Toro's Running of the Bulls Market Blog

It's Getting Stupid Again

The oceans of global liquidity are making their way to the usual places.

The World Bank warned Tuesday that the sudden reappearance of billions of dollars in investment capital in East Asia is "raising concerns about asset price bubbles" in equity markets across Asia and in real estate in China, Hong Kong, Singapore and Vietnam. Also Tuesday, the International Monetary Fund cited "a risk" that surging Hong Kong asset prices are being driven by a flood of capital "divorced from fundamental forces of supply and demand." ...

"This is the beginning of another big and excessive run-up in asset prices," said Simon Johnson, a former IMF chief economist.

The symptoms of a frenzy are most evident in Asia and the Pacific, where economies are recovering most quickly. In Hong Kong, high-end real-estate prices are soaring. A luxury flat in the tony Midlevels district is expected to sell for US$55.6 million, or $9,200 a square foot, said developer Henderson Land Development Co. Elsewhere, a bidder at a city-run auction to operate food stands at February's Lunar New Year celebration recently paid a record US$63,225 for the right to occupy a 400-square-foot stall to sell fish balls and other snacks. Prices in the auction of 180 stalls were up 33% from 2008.

Over the summer, a Singapore condominium developer raised prices 5% the day before units went on sale. After dozens of would-be buyers lined up on a steamy night, the developer -- a joint venture of Hong Leong Group and Japan's Mitsui Fudosan -- held a lottery for a chance to bid on the units. Singapore home prices rose 15.8% in the third quarter, the fastest rate in 28 years.

Australian real-estate markets also have heated up. After a Melbourne property-research firm recently predicted that average home prices will double over the next 12 years, a news report in Australia's Herald Sun said: "The staggering prediction shows the importance of buying a home as soon as you can afford it because the longer buyers delay, the more chance there is that their dream will slip out of their reach."

It is like a bad movie that we have seen all before.

In the meantime, I am under contract to buy a piece of land, which I will expound upon in the coming weeks.  One might as well take advantage of the world's policymakers' attempts to reflate the global economy and asset prices.

"The New Economy" and the Hot Canadian Housing Market

I have made the case on a number of occasions that the Canadian real estate market, or at least parts of it, have been in a bubble.  As someone who grew up in Saskatchewan, it was mind-boggling to me to see the prices of homes in Saskatoon - a city surrounded by prairie with -40C temperatures in the winter - double in two years such that Saskatoon became a more expensive city to buy a house than any city in the United States outside of the pacific coast, New York City and Boston.

I do not often agree with the columnist Murray Dobbin, and I am not sure if I agree entirely with the conclusions in this article, but relying on a report issued by the National Bank of Canada, Dobbin argues that Canada may not be as different as America as some Canadians think.

Some have made the argument that there is no housing bubble in Canada, and that because there has not been a concurrent collapse in housing, everything is fine.

This, in my opinion, is a logical fallacy, not dissimilar to the arguments heard during the Tech Bubble, c1997-99.  The fact that a market is different or has not collapsed does not mean it is so different and will not collapse. 

US bank stocks did not look like they were in a bubble in 2006 based on any metric one looked at - current earnings, forecasted earnings, book value, tangible book value, and so on.  And they were not.  But they were dangerous investments nonetheless because the assets that supported those valuations were overvalued.

Similarly, the Canadian housing market may not look like a bubble, but the structural foundations on which those home prices are based are probably flawed.

Let us review points of the broad economy of the past 10 years, one in which most economists either dismissed or ignored.

