Archive for May, 2011

Oil is not the only thing that trickles…

 We have all heard of the trickledown effect that oil has. All modes of transportation require gas (a derivative of oil).  Any increase in the price of oil will increase the price of gas. When the price of gas goes up, the price of transportation goes up. When the price of transportation goes up, producers, manufacturers, and the like increase the prices of their goods in an attempt to offset the increase in their expenses. Long story short, the prices that consumers are charged for just about everything that consumers purchase goes up which contributes to a rising inflation level.

The idea of the trickledown effect is simply based on dependant relationships. In this way, the housing market can also have a trickledown effect. Without going through every effect, I will go through a few of the biggest. First is the direct effect. Problems in the housing market will affect the home building industry. If homes are not being built, then home builders will not make money. This will negatively affect everyone working in the industry as layoffs will likely follow. The manufacturing industry is also impacted as the suppliers of appliances see a drop in demand.  Further, when people are not buying homes, they are not seeking new mortgages. This, of course, will lead to layoffs in this industry also. With all of these layoffs, the economy will likely suffer as consumer spending will take a hit potentially creating a deflationary effect.

Deflationary pricing creates a sort of vicious downward spiraling circle. To combat their lower revenue due to lower prices for their goods and services, companies will cut costs to keep profits up. This will lead to further job cuts and higher unemployment. This, again will add to lower consumer spending which we all know constitutes 70% of all economic activity.

There are also the indirect effects that are just as scary. Look at the banks for instance. Most, if not all of the major banks have an incredible amount of resources tied up in the housing and mortgage markets. If those areas take a hit, then the balance sheets and capital positions of the banks will take a hit which could be potentially devastating. The other group that would see or feel a potentially devastating effect would be the consumer. For about 95% of us, maybe even more, our house is the single biggest investment that we are likely to have. This means that so goes the value of our home, so goes our own perceived wealth position.

Where they say that consumer spending is 70% of the economy, there is no economy if there is no consumer confidence. Without confidence, the consumer input to the economy is worthless. And nothing hurts consumer confidence more that the feeling of being poor. When the housing market gets hit like it has, consumers feel poor because the biggest investment that they have is now a loss. Now they feel poor and pull the reins on spending back hard. This fact is probably the biggest problem confronting the government in its attempt to right the economy. As you can see, the housing market has a trickledown effect that at least rivals, and maybe even exceeds the trickledown effect in oil!

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Burning Down the House

 For those of you following the housing market, you probably already know that as the latest numbers show that market continues to deteriorate.  Late last year I predicted that there would be another 15 to 20 percent drop in housing prices by the end of 2011.  According to the latest numbers I turned out to be correct. From the time that I made my prediction to now, the housing market has seen a 15% drop give or take. You may be thinking WOW what an impressive prediction but before you become too enamored with my call realize that it looks like a second 15 to 20 percent drop before the end of the year and as much as this fact pains me because it ruined the accuracy of my prediction, the bigger situation is what this is going to do to the economy and our recovery going forward. 

Numbers released today show that currently one out of every 4 households is now under water on their mortgage. That number, obviously the highest it’s ever been, is downright terrifying. Financial damage aside, the real economic killer here is the psychological damage this creates. As you have heard from just about every media source out there, and no fewer than 10 times from each of those sources, consumer spending makes up a little more than 70% of all economic activity.  The government has lied, cheated, stimulated and even manipulated the economic data and the financial markets to try to keep consumer confidence levels up for this reason.  If consumers lose confidence and stop spending, there will be little to no chance for the recovery not only being real but actually gaining a foothold. 

The problem here is that for 95% of all Americans their house will be the biggest single investment that they will ever make. Therefore, most Americans will attribute the value of their home to their own personal wealth positions. If 25% of them are fully under water we will need to assume that somewhere near 50% are at break-even levels.  This means that the majority of homeowners believe that they have little to no net wealth position.  With that said, most are very likely to believe that they don’t have money enough to be out spending it in the way that the government would like to see and the economic recovery needs to see.  Therefore, the housing market is the central figure in any type of real recovery and as of now, with all the latest numbers in, the housing market has not grown, has not even stabilized but is continuing to deteriorate with NO signs of an end in sight. 

So long as this remains true, any recovery will be fledging at best.  This ugly situation will at some point in time show up in the performance of not only housing and housing related stocks, but also in financials, retailers, consumer staples, and yes even technology at some point in time(see blog thread entitled “Oils not the only thing trickling down”).  And when that happens, the market will have to correct.