Demographics

Darker days ahead from the long deleveraging process that just got started in Europe.  

There are roughly 19 million vacant dwellings in the U.S., of which around 4 million are second homes and a million or two are on the market. Let's stipulate that several million more are in areas with very low demand (i.e. few want to live there year-round). Let's also stipulate that several million more are in the "shadow inventory" of homes that are neither on the market nor even officially in the foreclosure pipeline, i.e. zombie homes. Even if you account for 9 million of these homes, that still leaves 10 million vacant dwellings in the U.S. which could be occupied. That means 1 in 12 of all dwellings are vacant. Even if you discount this by half, that still leaves 5 million vacant dwellings that could be occupied. Given that the total rental market is 40 million households, that constitutes a very large inventory of supply that remains untapped. Lastly, it is important to note that the ratio of residents to dwellings is rather low in the U.S., with millions of single-person households and large homes occupied by one or two people. The potential pool of existing homeowners who could enter the "informal" rental market by offering bedrooms, basements and even enclosed garages for rent is extremely large, and that is a difficult-to-count "shadow" inventory of potential rentals.

The revaluation that is underway now is beyond the simple scope of corporate earnings valuations, going to the very core of the system itself.  Just like the equity pricing regime (and investor expectations for equity assets) needs to adjust to the twelve-year-old bear market reality, pricing within the global banking system as a whole needs to adjust to the reality that the artificial growth of the economic textbook is not replicable.  The economic truth of 2012 is that much of the science of economics, and the foundation that gives to finance and financial pricing, was a temporal anomaly befitting only those specific conditions of that bygone era.  In other words, the entire financial world needs to reset itself outside the paradigm of pre-2008.  The secular bear market in US equities is one strand of this changing landscape, perhaps the first stirring of the collapse of the activist central bank experiment. In the end, the potential selling pressure of the dollar shortage is irresistible, no matter how “cheap” stock prices are to earnings, but none of it may matter in the grander scheme of a dramatic reset to the global system.  The inability of that global system to escape this critical state, to simply move beyond crisis and function “normally” again, demonstrates conclusively, in my opinion, the foundational transformation that is still taking place well beyond the stock bear.  Everything is a locked feedback loop of negative pressures in this age, no matter how much we want to see “value” where and how it used to exist. 

Paradigm shifts are rarely orderly, but there are warning signs.

What's more tiresome than a hastily rehearsed soap opera that replays the same boring plots again and again? Re-Runs of that soap opera. The Eurozone "drama" is now in re-runs and I for one am switching channels. Nothing will change until some critical part of the worm-eaten, corrupt construct of artifice and denial collapses in a heap. Until then, all we have is replays of the same boring plot lines:

Put-upon Greece: We were just minding our business here in the sunny south, living happily on borrowed billions in a thoroughly corrupt Status Quo, and suddenly we're debt-serfs squeezed by rapacious Eurozone enforcers of the banking cartel. What did we do to deserve this? It's not fair.

Put-upon Germany: We were just minding the store here, racking up 40% of our GDP in exports and raking in bank profits loaning money to our Eurozone compatriots, when suddenly everyone who's lived beyond their means demands that we refinance their debts because we're rich. Excuse us, but did anyone look at how we got rich? Hard work, cuts in spending, high taxes and a tight lid on wages. What did we do to deserve this? It's not fair.

Married couple in counseling: France and Germany: It's all his/her fault. They never bothered to understand me, etc.

Discord, the endlessly rising costs of keeping it alive, and threats of extortion.

The problems facing the U.S. economy are daunting especially when it comes the issues of Government spending and the current deficit. We recently wrote about the dependency on Government programs which is currently making up as much as 35% of personal incomes. Social Security, Medicaid and Medicare make up the largest portions of the current spending requirements of the Federal Budget. The current administration has promised that cuts will not be made to government "entitlement" programs but is that a promise that any administration can actually keep? When it comes to Social Security the facts are rather alarming. By 2017 the Social Security Administration will pay out more in benefits than it takes in. This is not surprising given that in the 1950's there were roughly 5 workers for every retiree. Today, it is roughly half of that. With 78 Million "baby boomers" moving into retirement the demands on social security are set to spiral higher in the coming years ahead. Is it really any wonder then that with demographics heading in the wrong direction, not to mention a much slower growth economy, that the Social Security Administration has moved up its estimate that the Social Security Fund will be exhausted entirely by 2033?