• A tech and stock market bubble formed in the 1990s.
• The Federal Reserve pumped large amounts of liquidity in the economy to save the world from the collapse of Long-Term Capital Management in 1998 and Y2K in 1999.
• Mainstream economists focus on inflation in prices paid.  They do not focus on inflation in asset markets.  In fact, many economists believe asset bubbles cannot happen, though fewer do so today than 10 years ago I would imagine.
• The stock market bubble collapsed.
• In response, the Federal Reserve cut interest rates to 1% and held them there for a year.
• Monetary aggregates in the early part of the decade grew 20%+. 
• Central banks around the world, particularly in Asia, begin buying dollars by the trillions to avoid currency appreciation, creating a flow of liquidity into global asset markets.
• Housing prices start to rise
• Wall Street ramps up securitization, creating all sorts of derivative products and off balance sheet structures, channeling more liquidity into the financial system
• Housing prices in many countries rise three, four and even five standard deviations above long-term trends and disconnect from other valuation metrics such as price relative to rent and affordability.
• Many economists say housing is not in a bubble, and that home prices are unlikely to fall much because they haven't since the Depression, including our esteemed Fed Chairman in testimony before Congress in 2006.
• Commodity prices explode because of 1.) Structural global supply/demand imbalances, and 2.) liquidity created by central banks and asset allocation decisions by large institutions such as pension funds.  As it pertains to (2.), oil goes to $147 a barrel even as demand is dropping and supply is rising, and commodity futures markets such as oil go into almost permanent contango. (Pension funds buy further out on the futures curve to take advantage of the "roll," whereby outer-dated contracts are cheaper in backwardation and "roll" up the curve to the spot price.  Roll accounted for roughly two-thirds of commodity futures index returns from 1950 to 2000.  Everyone trying to replicate this strategy creates demand out on the curve, driving future prices up, creating contango.)
• The housing bubble pops.
• The financial markets have their worst collapse since the 1930s.
• The economy plunges into arguably the worst crisis since the Great Depression.
• The Fed drops the funds rate to 0% and supports much of the credit markets.  Government stimulus, including both monetary and fiscal policy, accounts for an unprecedented 30% of GDP.
• Asset markets, such as stocks and commodities bottom and begin to take off.

Now, let us put this into a Canadian perspective, with some unique Canadian facts.

• Canada gets its house in fiscal order in the mid-1990s, becoming arguably the best run developed country in the world after being perhaps one of the most fiscally irresponsible during the 1970s and 80s.
• The Canadian economy, which is heavily reliant on commodity prices, takes off, particularly in western Canada.  However, the strong loonie hits the manufacturing base of eastern Canada.
• Hedge funds became far more prominent in the financial markets.  With the advent of technology, they search the world to take advantage of arbitrage opportunities and carry trades.  (A carry trade is when a fund borrows in a country with a lower interest rate and lends in another country with a higher interest rate.)
• Hedge funds and other financial institutions begin to allocate more money to Canada because of the commodities boom and because of Canada's fiscal position.  The Canadian dollar, aka "the loonie" rises above par vis-a-vis the greenback and hits a multi-decade high.  
• Liquidity floods into Canada, driving up asset prices, including home prices.
• Canadian banks were not as reckless as American financial institutions.  Banking is better regulated in Canada and banks hold more capital than their American counter-parts.  Banking is essentially an oligopoly, with six banks accounting for about 80% of the market in the country.
• Because Canada's financial system is stronger, there is less forced selling of financial assets.  A "death spiral" - whereby lower financial asset prices leads to impaired capital in the banking system, which leads to more selling, which leads to lower prices, which leads to more impaired capital, which leads to more selling, and so on - is fairly absent in Canadian fixed income markets.
• Therefore, Canadian housing prices fall less than their American counterparts as capital is not as constrained.
• Governments and central banks institute enormous amounts of stimulus around the world, depreciating the value of fiat currencies and increasing the prices of real assets, including commodities.  Stimulus in China is rammed through the financial system as banks are told by Beijing to lend, leading to stock piling of raw materials in China, and higher commodity prices
• The Canadian economy is highly reliant on the United States.  Roughly 40% of the Canadian economy is dependent upon exports, and 80% of Canadian exports go to the United States. 
• The US government's and the Fed's actions are bearish for the US dollar.  The US dollar becomes the currency to finance the global carry trade.  The dollar begins to fall and the loonie begins to rise.
• In response, the Bank of Canada keeps interest rates low to offset the weakness in the US and to avoid the loonie from rising too high against the greenback, lest the strong loonie wipes out the manufacturing base of eastern Canada.
• Low interest rates spur borrowing for mortgages.  Sales of Canadian homes reaccelerate.  In some cities such as Vancouver, home sales over the past few months are breaking all-time highs.

Because both the Canadian financial system and Canadian fiscal policy are better run than in the United States, the fall-out in Canada has been less severe than in America.  Canada is a beneficiary of global liquidity creation as it lowers Canadian interest rates and keeps commodity prices strong. This liquidity is being channeled into the Canadian housing market.  Canada does not need as much stimulus as the rest of the world, but the global carry trade is channeling liquidity and capital back into the country, igniting the Canadian housing market once again.

