Debt Rally Cracking? Equities Re-Valuing
A: The party never lasts forever. There are so many crazy things going on right now, mostly bearish, that to me it feels like the ground under our feet is very 'fra-gi-le, I think that's French'. Props to anyone that gets that movie quote!
Bloomberg reports, "Debt Rally Cracking as Double-Dip Fears Haunt: Credit Markets":
The rally that drove corporate bond prices to the highest in six years is showing signs of strain as worsening economic data rattle investor confidence that the U.S. can avoid relapsing into recession.Here is a list of what I see happening right now:A benchmark gauge of U.S. corporate credit risk for companies ranging from Alcoa Inc. to Wal-Mart Stores Inc. has climbed for five days, reaching the highest in seven weeks. Relative yields on corporate bonds have been little changed this month, after tightening in July.
“It’s inevitable that we fall into a double-dip recession,” said Komal Sri-Kumar, who helps manage $118 billion as chief global strategist at TCW Group Inc. in Los Angeles. “The employment situation went into a double-dip, housing is going into a double-dip” and “the next stage is the overall economy will go into a double-dip.”
Yields on Fannie Mae and Freddie Mac mortgage securities that guide U.S. home-loan rates reached the highest in three months relative to 10-year Treasuries.
Considering the rally in debt markets we saw, built on a fed engineered bank recapitalization environment, anything is possible on the way down. There are warning signs everywhere. Contrarians like to buy in times like these, but I just get the feeling it could get worse before it gets better due to where we came from over the past 12-14 months. If this is all we have to deal with, then we got lucky. Although Im skeptical and in the re-deflating camp, lets hope Im wrong.
Manhattan RE Needs More Inventory!!
A: As discussed 3 weeks ago, the Manhattan residential real estate market saw a slowdown across all metrics: inventory is down, sales pace is down, pace of listings taken off market is down, and pace of listings coming on to market is down. Clear signs of a seasonally slow summer. Typically the market ticks up again after Labor Day, but even that takes a few weeks to notice. Given the sharpness of this slowdown, its fairly easy to predict that activity has no where to go but up from levels seen here. As of today, I see only 639 contracts signed in the last 30 days; to put that into perspective, that is down from around 1,650 contracts signed in the month of April. There is no better measure of 'current demand' out there that I can think of than the pace of listings going from Active to In Contract.
Here is one more sneak peak at a chart that measures the monthly pace of listings hitting the ACTIVE marketplace from an otherwise off-market state; notice the slowdown in the last 4 months from over 3,000 listings coming to market to just under 1,500 listings in July:
But what about August? We need more real time data!! No problem! We designed our system to also show you the daily changes the Manhattan markets are seeing, as brokers update their listings from Active to Off-Market to Contract Signed and to Sold & Closed. In the above chart, I put a magnifying glass over August that leads to the 30-Day Broker Update box that is an integral part of our new platform. It tells you changes in the very short term. Notice that when we get more real time and see how many listings are coming to market in the past 30 days, it's down to 1,149! So, when the August bar gets added to this chart, it will likely be around the 1,200 mark - falling further from levels in July.
In short, Active inventory is declining as supply is simply not coming to market right now. Very seasonal. For Manhattan, I currently show Active Inventory at 7,013; down another 8% in the last 3 months. Expect this pace to rise again as we get past Labor Day and into October & November. In the meantime, motivated buyers will just have to deal with limited options for a few more months.
LOAN DELINQUENCIES PEAK!
Yes, believe it or not, according to data released by the Federal Reserve earlier this week, loan delinquencies appear to have peaked (View image). In Q2 2010, for the second quarter in a row, delinquent loans as a percent of all loans declined (on a non-seasonally adjusted basis). Delinquent loans began their ascent from a historical low of 1.5% of all loans reached in Q2 2005, climbing relentlessly until Q4 2009, when they hit a hellish 7.5% of all loans. During the previous real estate and credit crisis of the 1980s delinquency levels vacillated at very elevated levels above 4.6% for 6 years before peaking at 6.3% in Q1 1991. This was due to the rolling real estate recessions that swept across Texas/Oklahoma/Colorado, southern California and New England in the late 1980s, followed by the commercial real estate debacle of the early 90s. While two quarters of decline may not be indicative of a peak from a historical perspective (data back to Q1 1985), in this case I believe that charge-off patterns indicate cause for optimism. Just to review a few banking terms used to describe the formation of bad loans and their disposal:
1) Loans go delinquent, which means that people stop making their monthly payments.
2) Banks begin to reserve funds to cover whatever losses they believe are likely to form as a result of delinquency.
3) A small number of loans go from delinquent or "non-accrual" back to accrual status when the bankers remind the borrowers of the consequences of not repaying their loans.
4) Delinquent loans eventually go into the foreclosure process and are "charged-off" by the bank. Which means that the bank makes an estimate of what its loss on disposing of the loan is likely to be and takes a charge to its earnings to reflect the expected loss. The charge off is merely an accounting entry and does not necessarily indicate that the bank has disposed of the collateral underlying the loan. It does mean, however, that the bank is forced to prepare itself to take the eventual loss in terms of having capital in place to net against it.
5) The bank forecloses on the borrower, gets title to the property back and actually disposes of the property. The size of the loss incurred versus the amount loaned is referred to as severity. In some cases the amount charged off was larger than the bank's ultimate loss and some or all of the charge off is reversed. In some cases it is worse and an additional charge off is required.