The “austerity” and “growth” to which EU leaders refer are simply two sides of the same coin: that of assuming that massive problems can be dealt with superficially. It’s akin to polishing the brass on the Titanic as it sinks: in the short term, you’re making a small difference, but in the big picture, you’re ignoring the very real, enormous problem you need to tackle.

A rare moment of optimism from David Rosenberg: "I've said it once and I'll say it again. And believe me, this is no intent to wrap myself up in stars and stripes. But there is a strong possibility that I see a flicker of light come November. The U.S. has great demographics with over 80 million millennials that will power the next bull market in housing, likely three years from now. After an unprecedented two straight years of a decline in the stock of vehicles on the road, we do have pent-up demand for autos. I coined the term "manufacturing renaissance" back when I toiled for Mother Merrill and this is happening on the back of sharply improved cost competitiveness. Oil production and mining services are booming. Cheap natural gas is a boon to many industries. A boom in Chinese travel to the U.S. has triggered a secular growth phase in the tourism and leisure industry. The trend towards frugality has opened up doors for do-it-yourselfers, private labels and discounting stores.... Few folks saw it at the time. But it's worth remembering, especially now as we face this latest round of economic weakness and market turbulence. It is exactly in periods of distress that the best buying opportunities are borne...and believe it or not, when new disruptive technologies are formed to power the next sustainable bull market and economic expansion. Something tells me that we are just one recession and one last leg down in the market away from crossing over the other side of the mountain. And believe me, nobody is in a bigger hurry to get there, than yours truly. At the risk of perhaps getting too far ahead of myself, but you may end up calling me a perma-bull (at that stage, I must warn you, folks like Jim Paulsen will have thrown in the towel)."

We have all thought it. We have all muttered it under our breaths (and some of us have even written about it on blogs) but the Keynesian Krusader's borrow-and-spend-our-way-to-growth dogma was bazooka'd by former Senator Alan Simpson yesterday. "I say why don't you read our report and then get back to me", Simpson says of Krugman in a must-watch interview on Bloomberg TV, adding that "Paul Krugman is a great economist, but he ain't the best in the world. This is nuts...I love to read his stuff because it borders on hysteria" Critically, he adds on the growing demographic crisis "This is not 20 years ago, it isn't 10. It is now. You have 10,000 a day coming into the system. The demographics are there. It is all different -- it is not the same". The former Senator goes on to discuss whether US will become the next Europe, how lawmakers will sell cutbacks to the American public, whether policymakers keeping rates low are contributing to the problem, and finally on Simpson-Bowles 2.0. - "The people of America are telling their elected people how it is. Erskin and I go all over the country and tell them we do not do BS or mush, but pull up a chair and we will tell you where the country is, and they are thirsting for that."

Most informed people are familiar with the concept of Peak Oil, but fewer are aware that we’re also entering the era of Peak Government. The central misconception of Peak Oil -- that it’s not about “running out of oil,” it’s about running out of cheap, easy-to-access oil -- can also be applied to Peak Government: It’s not about government disappearing, it’s about government shrinking. Central government -- the Central State -- has been in the expansion mode for so long that the process of contracting government is completely alien to the nation, to those who work for the State, and to those who are dependent on the State. Thus we have little recent historical experience of Peak Government and few if any conceptual guideposts to help us understand this contraction. Peak Government is not a reflection of government services or the millions of individuals who work in government; it is a reflection of four key systemic forces that drove State expansion are now either declining or reversing.

Stocks are currently priced for a 10% growth rate which makes bonds a safer investment in the current environment which cannot deliver 10% rates of returns. We are no longer in the era of capital appreciation and growth. The “baby boomers” are driving the demand for income which will keep pressure on finding yield which in turn reduces buying pressure on stocks. This is why even with the current stock market rally since the 2009 lows - equity funds have seen continual outflows. The “Capital Preservation” crowd will continue to grow relative to the “Capital Appreciation” crowd.... According to the recent McKinsey study the debt deleveraging cycles, in normal historical recessionary cycles, lasted on average six to seven years, with total debt as a percentage of GDP declining by roughly 25 percent. More importantly, while GDP contracted in the initial years of the deleveraging cycle it rebounded in the later years.