This is very similar to what happened in the US housing market in the early part of this decade.  In 2001-03 in Silicon Valley and Manhattan, even though thousands of people were being laid off in northern California and New York City as a fall-out from the tech bubble implosion, home prices rose. There was brief dip in home prices in Silicon Valley but the massive amounts of fiscal and monetary stimulation stabilized and buoyed housing markets across America.  The Fed's policies at the beginning of the decade created vast secondary and tertiary unintended consequences, leading to the housing bubble. 

Now, in the "New Economy," where asset prices are of the utmost importance, similar distortions are being created. The fact that home sales are breaking records in some Canadian cities does not reassure me.  It frightens me.  It tells me that we have merely delayed the inevitable and are setting up for possibly worse consequences down the road, as we did at the beginning of this decade. 

There are structural reasons for higher asset prices in Canada.  However, there are still enormous imbalances in the global economies, and Canada may now be more vulnerable than most countries to the massive global liquidity creation now occurring, given that the imbalances favour commodity-based economies.

We now live in an era where governments actively support asset markets.  I dub this "The New Economy," whereby asset prices are a major input into the decision-making process by policy makers.  The enormous flood of liquidity and support by governments of asset markets is having secondary and tertiary unintended consequences, which are likely to be massive and have major ramifications in the future.  The Canadian housing market is a major benefactor of The New Economy.  The end-game is unlikely to be pretty.

Miami Condos Down as Much as 87%

When people are lining up overnight to put down chunks of money to buy a condo that does not yet exist - as they were in Miami as well as other places - you should be running away as fast as you can.

Condos on which they made deposits of up to $1,000 a square foot in 2006 are now selling for $125 to $350 a foot, said Jack McCable, a real estate consultant in Deerfield Beach, Florida.

The Religion of Rationality

Academics in the social sciences rely on theories and models of human behavior.  For academics whose entire career and livelihood depends on their theories, events that challenge their theories threatened their existence.  Thus, there are powerful incentives for those whose theories are challenged to explain away the events that undermine their credibility.

A foundation of classical economics is that people make rational decisions, or at least enough people make enough rational decisions such that their rationality nullifies the irrational.  From time to time, however, real events challenge this assumption.  In financial markets, these events are known as “bubbles,” which seem to be occurring with greater regularity. (And given the recent actions of the authorities, there is no reason to suggest this will change anytime soon.)

As one might expect, the revisionism and rationalization of the housing bubble amongst academics who say that the market was not irrational is already occurring.  At the blog Causes of the Crisis, Jeffrey Friedman argues that home buyers were not being irrational.  Why?

[I]n reality, very sober housing experts and economists (including Ben Bernanke) agreed that there was no bubble, and there was nothing “irrational” about this consensus.

First of all, there were several economists who thought otherwise, including Nouriel Roubini and Robert Shiller, as did investors such as George Soros and Jim Rogers, as well as academics such as Nassim Taleb.  Heck, even us shmucks at Running of the Bulls could see the insanity of the housing markets, and we certainly do not offer any pretense of being particularly wise and intelligent!  That we got it right and all these “experts and economists” got it spectacularly wrong is more cause for shame and embarrassment than them actually getting it wrong!

The fact that a “consensus agrees” does not make it correct.  By this logic, there was nothing irrational about the Nasdaq trading at 100x earnings when it peaked out in March 2000 at 5132 because the market “consensus” said that was what the Nasdaq was worth.  Many investors and economists at the time also argued that the Nasdaq was not a bubble.  This is not only specious reasoning, it is dangerous both to the economy and to your own pocketbook and well-being.

Friedman goes on.

After all, housing prices had risen steadily since the Depression as the U.S. population grew and its affluence increased. Why shouldn’t people keep buying bigger, more expensive homes? There had never been a significant nationwide housing bubble, and housing speculation in “hot” markets such as Miami and Las Vegas could be quite rationally dismissed as localized.

Friedman assumes that people logically processed these facts and rationally made decisions based on this information.  In fact, these were the reasons why people acted irrationally.  Because people believed such, they had a foundation for throwing caution and reason to the wind because they believed they could not lose.

I often wonder if the academics who purport this view ever actually talked to anyone who was involved in the housing market.  Yes, some were rational but many were not.   Amongst one of many examples I encountered, my friendly but uneducated neighbor who knows nothing about investing would become excited about the fortune he was going to make investing in coastal real estate in 2006, and he would cite these reasons in his excitement (not to mention other “truths” that are always bandied about at the top of the real estate market, such as “land is limited”).