As is notable from the chart of charge offs on all loans (View image) banks have ramped up the amount of loan charge offs much faster in this credit crisis than they did in the late 80s/early 90s, despite the ultimate peak in delinquencies being only a little higher (and potentially similar in magnitude as the prior stretch of high delinquencies lasted a very long time). This indicates to me that, despite what we hear about "extend and pretend", at least from an accounting and capital raising perspective, banks are being much more aggressive in preparing to deal with their delinquent loans (there are subtleties relative to extend and pretend related to maturity defaults we could discuss, but actual delinquencies are being dealt with). This lays the groundwork for expanding credit and general economic growth which would forestall another wave of delinquencies. Indeed as of the July 2010 Federal Reserve survey of bank lending practices we are already seeing bank lending loosening up just a little.
I would note that all the categories of loans I have been tracking for the last couple of years have seen delinquencies decline from recent peaks including credit card loans, commercial and Industrial (C&I) loans and most importantly residential loans, which have by far and away been the biggest problem for the economy and the banking industry.
This quarters' data from the banks supervised by the Federal Reserve (which include state-chartered member banks, bank holding companies, foreign branches of U.S. national and state member banks, Edge Act Corporations, and state-chartered U.S. branches and agencies of foreign banks) show that residential loan delinquencies declined quarter to quarter for the first time since Q1 2007, as illustrated in the chart below.
All thank god and say ye amen!
Perhaps with loan delinquencies finally headed in the right direction and banks aggressively reserving for and charging off their bad loan portfolios, bad loan disposition will begin to pick up and new lending can begin to accelerate. It is difficult to see past the current lull in the economy and the obnoxious action in the stock market, but with everyone looking for the end of the world, the contrarian in me prefers to focus on the positive data points that are being ignored.
Give Me Yield!
A: The fed once again has engineered an insatiable and dangerous 'search for yield'. As the carry trade and risk trade are on again, its clear the fed will do anything and everything to a) try to recapitalize the banks and b) engineer demand for risk assets. There is another term for this, 're-inflate' an otherwise deflating economy. For those following the bond markets, you have to wonder where one goes to find yield these days. Oh, and the 10YR is yielding about 2.6% right now which means record low lending rates are likely to cause some 'broker spin' on how wonderful a time it is to buy a home.
From Business Insider, "John Hussman Warns Investors Against Reaching For Yield In The Corporate Bond Market":
Just as dividends have to be evaluated in relation to the earnings available to cover those dividends, and the stability of those earnings, investors wishing to hold corporate bonds for additional "pickup" in yield should pay close attention to earnings stability, cash reserves, and overall debt burdens. We would emphatically avoid the debt of financials and cyclicals that are prone to massive "extraordinary" losses that can quickly wipe out available liquidity.In other words, beware the 'search for yield'. Companies are taking advantage of these times and piling up cash in an attempt to avoid a future liquidity squeeze should one occur again. By the way, Lutnick had it dead right back in mid-2009, that deflationary pressures "would 'constrain' treasury yields and that talk of a bubble is 4 years early..."While corporate cash levels may very well reduce liquidity risk for companies that would otherwise need to raise funds in a tight credit market, investors should not ignore that the overall debt burden of U.S. corporations is higher than it has ever been.
Mish recently wrote, "I do think corporate bonds, especially most junk is playing for the greater fool. In regards to treasuries, there is going to be an exit problem for sure, but that could be years away. In Japan, yields stayed low for a decade. Why can't it happen here? This is indeed uncharted territory thanks to the Fed pushing and pulling levers in a manner it does not understand. William Black, a former bank regulator, is one person who does understand."
What Mish refers to is the discussion William Black had with Aaron Task:
Aarron Task: In practical terms, what does the gutting of that rule mean for the banks?That's one way of looking at it. Another way of looking at is saying the fed is engineering a carry trade environment in an attempt to 're-inflate' crappy hidden asset values to levels that are not so damaging. To do so you must engineer an environment where money chases yield - hmmm, sound familiar? Recall what one of my hedge fund buddies told us back in March:William Black: Capital is defined as assets minus liabilities. If I get to keep my assets at inflated bubble values that have nothing to do with their real value, then my reported capital will be greatly inflated. When I am insolvent I still report that I have lots of capital.
Aaron Task: You can just keep kicking this down the road and have stagnant economic growth?
William Black: Geithner's original estimate was $2 trillion and of course things got much worse that their original estimates. The IMF estimates were in the $3 trillion range. So, there are trillions of dollars of unrecognized losses under these guy's scenarios. There is a huge slug, far more than they can pay for. What they are doing instead is these stupid subsidies for the biggest banks, with essentially no political oversight. It works, for the banks but it's really bad for the economy. It diverts money from small businesses, large businesses, and entrepreneurs.
"The carry trade that's on now has nothing to do with the FX carry of old. It's that a US bank can have illiquid assets on it's books at 40 when they are worth 10. They just make $10 a year for 3 or 4 years and write down the investment a little bit more each time around while still able to show a profit. So long as nothing drastic happens eventually they'll have it written down to market. That's why even if you bid 15 for it you can't get them to sell it. Yes the carry trade is on, but if banks can earn their way out then who cares?"Strange times indeed and I just dont see how the fed gets out of this thing without lots of pain and lots of moral hazard.
I think The Weeks 'Deal Signed' Award Winner Is...
A: Why not? With permission, Id love to start doing the "Great Deals" and the weeks "Best New Signed Deal" again, to kind of mix it up a bit. What do you guys think? Is there room for that kind of content here on UrbanDigs? I guess I think this way because I know the site is about to get 'all data' on you guys very soon. But, its helpful to ask and see what you guys want to hear about. Any tips in the comment section are appreciated! On to what looks like could be this weeks Best New Signed Deal - the PH at 459 West Broadway.
