Posted by Don Martin on Fri, Nov 23, 2012 @ 09:21 AM
Japan real estate crash demonstrates continued risk of U.S. real estate price dropping
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Japan’s real estate has dropped 80% from its bubble top. It has dropped even further in rural parts of Japan. In some cases vacation condos in rural Japan have dropped 90% from the top of the 1980’s bubble.
An article in the Wall Street Journal showed a new 3,000 square foot home in rural Japan with an acre of land and a view of the ocean that cost only $320,000 and would cost $2,000,000 in other developed countries.
The risk is that if the U.S. goes through a long Soft Depression like Japan then investors will be forced to sell off rural and vacation homes at fire sale prices and there will be an imbalance of sellers over buyers. When interest rates dropped to artificially low levels in Japan then retired investors needed to sell assets to make up for the lack of interest and dividend income, thus pushing down prices.
The risk of a continuing decline in U.S. real estate is asymmetric: What I mean is that the risk of replicating Japan’s real estate decline is greater than the probability that somehow the U.S. will recapture the boom time era of a high water mark for real estate. As more people come under stress due to shrinking yields on investments they will sell off other assets like (second) vacation homes, rural homes, ranchettes, undeveloped land, second tier ski resorts, jewels, rare wine, rare art, creating a deflationary climate. Of course primary residences immediately adjacent to employment centers in Silicon Valley in good school districts will not be affected.
Taxes on upper income people are going up. These people have the best job skills so they can afford to create a mini-boom in homes in their neighborhood, but if they come under financial stress from the Fiscal Cliff they may sell off their vacation home, wine collection, etc. If there are few buyers then prices will go down.
I remember talking to someone whose family tried to buy a prominent winery with a beautiful main building in Napa Valley during the Great Depression. They decided not to buy and a decade later the very low price remained unchanged. The effects of a Depression can take decades to reverse. I know a condo owner in Salinas, CA that saw their home value drop 80% since 2006.
I have written an article “Western nations have learned nothing and may repeat Japan’s mistakes”
Investors should seek independent financial advice.
Posted by Don Martin on Mon, Jul 30, 2012 @ 03:27 PM
Inflation versus Deflation Debate:
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Arguments in favor of the economy being reflated and returning to normal soon:
*Unemployed people will go to night school and learn a new trade in the economically hot fields of health care or information technology and this will solve unemployment
*Affluent people with career skills that are in high demand will earn and consume more to make up for lack of consumption by unemployed people
*High debt balances don’t matter if people have a very low monthly payment because of low rates
*Corporate profits using current year or next year’s earnings justify today’s stock prices
*Demand for goods and services will come from growth in tech and medical fields
*The government will find a way to borrow more to stimulate the economy
Will the Fed create excess money growth and inflation?
Arguments in favor of economy being mired in long term Japan-style Soft Depression:
*The unemployed are mostly at the lower educational levels in society and it is unlikely they will suddenly improve their study habits and IQ and get a technical education.
*Affluent people will not over-consume enough to offset lack of consumption by the poor and unemployed
*High debt balances do matter even if the monthly payment is “interest-only” with a very low rate. If the economy returns to normal then interest rates will go up and people will feel the pain of excessive debt. Also as time goes by a lot of debt financed things become obsolete and need to be replaced by a new one. So if you are still making interest -only payments on a machine that needs to be replaced and financed with debt and then interest rates return to normal then you will have unaffordable monthly payments. The high level of debt to GDP has never existed before and has increased dramatically in recent decades.
*Corporate profits are mean reverting and could easily drop by a third, which could make stocks drop by more than one-third. The best measure of stock values are the ten year inflation adjusted average of profits because it may smooth out temporary bubbles. This measure implies stocks need to drop about a third to about roughly 900 for the SP. Also, the economy could slip into recession and thus further erode profits.
*Demand for goods and services was manipulated by excessive increases in debt over several decades and due to the need to pay this down and save for retirement there will be less new debt and less extra cash flow available to consumers to consume. This has created an era of austerity since the crash started in 2008. It may take until 2023 to work of the excess debt and excess unemployment.