The idea that this behavior is “rational” comes from the mistaken belief in financial economics that Larry Summers described as “ketchup economics,” whereby if two 16 ounce bottles of ketchup are priced the same as one 32 ounce bottle of ketchup, the price is “right” and the market is rational.  This construct excludes concepts of intrinsic value and comparisons to price. 

Using Friedman’s logic, economists and investors argued that Cisco at 100x earnings in 2000 was “rational.”  After all, people had seen tech stocks rising to astronomical heights, with tales from friends and neighborhoods of instant wealth in tech stocks.  The advances in technologies, the story went, meant astronomical profits for tech companies.  Talking Sock Puppet Companies were “rationally” valued at over $1 billion and 100x sales because people would buy endlessly buy pet food over the Internet.  It is hard to believe that anyone who lived through that period could take such logic seriously.

In the above quote, Friedman makes no mention of the intrinsic value of a house.  One would think that if one were rational, one would undertake a discounted cash flow valuation of the cash flows of owning real estate relative to renting, estimate a sale price, then make a decision based on their calculation.  The number of people I know who did this was zero.  Instead, all people usually cared about was if they could afford the monthly payment. Homebuyers rarely calculated the value of the house and whether or not the price they were paying made sense relative to the intrinsic value of a home.

To the “rational” investor, the price of the asset will approximate its intrinsic value.  When the price becomes unhinged from its intrinsic value, the asset becomes irrational.  This is what happens during bubbles, including the housing bubble.

In any given market, there are always rational and irrational agents.  Markets tend towards rationality over time but are not always rational at any given time.  The level of irrationality in the market is a function of the both the number of irrational investors as well as the intensity of the irrationality.  Irrationality manifests into momentum.  Momentum investing is not always irrational but irrational markets are dominated by momentum investors. Momentum investors care not about intrinsic value.  They only care that the market is going up.  100x earnings?  Who cares?  Losses forecasted for a decade?  Doesn’t matter.  It is the price action that matters.  In a momentum-driven market, nobody is rationally calculating the value of an asset.  It is totally irrelevant.

I have spent nearly 20 years in capital markets, and I am always amazed when people tell me that irrationality does not drive markets.  I often wonder if these people have any actual experience at all. Markets are often driven by greed and fear.  The idea that people were rationally selling stocks at the bottom in March is laughable.  They were scared out of their mind. 

……………………..

Friedman attempts to debunk three myths of the crisis, of which the irrationality of markets is supposedly one.  He sets about two other so-called myths, executive compensation and the failure of capitalism.  I am not going to comment on his other two identified myths except for one – Friedman’s comments on MBS securities purchased by bond managers. 

Perhaps the most powerful evidence against the executive-compensation thesis, however, is that 81 percent of the mortgage-backed tranches purchased by banks were rated AAA[5], and thus produced lower returns than the double-A and lower-rated tranches of the same mortgage-backed securities that were available. Bankers who were indifferent to risk because they were seeking higher return, hence higher bonuses, should have bought the lower-rated tranches universally, but they did so only 19 percent of the time. And most of those purchases were of double-A rather than A, BBB, or lower-rated, more-lucrative tranches.

Now, I have not read the piece Friedman references, so perhaps I am wrong.  However, it appears that the author may be making incorrect assumptions about portfolio construction when drawing this conclusion.  His conclusion is only true if the portfolio manager’s choices are limited to mortgage investments, and if the asset allocation of mortgage bonds was at or below policy targets.

Some institutions have a target allocation towards credit ratings.  If a bank has an allocation towards AAA-rated securities, the money manager will often view AAA-rated mortgages the same as AAA-rated Treasuries since both are rated AAA.  However, even though both may have been rated AAA before the crisis, yields for AAA-rated mortgages were 20 to 40 basis points higher than AAA-rated Treasuries.