459 W Broadway PH Was Asking $16.5 Million
Marketed by Keith Copley at Sotheby's
In just over 3 months too, nice job Keith! The markets general trend shows a very seasonally slow market these past few months - which also happened to be two very hot and humid months with everyone getting out of the city on weekends. So its nice to see some big deals getting done. Lets check on the markets as we get through Sept and October before making any calls on significant price action.
Stocks or Bonds? And We Have Our Answer...
A: It all becomes clear why bond markets disconnected so much from equities recently. The reason is because the marts sniffed out more QE by the fed, and today's announcement confirms the new plans.
Via Bloomberg, "Fed to Reinvest Mortgage Proceeds Into Long-Term Treasuries":
Federal Reserve officials decided to reinvest principal payments on mortgage holdings into long-term Treasury securities, making their first attempt to bolster growth since March 2009 to keep the slowing U.S. economy from relapsing into recession.Bonds were pricing that in over the past month and the moves today are being amplified by the announcement. Sometimes its buy the rumor, sell the news and other times the news sends the trend into euphoria. Risk assets may get another ride with this news, and explains why stocks held their own while bond markets seemed to be pricing in economic weakness ahead.“The pace of economic recovery is likely to be more modest in the near term than had been anticipated,” the Federal Open Market Committee said in a statement in Washington. “To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level.” The Fed retained a commitment to keep its benchmark interest rate close to zero for an “extended period.”
With growth weakening in the second quarter and company job gains in July falling short of estimates, today’s step signals that risks of a downturn have increased enough for the Fed to delay its exit from unprecedented stimulus. Chairman Ben S. Bernanke told Congress last month that the Fed was “prepared to take further policy actions as needed.”
The Fed said it will “continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature.” The reinvestment policy applies to agency debt and agency mortgage- backed securities held by the central bank.
How long the chase for yield goes on for, is anybody's guess. For now, party on!
Who's Right: Bonds or Stocks?
A: Wow, talk about the bond markets and equity markets showing diverging signals. The bond markets are warning of deflationary risks and a slowdown, while equities just seem to do their irrational march higher. If history is any guide, its usually stock prices that are mispriced; like it was in late 2007. So what do you think is going on?
It was only 3 days ago that David Rosenberg said: "One has to question which asset class has it right – stocks or bonds. It is extremely difficult to square a sustained economic recovery which is what the equity bulls are telling us with a $38 billion 2-year note auction that was sold at a new record low-yield of 0.665% (as was the case on Tuesday)."
So, Are bonds right? Or are Stocks right? What is being priced in right now? Deflation or a simple pause in an otherwise ongoing recovery?
Barron's "Stocks Ignore Green Shoots' Turning Brown", discusses:
"What's remarkable is that the fixed-income and currency markets have taken due note of the signs of economic slowing, bringing down bond yields and the dollar, while the stock market rallies on its merry way. The Dow Jones Industrials have been able to hold onto Monday's 208-point pop through Tuesday and Wednesday's somnolent sessions, putting it within 6% of April's peaks.Is it possible bond markets are pricing in future weakness that triggers more QE by the fed, while stocks hold on to gains due to the powerful short term effects that comes with debt monetization policies? Will the chase for yield have a second wind, driving money into risk assets? Are the equity markets pricing that in now? But how can that be, if bond markets say money is fleeing to safety? This is the divergence and what I'm curious you guys think about it.In the bond market, however, the two-year Treasury set another record low of 0.53% Tuesday and the benchmark 10-year note remains well under 3%, at 2.95% Wednesday. It is quite puzzling how equity investors see the proverbial glass more than half full while their counterparts in the fixed-income and currency markets see it half empty. "
Here are some new bears:
Pimco's Mohamed El-Erian via Bloomberg's, "Pimco’s El-Erian Says Chance of U.S. Deflation Is 25%":
“I do not think the deflation and double-dip is the baseline scenario, but I think it’s the risk scenario,” said El-Erian. Companies are accumulating cash and individuals are saving, making it tougher to counter deflation, El-Erian said. That reduction in private-sector spending makes government policies to stimulate the economy less effective, he said.
John Paulson via Bloomberg's, "Paulson Said to Pare Bets on Recovery as Main Funds Decline :
Billionaire hedge-fund manager John Paulson, whose $32 billion firm has been betting on an economic recovery by 2012, has pared bullish bets across his funds, according to a person briefed on the investments. Paulson also cut bullish bets in his largest funds after they declined this year, the person said, asking not to be identified because the information is private.Sounds like Paulson had a bunch of stop levels hit, will take the loss and doesn't trust this market right now. Here's what I know:
We Peaked --> We Crashed --> We Troughed --> We Reflated --> We Seem To Be Re-Deflating ---------> what's next?I think we are Re-Deflating and that this process will see the 'dull' side effects that come after periods of extreme stimulus. It will be more drawn out, less sexy, and not subject to the severity of the shocks we experienced in 2008-2009. I think it will last years and we will have small waves along the way. I'm certainly not in Prechter's camp!
Remembering Joe Ferrara
The digital real estate world is saddened with the loss of one of its more inspirational and encouraging founding fathers, Joe Ferrara, founder of Sellsius Real Estate Blog. Joe lost his fight with cancer last evening. He will be deeply missed.
