eNewsletter for 5/17/2014 | Portnoff Financial LLC- Blog

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eNewsletter for 5/17/2014

The unemployment rate has been declining however we have to look beneath the surface to understand why. I've been saying for quite some time now to expect declining unemployment but it's not because we are adding all that many jobs. There are two reasons; long-term unemployed are simply not being counted and Baby Boomers leaving the workforce at increasing rates (5.5 million over the last 6 years). With less people in the workforce, the rate goes down. The declining unemployment rate also does not consider under-employment. If you were making $120,000, lost your job and all you could find was a $75,000 job, then you are counted as employed even though the economic value of what you are making is substantially less. This also extends to all of these "jobs" that have been created over the last 5 years. Are these jobs high paying or low paying? If a job paying $100,000 is lost and replaced with a $30,000 job that was created, the unemployment rate doesn't change yet the economic value of that net job creation is less. Of the 273,000 private sector jobs that were created in April, nearly 55% were below the median wage, and a full 43% were in the three lowest income tiers.

Housing prices are moving higher but mortgage applications have been declining. Mortgage purchase applications were up 9% for the week of 5/9/2014 but down 16% from same time last year. Existing home sales were down for the 7th time in 8 months by 7.5% continuing this downward trend. Prices however have increased about 7.9% over the past year. This movement seems to be dominated by investors as about 50% of all purchases were made with cash. As prices rise, the investment aspect becomes less profitable and we'll see a slowdown in these investor purchases. Meanwhile new home sales dropped 13.3% for the year while new home prices increased 12.6% for the year. This is not a good outlook as a decline in new home purchases means less middle class jobs in the housing market and less demand for related professions such as carpenters and plumbers. Now that Spring is here, it is difficult to continue to blame the Winter especially given that this has been a weak trend for some time now. Don't expect any rebound anytime soon.

Fed Chair Janet Yellen reiterated her stance that the US economy is on track for recovery but that further weakness could hold it back. She also continued that short-term interest rates would remain low for a long time. FED stimulus has the intended purpose of reducing short and long term interest rates to encourage spending. By reducing interest rates on mortgages for example, the expectation is it will convince people on the fence of buying a home to do so. The problem is two-fold; first this is bringing future purchases into the present which leaves fewer people to purchase later and it only encourages people who are at the margins to move forward. This is why housing will continue to struggle.

A reasonable guide to the direction of the housing market lies in the difference between buyers and sellers. Someone who is selling a home to purchase a new home creates little demand as such moves are mostly lateral or because of a home upgrade. The biggest driver is new home buyers which are young people forming their own households which has been on the decline for reasons such as lack of jobs and high student loan debt. Net sellers of homes are generally older people who become sellers when they either move into a child's home, nursing home, or they die. Either of these events usually is followed by the house sale. So if we want to get a sense of net demand, we look at buyers who peak at age 42 on average and di-ers who sell on average at age 78 in the US.  

As we can see there was a peak around 2001, a decent  bounce from 2009 to 2013 and then a clear trend downward for years to come. In other words, past 2013 we should expect to see more people selling their homes than there are people to buy homes and when you have more supply and less demand, prices go down. And no amount of stimulus is going to create people that will need, want, and be able to buy homes. Its demographics, its baked in the cake, and we just need to be prepared for it and have reasonable expectations when it comes to home price appreciation.

Another warning sign: Margin Debt.

Margin debt (borrowing) to buy stocks spiked to new highs recently which also happened just before the 2000 and 2007 crashes. Stock market peaks seemed to correspond to peaks in real margin debt as we see here in 2000 and 2007. Currently the real margin debt is nearly at the level it was in 2007 just before the market started coming down. Those peaks seem to come after a sharp acceleration in margin debt which we are seeing recently. Definitely cause for concern.

Also it is interesting how the S&P 500 has been closely following a Theoretical Bubble Progression Model. We keep bouncing around these historical highs; the market hits the upward resistance, drops down a bit, comes back up to slightly new highs, but the progression of this is narrowing meaning that the dips are smaller and smaller and the new highs are also smaller and smaller. At some point in such a model it breaks down and that's when the bubble bursts. Unfortunately most people don't see bubbles until it's too late and these bubbles tend to burst much faster than they build. Trends like this simply cannot continue forever because eventually prices get excessive, demand dries up, and then prices come down. There is no exception in history! How long it can continue is another matter. Look at how the DOW ran up from November 1994 to January 2000 which no one debates was a bubble, and compare how the DOW has risen from March 2009 to April 2014 yet few seem to think we are in a bubble now? 

(Source: Yahoo! Finance, 2014)

Just remember that the bigger the bubble the bigger the burst. When we zoom out and look the DOW since the mid-90's, we see what is called a "megaphone" pattern marked by higher highs and lower lows. 

(Source: Yahoo! Finance, 2014)

If this pattern holds, it predicts the DOW going to around 17,000 by mid-2014 and then a drop to somewhere lower than 6,000 by around late 2016. So it is possible to have a few more good years with stocks but being prepared and braced for the worst case scenario is the prudent strategy.  

Chinese Purchasing Managers Index (PMI) came in at 48.3 showing continued contraction. AS China slows, they are letting their currency begin to devalue which makes exported good cheaper to the rest of the world. Just another sign that China is slowing and as they slow, supply chains in other countries will be affected.

You can't solve a debt crisis by adding more debt and hoping that the economy will improve and that the market will keep going up is not a strategy. We need to consider all of the warning signs and decide for ourselves how we will act and protect ourselves from the possibility that our hopes don't play out as we would like them to. 


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