Submitted by Lance Roberts of STA Wealth Management,
This past week saw the initial public offering of the single most anticipated IPO of 2013 - Twitter. If you tweeted about it then you are not alone as the news dominated the media headlines and the market. With Twitter already sporting a 11x price-to-sales ratio, and no earnings, what could possibly go wrong? However, it is that growing complacency among investors that should be the most concerning as the general sentiment has become that nothing can stop the markets as long as the Fed is in the game. This week's issue of things to ponder over the weekend provides some thoughts in this regard.
1) Are We Heading Towards A Cliff?
"The odds are that the world is experiencing a bigger bubble than the one that unleashed the 2008 Global Financial Crisis. The United States' household net wealth is much higher than at the peak in the last bubble. China's property rental yields are similar to what Japan experienced at the peak of its property bubble.
The biggest part of today's bubble is in government bonds valued at about 100 percent of global GDP. Such a vast amount of assets is priced at a negative real yield. Its low yield also benefits other borrowers. My guesstimate is that this bubble subsidizes debtors to the tune of 10 percent of GDP or US$ 7 trillion dollars per annum. The transfer of income from savers to debtors has never happened on such a vast scale, not even close. This is the reason that so many bubbles are forming around the world, because speculation is viewed as an escape route for savers.
The property market in emerging economies is the second-largest bubble. It is probably 100 percent overvalued. My guesstimate is that it is US$ 50 trillion overvalued.
Stocks, especially in the United States, are significantly overvalued too. The overvaluation could be one-third or about US$ 20 trillion.
There are other bubbles too. Credit risk, for example, is underpriced. The art market is bubbly again. These bubbles are not significant compared to the big three above.
When the Fed does normalize its policy, i.e., the real interest rate becomes positive again, this vast bubble will burst. Given its size, its bursting will likely bring another global recession worse than the one after the 2008 crisis."
2) Three Potential Headwinds For US Housing
A while back I wrote an article about the real underpinnings of the housing market which pointed out that, despite media headlines to the contrary, home ownership was at the lowest levels since the 1980's and was showing no real signs of recovery. I stated then:
"As I stated previously the optimism over the housing recovery has gotten well ahead of the underlying fundamentals. While the belief was that the Government, and Fed's, interventions would ignite the housing market creating a self-perpetuating recovery in the economy - it did not turn out that way. Instead, it led to a speculative rush into buying rental properties creating a temporary, and artificial, inventory suppression. The risks to the housing story remain high due to the impact of higher taxes, stagnant wage growth, re-defaults of the 6-million modifications and workouts and a slowdown of speculative investment due to reduced profit margins. While there are many hopes pinned on the housing recovery as a 'driver' of economic growth in 2013 and beyond - the data suggests that it might be quite a bit of wishful thinking."
That statement of "wishful thinking" was confirmed this past week by Trulia chief economist Jed Kolko: (via ZeroHedge)
- Census 3Q homeownership, vacancy survey shows household formation “alarmingly slow,” vacancies “remain stubbornly high,”
- "Slow household formation number is one of the most alarming housing indicators to come out this year"
- Share of millennials living with their parents rose to 31.6% vs 31.4% y/y
- Household formation 380k in yr leading up to 3Q vs L-T “normal” increase of 1.1m
- No increase over past yr in young adults moving out of parents homes or getting jobs is “most worrying”
- Vacant homes still pose “problem” for recovery
- 53% of vacant homes were held off mkt in 3Q, highest share since before bubble
- 10.2% of all housing units are vacant, unchanged y/y, higher than pre-bubble level of 8.9% in 3Q 2001
Furthermore, Sober Look also noted:
"While the US housing market remains relatively robust, it is likely to face a couple of headwinds going forward. One is the lower affordability index, which is declining due to higher prices and higher mortgage rates (see discussion). On a year-over-year basis the declines have been quite steep."
The Federal Reserve has consistently been noting the strength of the housing recovery as evidence of a recovering economy. Those hopes are likely to fade in the months ahead as household formation lags, millennials remain on parent's couches and affordability declines.