Joe was a champion of transparency, a wonderful speaker at the Inman Conferences, and a great friend to anyone he encountered. He really was the kind of guy that truly cared about others, helped educate others, and would put his time aside at a moments notice to sit down and talk about whatever you wanted to talk about. A true people person. I first met Joe in 2006 at the Bloggers Connect and Inman conferences and we connected immediately. I must admit, my favorite times with Joe were with him and the real estate gang after the conferences in NYC and San Francisco. We had some great times and I'll never forget the Blog Tour USA that Joe & Rudy organized in 2007 to promote "blogging, real estate bloggers, real estate agents, Sellsius°, the Inman Bloggers Connect and more." Here is one of our pictures together:
Its rare to find someone that gets behind others in such depth and consistency that Joe did. I know his legacy will live on purely because of all the people he touched over the last 5 years or so as the online RE community grew by leaps and bounds. Joe was right in the middle of it. I am thankful to have crossed paths with him.
My sincerest condolences and prayers go out to the Ferrara family. Please visit the following site if you wish to DONATE TO JOE'S MEDICAL EXPENSE FUND, to try to make this difficult time a bit easier for his family.
Rest in Peace Joe! 'I'll catch you in another life brother!'
A 'Seasonally' Slow Manhattan Summer So Far
A: Its very clear that this summer has seen a noticeable slowdown in 'sales pace'; especially compared to the activity in the first four months of 2010. But I would like to dig a bit into why the drop in sales pace should be somewhat muted by a drop in inventory levels as well. Like the after-effects of a stimulus plan, the surge in activity from Feb-April is being followed by an overshoot to the 'dull' side later on. Well that 'later on' seems to be here and while the summer is hot, it seems sales pace is not. However, we should use caution before interpreting a slower sales pace to mean a new move down in prices is upon us. I'll discuss why below. Unless there are sellers out there with serious pressures to liquidate, I say what we got here is 'a very seasonally slow summer'. We should wait it out before making bold predictions on price action - although I'm sure we can give back a bit of the reflation. If this sales pace continues apace after Labor Day and macro forces deteriorate with it (equities take a sharp move down), then we have something to discuss.
First, let me show you some sneak peaks so you can see why I am thinking this way. The Broker Year-over-Year Contracts Signed Charts will show us the realtime movement of Manhattan property from ACTIVE to CONTRACT SIGNED, as the brokers update the status of their sales listings:
Looking at this form of 'sales pace' chart, the downward trajectory looks ugly and may lead some to believe a noticeable drop in prices is inevitable - similar to how a drop in sales volume after Lehman failed in Sept '08 led to a big price adjustment across all price points. Outside of seasonality which always should factor into our thinking, I would be wary of making bold price predictions for three main reasons:
1) First, before Lehman's failure in late 2008, Manhattan property was still trading right near peak levels - not so today. We always should keep in mind where we are coming from. In other words, today we are coming from a market that adjusted and then reflated a bit - not from a market trading at peak levels. Therefore its likely we will see less downward pressure should any new adjustment process be in the making.
2) Second, the level of fear floating around the environment two years ago versus today is quite different; today we do not fear systemic collapse or risk of a true depression. Rather today, a reflation mentality still seems in tact. The question is whether or not you believe in it.
3) Finally, the pressure to liquidate combined with a negative wealth effect of a plunging equity market is highly unlikely to mimic what happened from late 2008 to early 2009. Recall in that period, stocks were on their way towards a 45% nose dive - so ask yourself, do you see equities doing a similar move over the next 6-9 months causing the same level of panic?
In every market there will be sellers that must sell, sellers that want to sell, and sellers that are testing for a certain price. The confluence of factors that allowed an extreme move post-Lehman to occur, just doesn't seem to be in place right now. With that said, I think the mini-frenzy that produced some stronger than normal bids during Feb-April is clearly over. Its likely we see continued upward pressure in quarterly reports into late 2010 or early 2011, whenever the lagging deals eventually close and get caught by public record.
Now, the market is also seeing a move down in measured Active Inventory levels. Nothing major, but a decline in inventory nonetheless. I will not disclose the rules we put in to measure active inventory right here (you will have to wait for launch of the new site), but people should know that rules MUST be in place to properly measure what should be counted as active in this market - for example, a listing that is set to ACTIVE internally yet not updated by the listing broker in 90 days or 180 days, should NOT be counted as active! Those are stale, old listings more likely off the market yet never updated by the listing agent. Bear with me here.
Movement in sales pace should be analyzed with respect to relative movements in active inventory. What I mean is, imagine if sales pace stays constant but active inventory increases by 15%. Although sales pace did not change, one should interpret that as a slightly weaker market because demand is not meeting up with supply the way it did when inventory was 15% lower. On the flip side, if sales pace rises 10% and inventory falls 10%, that should be interpreted as a quickly strengthening market because supply is not keeping up with the pace of demand. These relationships could be due to seasonal factors or they could also signal a shift in the markets.
With me so far? One of the cooler charts we designed was what we call the Active-to-Pending Sales Ratio. It could be thought of as a reverse Absorption Rate chart with an equilibrium right in the middle. It will signal a weakening market when the ratio rises above equilibrium and signal a strengthening market as it falls below equilibrium. But it should factor in how different market forces may be enhancing one another or canceling each other out. Not a bad measure of volatility as well I guess.
So here you go, the Active-to-Pending Sales Ratio Chart since January, 2008:
First you notice the huge bulge that shows the severity of the adjustment Manhattan real estate experienced post-Lehman - pending sales fell about 70% while inventory rose about 30% during that phase, causing this ratio to surge with that weakness. The reflation that occurred in mid 2009 is also there. Finally, in the last month or so we see only a slight move up as sales pace noticeably fell. The main reason why this trend did not move up further, is because active inventory fell about 7% in the last few months; somewhat muting the effect of the drop in newly signed deals. It seems more of a seasonal thing than a 'market is about to see an adjustment' thing. When viewing the data trends as a whole, rather than piece by piece, I can confidently say that the pace of brand new listings hitting the marketplace in the last few months has slowed big time - and with it, deal volume.
