To paraphrase the highly regarded fund manager and notable bear, John Hussman, you can look like an idiot before a Bubble pops or after it’s popped.
I guess I’m squarely in the camp of looking like an idiot before the bubble pops. I might watch “The Big Short Again” for some “moral fortitude.” With history’s stamp of approval on my side, all I can do is shake my head and chuckle. As soon as the Dow crossed over 23,000 on Wednesday, the “experts” on bubblevision began speculating how long it would take for the Dow to hit 24k. I was actively trading and shorting dot.com stocks in late 1999 and the curent environment feels almost exactly like it felt then. Wake up everyday and wait for Maria Bartiromo to breath the name of a dot.com stock you were short and watch it spike up 10-20% on her signal. The Nasdaq ran from 2,966 to 4,698 – 1,700 pts or 58% – in 4 months. It was painful holding shorts but very rewarding after the brief period of “suffocation.”
It feels like the market could go into a final parabolic lift-off to its final peak before the inevitable. The non-commericial (i.e. retail) short-interest in the VIX – meaning retail investors are “selling” volatility – hit another all-time high this past week. This a massive and reckless bet against any possibility of any abrupt downside in the market. It reflects unbridled hubris. Don’t forget, smart money and banks are taking the other side of this bet.
To think that any Trump tax reform bill that might get passed will improve the fundamentals of the economy and lead to higher corporate earnings is absurd. The tax bill proposal is nothing more than a huge windfall for the wealthy (as in, 8-figure net worth and above) and Corporate America. The plan is, on balance neutral to negative for the average middle class household. Although it doubles the standard deduction, it eliminates the deduction for state and local taxes, which means you’ll lose the deduction for property taxes. It also will steer a large portion of middle class homeowners away from itemizing deductions, which means it will marginalize or eliminate the ability to use mortgage interest as a deduction. Corporations of course will benefit the most – as the tax rate would be lowered from 35% to 20% – because they throw the most money at Congress.
It’s estimated that the tax plan would cost the Government $6 trillion in revenues over the next 10 years. At $600 billion per year, this would have doubled the “official” spending deficit for FY 2017 (Note: if you include the debt issuance that was deferred until the debt limit ceiling was suspended – a little more than $300 billion – the amount debt that would have been issued by the Government in FY 2017 would have been about $1 trillion. This number is the actual spending deficit).
In short, even if some sort of “compromise” legislation is passed, the tax “reform” would do little more than shift trillions from revenue going to the Government to cash flow going into the pockets of Corporate America and the upper 1% (and really the upper 0.5%). That said, any notion that the stock market melt-up this past week is connected to the tax reform effort is idiotic. This is because it will add $100’s of billions per year in Government debt issuance requirements and will do little, if anything, to stimulate economic activity.
On the contrary, the stock market behavior is attributable to the last-gasp capitulation that characterized the coup de grace phase of any previous stock market bubble. This includes the re-surfacing of phrases like, “it’s different this time,” “it’s a new economic paradigm,” “stocks have reached a permanent plateau,” etc. CNBC even featured a graphic last week which showed Bitcoin as having a P/E ratio. Sheer madness.
It’s different this time? – As much as I hate to listen to radio ads when I’m driving (I listen to the local sports talk-radio programming and normally switch to music during the 5 min ad breaks), in the past several weeks I’ve been listening to the commercial breaks. The reason for this is that radio ads often reflect the current local trends in demand for services /products. Starting in late summer, frequent ad spots have been occupied by: 1) a service that offers IRS back-tax settlement services; 2) numerous mortgage brokers pitching “use your house as an ATM and take-out home equity loans to pay-down credit card debt and have money for the holidays;” 3) “make fast money” home-flipping seminars.
In terms of middle-class demographic trends, Colorado has always been regarded as a leading indicator for most of the country between the coasts. The IRS tax settlement service ads tell me that the middle class has run out of disposable income: can’t pay taxes owed, credit card debt is too high, and is worried about holidays. I’ve been discussing this development for quite some time. The tax thing is self-explanatory. There’s likely similar companies/law firms all over the country running ads pitching tax settlement services. Wage-earners will under-withhold their paycheck taxes to help cover current spending and hope that year-end bonuses, or whatever luck fate might have in store, will enable them to pay what they owe when they file.
