November 2009 Update of THE GREAT DEPRESSION of DEBT

“The Great Depression of Debt” is a hardcover updated edition of “The Second Great Depression, Starting 2007, Ending 2020.”  “The Great Depression of Debt” can be purchased at most bookstores or at Amazon.com: http://www.amazon.com/Great-Depression-Debt-Survival-Techniques/dp/0470423714 

THE WEEK’S STOCK MARKET AND THE STIMULUS

The important thing to note is that the market gain realized on Thursday when the positive GDP numbers were released was overwhelmed by the down market on Friday when the negative consumer spending numbers were reported.  The S&P 500 actually lost 4% for the week.  Apparently, more investors are recognizing that the 3^rd quarter gain in the economy was driven by the cash-for-clunkers program and first-time-home-buyer credit, which are both now ending.  There was no real economic recovery.

Congress is also aware of this and is thinking about extending both stimulus programs, with some modifications.  For example, on the first-time-home-buyer credit, they are considering extending the end date beyond November and including a $6500 credit for those who want to trade-up from homes they have lived in for more than five years.  Neither program will have much effect except to give money to those who were going to buy anyway.  A $6500 credit to someone to buy a more expensive home in a market with falling prices (and with a difficulty of even being able to sell their existing home) is not likely to motivate anyone.  And most first-time buyers already made their move since they thought that the program was ending in November.  So we will just be giving away taxpayer money to those who are going to buy anyway with no resultant long-term gain in the economy.

In fact, as reported in CNN Money, Edmonds.com has calculated that taxpayers paid $24,000 for every extra car sale generated by the Cash-for-Clunkers program.  Of course, the White House disputes these numbers and the way Edmonds calculated these numbers; but even if the per car costs are off 50%, it was a very expensive program versus any long-term benefit. 

The first-time-home-buyer credit has a similar cost issue.  The National Association of Realtors (NAR) reports that 1.8 million buyers got the first-time home buyer’s credit.  But the NAR estimates that only 350,000 of these sales were due to the first-time buyer credit. The National Association of Home Builders (NAHB) estimates that only 150,000 additional home sales were due to the first-time buyer credit.  On the basis of the above numbers, each additional home sale cost the taxpayer either $41,000 per home or $96,000 per home.  It is worth noting that neither the NAR nor NAHB are politically motivated to make these numbers look worse than what they really are.

In fact, the whole stimulus program has had questionable and costly results.  CNN money reports that after $150 billion in stimulus spending, 650,000 jobs have been created.  That is a $230,769 cost per job.

OUR FRIENDS IN CHINA 

Chinese-made drywall that emits sulfurous gases carbon disulfide, carbonyl sulfide, and hydrogen sulfide, was used in an estimated 100,000 U.S. homes built in 2005/2006 at the height of the home price bubble.  Not only do these homes now smell like rotten eggs and perhaps cause health issues, the pipes and electrical components are corroding.  To repair these homes is going to cost an estimated $80,000 to $100,000 per home.  Insurance companies are not only refusing to pay for the costs of repair, but they are also refusing to renew insurance policies on these homes.  Since most mortgages require home insurance, this and the cost of repair is forcing many of these homes into foreclosure.  Since many of these homes will be unsalable even after repair (would you buy one?), the banks could end up eating the whole cost of the mortgage.  If the home values average $250,000, that will be a total loss of $25 billion. 

As this is going on, a Chinese producer of wind power turbines has just won the contract to supply the components for a $1.5 billion wind farm in Texas.  Just a year ago, T. Boone Pickens attempted to build a giant wind farm in Texas but was thwarted due to lack of funds.  Somehow, our stimulus to help develop clean U.S. renewable energy isn’t working.  And after the Chinese’s performance on baby formula, children’s toys, dog food, dry wall, etc, I don’t think that I would want to stand under those whirling wind turbine blades!

SO NOW WHAT?

