I’ve Seen Bubbles and I’ve Seen Pain

Here’s something that I can almost guarantee to you.

You live in a house or an apartment.

Am I right?

And the likelihood is that you either own or rent that abode, unless you’re living at Mom and Dad’s, or you kids’ house. Which is great. Having the whole extended family under one roof is a time-honored tradition in some cultures. We housed my in-laws for several years and loved it.

But even if you are in an extended family home, I bet that you’re still interested in the real estate market. The single-family home market just might be America’s greatest spectator and participation sport.  

I was in the real estate business for much of my life, and I was an analyst for much of that time. I worked as a commercial real estate appraiser in South Florida for 15 years. Back in the late 80s and early 90s I appraised a bunch of big, failed projects. One of them was a giant high rise condo project in downtown West Palm Beach. It was one of the earliest failed projects of someone we all know. A big bank got stuck with a whole lot of condos that it could only sell for huge discounts to cost.

I know what can happen when bubbles burst. I’ve been there, boots on the ground. I wrote a bit about my history in the biz here. Oh, I’ve seen bubbles and I’ve seen pain.   

With the latest release of the NAR’s monthly “existing” home sales data showing some serious weakening, I thought this would be a good time for an update.

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I sounded the alarm for you back in early October when I wrote:

The housing market is rolling over.

And it will get worse as mortgage rates and house price inflation continue to rise.

Contrary to popular belief, initially this will make little difference to a booming US economy because housing stopped being a major economic driver after the last bubble collapsed.

But ultimately it will matter, big time.

When prices decline, the financial system will again be in crisis.

Millions of mortgages will be under water again. Homeowners will either walk away from their mortgages, or be foreclosed. The losses will ripple throughout the financial system and markets, just as they did 10 years ago. And taxpayers will be forced, yet again, to pay for the bailouts of Fannie and Freddie, because this time, we own them.

Ultimately, another housing collapse would trigger the Fed to reverse policy, but that’s still many months away. The Fed will continue to tighten the screws until well after the new crisis becomes apparent. Powell affirmed as much at his press conference when he said that the Fed won’t lower interest rates until there’s a sustained financial decline. And we should well remember just how long it took Bernanke to even acknowledge there was a problem.

So how long do we have? That’s hard to say. But here’s a little clue:

Transaction volume seizes up prior to price decline.

Now here’s the housing news you need, and what to do about it.

Home sales have begun to collapse

Here’s how NewsCorp’s Wall Street Journal, the public relations arm of another NewsCorp subsidiary, Realtor.com, spun the Tuesday’s release. They were surprisingly downbeat about it considering that the two subsidiaries are joined at the head:

Home Sales Dropped in December; Price Increases Slowed

Decline of 6.4% suggests sluggishness in the housing market may persist into 2019

“Home sales tumbled in December to their weakest level since 2015, ending a difficult year at a new low and offering fresh evidence that the housing market could be in for a bumpy ride in 2019.”

A bumpy ride? There are those euphemisms again. It’s like never having to say “inflation” and housing in the same report. For home prices, it’s always price “growth” or “appreciation.” I guess “bumpy ride,” is their word for a declining market or, heaven forbid, a crash.

As always, the news reports stick with the seasonally massaged data. We prefer to look at the real thing – the actual, not seasonally adjust (NSA) numbers. We can compare the month to month change with the same month in the past 10 years to get an idea of how the market is faring. I also like to look at the annual rate of change over the past 12 months to see which direction the market is headed.

Here’s how the current NSA numbers stack up.

Sales contracts, which the NAR calls “pending homes sales,” fell 7.7% year to year. In December, prior sales contracts that closed, which the NAR calls “existing home sales,” fell 11.7%.

Month to month, November contracts had crashed by 21.3%. Lead times from contract to closing are typically more than a month, so December closings fell only 7.1%. Based on the huge drop in November contracts, and the fact that closings only fell 7.1% in December, I’d expect a gigantic decline in the January existing home sales when the data is released in late February.

But how did the latest data look compared with the past 10 years? The November drop in contracts tied 2014 for the worst performance since the housing crash was in full swing in 2009. The drop in December closings was by far the absolute worst since 2009. In fact, normally there are more closings in December than in November. The current number is catastrophic.

There’s every indication here that the market is beginning to seize up.

Volume Leads Price and We’re Almost There

Once volume starts down prices follow. That’s what happened in 2006-2008. It’s simply a matter of supply and demand. High prices and rising interest rates start to bring forth more sellers, but demand has already started to decline, thanks to the same forces.

Sellers tend to be recalcitrant about accepting reality. They keep their listing prices high, hoping for the best. But the buyers are gone. Then, suddenly, a few sellers lower their asking prices. A few houses sell as prices start coming down. And the rout is on.

Prices fall rapidly as transaction volume plunges. As prices fall below loan values, next come the foreclosures, the jingle mail (when under water home owners simply mail in the keys) and the waves of foreclosure inventory. It’s a bad scene. We all remember it.

And now we have evidence that, indeed, price inflation is starting to come down. The year to year change in the median sale price has dropped to just 2.9%. A year ago, the annual house price inflation rate was at 5.7%. The inflation rate peaked in January of last year at 5.9%. Since then the inflation rate has been halved.

Click to view full size.

Here’s another way to visualize the change. House prices have a seasonal rhythm, normally peaking in summer. In 2018, prices peaked in June at a median of 273,800.  The median price in December was $253,600. That’s a decline of 7.4%. Over the previous 4 years, the June to December decline was never more than 6.4%, and that was just last year.  

Back in October I made a recommendation on how to play a weakening housing market for a stock market profit. I’ll follow up on that tomorrow so stay tuned right here!

Meanwhile, I’m still recommending being out of stocks, while collecting interest holding Treasury bills in a Treasury Direct account. You could still potentially gain big profits from market moves regardless of direction with options. They can multiply your trading account, but the risk is 100% so it’s critical to limit the size of your trades and manage them accordingly.

A trading game changer: What you need to know to get the most out of your profits in 2019

Regards,

Lee  

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