Managers are compensated based on their returns relative to their benchmarks and to their peers.  If a manager has a pool of AAA-rated securities from which to choose, he will attempt to pick up yield by shifting his allocation away from Treasuries to mortgage bonds because if he does not, then he will lag his peers and perhaps the benchmark.  Thus, it may not be correct to look at the breakdown of holdings within the different tranches of MBS in isolation, as Friedman appears to do.  Instead, the correct analysis would be to look at the breakdown of holdings within the allocation towards each rating.  How many more mortgage bonds were held relative to Treasuries compared to the past?  I do not know the answer to this, but my guess is that given that securitization exploded this decade, and managers probably shifted fund from Treasuries towards other AAA-rated securities such as mortgages.  And as we now know, many of those AAA securities were garbage.

Likewise, money managers will make decisions based upon policy targets.  If policy targets shift towards holding more structured products, the money manager will be forced to buy more structured products.  Again, I have no empirical data to back it up, but it is not unreasonable to assume that there was a policy shift towards structured products at institutions this decade as derivatives and structured products became more prevalent within fixed income. 

Unless I am wrong and the secular shifts in structured products are accounted for in the data Friedman cites (and I will acknowledge such here if shown otherwise), the composition of holdings within the mortgage market does not tell us anything about riskiness of portfolios and thus executive compensation.

No Real Estate Bubble in Canada?

Most of my focus on the bubbly Canadian real estate market has been on Western Canada.  This is primarily because over the last 10 years, Eastern Canada, i.e. everything east of Manitoba, has not much mattered in the global scheme of things as global investor demand has been focused on Western Canada, where things can be dug/mined/drilled etc. out of the ground.  It is out west where the bubbly activity in the housing market has occurred.

Worthwhile Canadian Initiative - one of my favourite economics blogs - cites data from Teranet to bolster their argument that Canadian home prices are not in a bubble.  It is an index akin to the Case-Shiller index in the US that tracks the changes in home prices in six Canadian cities - Vancouver, Calgary, Toronto, Ottawa, Montreal and Halifax.  According to the Teranet index, home prices rose 8.9% per year from 2003 through 2007 across the six cities in the index.

 

That may fast, but it is not a bubble.  So props to the economists.  There has been no bubble in all of Canada.

But there was no bubble in all stocks in the 1990s either.  Instead, there was a bubble in a select group of stocks, in particular technology and some growth and large-cap stocks.  Equal-weighted indices of stocks began peaking out at the beginning of 1998 while the bubble continued for two years. 

Thus, what is interesting is what occurs underneath the indices.  And from 2003 through 2007, home prices out west exploded.

 

Home prices doubled in Calgary and nearly doubled in Vancouver whereas they grew more slowly out east.

This is a graph scanned from Garth Turner's book, Greater Fool, of the Calgary real estate market from 1992 to 2006. (I apologize for the low quality.  Here at Running of the Bulls, you get what you pay for!)

This is what a bubble looks like.  It does not matter if the bubble is in stocks or real estate or commodities or paintings or fine wines.  When prices go unrelentingly straight up, this is almost always a sign that prices are disconnecting from fundamentals.

We also noted here and here the utter silliness of home prices in Saskatoon, where prices doubled in two years, and became a more expensive city to buy a house than most cities in the United States, even though Saskatoon is completely surrounded by farmland, is -40C for at least part of the year, and the population of Saskatchewan is about the same as it was 60 years ago.

Western Canada is where all the action has been. The demand for raw materials pushed up the value of the Canadian dollar, aka "the loonie," which was enormously positive for Western Canada but hammered the manufacturing base in Eastern Canada.  While Western Canada boomed, Eastern Canada struggled, at least relatively.

Worthwhile Canadian Initiative  posted these graphs to support their argument that home prices in Canada are rational.  I think they are wrong, at least out west, and I am going to tell you why.

First, the price of homes in the US and Canada.

They argue that if you scale house prices to gross national income, homes are not expensive.

 

They argue further that the improvement in gross national income is because of the improvement in Canada's terms of trade, i.e. the world wants more of Canada's stuff in the ground relative to what Canada wants from everyone else.  They note that half of Canada's increase in per capita income this decade has been because Canada's terms of trade improved.

There a few problems with these arguments.

First, people do not buy homes with gross national income.  They buy homes with after-tax income.  Thus, you should compare the prices of homes to household income, not gross national incomes.

I went to the Statistics Canada site to find the growth in income from 2003 to 2007, but CANSIM wanted me to pay them 36 bucks!  Well, that's not happening, so being the cheapo that I am, the free Canada Census data had growth in median income from 2000 to 2005.  For our six cities, growth in median incomes was as follows.