Consumers continue to cut spending, foreclosures continue to rise, and unemployment is expected to keep growing.  So, the likelihood of the government being able to cut back on stimulus seems unlikely unless they want to risk the economy getting as bad as it was in The Great Depression.  However, continued high deficits are also unsustainable.  So what’s a government to do?  Here are some examples (note, examples only!) of what our government could do to continue stimulus support for our economy while reducing our deficit.  These steps would reduce the continuing drop in the dollar, reduce the likelihood of extreme inflation, and give our economy the time needed to heal from its excessive consumer and government debt.

For a start, it may be worthwhile to compare the U.S. to other countries.  First, the portion of our country’s wealth that is in the top few percentage of our population far exceeds that of any other democratic country.  In fact, the average annual income of the top 1% of U.S. households is $1.2 million.  So, let’s put a 20% off-the-top tax on this income, which will increase U.S. tax income by $276 billion.  Now, that doesn’t solve our nearly $1.5 trillion deficit; but it sure takes a big bite out of it.  Some may say that this tax is unfair.  But was it fair that this top income group was the only group that has prospered by the economic gains of the last 10 or 15 years?  And, it isn’t like this tax would put this group into the poor house.  The poor dears would just have to learn to get by on an average income of almost a million dollars per year.

Another area where we differ dramatically from most countries is how much money we put towards defense.  The amount we spend on defense is almost equal to the total of all other countries combined.  And we spend nine times as much as China, who, as mentioned above, is coming in to build a wind farm in Texas because we can’t afford to do it ourselves.  Our 2009 Department of Defense budget is $651 billion.  And that includes the $1,000,000 it costs us each year for each added soldier in Afghanistan and nearly $500,000,000 for each soldier in Iraq.  Well, we can no longer afford to be the world’s policeman.  So, let’s cut this in half by bringing half of our boys (and girls) home.  Note!  We want to keep them in the service because otherwise we would add to our unemployment issue.  Our returned military personnel will be used to guard our ports and to help rebuild our infrastructure.  From numbers I can find, there are roughly 300,000 U.S. troops overseas.  If we bring half of them home, that would be 150,000 more people requiring housing and spending money in our own economy, both a positive boost.  And, several of the countries that currently have our troops, like Japan, don’t want them there anyway.

As for us being needed in Iraq, Afghanistan, and near North Korea to protect our security, few can show how troops on our own borders won’t protect us even more.  In fact, many people believe that our presence in the Middle East does more to promote terrorists against the U.S. than anything else.  But, in any case, if we keep running $1.5 trillion deficits, we are likely endangering our long-term future far more than if we pull most of our military back to the U.S.

So, if we cut our military budget back 50%, we will save $325 billion a year, even more than what we gained by taxing the extremely rich.  Between the two, the increased taxes and reduced military budget, we reduce the deficit by $600 billion per year.  That would reduce our deficit from $1.5 trillion to $0.9 trillion.  Still high, but this reduction will greatly reduce the pressure on the dollar and enable us to keep helping the economy until the consumer is whole and unemployment starts to go down.  Then the stimulus can slowly be reduced along with the deficits.

THE STOCK MARKET 

The Price/Dividend (P/D) ratio for the S&P 500 is now 54.  This can be compared to the historical median P/D of 26 and the 17.2 target I use to get back into the market.  At current dividends, the market will have to drop more than 50% to get down to its median P/D and drop 68% to get to my own entry target P/D. 

Do not interpret the P/D ratio as a predictor of the direction of the economy.  It is a historical unemotional measure that I believe reflects whether the market is overpriced.   The P/D ratio can stay very high for many years with little rationale, as it did in the nineties.

Here is where I get my P/D ratios. http://www.indexarb.com/dividendYieldSortedsp.html. Go to the bottom of the table and read the value opposite “Average Dividend Yield (%) of All S&P 500 Stocks.” Take the inverse of this number X 100 to get the price/dividend.

As always, people should use their own judgment/data to affect their own investment strategies; and they should not blindly use the above information.  Intelligent people can, and do, disagree. 