*The government can't borrow more to stimulate the economy because there is already too much debt
I wrote an article “Soft depression for another decade” and “Two items you must know about preparing for deflation”.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, Jul 23, 2012 @ 09:02 AM
Overcoming some economic prejudices to get better investment results
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There are some incorrect myths that can greatly mislead investors. One myth is that it is normal for interest rates to be between 5 to 9% for long term Treasuries. A second myth is that recessions only last a year and then everything goes back to normal. A third myth is that during a period of excessive government debt that interest rates rise to compensate for the increased risk of lending to an over-indebted government.
Myth 1. Inflation is normal and is a risk with a higher probability than depression.
The fact is: The history of the U.S. before the 1930’s was one of constant crashes and long term depressions lasting 15 to 25 years. Only after the start of WWII did the U.S. switch to a long era of inflationary Keynesian debt financed demand managed economy, culminating in a near hyperinflation in the 1970’s. Most people can only recall the past 71 years since the start of WWII. They need to see that Keynesian inflationary debt bubble methods are discredited and they need to consider the deflationary and depression experiences from 1790 to 1941. We had long term depressions in the 1830’s, 1870’s, 1890’s, 1907-1922, and 1929-1941. If the Central bank and Congress can’t stimulate the economy then the best guide to what will happen is the pre-1941 era.
Myth 2. Recessions only last a year and then everything goes back to normal.
Fact: Unfortunately the current recession is a Japan-style Soft Depression that will last a long time. Bond bull markets where interest rates go lower and bond prices go higher can last up to 25 years. Since the ultra-high rate era of Volcker was an aberration then the beginning of the current bond bull market should be marked from the time in 1997 when Asian countries encountered a crisis and Greenspan and the world’s credit markets lowered interest rates in response. The bond bull market could last until 20 years after 1997 which is 2017. Many bearish commentators have felt that is when the economy would get better, so that may be when the bond bull market ends.
Myth 3. During a period of excessive government debt that interest rates rise to compensate for the increased risk of lending to an over-indebted government.
Fact: As things get worse people panic and engage in a bidding war to buy seats on a financial lifeboat, which are Treasuries. The worse things get for the private sector the more the tax collector (who also has a printing press and debts denominated in the local currency) looks like the only reliable credit risk to lend money to.
Once investors learn to be unprejudiced about credit market myths then they can invest correctly.
I wrote an article “Deleveraging to continue”.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Jun 28, 2012 @ 01:27 PM
New Health Care Law Upheld by Supreme Court – How Does This Affect the Economy?
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The Supreme Court upheld the March, 2010 health care law that requires purchases of insurance and requires health insurance to include more services.
This will go into effect in 18 months. The result will be that health care costs will rise because of increased demand. Many employers with under 50 employees may end coverage, thus forcing employees to pay for coverage. Healthy insured people will pay more to subsidize the unhealthy people who are now allowed to buy forced placement of health insurance.
Thus the typical consumer and typical taxpayer will pay more, resulting in less purchasing power for other things. This could hurt the economy, resulting in layoffs at businesses not involved with the healthcare industry. Possibly the extra income earned by members of the healthcare industry could be spent thus offsetting the reduction in demand caused by the higher healthcare costs. Possibly the health costs savings that formerly uninsured people realize when they get insurance to pay for their medical costs will allow those people more purchasing power for other goods. Some of the detriments such as reduction of purchasing power will be partially offset. The risk is that there will be huge frictional costs so that when Mr. A pays an extra $3,000 a year towards new health insurance mandates and Mr. B earns extra pay for working overtime providing health care the after-tax income B gets will be less than the costs paid by A and thus there will be a net reduction in consumer’s purchasing power for all types of goods, leading to a deflationary situation. The extra bureaucracy for health care will require hiring more lobbyists, lawyers, CPA’s, etc. and this could reduce the amount of discretionary income the general public has to spend on all types of goods. The extra income the elites (lobbyists, lawyers, etc.) will earn from these new frictional costs will go to them and not to the masses of people. These elites could save their paycheck instead of spend the money which would be deflationary.