Let's wait a bit longer before changing views or declaring inevitable price adjustments in our near future. For those that must sell soon, enjoy the fact that inventory is declining but get aggressive on price because the pace of signed deals is telling me that buyers are being very patient right now or taking a break for the summer. It may be quite difficult to procure that strong bid for any property mis-priced and with no special features to offer.
What Are The Markets Trying To Tell Us?
Action in the bond, stock and commodities markets have been very confusing to me as of late. The stock market, which has broken critical technical levels (see my recent piece "Critical Juncture") has "hung in there" recently, partly due to the extremely bearish sentiment of investors, who typically "get it wrong" as a group in the short-term.
But much more perplexing to me than the stock market's refusal to completely barf over the stream of negative macro economic data points and poor technical action, is the lack of spread widening in the bond market in the face of plummeting bond yields. I know I'm talking "inside baseball", so let's back up and define some terms.
Risk spreads are the premiums demanded by bond buyers above the "risk free rate" (embodied by short-term US treasury rates - peanut gallery please refrain from Uncle Sam is broke jokes) in order to be persuaded to hold bonds with some non-zero risk of default. When bond investors get nervous about bond issuers ability to pay back their debts (weakening economy and/or liquidity crisis) these spreads (yield differentials) tend to "blow out" (widen). Shockingly, while bond yields are "breaking down like a soup sandwich" lately (their prices are surging and yields falling, indicating inflation pressures in retreat), riskier bonds are rallying almost as much, keeping spreads in check. As you can see from the chart below, which I borrowed from the Bank Credit Analyst, bond spreads have not blown out during the recent treasury rally. This is likely explained by the new peak in return on capital being reached by corporations (as their returns on investment are far eclipsing their cost of capital). This large spread is a cushion to corporations' abilities to support their debt, even if sales and/or profit margins were to contract to some degree.
Many investors believe that the bond market is less flighty and more rational than the stock market, particularly in light of the bond market's sniffing out the world financial crisis before the stock market did. For this reason I take the strange behavior being exhibited by bond spreads seriously. If one were to assume a less omniscient bond market, one could explain the current situation thusly: Investors are worried about deflation and are piling out of stocks and into bonds, they are also blindly buying credit risk in a desperate grab for yield. The expectation would be that eventually the slow economy would punish the yield seeking buyers by haircutting their bond prices (raising yields) and blowing out spreads versus treasuries.
But what if bond buyers are actually very smart and rational? What if they actually believe that the economy will slow, unemployment will remain high and inflation will not be a problem for a long time? What is they also believe that this does will not result in a slow down bad enough to cause bond defaults, maybe just earnings disappointments? Then bonds rallying across the risk spectrum would make sense. Interestingly, I believe that the recent action in gold prices is expressing belief in the same theory.
Gold has been a one way bet for the last couple of years. It has seemed to be "insurance" against two tail risks (unlikely but highly damaging occurances). In the first case, the market imagines that the economy stabilizes and begins to turn around and all of the bank reserves that have been stashed away and creating no economic growth because they are not being lent out, come rushing back into the market too rapidly for the Fed to mop them up, creating an economic overheating and inflation. In this case gold would participate in the inflation trend. On the other side of the coin, what if the economy went into a deflationary tailspin and the only way for the U.S. to pay of it's debts was to allow the dollar to crash, print money and devalue our way out from under our debt. In this case our cheapened dollars would barely buy anything, causing the hyper-inflation seen in undisciplined emerging economies in the past (think Argentina a few years ago). Gold would certainly retain its value and explode to the upside in a relative sense, under such a scenario. Recently, however, gold has tended to be more and more correlated to a rising stock market, and has felt more like a momentum driven risk play. As such, it has grown "tired" as the stock market has rounded over and churned. Click (View image) to see a gold chart which appears to be potentially topping out (note that during gold's multi-year run, it has had corrections of this duration and magnitude before and later moved on to new highs, although these seemed to follow more parabolic rises than the recent run.)
I like the self consistent picture that seems to be being painted by stocks, bonds and gold right now. In short, the action of all three assets suggests that the economy is slowing....enough to dent corprate earnings and stocks (though downside from here should be limited - stocks always go to extremes so maybe 10 - 15%), while tail risks (deflationary spiral/hyper-inflation or overheated recovery) are off the table, implying riskier credits will be okay and treasury bonds are not set to tank anytime soon due to the lack of economic traction. Oil, which is stuck in a trading range, also seems to concur. If economic growth were really about to plummet oil would be acting a lot worse. We will see if this explanantion plays out, for now it seems to best explain the interesting trends I see in the markets. Technical action in the stock market still leaves me cautious on equities, but I'm not in the deflationary spiral camp and I don't think Mr. Market is either.
Bull vs Bear Q & A: Rosenberg vs Paulsen
A: Interesting piece out in the journal interviewing David Rosenberg and James Paulsen. With my time completely dedicated to finishing this project, I'll be referencing more macro articles over the next few weeks. I am definitely in the Rosenberg camp on this one.