Warren

Mid-October 2009 Update of THE GREAT DEPRESSION of DEBT

“The Great Depression of Debt” is a hardcover updated edition of “The Second Great Depression, Starting 2007, Ending 2020.”  “The Great Depression of Debt” can be purchased at most bookstores or at Amazon.com: http://www.amazon.com/Great-Depression-Debt-Survival-Techniques/dp/0470423714 

THE JUMP IN THE STOCK MARKET   The market is experiencing an unbelievable positive run.  Since March 6, the S&P 500 has jumped 64%.  And, per the measure I prefer, the price/dividend ratio, this ratio is almost double what it was on March 6.  This is because as stock prices have been going up, dividends have been going down.  Investors are now willing to pay much more for much less!  Other measures also show how crazy these stock prices are.  Dan Burrows of Daily Finance, in an Oct 14 article noted that, based on trailing price/earnings multiples, “…the market is in the top 2 percent expensive terrain historically, and those other times basically covered the tech mania of a decade ago.”

HOUSING PRICES   One of the drivers of the market surge seems to be the reported news that housing is now in the recovery stage.  This news is based on the Case-Shiller home price index, which, as reported in my prior updates, is no longer valid because of a switch in sales markets.  Let’s look at housing with current data.

Per the Zillow housing report, which is little affected by a change in the market mix, inflation-adjusted home prices have dropped 25% since their peak in 2006/2007.  However, they still have to drop another 17.5% to get down to the inflation-adjusted home prices of 2000.  Home prices are still dropping at an inflation-adjusted rate of 0.2% per month for the third quarter.  Although the home price drop has slowed, probably due to the increased home buying that the new-home-buyer-credit stimulated, home prices are not going up as has been widely reported. 

 As I said in earlier updates, the problem with the Case-Shiller data is that foreclosures and resultant home sales have now moved into more expensive homes, making the average sales price of homes higher.  This is a change of sales market rather than a general increase in home prices.  Zillow’s chief economist reports that while high-end markets accounted for 16% of foreclosures in 2006, they now account for 30% of foreclosures.  In 2006, subprime loans accounted for 55% of foreclosures.  In 2009 they account for only 35%. 

 And all of this is about to get worse!  Per CNNMoney.com, in the third quarter of 2009, the number of foreclosure filings hit a record high.  Of special note is that the number of homes actually repossessed by lenders jumped 21% from the previous quarter.  This means that lenders are starting to work through the pent-up foreclosure inventory.  This means that even more homes are about to be dumped on the market, putting even more down pressure on home prices.  And in some low-end markets like Cleveland, lenders aren’t even following through on foreclosures.  Per Les Christie of CNNMoney.com, “In ever more frequent cases, delinquent borrowers want out of the mortgage worse than the lenders.” 

 A study by the Chicago Booth School of Management and the Kellogg School of Management determined that when home values drop 10% below the mortgage amount, people start to give up their homes.  You can see from the previous housing price data that most people who bought homes at their price peak in 2006/2007 with 15% down or less are already in that category.  The study also showed that when negative equity approaches 50%, 17% of households default even if they can afford their mortgage payments.  Many people with option rate mortgages are now in that category.

For the last quarter, repossessions were running at a 950,000 annual rate.  As bad as this is, in the last update I mentioned that several studies put the number of forecasted foreclosures at 6 to 7 million.  If this depression is to bottom out in 2012, as I forecast, the repossession rate will have to double to 2 million per year to reach the 6-7 million projections.  And that doesn’t even include the time it will take to sell the home inventory which will be coming on the market.

This continuing drop in housing value and the rise in foreclosures has another associated risk, which Elizabeth Warren, chair of the congressional oversight panel that is monitoring the TARP bailout funds, alluded to.  In an interview with Washington Post, she said that, “I believe that the middle class is under terrific assault.”  She compares middle class families now with their parents a generation ago, and says that the only way families could increase real household income was with a second wage earner, and that option is now used up.  So we now have flat middle class incomes with rising costs like health insurance and the requirements of two cars and childcare to support two wage earners, and the middle class are falling behind.  The loss of equities in their homes is just another hit.  Although the middle class do own stock, Hugh Smith of Daily Finance says that, “the vast majority of households own less than $10,000 in stocks or bonds, including IRAs.”  So loss in home equity means much more for most families that what the stock market does.

