Twilight Zone
Back in 1999, Ed Yardeni, an economist and stock strategist who identified the huge impact of technology on the economy and the tech stock theme very early on, got very worried about the Y2K software bug. He warned very consistently that this software bug could cause major dislocations in the economy by disrupting businesses, utilities and perhaps most importantly, payment systems. In the fall of 1999, Yardeni was asked to speak at a Y2K conference in the Middle East. He was beside himself; if these folks were just waking up to the Y2K issue, there was no way they could do anything to help themselves before zero hour struck. This suggested to Yardeni that the world was nowhere near ready for Y2K, particularly outside the U.S.
Well, January 1, 2000 came and went with nary a data processing error reported anywhere on the planet. We all know now that Yardeni (like the Maestro Greenspan) took the Y2K worry way too far.....thank goodness he did because voices like his motivated people to remediate most of the critical software bugs on time. I saw Yardeni speak 6 months or so later and he readily admitted his error. He joked that he felt like he must have been in his own private twilight zone. Maybe it was only he who got the invitation to the Mideast conference, and saw so many other data points suggesting the world wasn't ready for Y2K. Was it a cruel joke cooked up by someone to plant data points that would lead him to the wrong conclusion?
So here I am in my own twilight zone (do do do do). As the market has been rallying I have been looking at the papers, news wires and blogs over the last couple of days and here is what I saw:
The U.S. government decides to start monetizing our debt.
A Russian government owned company defaulted on its debt (first sign the government of Russia is willing to let it's obligations lapse).
China suggests it's tired of the dollar as the world's reserve currency (after saying it's worried about the Uncle Sam's ability to pay back debt).
Berkshire Hathaway credit outlook is downgraded could lose AAA rating,
Wells Fargo and B of A credit downgraded.
IBM cutting more jobs.
Gilt and Treasury auctions see tepid demand (and we haven't even gotten started with the mountain of fund raising Uncle Sam and the Bank of England have ahead).
Japan exports drop 49%
(that's not a typo)
The U.K. which has already started monetizing it's debt is seeing a surge in inflation due to it's weak currency and dependence on imported goods (hello! anyone listening).
The fact that the market can rally on this news will be taken by many as a sign that these events are all discounted by the markets already and the market is looking ahead to better times. Interestingly, Sovereign CDS spreads have been tightening, suggesting not only that worries about debt defaults by nations are easing, but more so that risk appetites generally are increasing (the risks of sovereign defaults are actually pretty small, generally).
Now I don't think our quantitative easing will kill the dollar at this time, because the rest of the world has problems as big as ours, but has been taking their time admitting them. Check out how Brazil's government officials are taking heat for optimistic outlooks, while the economy is breaking down like a soup sandwich. I think the downgrades of Wells, B of A and the outlook cut on Berkshire are backward looking. I think China is a windbag, with nowhere else to put their cheap currency subsidized, ill gotten monies, than the almighty buck. But guys, business stinks and anecdotally people I talk to in many cases need to see a pickup soon or they potentially face failures or foreclosures, yet listening to the talking heads on Bloomberg radio, you would think that the economy is about to turnaround and rev up. A bounce in durable goods orders (one of the most volatile economic series around) and the fact that 50%- off homes are selling to crazy short sale investors qualifies as reason enough to pronounce the bottom being in for the economy. Yeah, I know the stock market has made up almost all the losses that occurred in the last 4 weeks, so maybe my wife will let me stop sleeping on the couch, but come on. The de-levering cycle promises to be a long and painful affair and it's just getting started....is it really fully discounted? (I suspect that the ultimate depth may be but not the length).
Am I alone here in the twilight zone? or do things seem bad and getting worse to you? Maybe it's the fact that New York has lagged the rest of the country in entering this downturn, particularly on the real estate side, and I see business through the lense of the commercial real estate market, which is just beginning to really implode. This morning the Wall Street Journal says, the current commercial real estate downturn could be as bad as the early 90s.....maybe that's discounted by the markets already....after all it was discussed at length in Urban Digs quite some time ago.