Unlock secrets of Health Care Law
The new law requires taxes on investment income in addition to the other tax increases in 2013 that were due to the expiration of the Bush tax cuts. The new taxes will be deflationary, as any Econ 101 textbook will say raise taxes to cool down the economy, and reduce taxes to stimulate the economy.
The way that socialized medicine works is that the government is forced to cut costs by cutting benefits. In Canada someone was denied kidney cancer surgery for two years and finally they became so frustrated the patient paid $40,000 of their own money to get an operation in the U.S. In Britain the government insurance won’t pay $50,000 for Sutent, a kidney cancer medicine. Those that can afford the costs will pay out of pocket and this will reduce their purchasing power for other things, thus hurting the economy. Perhaps someday government controlled medical care in the U.S. will result in Americans going to Asia for medical treatment (that will be denied to them by socialized medicine), resulting in loss of jobs and taxes here.
I wrote an article “Establishment getting worried about the economy”.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, May 31, 2012 @ 12:31 PM
The jobless rate in tomorrow’s monthly employment report should show 133,000 new jobs based on my sources. See the good article in New York Times about employment rate. After adjusting for population growth of 125,000 a month the “real’ job growth rate will be close to zero. The average growth has been 150,000 a month for the past 12 months. The growth in winter was skewed by the extremely warm, dry winter, so in “real” terms adjusted for weather the job growth for the past 12 months was probably 120,000 monthly and if that figure was adjusted for population growth then there was a tiny loss of jobs in the past 12 months. And this is despite massive stimulus and tax cuts. Also much of the job growth has been low wage service jobs that have suffered pay cuts. This is deflationary, which explains why the bond market today reached record low yields.
Access the secrets of economics
Since home buying is constrained by the ability to get a loan which is constrained by employment and income then expect home values to stagnate. The exception is for homes located near Silicon Valley or Manhattan or Washington,DC where there are lots of good jobs.
The Treasury bond market has already anticipated and priced in the coming recession, however the economy could get worse than the bond market's forecast, making Treasury yields even lower.
I wrote an article “Record low Treasury interest rates today” and “Bond bull market to continue” and “7 things about deflation you must know”.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, May 14, 2012 @ 05:13 PM
China’s economy is cooling and when it settles down and cools off then there will be a huge drop in the demand for commodities causing the price to drop massively. Since inflation-phobic investors have overpaid for inflation sensitive investments such as commodities and real estate then when these investors are hurt by the very investments that were supposed to protect them then there will be a massive panic sale of those investments when investors realize they were overpriced.
Michael Pettis has an excellent article about the Chinese economy cooling down and the subsequent crash in global commodity prices. A striking article about the world going into deflationary slump because of China’s economic cool down was written by Ambrose Evens-Pritchard.
The main driver of global growth has been China and its global demand for commodities. Once that demand has faded away then there won’t be any major forces driving demand. And once the Eurozone loses its credibility in the fight to save the Eurozone then that will produce a global slump.
"Our feeling is that this commodity super-cycle has ended, and ended really in 2008," said Michael Shaoul, of Marketfield who was quoted by the Wall Street Journal.
The huge tax U.S. increases of 2013, starting in 7.5 months, as well as proposed state government tax increases will create a fiscal drag of 5% reduction of growth from positive 2% to negative 3% and this will also hurt demand.
Massive tax increase coming in 2013 as big as this pile of money
The inflation statistics released on Friday, May 11 show the core crude PPI was negative 1.8% last month and negative 4% in the past 12 months.
The best way to prepare for deflation is to look at the past 22 years of Japanese deflation and see that in Japan that only their Treasury bonds did well; all other investments were a false hope. A similar fate may await the other parts of the developed world, limiting investors to a choice of various investment grade bonds, cash, etc. as they wait for the storm to pass.