At what point does the middle class start actively rebelling against an economic system that continues to reward only those in the top few percent of incomes.  At what point will they no longer tolerate the average Goldman employee making $700,000 this year on what most people think of as non-productive money handling.  And this is after Goldman received a $12 billion government bailout.   I don’t believe that either those in government or in the large investment banks are aware of the seething anger that is building across this country. 

WHAT WILL START THE COMING MARKET DROP?   Frankly I don’t know.  It will be something unexpected, like a large jump in unemployment, retail sales dropping like a stone, or inflation taking off.  But once the drop starts, it is likely to be extremely sharp because there seems to be little real substance behind this current market bounce. 

ARE CONSUMERS BACK TO SPENDING?  An Oct 15 article by AP Economic writers Rugaber and Crutsinger is titled “Consumers Show Signs of Life as Prices Stay Low.”  However, the details are that September retail sales actually fell the most on any month this year.  The authors of the article are saying that without the September drop in auto sales, retail sales would have risen.  Apparently the authors think that September was a stand-alone month for lower car sales.  I don’t believe that!  Another measure of the consumer’s willingness to spend is their willingness to borrow.  August was the seventh straight month that U.S. consumers reduced their borrowing.  Consumers are spending less and saving more, which is good for them but bad for the economy, at least in the short run.

THE STOCK MARKET 

The Price/Dividend (P/D) ratio for the S&P 500 is now 52.  This can be compared to the historical median P/D of 26 and the 17.2 target I use to get back into the market.  At current dividends, the market will have to drop 50% to get down to its median P/D and drop 67% to get to my own entry target P/D. 

Do not interpret the P/D ratio as a predictor of the direction of the economy.  It is a historical unemotional measure that I believe reflects whether the market is overpriced.   The P/D ratio can stay very high for many years with little rationale, as it did in the nineties.

Here is where I get my P/D ratios. http://www.indexarb.com/dividendYieldSortedsp.html. Go to the bottom of the table and read the value opposite “Average Dividend Yield (%) of All S&P 500 Stocks.” Take the inverse of this number X 100 to get the price/dividend.

As always, people should use their own judgment/data to affect their own investment strategies; and they should not blindly use the above information.  Intelligent people can, and do, disagree.

October 2009 Update of THE GREAT DEPRESSION of DEBT

“The Great Depression of Debt” is a hardcover updated edition of “The Second Great Depression, Starting 2007, Ending 2020.”  “The Great Depression of Debt” can be purchased at most bookstores or at Amazon.com: http://www.amazon.com/Great-Depression-Debt-Survival-Techniques/dp/0470423714 

THE COMING MONTHS

In my Depression book written in 2005, I predicted that the depression would start in 2007, the economy would bottom out in 2012/2013 (after a few false recoveries), and the depression would not end until 2020.  Since we are in one of those false recoveries, it seems wise to see if the original premises for the depression are still there and if, indeed, this recovery is truly “false.”

HOUSING   In my last update, I reported that I had a problem with the Standard Poors/Case-Shiller index that showed home prices climbing 1.4 percent in June, the second consecutive monthly gain.  Well, the July Shiller numbers show a similar 1.2% increase. As we discussed, however, the shift in mix of sales towards the expensive zip codes is the cause of this erroneous appearance that housing prices have now bottomed out and are indeed rising.  The Zillow report, which is less affected by a shift in sales mix, still shows home prices dropping.  And it shows that housing must drop another 15% to reach historical inflation-adjusted prices.  This is extremely important because a continuing drop in home prices puts more people under water on their mortgages.  The degree a person is underwater, along with a growing unemployment level, are the main drivers for foreclosures.