I do have a theory I have been entertaining since year-end and that is, that we had a Lehman/AIG/Stock market induced CNN effect in the fourth quarter of 2008. Folks cut their consumption to nothing during that time and there is a natural propensity for some bounce back, if only to meager levels. Economic numbers are sure to reflect this, with the stock market sniffing out the "improvement" as well. If so the fall could live up to it's name, maybe then a real bottom can be put in.
What are your thoughts?
Comments (27)
Jeff,
I believe that your concerns are extremely valid. I do not believe that we have seen the "true" bottom. Of course this is only my opinion and my crystal ball happens to be at the repair shop today, so my guess is as good as the next guy.
There is one thing I do know, the market will be the market. As long as there is a buyer then there will be a seller, at the right price. The market is very good at incorporating publicly available information therefore if we really haven't seen the bottom yet it is because there is still information that has not risen to the surface or supposition/speculation as to the outcome of current actions.
I cannot respond to the latter of these two, because of the whole crystal ball thing, but the former I believe is still in play. There is still a lot of cloak and dagger stuff going on with our banks and our gov't. Case in point, AIG counterparties' identities are being protected, for good reason, but what could the potential impact be if that news ever came to the surface? Another bottom, probably...
One thing is certain, we are experiencing some trying times. All we can do is sit back and wait, unless you are a policy maker, in which case, there is work to be done.
Posted by FlipSide | March 26, 2009 8:54 AM
CR picked up that wall street journal piece:
http://www.calculatedriskblog.com/2009/03/wsj-commercial-property-faces-crisis.html
"The delinquency rate on about $700 billion in securitized loans backed by office buildings, hotels, stores and other investment property has more than doubled since September to 1.8% this month ... Foresight Analytics in Oakland, Calif., estimates the U.S. banking sector could suffer as much as $250 billion in commercial-real-estate losses in this downturn. The research firm projects that more than 700 banks could fail as a result of their exposure to commercial real estate."
Notice how since the bear market began, every fierce rally was sparked by a fed/treasury facility or rescue plan and met by economists as THE BOTTOM! These guys have proven wrong so many times, over and over again, that eventually they will be right and can claim - 'see, I told ya so!'.
Thats the world we live in. Stocks dont need a good reason to rally after plunging more than 60% in the past 16 months or so from peak. bear rallies are fierce, met with hope that the 'hogans' or 'haines' bottom is in, and painful for those that either sold out just before or got caught short in it.
jeff, we both know that traders LOVE these markets and that traders are making these moves very volatile; I know plenty of average investors that bailed out at Dow 6700 because they couldnt take it anymore, so how has this rally helped the little guy?
The markets are the stars that people look to for guidance on the strength or weakness of the economy. Three weeks ago near the latest bottom, the world was about to end. Today, after a 25% rally from bottom, the recovery is in place. Is this rational thinking or a sign that many dont know what the heck is going on.
This will be a multi year thing, and the deleveraging process will continue. We are yet to see true effects of commercial downturn OR the consumer deleveraging that hits those holding assets to credit cards, helocs, car loans, student loans, etc.. 30 years of debt expansion, and 16 months of contraction and thats it? I think not. So, let the rallies do their thing, in the end the markets dont move in a straight line.
Posted by Noah | March 26, 2009 9:08 AM
one last thing. Do we really think that all this fed action and rescues, have no side effects? That the only thing will do is re-inflate, with no unintended consequences.
And what will be the asset class that re-inflates?
People need to understand there are no free lunches and that when the unintended consequences kick in, it will be like nobody saw THAT coming. Yea right, many did. But our culture is spend now, worry later. Its what got us into this mess, and is what is being applied to get us out of this mess.
Well I worry about the later part.
Posted by Noah | March 26, 2009 9:10 AM
I agree there is a twilight-zone-ishness going on now. This morning the Q4 GDP # came in at -6.3% the worst since 1982 and a huge contraction by any modern standards. BUT the geeks with their pocket protectors in Washington predicted (a consensus of) -6.6% so this number is good news! (WTF?!)