The “use your house as an ATM” ad is disturbing. This was an idea originally proposed by Greenspan in 2002 and put aggressively into action from 2004 to 2008. In 2004 Greenspan advocated using adjustable rate mortgages. How did that end up? The reason it won’t go on for another four years is that households are stretched on their Debt-To-Income profile (pretax income to debt service ratio) relative to the 2004-2008 period. Household debt – auto/credit card/student loan + mortgage – already exceeds the 2008 peak. Back then, home values were rising right up until late 2007/early 2008. Currently, in most markets home prices are starting to drop (this was occurring by late summer, so it’s not just “seasonal,” which is an argument you might hear). I’m starting to get email notices of homes listed in every price segment that are dropping their offer price up to and over 10%. This includes apartments in the under $400k price-segment (according to the NAR, the average price of existing home sales declined 2.7% from August to September – more on existing home sales below).
As enough home sales are closed with price drops greater than 10%, the fun begins. As I’ve detailed in previous issues, an increasing percentage of buyers right now are flippers (those radio ads are occurring for a reason). Enough people have decided that they “don’t want to miss out” on the “easy money” being made flipping homes. Guess what? They’ve missed out. The majority of flippers who have purchased in the last 3-6 months that have not been listed or are listed but just sitting are soon going to be looking for buyer bids to sell into. The problems will start when the flippers who used debt to buy their “day-trade” discover that the current “bid side” for their home is below the amount of debt used to buy the house.
Just like upward momentum in stock and home prices induces daytraders and flippers respectively to chase prices up in anticipation that someone will readily be willing to pay them even more, falling prices in stocks and homes generates motivated selling and scares away buyers. With homes it’s slightly different. Falling stock prices tend to generate selling volume that “forces” the market lower quickly. With stocks, there will be short-sellers who provide some liquidity to sellers as the shorts cover on the way down.
Housing, on the other hand, goes from a “liquid market” in rising markets to an ‘illiquid market” in falling markets. A home is a “chunky, high-ticket” item that takes time to close. In falling markets, the value of a home declines measurably before the buyer closes. Because of this, buyers will disappear until the market appears to have stabilized. Unlike stocks, homes can’t be shorted, which means there are no buyers looking to take a profit on a bet the market would fall. Often price falls in a “step function.” By this I mean there will be price-gaps to downside in the market as buyer “bids” disappear completely (i.e. bid-side volume vanishes).
I’m seeing this dynamic in the over $1,000,000 market in Denver. I have friend who lives in a high-priced neighborhood in south Denver (Heritage Hills). He had his house on the market for close to a year and couldn’t move it at a price that was in-line with comps (he’s a licensed real estate agent). The problem is that homes were not selling in his ‘hood. I told him if he marked it down $100k he could probably move it. He said he would wait for the market to improve and took it off the market. That was in July. It’s too late. Homes over $1mm are being reduced in price in $100,000 “chunks” now. I’ve gotten several “price change alerts” for homes around Denver listed during the summer that are lowering their offer in $100k steps. Some of them have been lowered already 15-20% from their original listing price. It gets worse.
One of the Short Seller Journal subscribers who lives in the south Denver metro area sent me a note about a home he has been watching in Castle Rock, which is about 35 minutes south of downtown Denver in a very pretty area along the foothills. The area ranges from cookie cutter middle class neighborhoods to a high-end, exclusive country club community. It was one of the hottest bubble areas in the mid-2000s bubble. He showed me a home that was listed in May for $1.39 million. Since then it’s been taken down $400k in four price changes. The last price cut was $200k.
This is an example of extreme “step function” price drops. Maybe the house was over-priced to begin with, but not by nearly 30%. The original offer price has to be based loosely on comps or no listing broker would touch it. It’s on its fourth listing agent. Last summer (2016) it’s quite likely this house would have moved somewhere near the offer price. He also told me that he’s seeing more pre-foreclosure and foreclosure activity in the homes around $1,000,000 in that area. This is how it starts and I’m certain this is not the only area around the country where this is starting to occur.