Trading and Investing

I thought it would be cool to create a map that displays state-level housing price appreciation during the last five years. Check it out:

(I created this graphic using a map creator tool at http://monarch.tamu.edu/~maps2/us.htm. The data come from www.ofheo.gov)

In the last five years, home price appreciation in the US has gone totally gang-busters. Average prices have more than doubled in California, Florida, Hawaii, Nevada, Maryland, and Washington DC. The hot areas are concentrated in the northeast and the west.

It has been a pretty amazing ride for people owning houses in these areas. I hope for their sake the prices can hold.

From an investor point of view, I think it makes sense to look for areas with good growth prospects that have not gone through such a dramatic price surge. For the next 3-5 years, I like Texas, Georgia, North Carolina, South Carolina, Ohio, and Michigan.

Anyway, I just thought this was cool. I wish I could fast-forward time a little bit to see how housing develops. But I guess we’ll just have to wait and see!

– defo

What? You still aren’t convinced that housing is overvalued right now? Here’s another way of looking at real estate that might convince you.

Housing prices divided by rents provides one measure prices relative to fundamental value. I like this measure because it provides a sense for what an investor could earn by buying a house and renting it out. I’d like to think that this ratio fluctuates roughly around a long-run historical norm.

The two graphs below show price to rent ratios for New York City and Los Angeles over the last 20 years. I have also included graphs of annual price and rent increases during those years. Price data are from the Office of Federal Housing Enterprise Oversight (www.ofheo.gov) and rent data are from the Bureau of Labor Statistics (www.bls.gov).

(note that the y-axis is normalized so the actual number means something only in comparison to other years)

Both of these cities experienced similar (but smaller) peaks in their price-to-rent ratio in the late 80s. In the early 90s, New York City and Los Angeles housing prices dropped 10% and 20% respectively in nominal terms. After adjusting for inflation, these price declines were around 40% over 6 years.

Today’s price to rent ratios in NYC and LA are 25% and 50% higher than their late 1980’s peak. Unless the US economy takes off like a rocket ship, I’m guessing at least a 20% nominal price drop in these cities over the next five years. Inflation-adjusted prices will decline even more.

The other thing going on here is mortgage rates being near 20-year lows. But my calculations suggest that the difference between 10% mortgage rates in 1988 and 6% mortgage rates today can only account for about a 25% increase in a price to rent ratio.

If mortgage rates can stay low then housing prices might decline slowly over a number of years. If mortgage rates rise (unlikely but not impossible), then watch out. Fortunately the Fed knows this and will keep interest rates low as long as possible (and then watch out for inflation!).

Not every part of the country looks like NYC and LA, but most big cities show similar increases in price-to-rents. The exceptions may be Texas and some parts of the South. Out of the 24 cities across the country for which data were available, only Houston and Dallas are not at their 25-year price-to-rent peaks right now. Of the 22 non-Texas cities, price-to-rent ratios today are an average of 42% higher than their highest peak in the 1980s.

At the end of the day, I just don’t see most of these cities escaping substantial price corrections. Who knows how it will turn out.
– defo

…Nope!

Here are some economic data that came out today with barely a yawn from Wall Street (no surprise, it’s almost Christmas!). The chart below shows the National Association of Home Builders’ (NAHB) confidence index, which measures home builders’ confidence in the housing market:

I don’t know about you, but that decline doesn’t look over to me. After the number came out today, I turned my head to the tv only to watch people insist that the housing market has hit the bottom. “Time to get in and buy before you’ve missed your opportunity!”, says one realtor. I wonder what *his* motives are…it sounds to me like the stockbrokers who were trying to sell the Nasdaq in late 2000.
But let’s look at the timing of this index relative to the last national decline in housing prices in the early 1990s. The home builders’ index hit it’s low of 24 in the 4th Quarter of 1990. But the chart below shows that the biggest declines in housing prices during that real estate cycle were between 1990 and 1993!

The NAHB index is anything but a sign that housing is through cooling. If anything, it’s a sign that more price declines are on the horizon. Look for housing prices to continue to drop for the next 2-3 years. It will most likely be a slow but continuous trend.

And then get ready for one of the best real estate buying opportunities since the early 1990s.

– defo

On Friday, the Bureau of Labor Statistics released inflation numbers for November. Here’s the main table from the official release at www.bls.gov:

The headline CPI number showed no inflation between October and November. This is the third month in a row in which inflation has come in under expectations. Even core inflation (which excludes food and energy) has been slowing down lately, though it is still above the Fed’s annual target of 1-2%.

The sub-categories of the inflation index tell an interesting story. Some prices have been moving up lately: including housing (because the CPI counts *rents*, which are finally catching up to housing prices), food/beverages, and medical care. Other prices have been dropping: including energy, transportation (driven mostly by slower auto sales), and apparel.

Some would argue that the economy has never looked stronger. Inflation is low, corporate earnings are high, unemployment is low, and the stock market indexes are breaking records. Time to buy, buy, buy! Even the dollar has recovered 2% to $1.31 against the Euro in the past two weeks.

But other economic statistics are worrisome, including America’s massive trade and budget deficits, falling home prices (remember, the CPI measures rents, not home prices), and a negative individual savings rate. Can our country borrow it’s way to prosperity? So far there’s not much evidence against it, except maybe common sense.

For now, the stagflation scenario that I have been fearful of is not being supported by the data. Things to watch in 2007:

[1] value of the dollar versus the euro
[2] inflation data
[3] corporate earnings

More to come as the data unfolds…

– defo

In the past two weeks, the dollar has depreciated almost 4% versus the euro. The exchange rate has risen from $1.28 per euro to $1.33 in just 9 trading days. This kind of movement is not unprecedented, but it is representative of a 5-year trend during which the dollar has lost nearly 40% of its value relative to the euro. In Nov. 2000, the exchange rate was $0.83 per euro.

There are many factors contributing to the dollar decline. The first of which is our massive trade deficit (see http://blog.reblace.com/?p=26), which is now almost 6% of total US GDP. The second is our low interest rates. 30-year US Treasury bonds earn a measly 4.54%. The third is our outstanding budget promises, including an unfunded social security system, a massive war in Iraq, and a new medicare prescription drug bill that we just can’t pay for.

The only reason our dollar hasn’t plummeted already is because investors buy US Treasuries for safety, although it’s hardly safe considering the long-term devaluation trend. The dollar is widely considered to be the world’s reserve currency, but what happens if it is no longer considered so? Dollar devaluation is self-reinforcing because investor confidence can quickly deteriorate as the dollar declines.

Investors with all of their money in dollar-denominated assets need to think hard about their investment strategy. They may earn higher nominal returns, but their purchasing power is plummeting. The Dow is hitting new highs measured in dollars, but since 2000 the index has lost 35% of its value measured in euros and 50% of its value measured in gold.

It’s not a given that the dollar decline will continue, but a shift in investor sentiment can quickly transform a slow leak into a rout.