Durables rose and the market rallied. This number is computed Month-to-Month.. so it bounced from a very dismal number to a less dismal number.. great?! If you look Year-to-Year durables are down dramatically! And compare that to 2007 or earlier and Yikes!.. Same with housing data! Month-to-Month sure there will be some volatility bouncing around some record-shattering terrible numbers.. but Year-to-year we are still in a housing quagmire!
And don't get me started on CPI/PPI data! These numbers are so fudged (see: manipulated) that the masses think inflation is under control as Geithner, Bernanke, & Co. print new money at unprecedented levels! We are going to see a massive devaluation of the dollar-- both vs. foreign currencies AND as domestic inflation. When the inflation starts it will be swift and severe and catch many off guard. Wages will not be able to keep up with the inflation - which will (ironically) help eliminate our debt burden, but will extremely widen the rich - poor gap. The middle class will turn into the upper lower class.
Buy assets now! Rates are cheap! Lock in "valuable" dollars!
Gold & silver are a good inflationary hedge if you're an investor but for the common man, buy that house or car or whatever you've been eyeing cuz ur savings are gonna go poopy.
Posted by Anonymous | March 26, 2009 9:14 AM
Anon - I doubt that real estate will perform well with the form of inflation that is coming. I dont see wage/price inflation, I see a monetary inflation resulting from the HUGE printing of money that you talk about; yes dollar negative in the end. I dont think dollar will tumble until other currencies had their fall first. The US dollar will be the last to fall.
But do we see higher wages, strong jobs market, strong credit markets, easy lending, cheap money, booming the housing market all over again after what we just went through and where housing prices came from? Doubtful. Even the thought of housing as an asset class for the average Joe will be greatly affected by this whole experience. No longer will the home be the place that gets you 20% appreciation per year. Its a place to live in, and if your not careful, can cause you personal economic ruin.
For me, I see the next bubble occuring in precious metals, and perhaps other commodities, if/when the bottom does fall out from the dollar. For now, I think the metals are a anti-fiat currency trade, not a dollar hedge yet. That kicks in later.
Posted by Noah | March 26, 2009 9:29 AM
Great piece Jeff. I tend to WANT to agree with Noah re: commodities, in particular gold, being the next bubble to burst but truth is I just don't know. Food and water demand don't go away because banks are underwater - so my hunch says that sovereigns may bolster agriculture. I liken the transformation to being hobbled - as in James Caan hobbled. There is an immediate painful shock and then there is the slow, adaptation to learning how to get around without the use of your feet. There will be layers to the recovery and some of them will take longer to accept that prices aren't necessarily coming back. The benchmarks will adjust and folks will stop talking about peak to trough losses in RE and will start to focus on what RE makes sense. BofA's jumbo program is a prime example - they will lend but they are basically asking for twice as much equity in a home as was required two years ago. I am waiting for yields to come down on the debt side and then I think we'll start to see more private capital interested in buying RE at the right value. Pricing for smaller commercial is in fact coming down - much less so in NYC - but along the I-95 corridor, it is happening, rather quickly I would say. As an example I saw a bank commercial short sale near Greenwich yesterday that is 20 cents on the dollar versus 2006's valuation. Multifamily outside of Manhattan is probably a good place to focus since folks ultimately need a place to live but the era of the 6% cap is coming to an end. There is a lot of lower grade smaller stuff on the market for 9%s and 10%s but it's usually pretty hairy. The nicer stuff is in fact getting to 7% and I think we'll see multifam hit high 7s to 8s depending on the zip code.
Posted by Fred | March 26, 2009 10:02 AM
Jeff-
Great post. Part of me, dismisses the latest rally as just another bear market bounce and is happy to stay on the sideline. The other part thinks about what the sages of investment world had to say when S&P was at 700- Jeremy Grantham, Buffet and Jeff Saut- bad news has been discounted, valuations are decent, time to start buying.