Halifax 2.1%

Montreal 0.4%

Ottawa 5.8%

Toronto 1.1%

Calgary 5.1%

Vancouver -3.6%

That is total growth over those five years, not per annum growth.

From 2003 through 2005, home prices rose 21.8% in Halifax, 30.5% in Montreal, 16.4% in Ottawa, 18.6% in Toronto, 24.9% in Calgary and 40.8% in Vancouver.  Thus, home prices far outstripped growth in income. 

Of course, it is not only income that matters when purchasing a home but also affordability, in particular mortgage rates and average monthly payments made by home buyers.  However, as you can see, incomes and affordability would have had to double in the western cities in 2006 and 2007 for incomes to keep up with the prices of homes, and that did not happen.

The other potential flaw in logic in their argument is assuming that changes in the products driving improvements in the terms of trade are rational.  Since Canada's terms of trade were driven by increased prices in commodities, the question becomes whether or not the changes in commodity prices are rational?  

This is far from clear.  Certainly, some of the price moves are rational.  With the inclusion of China, India, Brazil, et. al. into the global economy, along with supply bottlenecks, there has been a structural shift upwards in the global price curves of most commodities.  But how much of rising commodity prices is due to structural shifts and how much is due to speculation is unclear. 

Was oil at $147 rational?  Today, oil has more than doubled in four months to $70 yet inventories are at 20 year highs.  Is it rational for oil to be at $70?  Maybe, if the recovery absorbs all the excess inventory, but without a doubt, financial market speculation has and is playing a significant factor.

This is an important concept to understand - If the underlying security is being supported by an asset bubble itself, even if the security appears fairly priced, then the underlying security itself is in a  bubble. 

For example, financial stocks did not look expensive in 2006 based on current earnings.  However, earnings were based on asset markets which were egregiously over-valued.  Thus, when home prices collapsed, so did the earnings of the financial companies.  Financial stocks were very over-valued because the true profitability was overstated by the bubble in home prices.

Likewise, if Canadian home prices appear fairly valued based on incomes while commodity prices are over-valued, the country's terms of trade are skewed and underlying incomes supporting home prices are too high.  If, for example, the structural long-term average of the price of oil is $50, the terms of trade for Canada will decline, incomes will decline (or grow slowly) and home prices are currently too high.

Canada Farmland

Investing in farmland is becoming in vogue these days so I wanted to see how well prices of farms have done as of late.  Below are the growth in farmland values for Canada, which were attained from Farm Credit Canada.  I will address American farmland in a future post.

Since 1995, the compounded annual growth rate in the nominal price of farmland in Canada has been 5.6%.  Adjusted for inflation, farms have risen by 2.9%, slightly faster than the rate of economic growth in the country.  In 2007 and 2008, the nominal price of farmland rose by 18%, or 8.7% compounded, well above the 14 year-trend.

In British Columbia, the nominal price of farms has increased by 8.2% per year since 1995.  BC has experienced the highest rate of price appreciation over the past four years, with farms rising by 75.2%, or 15.1% compounded, an unsustainable rate.

In Alberta, the nominal price of farmland rose by 7.9% compounded since 1995.  Over the past two years, prices rose 28% in total, or 13.1% compounded.

In Saskatchewan, Canada's breadbasket and location of the country's greatest football team, prices before inflation lagged, rising only 3.8% per annum.  However, the past two years saw significant gains, with nominal prices rising 27.6%, or 12.9% per year.

Manitoba did slightly better, rising 5% per year before inflation since 1995.  Prices rose 20.8%, or 9.9% compounded in 2007 and 2008.

Farms in Ontario were up on average 6.5% over the past 14 years.  Prices lagged in 2007 and 2008, rising 10.8%, or 5.3% compounded.  The economy of Central Canada has been relatively weak as the strong Canadian dollar hit the province's manufacturing base.  High commodity prices benefited the West, which is reflected in stronger farmland prices over the past few years.

The best performing farmland prices since 1995 have been in La Belle Province, Quebec, where nominal farm prices increased on average 8.3%.  The past two years were steady as she goes, rising 8.2% on average in 2007 and 2008.

Prices went ballistic over the past few years as the ocean of global liquidity flooded Canada's farms.  The question now becomes whether the country will see a repeat with the tsunami of money being unleashed on the global economy by the world's central banks.