Via The Wall Street Journel's, "A Mid-Year Bull vs. Bear Investing Smackdown":
Q: Where is the market headed the rest of this year and over the next 12 to 18 months?Interesting to hear Paulsen's last bit on becoming bearish if inflationary pressures start to creep in, causing bond yields to rise. Many, including yours truly, have discussed the 'end game' of this crisis and actions taken to stem this crisis as being a collapse in bond markets sending yields much much higher. But that phase seems to be years away. Right now, deflation is the main concern and the drive to safety is constraining US bond yields. That game lasts until the market starts to perceive the safety of US Treasuries in a different way. Think Greece, Italy, Spain, and Portugal. Sure we are the great US of A, but you never know when the markets may force the fed's hand and start sending the longer end of the curve for a ride. Again, I think that is years away and deflationary pressures are still in the pipeline for us to go through first. Perhaps a 2012-2013 issue. Maybe later.PAULSEN (the Bull): Investor optimism, which got ahead of itself in early spring, has been checked, considerable liquid asset holdings are on the sidelines and concerns about a potential double-dip recession seem overblown. Recently the dividend yield on the Dow Jones Industrial Average rose above the 10-year Treasury-bond yield for the first time in decades, and the price/earnings multiple on year-end estimates has declined to about 13.
With interest rates and oil prices down, earnings still rising and policy officials showing no inclination of taking the punch bowl, the upside potential for stocks is encouraging.
ROSENBERG (the Bear): The market is not cheap. By the end of secular bear markets, stocks trade no higher than P/E multiples of 10 and at least a 5% dividend yield. We very likely have quite a long way to go on the downside.The market moves in cycles -- 16- to 18-year cycles, in fact. This secular down-phase began in 2000. The best we can say is that we are probably 60% of the way into it. In a secular bear market, rallies are to be rented, not owned. We're in a primary bear market, not unlike what we endured from 1966 to 1982. Back then, the principal cause was inflation; this time, it's deflationary debt deleveraging.
Within the next 12 to 18 months, I can see the Standard & Poor's 500-stock index breaking back below 900 [it's currently at almost 1100]. A substantial test of the March 2009 lows cannot be ruled out.
Q: What should investors keep an eye on?
PAULSEN: The job market will likely determine conditions in the stock market during the balance of this year. Either job growth will soon accelerate or concerns about a double-dip recession or a crawling recovery will overwhelm stocks.
ROSENBERG: The economic recovery phase is behind us. The boost to growth from the inventory bounce has run its course and the stimulative effects of fiscal policy will diminish amid a public backlash against increases in government debt. That constrains the government's ability to try to fine-tune the economy.
Even if we manage to avert a double-dip recession, the chances of a growth relapse in the second half of the year are higher than the equity market assumes. The U.S. unemployment rate will stay near double-digit terrain, and inflation and interest rates will remain low.
A market priced for peak earnings in 2011 could be in for some pretty big disappointment. We'll see that with guidance from companies when second-quarter results stream out in the next few weeks.
Q: What should investors do with their portfolios?
PAULSEN: We recommend sectors most sensitive to the economic cycle, such as junk bonds and energy, materials, technology and financial shares, which have been left for dead. Now that China is done tightening, the emerging-market story may regain prominence. Cash offering zero returns (with today's ultra-low interest rates) and relatively "risk-free" 10-year Treasury bonds at a 3% yield don't offer much. Defensive economic sectors like health care are relatively overvalued. We like small-cap stocks and industrial stocks longer term, but both also seem a bit overvalued.
ROSENBERG: My primary theme has been SIRP -- "safety and income at a reasonable price." Yield works in a deleveraging deflationary cycle. The median age of the boomer population is almost 55, there is very strong demographic demand for income and with bonds comprising just 6% of the household asset mix. So appetite for yield will expand.
Within the equity market, squeeze as much income out of a portfolio as possible -- a reliance on reliable dividend yield and dividend growth makes perfect sense. Gold makes up a mere 0.05% of global household net worth, so small incremental allocations into bullion or gold-type investments can exert a dramatic impact. And central banks, selling during the higher interest rate times of the 1980s and 1990s, now are reallocating their reserves toward gold, especially in Asia.
Q: What makes you most enthused about the investing environment?
PAULSEN: If 2000 was the era of "irrational exuberance," today must be the era of "irrational pessimism." Too many are too pessimistic and are greatly underappreciating potential investment returns.
ROSENBERG: We are entering into a period of stable consumer prices that should last at least for a generation. This will help prevent erosion in real household incomes.Q: What could happen that would turn you into a bear/bull?
PAULSEN: I could become a bear again if the massive policy stimulus introduced during this crisis prove too highly inflationary. That could raise bond yields, force more extreme Fed tightening and lead to a collapse in stock P/E multiples.
ROSENBERG: Signs that the debt deleveraging cycle has run its course. A new "killer app" or major technological breakthrough. A sustained decline in oil. Structural economic reforms in the world's "surplus saving" countries like China, India and Germany that stimulate their domestic consumer spending. Progress toward working our way though the repair process of the balance sheets of domestic households and businesses.
As for the reflation, it was always built on an unstable foundation of stimulus and a fed engineered dollar carry trade. So of course it would not last forever. The difference I find myself in lately with colleagues and friends about these topics, was the artificial and unsustainable nature of that reflation; whereas many looked at the rebound as a solid, economic recovery. Clearly this seems not to be the case. We are yet to see the unintended consequences of all the policy actions taken to stem this deflationary debt crisis. For now, its kick the can down the road as long as we can. As many wall street trades tend to go, that works until it doesn't anymore.