We have already discussed how Option Rate ARMs are just beginning to raise their ugly heads, which will cause many people to see their house payments nearly double and drive them into foreclosure.  But let’s look at some other estimates for the number of coming foreclosures.  Michael Barr, assistant Treasury secretary for financial institutions, estimates that more than six million Americans are at risk of foreclosure in the next three years.  Laurie Goodman of Amherst Securities Group, using data related to how many people are delinquent on their mortgages, estimates 7 million homes.  To put these numbers in perspective, per RealtyTrac, in 2007 there were 1.3 million foreclosures; 2008 had 2.2 million foreclosures.  In comparison, the total annual rate of sales for previously occupied homes is only 5.1 million.  The 6 million to 7 million coming foreclosures are going to be a major disaster!

Note that the above foreclosure data is very optimistic because it is based on current percentages of mortgage holders who are delinquent.  It is hard to believe that this percentage of delinquent home owners will not go up as more people get underwater on their mortgages, Option ARMs are reset and unemployment continues to rise.

Given these data, how likely is it that anything about the housing market has bottomed out?  The recent jump in home sales was certainly influenced by the $8,000 dollar credit for first time home buyers.  But August sales of existing homes fell 2.7% as it became impossible to get the sales/financing/move completed by the credit deadline.  And we are now about to see a complete drop-off in home sales.  Sure, the government may come up with an expanded stimulus program to encourage more home buying.  But this will only cause a momentary blip as home sales and builds must eventually adjust to the real market demand.

CONSUMER DEBT   In order for the economy to get back to where it was a few years ago, we need the consumer to get back to spending.  But is that even possible?  Per the Federal Reserve Board data, consumer debt payments as a percentage of disposable income peaked in 2007 at 19.37%. Through second quarter 2009, their payment/disposable-income had dropped to 18.05%, so they are starting to pay down their debts.  But to get back to a more healthy payment debt level as in the early eighties, the consumer payment debt level would have to drop to 15.5%.  We have only moved one third of the reduction in debt payments needed to get down to that more healthy level.  And stimulus programs like Cash-for-Clunkers, which likely pushed up future debt payments for many people, do nothing but delay this needed process of debt pay-down. 

UNEMPLOYMENT   As we have seen, nothing about our economy looks very good.  The Institute of Supply Management’s September index of manufacturing activity fell when it was expected to rise.  The Labor Department said that new claims for jobless benefits rose to 551,000, far more than what was predicted.  Automakers, which had gotten a 700,000 positive hit from the Clunkers program, saw their sales dive (surprise, surprise) in September.  Sales at GM led the drop with a 45% plunge.  All of this data bodes poorly for any kind of improvement in the unemployment picture since manufacturers will respond to any further slowdowns with more layoffs.

BANKS   Banks remain a mess.  Nearly 100 have failed this year and the F.D.I.C. is looking for a $45 billion bailout.  U.S. large-loan bank losses tripled in 2009 to $53 billion.  The IMF, in its Global Financial System report, says that banks face another $1.5 trillion in writedowns.  This is on top of the $1.3 trillion already taken.  And the CIT Group, the largest U.S. lender for medium and small businesses, is again on the brink of collapse.  This financial firm already got $2.3 billion in bailout money a year ago.  Who said that the financial crisis was over?

THE STOCK MARKET AT YEAR END   One of the readers asked for my current estimate (guess?) for the S&P 500 by year end, and my response was 750 (slightly higher than an earlier prediction I had made).  This will be a drop of 27% from the current level.  This seems like a big drop, but exactly one year ago, from October 1 to October 17, the market dropped 38%.  Sure, the specific economic news was different then, but the same underlying weaknesses of the economy are still the same.

THE STOCK MARKET 

The Price/Dividend (P/D) ratio for the S&P 500 is now 54.  This can be compared to the historical median P/D of 26 and the 17.2 target I use to get back into the market.  At current dividends, the market will have to drop more than 50% to get down to its median P/D and drop 68% to get to my own entry target P/D. 

Do not interpret the P/D ratio as a predictor of the direction of the economy.  It is a historical unemotional measure that I believe reflects whether the market is overpriced.   The P/D ratio can stay very high for many years with little rationale, as it did in the nineties.