OK- now my logic - there is a good consensus now that this crisis was caused by over-leveraging and resultant breakdown in velocity/credit creation mechanism. From where I sit (a large commercial/investment bank), I don't see any improvement in the credit environment. Raising bank financing at anything approaching reasonable standards is still impossible. There is no material improvement in investment grade or high yield spreads though the market for new issuance has opened up a tiny bit. Thus my view that this is just a bear market bounce – from oversold sentiment and technical indicators. My views will change if I see credit markets participating in this rally, but of course that might be too late.
Posted by Valueseeker | March 26, 2009 10:14 AM
Jeff, Remember when you and Noah spoke of two crises? There was the financial crisis and the economic crisis. I think we may be seeing people thinking there is a bottom in the financial crisis. They are seeing bottoms in bank stocks ("how much further can they drop than close to 0"?) and that the governments won't allow banks and financial institutions to fail. This may or may not be the case. Certainly they have the option of printing up all the $ necessary to make it happen. The problem is at what cost?
The economic crisis, I think, is finding a bottom. Companies and people are finding their new equilibriums. it will take time and there will be more damage along the way, but seeing a really tough path ahead is a lot better than when it was easy and no one knew to prepare. This part of the two crises can be fixed with stimulus, forbearance, and time. Of course that is just so long as we don't get hit by something new. I happen to think that there is a "something new" around the corner. If it isn't financial it will be fiscal in nature based on the very poor priorities being set by our populist executive and legislative branches. Of course it might take another year or two for that to become evident and people will be complacent until then.
I have learned never to underestimate the limited vision of what are often very brilliant or at least really smart people. Today they see a plateau or a slight rise as a sign things are going to get better because in the past that was what it meant. Few people, especially those who have not lived in business, understand causalities beyond the first order and fewer know of or can figure out the unintended consequences (even the simple ones). Yet big decisions, ESPECIALLY those that seem to have no downside, will have unintended consequences, and the less likely you are to see them the more likely they are to be really bad ones.
Posted by AvUWS | March 26, 2009 11:27 AM
Guys,
Thanks very much for all the well thought out feedback. Fred I am also seeing cap rates moving up nationwide on multi-family and it is striking that the housing oversupply and economic downturn are causing defaults on multi-family to actually be as bad as retail. I am going to see a bank about some financing for a top quality borrower, who dosn't need the money today. It will be interesting to see how that conversation goes. I am also going to take a little tour of a couple of NYC condo buildings I suspect are zombies and will be coming back to market at REO in the next year. There is still a lot of mess to be cleaned up. I agree with ValueSeeker that functioning credit markets are key and I hope that loss assumptions have factored in this commercial real estate mess sufficiently such that the current bailouts can have an impact. I am still holding my gold in case risk aversion returns.
Posted by jeff | March 26, 2009 11:40 AM
Just to clarify my last comment, the first paragraph was my emotional monkey mind and the second paragraph is my logical alien brain.
Posted by Valueseeker | March 26, 2009 11:57 AM
You guys should run a story on commercial real estate tenancy. It may sound off topic but it really is very relevant.
CRE tenants make up a big part of the funding base for NYC Manhattan residential buildings b/c they occupy the critical ground floor space.
W/so many stores and businesses going bankrupt that is going to definitely put a dent in the property's values - to say nothing of the impact on the RESIDENTIAL tenants (who will no doubt see an increase in their maintenance fees).
Maybe you ran a story on this earlier but the topic is ever evolving and could use a good update.
PS - watch out for Borders Group (the bookstore). They are a penny stock yet occupy prime retail space all over Manhattan. Could they be the next Circuit City?
Posted by In Debt We Trust | March 26, 2009 12:47 PM
Debt - a lot of those vacancies are landlord decisions, not bankruptcy. I have spoken to proprietors who were closing in my neighborhood and a few told me they were doing less biz because of the economy but were doing well enough to get by. It was the lease increases being asked that was leading them to close. While I understand that these leases, often 5 or 10 years, are often from another age, the landlords are often not looking at the myriads of vacant spaces around them. They seem content to let the property lie fallow for what will probably be years.
