Risk/Reward Vol. 220
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"If I listened long enough to you
I'd find a way/To believe that it's all true."---lyrics from "Reason to Believe" sung by Rod Stewart
"It was a teenage wedding/ And the old folks wished them well
You could see that Pierre/Did truly love the mademoiselle
C'est la vie say the old folks
It goes to show you never can tell"---lyrics from "Never Can Tell" sung by Chuck Berry
"Pardon the way that I stare
There's nothing else to compare."---lyrics from "Can't Take My Eyes Off of You"---sung by The Four Seasons
According to Federal Reserve economists, after previous recessions, pent up demand for residential housing has led economic recovery. Not so this time. That is why housing and, in particular new home construction, dominated the news this week. It started on Monday with Warren Buffett's expression of surprise at how sluggish that sector has been. That comment was followed by an article in the New York Times reporting that housing has been a net drag on the economy. Later, noted investor Jeff Gundlach stated in his speech at the Sohn Conference that any hope that housing would lead the recovery this time around was "overbelieved." But what really focused concern was Janet Yellen's testimony to Congress on Wednesday and Thursday that the "flattening in housing activity could be protracted." This is troubling considering that the Federal Reserve has bid upon and purchased over $1.6TRILLION in conventional home mortgages since January, 2009. Indeed, it now owns 17% of ALL currently outstanding home mortgages. Like bonds, the interest rates on mortgages fall if the prices paid therefor increase. Thus, the Fed's upbidding has kept mortgage rates artificially low in an attempt to jump start this traditional recovery bellwether. It hasn't worked. We’ve been “listening long enough” for a "Reason To Believe" that it will rebound. The fact remains that housing is in the dumps---even if Warren finds it hard to “believe that it’s all true.”
I predict that housing will not only fail to lead the recovery, it will not recover at all. The reason has nothing to do with the economy, and everything to do with demographics. According to the US Census Bureau, between 1997 and 2006, on average 1,350,000 net new households (independent living units with one or more persons) were formed each year. Since 2007, annual net household formation has averaged 550,000 and is declining. Meanwhile, the total number of family households (e.g. husband+wife with or without children) has fallen. In other words, today when "Pierre truly loves the mademoiselle" there is no wedding even if the "old folks wish them well." With home ownership proving to be a poor investment, why would any single person or any couple, for that matter, buy a house unless they have children? Note the following two points. First, as reported on Thursday, 43% of all existing home sales in Q1 2014 were cash sales. Believe me these are not first time buyers which is the group the Fed wants to attract with low interest rates. Second, as noted in Vol. 218 (www.riskrewardblog.blogspot.com ), as a nation we are reproducing at less than a population replacement rate. Do you think I'm off target regarding the impact of demographics? Take a look around. When Barb and I were 33 we had four children, had bought and sold one house and had purchased, remodeled and furnished a second one. We lived in a neighborhood of similarly situated couples. How many 33 year olds do you know with four children, how about three, how about two, how about one? How many are even married? I make no societal judgments here, but you have to be blind (or the Federal Reserve Chair) not to see that housing, particularly single family home construction, is not going to rebound. “C’est la vie says this old folk/It goes to show you never can tell.”
So what does this mean for investors? The answer was supplied by Fed insider Jon Hilsenrath in an article published in Thursday’s Wall Street Journal headlined “Housing Doldrums Worry Fed Officials.” Therein, Hilsenrath wrote: “If housing fails to revive as expected and holds back the broader recovery, Fed officials could decide to take even more time on an already slow path to eventual interest rate increases.” Believe me that is not speculation on Hilsenrath’s part. That tidbit came straight from Yellen’s lips to Hilsenrath’s ear to WSJ’s front page. As a consequence my overweight position in income securities priced in relation (or spread) to the interest rate on the all important 10 Year Treasury Bond continues to look good (remember lower interest rates mean higher prices). So, “Pardon the way that I stare” at the interest rate on that all important security as it continues to trend downward. It now hovers around 2.6% ; this despite the consensus prediction last fall, last winter and this spring (except by yours truly—see Vol. 186 www.riskrewardblog.blogspot.com ) that at this juncture, it would be well over 3%. And continue to stare at the yield on the 10 Year I will, because there is “nothing else to compare” when it comes to predicting how income stocks will fare. I "Can't Take My Eyes Off Of It."
Even if historically it has led the way out of recessions, the sale of new and existing houses only represents 4-5% of annual GDP. So why is the Fed so obsessed with it? I suspect there is another reason why Ms. Yellen has “Got It Under Her Skin”, one about which she has spoken in the past. (Google: "Yellen speech Feb.11, 2013). A house has been the average American’s largest investment for generations, and no generation sunk more of their net worth into housing than the Baby Boomers. We were weaned on the belief that houses never depreciate. Mortgage interest was our only tax break, and we used home equity as our piggy bank. So, if housing prices fall (which is more likely if mortgage interest rates go up), a huge percentage of Baby Boomer wealth will evaporate just as they enter retirement. This prospect carries significant deflationary implications. I suggest this is her greater concern and one more reason why she will keep interest rates low indefinitely
“In spite of a warning voice that comes in the night
And repeats, repeats in her ear
Don’t you know you fool/You never can win
Use your mentality/Wake up to reality.
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