I wrote an article “Will China slowdown hurt commodities?”
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Jul 28, 2011 @ 09:01 AM
Diagnosing the government debt problem
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The Treasury debt crisis is due to excessive and ever increasing spending which is due to government paid medical costs spiraling out of control. Non-medical costs are projected to actually shrink. So essentially the problem is the Federal government is in the medical business and does not collect enough revenue to support it.
Advice from a Financial Planner about long term budget projections
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In doing long term financial projections for clients I have noticed how a slight increase in expected investment returns and earned income and a slight decrease in inflation can make a huge difference when compounded over a lifetime.
So when economists forecast the Federal budget 30 years in advance, the problem is that the confidence level of the forecast is going to be very low.
There is the possibility that there will be less expensive new breakthroughs in the development of new medical products. What if there are no new breakthroughs in medical discoveries? The current medical technology will eventually go off-patent and become a cheap generic.
The reason medical care has become so expensive is mainly due to new breakthroughs in medical technology. As a result of these breakthroughs people feel worse off because they have the opportunity to save their life by paying for expensive medical treatments that did not exist. So yes, the cost went up, but so did the benefits. The rising cost of medical care should not be seen as a bad sign because it is a result of new technology. Imagine if someone went to a doctor and said “to save money just treat me with whatever tools existed 40 years ago”. The cost would be much lower, especially if the patient went to a third world country.
More people in the workforce could decide to change careers and become doctors, nurses, physician’s assistants. If society has a 200 year trend of becoming more educated where an increasingly greater percentage of the population becomes highly educated professionals, then perhaps in the distant future a much greater percentage of the workforce will be medical professionals and with the increased supply, the price of medical care will go up less than forecast.
Assuming that there is a long term trend of Japan-style deflation and high unemployment that will continue for five or ten more years then on the margin more members of the workforce will change careers to health care and vendors will develop lower cost treatments. Once those career changers have changed and then the economy gets better then they may not want to change back to their old non-existent career and will stay in health care.
The irony is that rising medical costs incurred by the government have lead to a debt crisis that will be solved by either cutting government spending or by raising taxes, both of which are deflationary and which if done in today's fragile economy will lead to a depression. And as a result of a depression more people will have to change careers to health care.
Unlock the secret: what caused the deficit?
If the U.S. continues to be the first choice destination for educated professionals and for entrepreneurs and it increases this with intelligent tax codes (low income tax rates and high sales tax that is waived for exports) then the economy can try to grow out of its problems. If the country has a disproportionate number of upper middle class professionals who can work past age 65 and afford to pay higher income taxes than if they were in a working class career, then the country can realize a better than forecasted tax revenue. Assuming that corruption and cronyism continue to plague the Third World then more professionals and entrepreneurs will move to the U.S. assuming they are allowed to and are offered competitive income tax rules and rates.
These things are too far in the future to have enough information to do a reliable forecast. However worrying about the unaffordability of government financed medical care is correct, but one must have a positive attitude that macroeconomic demographic and political changes can occur that will be better than forecast.
During the Great Depression many people thought we would never get out of it and during the boom of the 1990’s many thought the boom would last forever. Trends can change. Further, all that extra spending on senior citizens medical care in thirty years has to go somewhere to someone who will earn money providing services, resulting in more income that can be taxed.
I wrote a post "Thanksgiving things to be grateful for". Despite being bearish it is very important to keep positive attitude so as to be open to new opportunities.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, Jul 13, 2011 @ 02:02 PM
Deflationary News Items Imply Bull Market for Treasury Bonds
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Bernanke hinted at starting QE3 today only a month after denying that he would do more QE (Quantitative Easing). "The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might re-emerge, implying a need for additional policy support," Mr. Bernanke said,
Bond experts Hoisington and Hunt said today “… deflation is our largest concern and we remain fully committed to the long end of the Treasury market.”
Komal Sri-Kumar, chief global strategist at bond fund TCW, talked on Bloomberg about the U.S. economy and Federal Reserve monetary policy. He said if he was allowed only one trade he would buy 10 year Treasury for a short term trade and hold until the rate went down to 2.5%. It now at about 2.89%.
