Sometimes We Get Lost In The Dark
Its midnight and your lost in the woods with no backpack or flashlight. I can see a vision of bruised adventurers running around in circles, scratching their heads as they ask each where they are? The only consistent is the collective sigh of "how should I know"?
As the lost group attempts to charter previously unchartered paths, they stumble upon the larger rocks on the ground here and there. Sometimes they fall, sometimes they don't but they always get up and continue on their way; each time a bit more wary than before. The group sub consciously walks slower with each fall as they fear what may lie ahead. Hours go by as slow as months as you try to navigate the herd back home without having to sleep in the woods with no equipment. But you know what, sometimes you have to sleep in the woods with no equipment.
This scenario in my opinion accurately describes what we are all facing right now. Fact is, we are in unchartered territory on the following levels:
a) the use of leverage to support a 5 yr illiquid asset boom (housing)
b) period of time AFTER a financial innovation results in the dysfunction & seizing up of the actual marketplace where the products are traded
c) housing deflation + commodity inflation
d) balance sheet black hole
No matter what you hear about this current situation, we can't argue that we are in a period of de-leveraging. Risk is being repriced and the credit markets are in shut-down mode as the industry around it attempts to corrects itself. Games that worked before, do not work now. And since housing is illiquid and nobody knows how Americans will be impacted by any economic slowdown, which few deny is here, it is impossible to predict the short term bottom for prices.
The additional threats we face relate to the rocks/trees we can't see as we navigate ourselves blindly through an unfamiliar terrain. We don't know what will happen. We don't know the side effects of the events that will play out over the near term. We are completely lost. In the near term, we know we will find out:
1. who is holding toxic securities - we just found out that Bristol Meyers Squibb & the life insurance companies are the latest company's to announce exposure to subprime mortgage backed securities
2. resolution to bond insurers saga - private takeover, gov't bailout, cash injections, etc..In the end, its all about one thing: RATINGS! Will the ratings remain AAA, or get downgraded. A downgrade, in any way, shape or form, will result in its own wave of losses to anybody holding anything toxic insured
3. economic data - we know its coming and the fed said it too; higher inflation and rising unemployment. Unemployment, GDP, ISM, and jobless claims are all expected to be pressured over the next few months at the very least.
We don't know what other obstruction may pop up. We don't know the level of certainty or uncertainty that this information will bring with it. So we look to the stars for some sense of direction. The stock market is the stars, and is the tool that most use to figure out where they are when confused, or lost. But in this unchartered world where we don't know what lies ahead, this widely used, widely publicized vehicle is not a very good navigator for one real reason. Stocks trade on information available and investor sentiment for the near term, lets say the next six months. If the world around us slows and earnings come down, then the entire valuation model of equities (p/e) will have to re-adjust to the weaker times that we know are about to come. Here is a great recent example:
APPLE (NASDAQ: aapl), was trading at a higher price/earnings ratio only 4 weeks ago when shares were hovering near $160 a share and off its high of $200; lets say 31 although I don't have the exact #. Then something happened. On JAN 23rd, the earnings forecast disappointed. The stock fell 11% as investors re-adjusted the share price to be more in line with the lowered earnings forecast. As with most earnings disappointments, the adjusting stock slowly slipped over the following few weeks to a current trading price of $118.This very dynamic, is why stocks CAN'T be used as an accurate gauge to our current situation; yet I am sure it will. Right now, we are lost in the dark and for me, there are clouds obscuring the stars! Oh how I wait for those clouds to clear or for the sun to rise! Shit. A cliff. Didn't see that coming.
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Comments (10)
i enjoyed this Noah and would like to see more every once in a while on this blog
Posted by reader | February 22, 2008 3:21 PM
thx!
Posted by Noah | February 22, 2008 4:05 PM
Many of your observations are correct. In a free market, there are always transitional periods where assets, credit, sentiment, valuations and opportunities shift and reset. The primary question that needs to be asked, and reflected on, is what type of response is being offered by the government and the Fed, and is it appropriate.
Government: The economic stimulus package is, in my view, a non-issue. It will not address the challenges that the economy is facing, nor does it do enough to help businesses, which are and will be the engine of economic growth. I don't think it will make things worse, but it won't do much good.
What we need is for the government to LOWER CORPORATE TAXES, which will stimulate investment in our economy, as well as entice foreign companies to set up shop in America, which they would love to do but don't, because of high taxes and resk of exposure to our overly litigous country. This leads to the next step government must take, TORT REFORM.
Unless we do something to rein in the trial lawyers, business investment will continue to stall or seixe up, which will lead to loss of jobs and less entrepenuership. Finally, ENTITLEMENTS.
If we do not rein in social security and medicare, we will go bankrupt, literally. Needless to say that few politicians address this issue due to its potential to harm them in the polls, but it needs to be addressed.
CONCLUSION: If Obama wins, these problems will get worse and our economy will surely suffer. If McCain, we will get some tax relief, and maybe some tort reform and entitlement reform.
