Talking Out Loud

You know, I want to switch it up a bit and just talk out loud for a discussion today; I'm warning you its a bit longer than normal so have your cup of coffee handy. These are some crazy times, I must say. While the Manhattan real estate market softens, and yes it has softened as buyer confidence declined, lending standards tightened, rates ticked up, and inventory jumped, my business is quite strong; the last two weeks felt like wall street bonus season for me. I have this blog to thank for that I guess and that means I have all of you to thank. But just because I'm busy, doesn't make the entire market a frenzy, as we saw from The Real Deal's survey of brokers last week! What is really going on out there?

Almost every broker I speak to is experiencing softness in some way, shape or form compared to this time last year. That in and of itself should not be a surprise to anyone reading this, but when it comes to my feelings about it, here goes.

First off, inventory surged since DEC 2007 about 40% or so until about 3 weeks ago. So what happened? Did listings just stop coming onto the market OR did sales volume begin to tick up? In my humble opinion, a bit of both. Nothing goes in a straight line forever, and that includes inventory trends. We just jumped 40%, thats 40%! Of course a pause, or even a retracement isn't out of the question here or healthy. But I think there's a bit more to it. The seriousness of a seller is starting to show right now!

If you have to sell, it will show. Other than that, listings have tamed down a bit heading into the hot summer slow months, and perhaps those sellers that tried to test the market during this past sluggish wall street bonus season are giving up and removing their listing from the open market. One thing is for certain, this summer will be slow all around. Sellers will find it slow because of the seasonal component, and buyers will find it slow because options aren't growing! Get used to it. Expect inventory to waddle around 7,500 and then tick up a bit as we get closer to the end of the year. I also expect sales volume to be on the lower end, proven at a lag of course.

In regards to the stock markets, well we just had a 900 point selloff in the past 3-4 weeks. That's quite a shock to even novice investors and a noteworthy negative wealth effect for those that count on their portfolios to decide their max budgets in real estate purchases. But where do we go from here? Honestly, I'm confused right now; which is why I covered about 75% of my short positions and mostly in cash right now. I do know that inflation is about to rear its nasty head starting in July as the seasonal adjustment trick is no more. And evidence of this is being shown in the bond markets as yields rise, pricing in a rate hike campaign by the fed. The question isn't one of IF, but WHEN. Personally, I feel like the economic weakness is just about to really show (as we see the damage from the credit hurricane), so I don't see the fed hiking rates so quickly. Which is good and bad. While lending rates might have relief days ahead, for a short while, it is at the expense of a very weak economy (after the rebate stimulus effects pass that is).

Do not discount the negative effect that higher yields are causing right now. Lending rates are surging, banks profits are being crunched, and money in general costs more to borrow. As to commodity inflation, we are yet to experience the side effects of $135/barrel oil, trust me! That will come in future inflation datasets for sure, and our fed will shift bias real fast! When a fed hikes rates because they are forced to with rising inflation pressure as opposed to overheating growth, that's a problem. Why? Because it will hamper the recovery that didn't happen yet!

When I see reports that mortgage equity withdrawal (MEW) is down 60% from Q1 2007, courtesy of Calculated Risk, I see the credit machine for growth broken. When I see a shake-up in Lehman, only weeks after the CFO assured us all is well, I see a crisis in confidence. When I see lending standards tightened across the board, after 4 years of easing standards, I worry about future growth potential and availability of credit for investments. Did I mention MEW (chart below from Calculated Risk)? MEW is that little thing homeowners do to pull out money from their homes equity and spend it; so yes, down 60% year-over-year is noteworthy.

This is a significant amount of money that is simply gone, and not available for use either now or the near term. What's the lag time? As a CR commenter asks:

Bob_In_MA: And the lag time for MEW/spending is probably 2-3 months, right CR?

CR: Bob_in_MA, maybe even a little longer. MEW appears to be spent over several quarters. But this will be a drag on consumption this year. It's hard to distinguish the MEW drag from the rest of the economic slowdown, but I think the effect is real - if not perfectly measurable.

There are a lot of reasons to be negative, and for this trader, to be short stocks. But one thing is very sure, I am feeling a lot less negative now than I did 8-10 months ago! We are now going through the mess that I stated 10 months ago we needed to go through to get past the mistakes we made. Its part of the process. Its healthy and it hurts, and its going to hurt more before it gets better and there is nothing that any of us can do about it.

FOR MANHATTAN REAL ESTATE

Buyers: Expect the recent inventory surge to flatten out. If you don't like what you see now in your price point, you will have to wait for price reductions to reveal a deal. I don't expect inventory to surge for the next few months, and rather, I expect a slight correction in the upward trend until later in the year. Options will not grow as fast as it did in the first 6 months of 2008, and rates will be pressured to the upside; especially when inflation data really comes out and the fed has to talk tough on inflation.

Sellers: Wake up to reality and price right to sell and get traffic in. Either you re-price to this new market or you risk being behind the curve and playing catch up with a stale listing that was overpriced to begin with. If you are overpriced, both traffic and bids will be low. True colors will get you action, and that means pricing power will determine your fate. Expecting a 15% appreciation from 2007 comps is a fantasy; but if you happen to get it, TAKE IT and don't think twice.

FOR STOCK MARKETS

Volatility. Up 900, down 900, up 900, down 900. Thats the game. At any point the event risk is to the downside, not upside. We can not have a sustainable bull market rally until financials recover and that is a multiple quarters out at least. Sure, they may be oversold bounces, but in the end the wall street revenue model is broken. With money costing more to borrow and credit being crunched, downside risk is still slightly favored; although that is way more positive than I was only 7-8 months ago. Lets not forget, if corporate profits fall, then equities will have to be re-priced to this new and more sluggish environment. Are your stocks both prepared and priced for this threat?

FOR RATES

Pressure to upside as I discussed 2 weeks ago in my piece, "Inflation To Fly? Bond Yields Hitting Mortgage Rates". Bond markets are pricing in inflation pressures right now in yields, and starting next month the seasonal aberration is removed and we will see the effects of soaring commodity prices in the inflation data. Expect this to continue and certainly expect the next big campaign by the fed to be one on the hiking side. Its a question of when it starts. The medicine that saved our financial system and helped to 'forestall economic weakness', has side effects, and those side effects are just beginning. Inflation, at the same time of stabilization for the economy, will be the rock and the hard place that the fed finds itself in between. The fed very well could be forced into raising rates if commodities don't correct and that could set up a dog fight for 2009: ECONOMIC RECOVERY vs INFLATION BATTLE! I still view deflation as a problem near term.

Continued nervousness in the mortgage markets and banks facing quarters of balance sheet repairs and capital raising from write-downs, a future environment of rising rates will likely see a correlational rise in lending rates; from the continued re-pricing of risk that comes from an out of favor secondary mortgage marketplace. Huh? Let me rephrase:

If housing is still out of favor that means securitized loans as an asset will also seem out of favor and more risky. If the secondary mortgage market is still weak, risk will be priced into mortgages, and that means continued higher rates as we see now. If fed funds rates jumps from 2% to 4% and bond markets follow, we could see lending rates jump with it from 6.5% to say, 8%, if risk is still being re-priced at that time!

There is plenty of uncertainty in our future and if anything, I feel that upside could come just as easily as downside (stocks are irrational and damage is somewhat priced in right now as lagging effects of monetary/fiscal stimulus is ahead of us); a new & positive feeling that I recently favored more to the downside from AUG 2007 - APRIL 2008 (I think my past posts here on urbandigs can show that sentiment). So, that's my ray of hope. Hey, I need at least one!

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