Here is where I get my P/D ratios. http://www.indexarb.com/dividendYieldSortedsp.html. Go to the bottom of the table and read the value opposite “Average Dividend Yield (%) of All S&P 500 Stocks.” Take the inverse of this number X 100 to get the price/dividend.

As always, people should use their own judgment/data to affect their own investment strategies; and they should not blindly use the above information.  Intelligent people can, and do, disagree. 

Warren

Mid-September 2009 Update of THE GREAT DEPRESSION of DEBT

“The Great Depression of Debt” is a hardcover updated edition of “The Second Great Depression, Starting 2007, Ending 2020.”  “The Great Depression of Debt” can be purchased at most bookstores or at Amazon.com: http://www.amazon.com/Great-Depression-Debt-Survival-Techniques/dp/0470423714 

HOUSING   In my last update, I reported that I had a problem with the Standard Poors/Case-Shiller index that showed home prices climbing 1.4 percent in June, the second consecutive monthly gain and the biggest increase since June 2005.   The reason I doubted these numbers is that the shift in mix of sales towards the expensive zip codes is causing this study to give the erroneous appearance that housing prices have now bottomed out and are indeed rising.  This positive outlook from the Case-Shiller study has been one of the drivers for the recent upswing in the stock market.  Data showing that home prices have bottomed out makes no sense given the continuing growth in foreclosures, the inventory of unsold homes, and growing unemployment.

But we need a correct measure of home prices, since dropping home prices are one of the drivers of the current downturn and we need to know when they bottom out.  I think that the Zillow Real Estate Market Report for the U.S. will work for us.  This report correlated closely with the Case-Shiller numbers until recent months.  The Zillow report, although not perfect, is less affected by a shift in sales mix.  This report shows that home prices in the U.S. are still dropping at a 5% annual rate and must still drop another 13% to get down to their inflation-adjusted year 2000 prices.  At the current Zillow rate, home prices will bottom out in 2012, which is consistent with the projected reduction in ARM resets.

One of the issues with the Zillow index is that the prices of foreclosed homes, which are less likely to be maintained than surrounding homes, make it look like home values have dropped more than they actually have.  Given this, homes are likely to drop more than 13%.  But I have no precise data on how much more.

Of course, the government seems to be doing its best to continue the problem of people getting over their heads in home ownership.  Some first-time home buyers got an $8,000 tax credit, and they could get a Federal Housing Administration loan to buy a home with 3.5% down.  So, with a little creative money switching, first time home buyers could essentially buy a house with nothing down.   As noted above, it is expected that housing will drop at least another 13%.  So, these new home buyers may shortly find themselves over-their-heads, with houses worth much less than their mortgages.  And, as mentioned in an earlier blog, the best predictor of foreclosures is how much a home owner is under water rather than if they can afford to make their house payment.

THE RECENT STIMULUS EFFECTS ARE ABOUT TO END   The cash-for-clunkers program is over, and the $8,000 tax credit for first time home buyers is effectively done given the time needed to complete home financing, etc.  So we will see home and auto sales drop immediately.  But, there is a residual benefit of these programs because both home builders and car builders are replenishing their inventories.  So, for a month or two, we may see a leveling off of unemployment.  But, by November or December, the economic numbers we will be seeing are likely to be disastrous.  If I were going to try to time the coming drop of the stock market, which I am not, I would look at the last quarter of this year.

Now, much of the stimulus money will be released in the last quarter.  But the remaining stimuli are for things like smart grid projects which will be slow in developing and not likely to affect the economy for several years.  Don’t get me wrong!  I love these projects, and they will help our recovery out of the depression.  But they won’t stop the coming downturn.

WHOLESALE INFLATION   Wholesale core price inflation over the past 12 months is 2.3 percent.  Although this is not high inflation, it runs counter to those who have been saying that we are in a deflationary mode.