By the way, one of the proprietors was willing to stay on on a year to year lease. I admit I don't know the details, but I do know there are a lot of vacancies and that the lost cash-flow seems not to be that great an issue for some of these LL's.
Posted by AvUWS | March 26, 2009 1:43 PM
Jeff,
Not to quibble, but I think a better title would have been "Mission Impossible".
Still, it looks to me like this market still has plenty of legs under it. Looks like we will test 8,000 again soon and then what, 8,500, or dare I say, 9,000.
Regardless, my gut is the rally is not sustainable in the medium term, but through the summer... maybe so.
Posted by lars | March 26, 2009 1:56 PM
Lars- totally agree, although I am starting to nibble on some ultrashorts that were beaten down. Market does 'feel' like it wants to go up more
Posted by noah | March 26, 2009 2:18 PM
AvUWS, thanks for the update.
I guess my attention has been taken by the "big name" store failures (circuit city, virgin, tower recods, etc.).
But what about all the small mom and pop stores that occupy the ground floor? Like the myriad Korean delis, frozen yogurt places, luxury retailers, and family run restaurants (it seems there are 10 restaurants per block in Manhattan).
Posted by In Debt We Trust | March 26, 2009 3:22 PM
noah - skf?
Posted by short | March 26, 2009 4:49 PM
no, i bought some fxp, eev, mzz, and srs
market has some legs still i think though for a bit, so going to watch a while before adding to these
Posted by noah | March 26, 2009 4:51 PM
I have a great source for info on NYC retail. I will definitely do a piece and talk a bit about the large income contributions to Coops from their retail components - those that didn't do cond-op sales. I agree with AvUWS that the strange thing about this downturn is that things were so overheated before we fell off a cliff that some weird things have happened. Long established mom and pop stores in Harlem were closing left and right because landlords wanted huge increases in rent to reflect the new value of the neighborhoods to chain stores. All of a sudden the economy tanks and the chains are imploding. Landlords have only recently "gotten the memo" that rents are plunging not soaring and in many cases they will be SOL on finding a new tenant at the old rents. I could do a piece on this pervasive de-celeration driven disconnect all by itself. For example I called up about a development site in Harlem the other day, the broker growled the price they wanted, which equates to over $190 per buildable foot. A day later I saw a price cut on a development site not that far away, the seller is asking $77 per developable foot.....OOOPS! Adjustments like this are coming soon all over town.
Posted by jeff | March 26, 2009 8:02 PM
I'm an architect in NYC and have a couple observations:
- my profession feels like its in the apogee of the Wile E Coyote moment and is about to take a serious drop (coinciding with the virtual halt in new building around the city). I remember thinking after 9/11 that the dot-com bubble would finally catch up but it never did; we just kept building. I think its possible that we're already massively over-built and we have these symbolic driven projects (wtc) that will throw a bunch more space on the market in the coming years. Ghery's chopping 20+ stories off his tower downtown seems a reflection of this. my sense is we're 2 - 3 years behind the national curve in real-estate, and i expect to be unemployed by fall.
- my personal twilight zone: i think worker productivity has been massively UNDER-estimated, and this downturn will provide companies with the excuse & timing to liquidate everyone who's been spending the past few years checking their email, shopping etc at their desk instead of doing billable work. i think many industries could see staffs shrink 30% - 40% and find those jobs never need to come back when economic activity revives. In fact, I think that liquidation WILL could be the source of revival, and we may find ourselves in the extremely difficult position of having a nacient recovery AND very high unemployment. in essence, i think the combination of true paperless offices; remote coferencing; and much more efficient internet/software tools will force a lot of dead weight to be jettisoned and that this is a silent but pervasive factor in our current condition.
Posted by Pain Participant | March 26, 2009 8:44 PM
Noah...yer a smart dude...i've been reading you for a year or so since i got canned and moved out of NYC. I have no original opinion to share -- my views are very similar to what everyone has stated already. I especially agree with the view that the USD isn't doomed as everyone assumes...we are the best of the worst in a full "fiat" world -- all countries will follow our lead and print money. If they don't they lose out. Gold bugs have an argument rooted in gold standard times -- we don't have that anymore -- nobody' currency is tied to gold -- so why buy gold? Thank you again for running and maintaining this blog....it's great!
