy.

I like wheat, btw. With all this ethanol stupidity, farmers are planting less wheat.
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We did ok for a short week.

HIGH TECH
AMX – Up 6% and hit a new high.
CTSH – Up 3.2%. An interesting reversal. CTSH has made to the latest US based Business Week magazine's list of the world's 100 hot growth companies with significant growth potential. That’s what I said, and now that it’s official – maybe we’ll be moving back up.
NUAN – Up 3.4%. the Wall Street Journal did a big article on voice recognition, mentioning Microsoft and Google. Both MS and Google rely on NUAN.
PWR – Up 5.8%. No news
TRID– Up 2.6%. Floating with the market.
UCTT – Up ~7%. No news. I hope that my prediction is correct and it is going to repeat last quarter: 50% growth in one quarter. It was actually up another 3% today before pulling back

OIL SERVICES/EQUIPMENT
Still incredibly undervalued
ATW – Up 3.5%. So much for missing earnings.
CLB – Up 3.6%. Coming back from that downgrade.
ESV – Up 3% hit a new high
MDR – Up 6.6%. Another new high. More contracts.

BIOTECH
DIGE – Up 2.6%.
HOLX – Up 3.7% on strong volume. I was going to leave but held back a bit. Glad I did
IMA – Up 10.4%. I’m really glad we waited out that Biosite bid. IMA hit a new 52 week high.

OTHER
KSU – Up 6% and a new 52 week high.
OCN – Up 1.6% a little bit each week.
PCP – Up 2.2%. Pulled back 2% after hitting a new high Friday. Lots of volume.
TIE – Flat. Ridiculous now. ATI & RTI both up 6%~10%.

Very important day Today

Three things are top of my mind
Fed report
China's market crash
Unemployment numbers

Let's start with the China Stock market Crash. It's down 6.5% but our market seems relatively unaffected. I put in some orders for a few stocks at 10% discounts to what they are selling for (PCP for $100, for example), and I need to find out if I got lucky.

The China market crash was the second engineered crash in 3 months.
What really, relly surprised me is the US market's resilience. Either folks got out after Greenspan's comments last week, or the tide has yet to hit us. Or, more likely, the market is aiting for the Fed results. I think that the Fed will announce a softer bias (ie recession is coming) and that will excite the market because of th einterest rate drop potential on the horizon

Meanwhile, the stocks I have been watching and posted about are almost all uniformly up even when the market wsa way down.

Now let's talk unemployment and the Fed.
For the longest time I have been expecting rising unemployment because it is a fact that lenders have been firing in the 1000s, real estate agents are getting laid off, home building related companies are laying off 1000s, and construction workers especially aren't in demand. Pulte just announced that they are laying off 1,600 and they subcontract a lot - which means that they are affecting at least 10,000+ jobs.

I expected this activity to translate almost overnight into rising unemployment but the rate has stayed flat. My core assumption was that these workers were not illegal immigrants. Most construction work is done by unions and they go nuts when they encounter non-union workers. And I doubt many illegal immigrants worked for lenders.

The importance of illegal immigrant population among manufacturing and construction workers means that they are unregistered in unemployment figures. If they were jettisoned the past few months, then unemployment rates wouldn't change. Only when companieslike Pulte start firing legal, documented workers will unemployment start to rise.

So lets follow this hypothesis a bit further. If the fat has been cut and now companies are working on the meat, that will show up starting next month. And it will accelerate. By January, we might even close on 5% unemployment. While that will set off a chain reaction of fear, it is also able to give the Fed an excuse to raise interest rates because labor cost inflation will be diminishing.

Unemployment rates up, interest rates down. What else? Inflation will be down except for food and energy. Already the housing slowdown is driving down prices for cement, lumber, drywall, and so on. Follow the drop in demand and prices of inputs, and you will see a drop-off in demand for consumer items as consumer spending enjoys its last hurrah this Fall.

With this a few months away, I see the Fed as treading water. As I have said for a long time, the Fed doesn't care about housing: they won't drop rates to prop up the housing market. Instead, they are looking out a few months and they realize that inflation is fairly contained and now the concern is the economic growth cycle.