WATCH OUT FOR CHINA   President Obama just increased the tariff on Chinese-made tires to 35%.  In response, the Chinese government announced it was launching a probe into whether the U.S. was dumping auto parts and chickens into their market.  If this turns into a trade war, we could see something similar to what happened after the U.S. implemented the Smoot-Hawley Tariff Act at the beginning of the Great Depression.  We effectively shut down international trade and contributed to the worldwide depression.

The U.S. imports 50 million tires from China every year — more than one-fifth of all the tires sold in America.  The price on these tires will go up very quickly, hurting price inflation. 

Companies like Goodyear Tire and Cooper Tire have factories in China and will be negatively affected.  They will probably just have to import tires from countries other than China since we no longer have the required manufacturing facilities in the U.S.

I believe that we continue to under-appreciate how much China can affect our whole economy.  Besides owning much of our Treasury debt, their hybrid government can move at a speed far quicker than our government.  They don’t have to worry much about the opinions of unions, companies, etc.  For example, on energy they are signing long-term contracts with oil companies worldwide, locking up energy supplies.  And they just announced that they are going to build the largest solar power plant in the world.  The project will eventually cover 25 square miles of Inner Mongolia.  At 2 billion watts, the solar plant will be able to pump as much energy onto China’s grid as two coal-fired plants, enough to light up three million homes.  We would have a difficult time doing such a project in the U.S.   Even installing the required power lines is regularly challenged by competing interests from government agencies, environmental groups and disgruntled residents.

THE STOCK MARKET 

The Price/Dividend (P/D) ratio for the S&P 500 is now 50.  This can be compared to the historical median P/D of 26 and the 17.2 target I use to get back into the market.  At current dividends, the market will have to drop almost 50% to get down to its median P/D and drop 66% to get to my own entry target P/D. 

Do not interpret the P/D ratio as a predictor of the direction of the economy.  It is a historical unemotional measure that I believe reflects whether the market is overpriced.   The P/D ratio can stay very high for many years with little rationale, as it did in the nineties.

Here is where I get my P/D ratios. http://www.indexarb.com/dividendYieldSortedsp.html. Go to the bottom of the table and read the value opposite “Average Dividend Yield (%) of All S&P 500 Stocks.” Take the inverse of this number X 100 to get the price/dividend.

As always, people should use their own judgment/data to affect their own investment strategies; and they should not blindly use the above information.  Intelligent people can, and do, disagree. 

Warren

September 2009 Update of THE GREAT DEPRESSION of DEBT

“The Great Depression of Debt” is a hardcover updated edition of “The Second Great Depression, Starting 2007, Ending 2020.”  “The Great Depression of Debt” can be purchased at most bookstores or at Amazon.com: http://www.amazon.com/Great-Depression-Debt-Survival-Techniques/dp/0470423714 

PROBLEM NUMBERS   Looking at several key economic numbers, the economy is starting to turn around.  But, as we like to do on this blog, let’s try to understand what is lurking beneath these numbers.

NEW HOMES   July sales of new homes jumped almost 10% versus June.  Sales are up 30% from January.  The July median sales price was $210,100, versus $205,100 in March.  Of course, this was probably driven by the $8,000 federal tax credit for first time home buyers, which expires at the end of November.  And, since the sale must be closed by the end of November, with the buyer in the home, buyers were rushing to get this moving.  One might wonder how much of the $5,000 increase in median home price was enabled by the enthusiasm of the buyers to get that $8,000 tax credit.  And, of course, when this tax credit ends, new home sales are likely to drop below what they were before the credit, since some of these buyers just moved up the date of their planned purchases.  To show how real this is, as reported on Yahoo!.Finance, A.F. Sterling Homes in Tucson, Arizona already saw their sales drop in July because they couldn’t guarantee that homes could be finished in time to qualify for the $8,000 credit.  And, since some builders actually have started building more houses to build up their inventories, this will add to the already 1.5 million extra homes that were built for the artificial demand of a few years ago when anyone who could cloud a mirror could buy a home.