3) Seeds Are Sown For The Next Financial Crisis
After the crash in 2008, Congress leapt into action to pass legislation, which has yet to be fully written, to make sure the financial shenanigans of Wall Street were never repeated. Unfortunately, that was then, and this is now.
"A new law written by Citigroup lobbyists (we couldn’t make this stuff up if we tried) exempts derivatives trading from regulation, and was passed this week by the House of Representatives with broad bipartisan support.
It sounds bad… but don’t worry, it gets much, much worse:
The New York Times reports that 70 of the 85 lines in the new House bill were literally written by Citigroup lobbyists (Citigroup was one of the mega-banks that brought our economy to its knees in 2008 and received billions in taxpayer money.)
The same report also revealed “two crucial paragraphs…were copied nearly word for word.” You can even view the original documents and see how Citigroup’s lobbyists redrafted the House Bill, striking out ideas they didn’t like and replacing them with ones they did.
The bills are sponsored by Randy Hultgren (R – IL), and co-sponsored by Rep. Jim Himes (D-CT) and others. Himes is a former Goldman Sachs executive, and chief fundraiser for the Democratic Congressional Campaign Committee.
Maplight reports that the financial industry is the top source of campaign funding for 6 of the bills’ 8 cosponsors.
Maplight’s data shows that members of the House received $22,425,740 million from interest groups that support the bill — that’s 5.8 times more than it received from interest groups opposed.
“House aides, when asked why Democrats would vote for this proposal even though the Obama administration opposes it, offered a political explanation. Republicans have enough votes to pass it themselves, so vulnerable House Democrats might as well join them, and collect industry money for their campaigns.” — New York Times
4) Valuations And Future Returns
I have discussed the importance of valuations on future returns many times in the past, however, Mebane Faber did an excellent job recently noting that if you are still heavy U.S. equities it may be a good time to reevaluate.
5) Budget Deficit Reduction Only Temporary
In my post on Q3-2013 GDP, I pointed out that the reduction in the budget deficit was due to a temporary anomaly in tax receipts. I stated:
"The reality is that the surge in tax revenues was a direct result of the "fiscal cliff" at the end of 2012 as companies rushed to pay out special dividends and bonuses ahead of what was perceived to a fiscal disaster. The large surge in incomes was primarily generated at the upper end of the income brackets where individuals were impacted by higher tax rates. Those taxes were then paid in April and October of 2013 and accounted for the bulk of the surge in tax revenue to date. Also, it is important to remember that payroll taxes also increased due to the expiration of the payroll tax cut from 2010."
However, the Rockefeller Institute recently wrote a research report entitled "Temporary 'Bubble' in Income Tax Receipts" which points out a secondary anomaly created by just one state:
"Personal income tax collections had the strongest growth among the major taxes, at 20.3 percent.
However, the strong growth is attributable not only to the acceleration of income into calendar year 2012 and the 2012 stock market, but also to strong growth in a single state, California, where income tax collections grew by nearly $7.1 billion, or 40.7 percent, in the second quarter of 2013. The large growth in income tax collections in California reflects the acceleration, as well as recent increases in income tax rates that were only partially reflected in withholding. On November 6, 2012, California voters adopted Proposition 30, which increased the personal income tax rate on taxpayers making over $500,000 for a seven-year period that is retroactive to January 1, 2012, through December 31, 2018. If we exclude California, income tax collections in the remainder of the nation grew 14.9 percent in the second quarter of 2013..."
Plus 1) The Boy Who Cried "Wolf"
Lakshman Achuthan, from the Economic Cycle Research Institute, has been chastised in the press over the last couple of years for calling for an economic recession that didn't occur. However, he remains adamant that the U.S. has actually been in a recession for the last year and remains so accordingly to the underlying economic data. Once again, he has been summarily dismissed by the media for his statements because with the stock market near all-time highs that surely means the economy is recovering, right? Well, as he states, if that was indeed the case then "you wouldn't have four years of zero-interest rate policy and quantitative easing."
He also has a take on something that I have been questioning myself with regards to the ISM and PMI data which has come completely detached from the underlying fundamental data.
There is one important point to remember about the "boy who cried wolf;" eventually the wolf did come.
Have a great weekend.