My bet is that after a pause this year, Canada's farms, as well as most real assets, will rise higher as governments continue to promote policies which will lead to a resumption in asset inflation.

So Home Prices Never Fall, Eh?

From the Wall Street Journal

Kendrick Brinson/WSJ

This Atlanta area home, with an original principal amount of $236,000, was bundled for securitization. It was later foreclosed and sold for $30,000.

That is a decline of 87%!

And then there is this interesting snippet from Michael Lewis's article on AIG in Vanity Fair, which I highly recommend for reading.

He simply claimed that the fact was irrelevant: for the bonds to default, U.S. house prices had to fall, and Cassano didn’t believe house prices could ever fall everywhere in the country at once.

Simple assumptions and beliefs, especially when they are taken as "common knowledge," can have massive consequences. 

Manhattan Apartment Prices Drop

The expansive staff here at Running of the Bulls have been of the opinion that if the national residential housing market was not at the bottom, then it is closing in on one.

However, we have been at pains to note that even though the national data may be in the process of bottoming, the regional data bore wide disparities.  Florida and California, for example, were probably at a bottom.  Manhattan, however, was just at the beginning of their descent.

And now, the Manhattan descent has begun.

Manhattan apartment prices dropped for the first time since 2002 in the second quarter as the collapse of Lehman Brothers Holdings Inc. and Bear Stearns Cos. caught up to property owners in the nation’s most expensive urban market.

The median price fell 18.5 percent from a year earlier to $835,700, New York appraiser Miller Samuel Inc. and broker Prudential Douglas Elliman Real Estate said today. The number of sales plunged by half, the most since Miller Samuel began keeping data in 1989.

A significant decline in Manhattan is inevitable, in my humble opinion.  Bad for those living there, good for everyone else. The roadmap for the national/international housing collapse has its end when the last market standing falls. As every student of market history knows, in a severe bear market, the bear mauls everyone. Nobody is spared. 

For the bear market in housing to end, Manhattan apartment prices had to fall.  That is now happening. And unfortunately for those in New York, it still has some ways yet to go.

Articles and Commentary on This and That

The following are links to several articles I found interesting over the past week or so.

First, a comment on the market. 

I am still substantially net long but have not bought or sold anything over the past while. However, I am more of a seller than a buyer at these levels.

The trend is still up, though with the S&P 500 trading at about 14x normalized earnings of $68 a share, the market is more than fairly valued.  Economic and financial apocalypse is off the table but the economy still has structural problems such that earnings and equities returns will be capped for some time.

I believe that today's market most closely mirrors the latter half of the 1970s or the late-1930s to early-1940s when the market bounced hard off the bottom then meandered for several years.  We are currently in the bounce phase, and my playbook is for the S&P 500 to get over 1,000, but I am more than willing to change my mind if it appears the market is rolling over.  However, the market is showing no signs of turning, so the trend remains up.  It gets tricky when the uptrend ends.

I rely primarily on fundamental analysis when investing but I also use technical analysis as a tool for entry and exit points.  Paul Tudor Jones - perhaps the greatest hedge fund manager of all time - explains why technical analysis is important.

The inability to read a tape and spot trends is also why so many in the relative-value space who rely solely on fundamentals have been annihilated in the past decade.  ...

Today there are young men and women graduating from college who have a tremendous work ethic, but they get lost trying to understand the logic behind a whole variety of market moves. While I’m a staunch advocate of higher education, there is no training — classroom or otherwise — that can prepare for trading the last third of a move, whether it’s the end of a bull market or the end of a bear market. There’s typically no logic to it; irrationality reigns supreme, and no class can teach what to do during that brief, volatile reign. The only way to learn how to trade during that last, exquisite third of a move is to do it, or, more precisely, live it — a sort of baptism by fire. One has to experience both the elation and fear as markets move five and six standard deviations from conventional definitions of value.

The OECD believes the global economy is approaching a low.

Most of the world’s big economies are close to emerging from recession, according to data published on Monday by the Organisation for Economic Co-operation and Development that pointed to a possible recovery by the end of the year.

The Paris-based organisation reported in its latest monthly analysis of forward-looking indicators that a “possible trough” had been reached in April in more developed countries that make up almost three quarters of the world’s gross domestic product.

The composite index for 30 economies rose 0.5 points in April, the second monthly rise in a row, after falling for the previous 21 months. The index seeks to identify turning points in the cycle about six months in advance.