Posted by wall street | March 26, 2009 10:46 PM
Noah...yer a smart dude...i've been reading you for a year or so since i got canned and moved out of NYC. I have no original opinion to share -- my views are very similar to what everyone has stated already. I especially agree with the view that the USD isn't doomed as everyone assumes...we are the best of the worst in a full "fiat" world -- all countries will follow our lead and print money. If they don't they lose out. Gold bugs have an argument rooted in gold standard times -- we don't have that anymore -- nobody' currency is tied to gold -- so why buy gold? Thank you again for running and maintaining this blog....it's great!
Posted by wall street | March 26, 2009 10:47 PM
PainParticipant,
I feel you man. I try to tell myself that things can't possibly remain as bad forever as they feel like they are/going to be right now. I do have faith that whatever world order comes out of this global reset, the people of the U.S. will rise to the occasion as they always have. So let's all just muddle in between till 2013.
Posted by jeff | March 27, 2009 9:05 AM
Hey,
I know you guys focus on Manhattan. But does anyone know if the Atlantic Naval Yard project will be complete? Or those condos in Coney Island?
Thanks.
Posted by In Debt We Trust | March 27, 2009 12:17 PM
In Debt You Trust - atlantic yards was financed by AIG. more to the point, brooklyn is going to half of 2006 prices so the whole concept is going to be re-evaluated. aig's real estate group will probably get sold in the next couple of months and i can only imagine the new money will can this deal. some of the uninteded consequences of hot cdo money was that big RE projects got financed at really stupid valuations - stuy town anyone? uhhhhhhh.
Posted by Fred | March 27, 2009 1:21 PM
One follow-up post to my earlier comments & the Crain's report today that Manh Class A commercial vacancies have increased 66%, to 13.5% in midtown:
Office buildings and office fit-outs have, to this moment, been designed based on pro-formas that have a significant % of floor area occupied by paper storage. Lateral files, box files, you name it: every 48sf workstation consists of 6 - 8sf of paper storage, and often there's another 6sf - 8sf somewhere else on the floor.
I think the paperless revolution is finally taking hold and that the "shadow" floor area presently devoted to paper files will be released as a result - call it 10% - 15%? Whatever it is, a significant factor, compounded with great efficiencies that will exacerbate the vacancy rates.
As an anecdotal example of this, we're finally admitting that our binder catalog library (hundreds of 4" thick glossy catalogs of light fixtures, plumbing fixture, etc.), formerly critical to the practice, has been supplanted by Google and, thus, is a waste of space. We'll move people in there and give up temp space that we've been renting.
Is all this Class A office space the equivalent of the magnificent but ultimately unused train stations built just as automobiles destroyed the viability of train travel?
Posted by Pain Participant | March 27, 2009 8:06 PM
And the Freedom Tower is going to add EVEN MORE office space!
Supply and demand. How could architects, bankers, and construction co.'s get it so wrong????
Posted by Anonymous | March 27, 2009 10:29 PM
Anon 10:27:
Speaking only as an architect, I was happy to ride the supply-side train, it was fun while it lasted, and like the construction companies I think we were generally dancers in this thing, not calling the tune. Who would have listened three years ago if you'd said midtown office space would soon have spiking vacancies? No one.
Freedom Tower is a great example of building as (fraught) political enterprise, and as responsible as the bankers may have been for this collapse (or, more precisely, return to normality), the entire sub-prime/mortgage securitization implosion might better be viewed as a toxic mix of the political mandate of Ownership Society at all costs and the contradictory gluttonous appetite for consumption on the part of the american people. After all, if all those flat-screen refi'ers were paying back their loans per the contracts they signed, we'd probably not be in this mess.
Its not unlike the drug war: a unjustly applied regulatory environment shaped by an unrealistic political goal undermined by middle-class consumption with very costly unintended consequences.
Posted by Pain Participant | March 27, 2009 11:10 PM