I also expect that they will revise Q1 GDP down and Q2 will come in pretty light as well. We will show signs of a 1% GDP not a 2% GDP. Recession in a Presidential election year. A Democrat will be elected partly because folks want a rotation, but partly because the economy will suck: home prices down, lots of foreclosures, unemployment rising, consumer confidence dropping, recession, money spent on an Iraq war instead of domestically, etc. The US will be turning inward the next few years.

An interesting note about the housing market in the bay Area. A report out shows that the Bay Area is suffering from a shortage of students. Apparently, many families continue to leave the Bay Area for less expensive places to raise children. That plus the fact that wealthier residents tend to have fewer kids means that San Mateo and Santa Clara counties are talking about closing schools.

Meanwhile Santa Clara County (the heart of Silicon valley) has a rising median home price but is also in 3rd place in the Bay Area for foreclosures.
Next year is the year that folks start saying that the Emperor has no clothes.

And anyone who says that real estate is local apparently hasn't caught up to the digital age. Whether it is Europeans investing in Florida Real Estate, Chinese buying California real estate, or Californian's investing in Nevada real Estate, local markets are most definitely affected by the global cheap money. When that money wave recedes, as it has been doing, the local real estate prices are left to what the local markets can support. And that will be a lot closer to the 5X median salary than the current 10X median salary. That's a 50% price drop.

Also, thanks to the digital age, the word will spread a lot faster than ever before and the drop will happen a lot faster than ever before.

2008 - The Year we say the Emperor has no Clothes. Also called the Year when homeowners become landlords
2009 - The Year of Panic

The bottom will arrive when the cost of building a new home is more than th ecost of buying a used home. Like any other product, market forces dictate that new is more valuable than used. (Except for Collectibles and crappy newly made products.) A lived in home should be cheaper than a new home because it is lived in: banged up, parts showing wear and needing replacement, and so on.

Stocks I like now

I've been watching these stocks:

FWLT
BW
FCX
CELG - been watching them for a year and I see them accelerating faster
ICE - Been on the sidelines too long
CPO
WFR - been watching too long
CTV
PCR
NOV

I'm thinking about doubling down on the oil services and energy sector as well as the China growth play (raw material and infrastructure demand)

LiveRocket Week 21 Performance - Down -1.35%

TIE really hit hard, but then it pushed us up hard previously.

I am re-balancing the stocks this week. I'll explain where in a separate posting. For now, a brief overview of the portfolio today.

Most of our stocks are now in a simple trading pattern with some exceptions. Trading stocks will stay in the zone for another 2~3 weeks.

HIGH TECH

AMX – Up a tad.

CTSH – Down 4%. Non-stop $15 slide. Now it really is undervalued and I am going to wait for the next earnings release.
NUAN – Flat after hitting a new 52 week high.

PWR – Flat.

TRID– Flat.
UCTT – Flat

OIL SERVICES/EQUIPMENT

ATW – Up 2%.

CLB – Down 6%. The downgrade really hurt. 25 P/E for a company growing 50%+ and raising guidance. Makes no sense.

ESV – Down 1% but hit a new high
MDR – Up 1.3%. Another new high.

BIOTECH

DIGE – Up 3%. It’s looking like we bought near the bottom and it’s starting to move up.

HOLX – Down 9%. We are leaving and taking the 5% gains. We’ll be back later.
IMA – Up 10%

OTHER

KSU – Flat but hit a new 52 week high. I’m hearing rumors that Buffet’s purchase of Burlington is a move to raise rail rates. While railroads are an oligopoly, in reality they are a monopoly for shipping certain materials. Raising prices is easy. KSU could enjoy some favorable Buffet-led changes.
OCN – Up 1.6%
PCP – Flat

TIE – Down 8.5%. Takeover rumor did not materialize and I was greedily hoping. Put into perspective, TIE is doing better than the competition even with the pullback. Simmons is 75 years old. He has to get out sometime.