Tuesday, August 24, 2010

Are We Now in a Depression?

Famed economist David Rosenberg thinks so.  David's piece starts at the 6:30 minute mark on the video if you want to skip through the Fast Money babble:




My Take:

It's time to call a spade a spade.  Without the government stimulus statistically we would already be in a depression.  

I agree with David, after today's housing numbers you can be asssured that we are definately in a depression.  Money continues to soar into bonds.  Millions are scared and unemployed.  Home sales dropped a whopping 27%  despite record low interest rates. 

Will it be our Greatest Depression?  This remains to be seen.  What I love about Rosenberg is he is able to go back in history and recognize that this is not a normal recession.

Virtually every economist that I read or listen to consistently tries to compare this recession to the mild ones we have seen since The Great Depression. 

The problem with analysis like this is you are not comparing apples to apples.  What we experienced in 2008 was every bit as bad as the credit collapse in 1929.  The one key difference is the government responded much more rapidly this go around.

Nonetheless, the crash this go around was just as severe if not worse.  Therefore, when you are trying to use economic models to try and predict how we will recover from a catastrophic collapse, you must use models that resemble a catastrophic sollapse.  The last period that we experienced anything like this was in the 1930's.

IMO, if you fail to make the 1930's scenario a key part of your economic model then your economic analysis becomes both invalid and irrelevant. 

As David brilliantly explains:  The emotional scars from such an event are just as important as the statistics.

When you are knocked down by an economic version of Hurricane Katrina you don't immediately stand back up and say "Wow, that sucked, Let's go buy a house!".

Essentially this is what many of the bulltards think.  Most economists expect our economy to bounce right back as a result of the Fed's "wonderful" stimulus. 

I am sorry folks but it doesn't work that way when you are just getting back on your feet after getting bombarded by a job loss, foreclosure, bankruptcy or a combination of all three.

Markets are very psychological and they always have been.  When people lack confidence in the economy like they do now they lose their "animal spirits".  Just look at the bond markets right now if you need proof of this!

Let's take a psychological look at how Main St must be feeling right now:

Before we start start:  Let's remember that Main St is still badly "scarred" by the fact that they lost 50% of their 401k's twice in the last decade.

Now add this to the mix:

-  Millions are now losing their jobs as a result of the crash of 2008.
-  Many are now finally realizing their losses in housing.
-  They are now making zero yield on what little money they have saved.
-  They see millions of people panicking into bonds which creates more fear.
-  Their stock investments have turned highly volatile which has made them even more nervous.

This financial hurricane has given Main St. a bad case of PTSD(post traumatic stress disorder).  Can you blame them?

It's going to take years before anyone has any real desire to take on serious risk.   We are not going to "bounce back" from this like we have during our previous small recessions because it's a depression not a recession.

It's time for the Wall St economists to start treating it as so.  If they don't than they most assuredly will drive their clients right off a cliff because their interpretations of the data will be highly inaccurate.

Just think about how many of them got it wrong in 2008 as they failed to recognize the severity of the problem?  The examples are endlesss.

Housing

I wanted to spend a little time here before The Bottom Line.  Let's take a closer look at the July home sales debacle:


Quick Take:

I just wanted to highlight a few things here.  First of all, the area of the market that took the biggest hit was the mid to lower end of the market (-500k).  This was likely a result of the ending of the tax credit.

The problem we have here is look at where the majority of home sales were seen.  A whopping 89% of the sales were in the (-500k) or less category.  66% of the sales in July were seen in the lower end of the housing market(-250k) or less category. 

So essentially the strongest part of the housing market from a sales perspective in July was where we saw the largest drop off in sales.

This does not bode well for future.  Let's also note that there is now 12.5 months of inventory which is a record and twice the level of a healthy market.

We should also not be surprised that the lower end of the market is what is moving.  The reason for this of course is people can qualify for a mortgage because homes become affordable relative to incomes at these levels. 

It's a virtual guarantee that almost all home sales will be in the 250k and less category in the future once lending standards begin to rise.  Only the rich will be buying homes for 500k and up moving forward.



Also of note:

CNBC had a real estate attorney on today that estimated there were a mind boggling 7 million additional homes in shadow investories.  Her estimation was on average these homes would have to be sold at an additional 30% discount from current levels in order to clear them out.

Today was not a good day for the housing industry to say the least..

The Bottom Line

So what does this all mean from a market perspective?  Longer term it's not good.  The 10 year once again soared today:


Yields closed under 2.5%.  This parabolic move has me totally speechless folks.  It makes me absolutely petrified for the future. 

I have decided that it's time to sell some PTTRX because it's my largest holding. 

I have held this for 4 years and it's been a great ride but I feel like the best times are behind us when it comes to bonds. 

As I said earlier this week once the 10 year got under 2.5% I was more interested in the short side than the long side.  That being said after watching the market this week:  I decided that I can't short treasuries because I don't know where else the money can go until we see more economic data. 

The way I see it there are three scenarios that will likely play out when it comes to the bond bubble:

1. Treasuries will continue to rise as the economic data continues to get worse(which I believe it will).  This is a fear trade folks.  The worst the data gets the more appealing bonds will look for desperate investors.

Stocks will likely continue to fall during this scenario as the money continues to flock into bonds.  We have been seeing this trade over the past week or so.

2.  Treasuries drop as the economic data improves(I doubt this one).  This could also create a powerful rally in the stock market.

3. Treasuries collapse as concerns around our deficit increase.  Let's call this the "Greece" scenario.   BTW, there was a debt downgrade on Ireland after hours.

If scenario three hits then you can expect both stocks and bonds to sell off.  This scenario for the short term is the most unlikely one.  Nonetheless, I believe the risk of it ocurring is very real.

Of all of the scenarios I think #1 is the most likely conclusion for now.  We could see a bounce or two of course, but the trend will be downward if the economic data worsens because Wall St. will become more terrified of delfation.

The one thing that could change all of this is the potential of a QE2 by the Fed.  Goldman was out calling for another trillion in QE today.  I know shocker right?....Sigh

I will end it here today.  Until next time!

Disclosure:  No new positions taken at the time of publication.


4 comments:

Anonymous said...

Got Gold?

This Greatest Depression will be one for the ages.

Inflation will be through the roof on the goods needed to survive.

btw, Colts Superbowl Champs 2010 season.

FA in CA

getyourselfconnected said...

Excellent post, nothing more to say.

Jeff said...

Hey FA

Nice to see you!

Boo Colts! Go Steelers!

Jeff said...

Get

Thanks bud.

How are those Patriots looking?

Brady seems a bit cranky this year so far in the press.

I see futes are up. A little bounce tomorrow perhaps?

GDP revisions on Friday!