The Barnard Observer
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Home Picks Figures Great Investors Vault OpEd Contact c2003-04 Thomas Barnard
The Housing Bubble Hasn’t Popped Yet
Well, I’m paying 80 bucks a year for this website and for months now I’ve had nothing much I felt like writing about.
Yes, I think there is a housing bubble. Just because things are going along handsomely now does not mean that things will continue that way. In the late 1990s everyone knew the market was toppy, but we all stayed in and rode it down (thinking it was another buying opportunity).
Originally, I thought that higher interest rates would be the thing that brought the house of cards down in the home market (and it’s still possible, see below), but now I think it could just be a speculation and exhaustion cycle. U.S. interest rates are already higher than the rest of the world's, so money from the rest of the world keeps finding its way here to take advantage of those rates, and that oversupply of cash will keep rates from rising. As a result of being a magnet because of the higher interest rates, the dollar has been going up against other currencies.
And if the economy slows down, Greenspan and his successors will likely lower interest rates to break the fall. Unless inflation picks up, and even higher oil prices have had little impact, it doesn’t look like they’ll need to raise rates to break the back of inflation.
No, I think it’s going to be sheer speculation that pops the bubble, though it may get aided by things like higher assessments and higher property taxes. It is estimated that 20% of all home purchases are made by people who intend to flip ‘em. The problem will arise when there aren’t enough end-buyers for the flippers to flip to.
Fortune reports that 1.2 million new households are formed each year, but they’re building 2 million homes. Classic oversupply.
Another tipoff that it’s going to be speculation that ends the housing bubble is the myriad ways the lenders are confabulating (if such a word exists) the loans. 100% loans, no-interest loans, ARMs, 40 year fixed loans. Loans where you pay only part of the interest, and the rest of interest gets added to the loan amount. Pretty soon there will be 100 year fixed loans and mortgage loans with credit card attachments, so you can add your credit card balances to the mortgage.
And loan standards are falling. “Bankruptcy? No problem,” read a fax I received. The number of no-doc (no documentation) loans is rising dramatically. No-doc loans for the uninitiated, are loans that do not require the heavy underwriting of a regular loan. They are considered lower quality loans than regular underwritten loans.
I suspect that when the bubble bursts that that will be the end of 100% loans for a good 30 years. Banks will once again demand substantial down payments to protect themselves against a loss of value on the property. In 1929 before the crash, stock buyers only had to put down 10%, afterwards the Fed insisted on 50%, where it stands today, 75 years later.
Certainly, the banks making these kinds of crazy loans are shorts. I have not identified any such banks as yet. But who in his right mind assumes 100% of the downside risk for a measly 5%-6% per year? The fallout will be substantial.
Another thing which tells you that this cannot go forever, though the creative mortgage bankers will try to keep it afloat, is that housing prices are rising 20% in some places, but incomes are only going up by dribs and drabs. There’s your ultimate ceiling.
Is the housing bubble an isolated phenomenon? Well, yes, to start. It’s the new construction that gets the 100% loans, and that’s where the flippers are. So, that’s where the pricing damage will start. When they can’t find buyers. It will continue when a recession kicks in and young buyers can’t make the payments on their condos, and walk away. When people lose their jobs.
The bankruptcy law may provide some protection to these lenders, giving them better access at the lenders, but this will backfire in the long run, because it means that those least able will have to make good, and for a consumption economy, this is a disaster.
It's official. I saw it on CNBC: the insiders are selling the home builders in quantity. Some of the homebuilders will eventually run into trouble. Get ready to pick your short.
The Chinese have finally released some of their control of the yuan. There are two possible effects of this. One is that if the Chinese quit buying so many dollars, it may take higher interest rates to attract the same amount of money. Another is that Chinese goods may start to go up in price, and higher prices could mean higher inflation here, and for that, the Fed would have to raise interest rates. Higher interest rates will quickly snuff out the housing boom.
Is Google too high? Well, I think it’s great company, but like the banner ads of the 1990s, I think the pay-per-click model may also run into trouble. Already, advertisers are angry about paying for the pranks of those who click with no intention of following through. I did this myself inadvertently, and was admonished by someone at the other end of the line, who told me, “Please be careful. We pay when you click on our box.” I said to that person, “Why should I?”
When things slow down, advertisers will get very wary, and I don’t think that Google will be the exception. The PE on Google is 84. Earnings are going to have to go up a lot not to suffer a significant investor upset at some point.
So, I think Google’s in for a hit, but I’m not shorting it. It’s too volatile, and it has a great following and not such a big float.