Frederick Peters: Manhattan RE Mid-Year Report
A: Here is an excellent summation on the first half of 2010 by Frederick Peters, President of Warburg Realty. Fred really combines his experience and wisdom with his 'in the field' observations, anectdotal reports from his agents, and whatever data he has access to for this report. From where I am standing, the observations are spot on. The entire article is worth a read, with some highlighted points to focus on. After you read this, go back and check the Real-time Contracts Signed (direct from broker updates signaling the pace of listings entering contract from a previously ACTIVE state) chart I posted last week and you can see the confirmations in the data.
From Frederick Peters, "Warburg Realty Mid Year 2010 Market Review":
Thanks Fred! Keep the reports coming in.The second quarter of 2010 behaved like March in the old adage: it came in like a lion and went out like a lamb. April was the acme of a sales avalanche which began gaining force in the fall of 2009. Throughout Manhattan and western Brooklyn residential properties of every category were snapped up, often with competitive bidding, at prices averaging only 10-15% below the 2006/2007 peak. Numerous all time price records were set, especially in mid-sized and larger apartments, during March and April. Confidence and the stock market surged higher.
Buyers began emerging and becoming active during the fall of 2009, as gradually rising prices made them apprehensive lest they miss the opportunity to purchase while the market was still depressed. The wave of purchasing gained traction during the winter, and by March inventory had dropped from a 19 month supply to an 11 month supply, essentially normalizing the marketplace. Larger properties saw particularly robust gains during this period. While the absolute top of the market (properties asking $20 million and above) remained sluggish, demand for properties of six to twelve rooms was intense. It was precisely these properties for which demand had declined so precipitously during the period between September of 2008 and September of 2009. There was little available in this category, especially on the Upper East and Upper West sides, and only those buyers who acted quickly and aggressively succeeded in making a purchase. The early months of 2010 were replete with cognitive dissonance: buyers simply could not believe that they had missed “the bottom” and that failure to act decisively once again left them empty handed just as it had three years earlier!
The smaller apartment market, which had suffered less during the recession, rebounded less dramatically. The one- and two-bedroom markets did see significant absorption, but with lesser price increases and little competitive bidding, as supply for the most part continued to outweigh demand. The inconvenience surrounding construction of the Second Avenue subway depressed prices along that corridor and helped moderate demand for the postwar inventory which makes up the bulk of the housing stock north of 59th Street and east of Third Avenue. In the Village, in which the housing stock remains primarily rental, scarcity drove the market as it had before the recession, with many buyers competing for the few available offerings, especially in the larger two- and three-bedroom categories. In both Tribeca and the Financial District an overhang of unsold inventory from the condo construction boom helped keep prices moderate, while at the same time demand remained strong for the “old” Tribeca lofts, with their high ceilings and enormous windows, in the prewar industrial buildings for which the neighborhood was originally known. In Williamsburg, developers responded early and dramatically to the recession, slashing prices at their buildings and guaranteeing a level of activity which was the envy of most other emerging and more recently gentrified neighborhoods.
As April moved into May and May into June, first economic and then seasonal factors came to bear on the marketplace. Debt crises in Greece and Spain and a falling euro sidelined many Eurozone investors whose interest in New York real estate had buoyed the condo market for years. In our new global economy those European debt concerns began to weigh heavily on OUR equity markets as well. Consumer confidence here at home was further shaken by the program trading driven rout in stocks on Thursday May 6, which temporarily reduced many issues to near zero values. Although the market rebounded, the confidence did not. The jobless nature of our recovery, our mounting national debt burden, and government gridlock, both in Washington and Albany, further depressed the Dow, which lost value during much of June. And then, of course, summer arrived.
Real estate purchasers react in different ways to times like these. While recent developments have certainly taken the sizzle out of our market, deal flow remains healthy as buyers see a home purchase as an alternative to stocks and bonds, with significant collateral benefits. The latter half of June, July, and August are always slower in the residential sales, as both buyers and sellers spend more time out of the city. But with the market a little slower, real opportunities exist for buyers. Some sellers will still be holding out for pie in the sky, but for now that mad moment seems to be over.
A Glimmer of Light in Commercial Real Estate
Bob Knakal of the eponymous New York City commercial real estate brokerage Massey Knakal put out his "Summer Commentary" recently. While Bob has every reason to paint a rosy picture of New York City commercial real estate (his firm is consistently the largest broker in NYC in terms of number of deals due to their dominance in sales of smaller buildings). Bob actually is as much of a straight shooter in his market commentaries as he is in real life....no grain of salt needs to be taken with regards to the following:
According to his summer commentary "the acute imbalance between supply and demand today appears to be impacting the market more than it usually does. Presently there is excessive demand met by a relatively weak supply of available properties for sale." Sound strange? It is actually highly intuitive. Those who are not over-levered or facing maturity defaults (see my recent piece "Real Estate & Banking Reality Check") don't feel a great need to sell into a market overshadowed by a slow economy and high unemployment and dominated by vulture buyers. Meanwhile distressed sellers are being thrown lifelines by their banks. As opposed to the popular belief that they are under-capitalized and can't afford to take the losses (they have all taken TARP and raised equity), banks simply imagine a better time to liquidate REO (real estate owned) than today and also don't want to miss Wall Street earnings estimates by prematurely calling in loans. Knakal goes on to profess that investment sales volume will increase by at least 40 percent year to year in the second half of 2010 as sellers seek to beat the increase in cap gains taxes, pent up demand for 1031 exchanges is released and (my words not his) funds put together in past years invest it as opposed to handing it back to their limited partners (at least they can continue to collect fees).
