The bills for the housing bubble and all the debt that's been run up in the last few years are coming due. That means pain for stocks, for homeowners and for consumers with too much debt.
By Bill Fleckenstein
At a speech presented to the precious-metals conference in May 2004, I introduced the concept of "The Next Time Down" -- a bearish process that has begun to unfold, some two years later, in the financial markets and economy. (Obviously, I was early, as usual.) This week, I would like to give readers an update as to where I think we are in the process. First, though, a quick synopsis, which comes directly from my speech:
"The 'use-your-house-as-an-ATM-to-live-beyond-your-means' stimulus is finished, thanks to the recent de-leveraging/crackup in the bond market. The refi game and the bull market in housing it created postponed the consequences of the largest stock market bubble in history. Though the Fed and the rest of the government succeeded in postponing the fallout from the massive misallocation of capital that took place in the mania, they have also succeeded in compounding and exacerbating those consequences. Even more leverage was created in the system, as we attempted to speculate our way to prosperity.
"In short, the excesses from the bubble have not been cleared away, but they will be, along with the recent excesses from the refi bubble … These developments will tend to be self-reinforcing, and especially damaging, if and when housing prices join the decline."
Exhaustion: built into a bubble
The Federal Reserve precipitated, aided, abetted and cheered the largest (by dollar volume) stock mania in the history of the world. That mania exhausted itself in 2000. The exhaustion was not caused by the Fed tightening, contrary to what many folks believe, any more than the 1929 market break (and ensuing Great Depression) was caused by Fed tightening.
Manias end in exhaustion, though there are always coincident events surrounding the end of the move that get blamed for the decline. In both 2000 and 1929, higher interest rates were present, but they were not the cause. The preceding bubble was the cause of both the subsequent exhaustion and the ensuing bust.
Stock-splits out, split-levels
In an attempt to avoid the consequences of the late-1990s stock mania, the Fed managed (after 13 rate cuts and several tax cuts) to precipitate a bubble in housing. That bubble, in my opinion, is a far more dangerous problem than the stock mania was, because of all the leverage involved -- and the damage that will eventually inflict on the financial system, in addition to consumers whose overspending ways will be throttled back as the housing mania unwinds.
The next time down has been slow in developing, due to the fact that the housing bubble lasted longer than I would have expected (bubbles always last longer than anyone expects). And that is mostly due to the incredible abdication of responsibility on the part of all manner of lenders. That the public was gullible enough and willing to take on the debt is somewhat surprising (given that many people were burned by the preceding stock mania), but it wasn't shocking.
As I noted in two previous columns ("Straight talk on what the Fed has wrought" and "It's RIP for the housing boom"), the housing mania peaked a year ago. Mortgage applications have declined since then, transactions have stalled out and inventories of new and existing homes have grown. Last week's release of May existing-home sales showed that inventories climbed to 6.5 months. To put that into perspective:
In the spring of 2003, when the economy was near the lows, existing homes for sale stood at five months' worth of inventory.
In the middle of 2000 (not exactly a weak period), the number was about 4.2 months.
Thus, we are on the verge of a big down-leg in housing prices.
Overview of an aftermath
The next time down will be a time where people will be squeezed financially, because their main asset, i.e., their homes, will be declining in value. Meanwhile, their loan will be rising as a percentage of the value of that house and, in many cases, may ultimately pass 100%.
Jobs will be difficult to come by, as they have been for many, and that's a lingering residue of our prior stock mania and our general lack of competitiveness (productivity protestations to the contrary). It will indeed be a very ugly period, as the economy shrinks and people scramble to figure out how best to service their enormous debt loads. This will play havoc with the dollar, and I believe the "vaporization" of the dollar will be part-and-parcel of the next-time-down scenario.
When unmasked at last
Meanwhile, the Fed will become thoroughly discredited at some point. It will ultimately be seen as the culprit that created the conditions for the bubbles (the cause of the next time down). And, more importantly, the Fed will be seen as impotent to do anything about it. The Fed will cut rates, which really won't be effective, though it will put tremendous pressure on the dollar. Of course, the Fed won't care about dollar weakness until it's a problem, in the form of funding the Treasury market.
So, in the environment that I envision:
Stocks will decline dramatically in value.
The dollar will see serious weakness.
Foreign currencies (as lame as they are) will do well.
Precious metals will do the best, because they are currencies beholden to no central bank and without liabilities.
We are now only starting the process with metals, and metals (as well as foreign currencies) have done well before the point in time where I've felt they would provide debasement insurance. And, when we are in the period that I see us eventually entering, metals will go up, even as stocks go down. Likewise, metal stocks will rise, even as stocks generically decline.
En route to the zero-correlation zone
None of that has been the case thus far, because just the opposite of what I expect to happen has happened. By that I mean: The Fed has managed to maintain its credibility.
Currently, everyone is afraid of the Fed, which causes all asset classes to trade off together. Thus, there is no discrimination among them (creating casual correlations that will turn out to have been ephemeral). As you can see from what I've said, I expect quite a good deal of discrimination prospectively.
No comments:
Post a Comment