Every quarter as part of its refunding announcement, the Office of Debt Management together with the all important Treasury Borrowing Advisory Committee, which as noted previously is basically Wall Street's conduit telling the Treasury what to do, releases its Fiscal Quarterly Report which is for all intents and purposes the most important presentation of any 3 month period, containing not only 70 slides worth of critical charts about the fiscal status of the country, America's debt issuance, its funding needs, the structure of the Treasury portfolio, but more importantly what future debt supply and demand needs look like, as well as various sundry topics which will shape the debate between Wall Street and Treasury execs for the next 3 months: some of the fascinating topics touched upon are fixed income ETFs, algo trading in Treasurys, and finally the implications of High Frequency trading - a topic which has finally made it to the highest levels of executive discussion. It is presented in its entirety below (in a non-click bait fashion as we respect readers' intelligence), although we find the following statement absolutely priceless: "Anticipation of central bank behavior has become a significant driver of market sentiment." This is coming from the banks and Treasury. Q.E.D.

In spite of the holiday in Europe, the region is still one of the biggest issues in the market.  We are not sure how the debate has turned into austerity versus growth?  Growth, or at least sustainable debt levels is the goal.  Austerity and Spending are ways of achieving that sustainable debt level. Growth is one way of achieving a sustainable debt level.  A bigger economy would more easily support the existing debt.  The key here is not creating more debt than the growth can cover. Reducing debt and reducing expenses is another way of achieving a sustainable debt level.  It is depressing and a bit scary that governments have promised far more than they can deliver. So new spending that creates more growth than it costs should be pursued.  It won’t be easy to find that many obvious projects, but at least politicians have an easy time spending more money. But there is the pink elephant in the room, or in this case, the black market.  Spain has an official unemployment rate of 24%.  They project it to be 22% in 2015.  This is structural.  I cannot imagine the U.S. surviving with that level of unemployment.  The unemployed would have taken to the streets long before it hit that level to demand change.  In fact, I find it difficult to imagine any country surviving on that level of unemployment, unless it is structurally encouraged.  Are the benefits too good?  Is it too easy to avoid working? If a country like Spain is paying huge amounts of money to the unemployed, and that is causing a spike in debt to unsustainable levels, then something needs to be done.

While the most commonly held perspective on the aging demographic in the US is a retiring Boomer generation that is increasingly risk-averse (rotating to fixed income) and in desperate need of a growing segment of the healthcare pie, it appears that this may not be the entire picture. The data shows, via UBS Larry Hatheway, that in fact asset preferences do not change much by age cohort and therefore is not the driving reason behind a secular rotation out of stocks per se (as opposed to more simple reasons such as mistrust) and more notably the perception of an increased longevity could actually incentivize older investors to extend investment horizons (whether in stocks or fixed income). There does, however, remain a clear correlation (intuitive rather than causal if one is splitting hairs) between equity valuations (P/E ratios) and the older cohort (implying expectations of dropping equity valuations). Critically though, it appears from the data that older investors are not more risk averse. There is one further issue that is quietly emerging and that is US fertility data which points to an 'eventual' rejuvenation of US society - which could eventually shift the demographic influence back in the opposite direction. The simple take-away is that while old people continue to desperately cling to wealth preservation in their longer-than-expected lives, with their notably higher-than-average net worths, there will be an increasing pressure to stealthily tax part the aged of their wealth to cover the costs of a growing and even more state-dependent youth demographic that is emerging. Forget the 99% versus the 1%, it appears the new and more clearly-defined class warfare could well be the old versus the young.

Once again pundits are claiming that housing is "finally recovering." But they're overlooking three peaks: Peak Housing, Peak Financial Fraud, and Peak Suburbia, all of which suggest years of stagnation and decline, not "recovery." Once the belief that housing is the bedrock of middle class wealth fades, so too will the motivation to risk homeownership in an economy that puts a premium on mobility and frequent changes of careers and jobs. Only one aspect of housing hasn't yet peaked: property taxes. If the risks of homeownership weren't apparent before, they certainly are now as local governments jack up property taxes to indenture homeowners into tax donkeys.