Interestingly, a similar scenario seems to be playing out in other markets around the country (particularly Boston, San Francisco and Washington). A recent Time Magazine article entitled "Is Commercial Real Estate Bouncing Back", quotes Mike Kirby of respected REIT research firm, Green Street Advisors, saying that "It's mainly Arab money. They have been the main source so far. The German syndicators are back in business. They've been toeing around the market. There's also been interest from sovereign wealth funds of all stripes.". Kirby contends that prices for commercial real estate are up 20% off their lows, which has not yet been captured by market indexes which track closed rather than announced transactions.
A Dow Jones Newswires article last week entitled "Commercial Real Estate Bargain-Hunting Makes Bargains Scarce" discussed how investors are bidding aggressively for assets in foreclosure, paying as much as 90 cents on the mortgage dollar. So, despite delinquency rates of 10% versus a more normal 1%, according to Jack Taylor a managing director and head of Prudential Real Estate Investors global high-yield debt group, "There is no such thing as a distressed asset". According to Maury Tognarelli, President and Chief Executive of real estate management company Heitman LLC, "Demand has exceeded supply, and as a result, the pricing is just not appropriate for the risks still there". John Murray a senior vice president and portfolio manager at PIMCO added "this makes some investors think a rapid, broad-based recovery is underway; but these transactions don't paint a good picture of what's happening for a substantial segment of the industry, where properties remain under-capitalized".
From my perch covering regional and local banks this promises to be an interesting earnings season as construction and development loan write-offs hand the baton to maturity defaults on commercial owner occupied and investor owned property loans. Troubled Debt Restructurings (TDRs) will be the topic of discussion for those with significant numbers of maturing loans, however in many markets, commercial bank loans were largely made with 10 year or longer maturities (5 with an option for 5 more was typical in NYC) and these loans will not be recognized as problems as long as payments continue to be made. Considering the generally well capitalized status of survivor banks (there are certainly many zombies that will be merged and purged by the FDIC) I don't expect properties to be blown out with 20 - 30% liquidation discounts. The banks that acquire troubled loans through FDIC assisted takeovers have strict reporting requirements which will enable regulators to see whether they are leaning too hard on loss sharing deals by liquidating bad loans willy nilly.
According to a recent Bloomberg article, data from Real Capital Analytics shows commercial real estate sales rose 58% year-to-year in the first half, despite running at a quarter of the rate of the prior six years. In my mind, while some unique circumstances have conspired to cushion commercial real estate's fall, the avoidance of "liquidation discounts" is probably a positive for the economy (prevents further deflation due to acquirers with super low basis costs slashing rents) and the improved liquidity being evidenced in the markets bodes well for the commercial real estate market, the banking system, and by extension the economy. If we can avoid a bear market in stocks, that would help too.
Related Articles:
Commercial Real Estate Shows a Faint Pulse
Back Thursday - Some Charts
Away for 4 days and back to work Thursday. While we finish final structural improvements and front end design UI to wrap around the analytics platform, here are a few more sneak peaks comparing the Upper East vs Upper West sides for you. Consider as beta for now as we are yet to implement a few structural upgrades to data. The new site was designed to allow subscribers with the flexibility to customize charts to submarkets and price points. Here are just a few examples without the new UI code:
2 YR TRENDS OF PENDING SALES FOR ENTIRE UES vs UWS MARKET
2 YR TREND OF PENDING SALES FOR UES vs UWS 2-BATH (minimum) MARKET BETWEEN $1m-$2m
**Note: These are pre-launch snapshots and may not reflect the final version. We have a few major revisions yet to finish to enhance data quality and measurement quality for all statistics, that are not reflected in the above charts. Use at your own risk for now, as final numbers may change a bit for official launch when all coding fixes are fully implemented.
The new system was designed from the ground up around the idea that Manhattan is a highly segmented marketplace. In other words, there is no ONE market. Rather, Manhattan consists of many various sub-markets and price points ranging from studio apartments in FiDi to 3BR/3BTH+ apartments in the Upper West Side; and everything in between and outside of that. I'll try to give some more sneak peaks as we progress towards launch.
Back to posting end of week!
10YR Manhattan Median Sales Snapshot: 2000 - 2010
A: MillerSamuel did some nice upgrades to his data search engine last week, and I was able to play around a bit with it. I figured it might be interesting to check out the Median Sales Price for Manhattan over the past 10 years to try to visualize the boom, the adjustment, and the reflation we experienced. Here goes.
The reason I use Median Sales Price over the Average Sales Price is to filter out those occasional uber high-end sales that tend to happen from time to time. Certainly the conversion of The Plaza and new dev 15CPW highly skewed average sales prices from late 2007 to late 2008 when deals closed and were captured by ACRIS public record - and then counted in the reports that we analyze. I think when looking at this 10yr chart you get a fairly good idea of what this market has done in reaction to a credit boom, a credit bust, and a fed engineered reflation environment.
Via Miller Samuel Aggregate Search Data Engine:
This is for all Manhattan sales, ranging from studios to 4BR+ apartments. Clearly Manhattan is a highly segmented marketplace comprised of many submarkets with varying price points - something that makes this market so unique from many other local markets across the country. What we see here is a general story, not so much a specific one. What would be interesting to parse is how the different submarkets behaved over time. In other words, how did the Studio market hold up relative to the 3BR+ market from late-2008 to mid-2009; and so on? Given the nature of the crisis we faced, it was the high end market in Manhattan that virtually shut down and saw the greatest percentage drop in price action from peak to trough. These are the challenges I'd like to tackle to add more transparency for analyzing Manhattan residential real estate in the months ahead.
I wish everyone and happy & safe 4th!!