Bond guru Bill Gross has reversed himself, reducing bets against the value of U.S. government debt in June as investors sought safety in Treasuries. Pimco’s Total Return fund increased its holdings of Treasury debt for the second consecutive month.
Economists Opening up Mental Doorways to Bond Bull Market
I wrote blog posts “7 things about deflation you must know” and “Ricardian equivalence” warning about how deficit spending can backfire and make the recession worse.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Jun 02, 2011 @ 01:19 PM
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Investment climate moving toward a crash
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The market continues to give bearish signs. The Conference Board Consumer Confidence index is at 60.8. It should be about 73 in a recession and 100 in expansions. On a chart the index has dropped to a level that is at the lows of the 2002 crash. The bad numbers of the past three years where it was below 60 were last seen in the 1992 recession.
There will be no QE 3 and there will be fiscal tightening with budget cuts in August when the Federal government runs out of borrowing authority. The new Republican members of Congress are determined to cut the deficit even if it causes them to be denied reelection. This is a new era of political will power that is rarely seen in Washington and this determination will result in less fiscal stimulus at a time when the Federal Reserve will stop Quantitative easing.
New political battles over budget
The bond market understands the gathering recessionary storm clouds and cut the rate on the 10 year Treasury bond to 2.95% yesterday. The stock market is too busy experiencing a tech bubble to notice that the economic fundamentals have deteriorated, but the stock market will eventually realize the market is overpriced and then it will crash.
I have written “Can independent investment advice protect investors from a crash?”
The Emerging market economies are more fiscally sound than the U.S., so they may be a place to invest for the purpose of reducing the risk of dollar devaluation, or the risk of developed country government insolvency. Important: Get more information in my free Special Report about emerging market currency investing.
Investors should seek independent financial advice.
Photo from Gregory Szarkiewicz
http://www.freedigitalphotos.net/images/view_photog.php?photogid=252
Posted by Don Martin on Tue, May 17, 2011 @ 11:40 AM
Russell Napier forecasts SP dropping to 400
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Russell Napier on was interviewed on Financial Times. He said real rates are negative in most countries and once they go up to normal then that will create deflationary shock, leading to SP 500 plunging to 400 points from the current 1300 range. He favors, as I do Emerging Market currencies.
He said U.S. Treasury rates to go up but the increase could be modest. He likes PE 10 and Q ratio as I do. Fair value in 2009 was 666 for the SP, but it was not a true bottom because no capitulation phase attitude of despair had developed. Negative real interest rates distort equities and when rates are reset up to normal levels that will cause equities to crash. This reminds me of my blog post “U.S. equities are 70% overpriced”.Unstable pyramid?
Shadow banking in China still done by trust companies
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Financial Times ran an article today about non-bank trust lending in China. This is like what I wrote in yesterday’s blog post “7 things about deflation you must know” about shadow banking creating a crack-boom that ultimately leads to a crash. The article said “Traditional trust products surge because of property related products.” So, as in America when the economy booms a borrower tells the lender that based on rising value of collateral the lender should be encouraged to make the loan. This in turn leads to excessive growth and creates statistics that imply strong growth. However some (not all) of the growth would never have happened if it were not for incorrect lending. The ultimate source of the funds are naïve business owners with excess cash who do not understand loan underwriting and merely seek to get a higher rate of return by lending it to a real estate developer. Interest rates of 17% are being paid by developers. This is a symptom of a bubble. It is hard to make a return on assets in excess of 15%, so when someone pays 17% that type of borrower is very risky. This risk implies a crash may follow when the over-idealistic borrower realizes his business can’t produce enough profit to pay the interest he is forced to liquidate, possibly at panic-sale prices, thus leading to downward pressure on asset prices. This in turn would be deflationary or disinflationary especially on commodities since China is using a huge amount of commodities to construct buildings.
Investors should seek independent financial advice.