EXISTING HOMES   Per a survey by a real estate data firm Zillow, only 19% of those surveyed expect their own homes to decline in value over the next six months.  And to back up their optimism, the Standard & Poors/Case-Shiller index reported that home prices climbed 1.4 percent in June, the second consecutive monthly gain and the biggest increase since June 2005.  As with new homes, the $8,000 tax credit increased the interest in home buying and this probably accounted for some of the increase.  But, as noted by a commenter to this blog, the Case-Shiller index was designed for a consistent sales mix of homes.  And that hasn’t happened recently.  Foreclosures until recently were concentrated in the sub-prime mortgage market, which tended to be lower priced homes.  So a disproportional number of sales used in calculating the Case-Shiller home prices were in the lower cost home group.  Well, starting recently, (reference
http://activerain.com/blogsview/202178/adjustable-rate-mortgage-reset-schedule-graph-), other mortgage resets/foreclosures started to increase, changing the mix of home sales to more expensive housing.  This increase in more expensive home sales made the median home price, as measured by Case-Shiller, go up.  Here are some quotes from other sources related to this problem:

“All of the indexes suffer from what economists call the sample selection problem,” says Patrick Newport, an economist at IHS Global Insight in Lexington, Mass. The indexes are based on transactions that occur, which aren’t necessarily a representative mix of all existing homes.”

“Another provider of housing data, RadarLogic, also says that a change in the mix of homes being sold is affecting its results. “The shift in the mix of sales toward the expensive zip codes has contributed to year-to-date price gains” in most metro areas, its report says.”

The Case-Shiller number will lose even more meaning as prime and option rate mortgages increase and these homes start to foreclose, because these mortgages represent the most expensive homes.  This presents a problem for many investors because the Case-Shiller numbers have a big effect on the market, as we saw when Case-Shiller released their most recent numbers.  It also presents a problem for those trying to predict when the market will drop, because the Case-Shiller numbers showing that housing prices are going up are misleading many investors and giving them a false-positive feeling about the economy. 

As for the rest of us, we are going to have to monitor other data.  The above mentioned site address showing mortgage reset dates is one important piece of the pie.  You can’t have that many resets without driving up foreclosures, which will drive down home prices.  In fact, per RealtyTrac, in July there were 360,000 U.S. households that drew a foreclosure filing.  This is a new monthly record since RealtyTrac started keeping records in 2005. 

The other number to watch is unemployment.  Unless employment returns, people will keep losing their homes, driving down prices.  In fact, if you look at the aforementioned chart on mortgage reset dates, we should have seen a big lull in foreclosures the first quarter of this year.  We didn’t, probably largely due to the rise in unemployment.

CASH-FOR-CLUNKERS  This program cost the taxpayer almost $3 billion.  Due largely to this program, August car sales were up 40% over July.  But J.D. Powers and Associates believe that 70% of the sales made within the Clunkers program “may” have happened before the end of the year anyway.  Toyota was the biggest beneficiary of the Cash-for-Clunkers program, topping GM and Ford when you consider sales of vehicles subsidized.  And purchasers of these cars, besides likely going even more in debt, probably saved a lot less than what they thought because before this program dealers were steeply discounting cars.  Those discounts vanished as dealers got tight on inventory.  And guess what is going to happen to car sales over the next several months?

THE STOCK MARKET 

The Price/Dividend (P/D) ratio for the S&P 500 is now 53.  This can be compared to the historical median P/D of 26 and the 17.2 target I use to get back into the market.  At current dividends, the market will have to drop over 50% to get down to its median P/D and drop 68% to get to my own entry target P/D. 

Do not interpret the P/D ratio as a predictor of the direction of the economy.  It is a historical unemotional measure that I believe reflects whether the market is overpriced.   The P/D ratio can stay very high for many years with little rationale, as it did in the nineties.

Here is where I get my P/D ratios. http://www.indexarb.com/dividendYieldSortedsp.html. Go to the bottom of the table and read the value opposite “Average Dividend Yield (%) of All S&P 500 Stocks.” Take the inverse of this number X 100 to get the price/dividend.

As always, people should use their own judgment/data to affect their own investment strategies; and they should not blindly use the above information.  Intelligent people can, and do, disagree. 

Warren