FED: Right now the Fed is doing everything they can to pump liquidity into the market. They are late to the game, and it may well take a year or more for their actions to bear fruit. However, they have no other choice. To tighten up on liquidity right now would lead us into a harsh and protracted recession.
INFLATION is a real concern, however, oil prices are being driven higher by speculative trading, not by high supply and limited demand. Therefor, the government must step in limit or eradicate this type of speculation in such a vital commodity, because if Oil is driven to the highs by sepculation, and stays there, it will greatly impact the consumer, and thus the economt at large.
Food costs are high largely due to the moronic diversion of food crops to ethanol. This problem must and will be fixed and food prices will stabilize in the next year. However, increasing wealth in third world contries, where people are now eating twice a day, instead of once; as well as the greater consumption of meat in emerging wealth classes, will continue to put pressure on the food supply, and therefor we need to realize that prices will probably trend higher in the long term.
As for Manhattan real estate, there was an article in the Sun yesterday about investors still puchasing rental buildings, and there was another article about a vulture fund that is getting read to swoop down on any signs of weakness in Manhattan. This leads me to the conclusion that the fundamentals are strong, though sentiment is weak. If sellers hold their ground, or shift to renting, if they can, this market will probably be stable. If sellers panic and give in to negative sentiment, there are plenty of buyers on the sidelines, myself included, that will happily purchase for a discount.
Posted by mh23 | February 22, 2008 4:34 PM
On oil I meant to write low supply and high demand
Posted by mh23 | February 22, 2008 4:38 PM
mh23 - great comment!
I would like to quickly respond to your last point as I have to head out for showings..
you said.."If sellers panic and give in to negative sentiment, there are plenty of buyers on the sidelines, myself included, that will happily purchase for a discount."
Do not discount the potential effect of the herd like mentality to BACK-OFF, on any actual evidence that Manhattan real estate prices went down across the board. Nobody wants a depreciating asset and at least admit that the credit cycle will include further tightening of credit/lending as the cycle plays out, and this effect must be taken into account too on the overall picture for nyc real estate
Posted by Noah | February 22, 2008 4:41 PM
Agreed. What are your thoughts n rentals. Crain's reported that rents are up 5.5%, and in 06 they were up 10%. I guess they mean that rents are increasing, but at a slower pace.
Posted by mh23 | February 22, 2008 5:02 PM
Rents are going to keep increasing until employment is substantially impacted, or the city becomes undesirable to live in. The breakeven rent increase vs. occupancy levels (occupancy levels at which you increase rents and risk more vacancy) is ~93% - meaning you hold rents stable at 93% occupancy rates. Rentals in manhattan are running at more than 99% occupancy, and even the most conservative view of Manhattan would be that market rate rentals are 96% occuppied (more realistically, they're around 98%). Increasing rents are inevitable.
RE: you're point on Apple. Apple has a habit of giving shoddy price guidance (lower than expectations) and then crushing that guidance in future earnings. I can only speculate as to why they continuously do so, but so can anyone else. As a shareholder, it's frustrating to watch. I'm not in the business of selling investment advice, but I'm a bull on Apple relative to the market. It just seems like the company is too good at putting useful innovative gadgets on the market that become mainstream necessities worldwide to stay down for very long.
That said, the example is perfect for describing why stocks don't reflect the reality of the market. I would definitely stay short financials - there's a lot more mess and weak profits to clear.
Posted by Mike | February 22, 2008 6:18 PM
This kind of gloom and doom stuff can't be all that good for anyone. Seems like whenever anything positive happens (like the AMBAC bailout), Mr. Urbandigs finds some cloud in the silver lining. This tricky tactic of negativity to get sellers to lower their prices may backfire, as trying to talk down the rather strong Manhattan RE market may be a risky strategy. UDiggs has every right to slant things to the negative to achieve his goals, but I'd personally like to see more of a sense of responsibility.
Posted by George | February 23, 2008 5:01 PM
George,
Wow..you obviously are a somewhat new reader and was not around here when I was bullish on stocks in late 2005/2006 and NYC real estate up until early 2007 or so when credit started to show signs of trouble.
Of course you are entitled to your opinion and pinning me as a doom & gloomer bread line personality is not new, I see myself as a realist.
Everything I discuss is REAL. This Ambac bailout is nothing more than banks and insurance regulators attempting to avoid a systematic financial shockwave that would occur IF THE BOND INSURERS HAD THE PROPER RATINGS ASSIGND, AND ITS NOT AAA!
If you think this is a solution, you are totally wrong and do not understand what is going on in the credit markets.
Posted by Noah | February 23, 2008 6:05 PM
George - how do you interpret the fed acknowledging and now predicting
a) higher inflation
b) rising unemployment
c) slowing economic growth
They said it last week, and here is a link via BR's blog:
http://bigpicture.typepad.com/comments/2008/02/fed-cuts-of-a-d.html
THE FED IS TELLING YOU THIS!
The actual thought that I, this lone voice, can bring down Manhattan real estate is so absolutely absurd. Are you serious?
Posted by Noah | February 23, 2008 6:08 PM