Investors Intelligence readings are 55.9% Bullish, and 22.6% Bearish. As a contrary indicator, it is too bullish to be very positive.
Value Line is slightly negative with a VLMAP (Value Line Median Appreciation Potential for the next 3 to 5 years) reading of 50%, but Value Line is advising clients keep 80% in stocks and 20% in cash, which is bullish.
The Dow Theorists are nonplused, waiting for either a bullish signal (going above the March highs), or a bearish signal (going below the April lows).
The VIX with a reading of 12 shows there is not much volatility. In other words, everyone is pretty relaxed, which is not positive. No one’s climbing any wall of worry.
Insiders appear to be selling less than they were, and that can only be viewed as positive, though they have been selling a lot the last few years and the selling can come as much as two years before the correction.
To sum up, I don’t think the market is telling us very much from a technical point of view.
There have been plenty of negative news stories. The Fannie Mae news story was very adverse, and as far as I know its capital position still needs to be improved by $9 billion per its federal oversight commission.
Ford and GM have terrible finances. Their bonds now sport junk ratings. They can’t sell their SUVs without giving away the store. But Kerkorian thinks it’s bargain and wants to buy 9%, and he can’t even get all the shares he wanted. And the stock’s back up to $36 from a low of $25.
Oil keeps pressing higher ($61), and the Fed keeps raising interest rates. There’s a housing bubble that will be popped someday. But the market doesn’t seem to care.
Sure, I think low interest rates have stolen sales from future demand for both autos and homes, but until overall sentiment changes, I think stocks will drift higher. Earnings have been good, by and large, and that will help.
Investment Advice
Suncor (SU - $51) still has interest for us even though I liked it a lot better when I originally recommended in January at $32.50. Huge reserves, stable location (as compared with the Middle East), reasonable cost of recovery. Risks: worldwide recession and concomitant reduction in demand, and the high price of oil may encourage oversupply by producers. You might consider an airline company against the price of oil dropping, but I am not necessarily recommending that at this time.
I have other suggestions but I have decided that I will reserve those ideas for people willing to invest with me, although I’ll make some hints further down. I have set up an entity called The Barnard Partnership. Warren Buffett’s partnership (in the pre-Berkshire days) paid him 25% above 6% return guaranteed to partners. That’s too complicated for me. I want a straight 20%. If you’re interested, email me at tbbarnard@yahoo.com.
I’m not going to present my ideas with enough keywords for a Google search, but I will hint. Mining, but I’m not going to say anything beyond that (of course it has something extra). Mining generates 35 million Google hits.
Internet telephone (56 million Google hits). It’s hard to find a good pure play here, and I don’t think you’ll ever find it searching on “internet telephone.” Pretty soon all of the baby Bells will be offering this service. Telephone prices will go down some more, so obviously I’m not big on the baby Bells. But my play may not work out either, although it’s pretty interesting. I tried to find a pure play for cash machines in the 1980s, and could only find Universal Money Centers, which might have been okay except the owners fleeced it. So, it went to zero. The problem was that there never was a real good pure play on cash machines.
What else? A home building materials company (just in case the housing bubble continues) with a special product. No earnings yet but sales are increasing right along at a high rate.
Oil, maybe. Nanotechnology, maybe. Something in China. A biotech with a general cancer cure. Sorry, but I’ve been reading Business Week and Fortune since I was 13, and while everyone feels stock picks should be for free, I think I’ll favor those who favor me. Winners? I’ve had plenty. (Losers, too). A couple of years ago I owned both Sirius and XM radio, and made 200% even selling early. I think they’re overpriced now because there is something coming up which could knock them out of the box, satellites and all – internet radio. And this is scary to me, because maybe they were only worth owning for a very few years. You may be able to scalp a few dollars off the news stories, including Howard Stern.
It’s not a great time to invest, P/Es are too high. In December 1974 I bought on the last day of the bear market. It was an accident, but I will confess I thought prices were low. The stock I bought was the hospital company American Medical International at $3 per share. The P/E was 3, (I remember it was earning $.97 per share) it was high on Value Line’s 3-5 year list. I subsequently sold at $9, but it went to $90. The downside risk was minimal (I bought it at the very bottom). The upside was fantastic. But now average P/Es are like 19. I have to work very hard to find stocks with spectacular prospects. They feel flimsier to me, the earnings aren’t there, and I’m not satisfied the downside is so minimal as it was 1974. Going back to XM and Sirius – neither one is making any money (that's what I mean by flimsier) but they’ve gone up 10 times their lows. So, the money-making opportunity was spectacular.
Good luck to all serious investors.
August 3, 2005