The OECD said its overall measure of advanced member countries – ranging from the eurozone and the UK to the US, Mexico and Japan – now pointed to “recovery” instead of the “strong slowdown” they had been suffering since last August.

Good news!  Fewer and fewer Harvard grads are going into financial services.  Generally, tops are marked by more grads going into financial services and bottoms by less grads going to Wall Street.

The number of graduating Harvard seniors entering finance and consulting has fallen by half in the past year, the Harvard Crimson’s annual survey found. About one fifth of all seniors seeking full-time employment are taking jobs in one of the two sectors.

The number of seniors entering finance and consulting has fallen from 47% in 2007 to 39% in 2008 to 20% for the current Class of 2009. The financial sector saw the largest reduction, falling from 23% to 11.5%, while the share of seniors entering consulting fell from 16% to 8.5%.

Sam Zell says that commercial real estate is far from dead.

While it is true that there will be a few implosions, a housing style bust may not be in the offing. A simple reason may be the string of payments. Unlike a homeowner who loses their job then their home, the owner of CRE has a buffer. First the rents of the tenants pay the loans, and only when they are not enough to cover, do the owner then dip into their own pockets.

In short, the risk/payment responsibility is dispersed among several parties. Again, this is not to say that there will not be defaults, many of them or that REIT's will not suffer, it is just the widespread and pervasive losses we are seeing in RRE may not be in the cards (losses here are defined foreclosures on CRE).

Tobin's Q may be signaling a low in the market.

Finally, hedge funds still have too much cash, which could power the market higher as lagging hedge fund managers put cash to work.

The fast money is proving slow to jump on the market's bandwagon.

Hedge funds, decried by many as quick traders, have played catch-up during the market rally since March. The average fund was 45% "net long" as of May 19, or had investment holdings valued at 45% more than its bearish "short" positions, according to Hedge Fund Research.

That figure is up from 33% earlier this year, but still is far below its 55% level a year ago. Funds are less bullish now than they were just before the market crumbled last fall.

Hedge-fund managers, and their investors, said many remain in a neutral position. Hedge funds tend to underperform stock-market averages at inflection points, in part because they aim to create a "hedged" performance, rather than ape the market.

Bidding Wars Emerging for Foreclosed Homes

It is still too early to call a bottom in housing.  However, it is not too early to begin looking for an end to the collapse in housing prices. 

And we are seeing evidence that the end is not far off.  As the Wall Street Journal notes this morning, bidding wars are emerging for foreclosed properties.

Falling home prices are starting to ignite bidding wars in a few parts of the U.S. as first-time buyers compete with investors for the same foreclosed properties.

In most of the nation, the supply of unsold homes continues to swamp demand. Home prices in many markets continue to fall, and foreclosures, which slowed in late 2008 as mortgage companies delayed taking action against delinquent borrowers, are picking up again.

But real-estate brokers say multiple offers on certain homes have recently become more common in parts of California and Arizona and the Washington, D.C., and Minneapolis-St. Paul metropolitan areas.

Tamby Leonard of Santa Ana, Calif., southeast of Los Angeles, says she has been outbid four times since January when trying to buy a home for her family of five. The more appealing bank-owned homes in her price range, around $300,000, tend to be sold quickly to investors who can pay cash. The market for homes in the Santa Ana area in that price range is "blazing hot," says Ed Mixon of Altera Real Estate, Ms. Leonard's agent.

On Wednesday, the Federal Housing Finance Agency reported that home prices nationwide rose a seasonally adjusted 0.7% in February from January, led by gains on the West Coast. When compared with a year earlier, however, home prices were down 6.5%. ...

January saw a 1% rise in home prices.  This is the first time since 2007 when home prices have risen two months in a row.  Not something to get all giddy over of course, but a slight improvement nonetheless.

The Wall Street Journal's quarterly survey of 28 major metro areas shows that there is still a glut of homes available in most markets. But the glut has shrunk, and some areas are running into shortages of moderately priced homes in middle-class neighborhoods. ...

Across the nation, there is still a tug of war between bullish and bearish forces. On the bullish side, falling prices and the lowest mortgage rates since the 1950s have made homes far more affordable, luring shoppers like Ms. Leonard, who has been renting for years. Adding to the attraction, the U.S. government is offering tax credits for certain people who buy homes before Dec. 1. The credit -- equal to 10% of the purchase price, up to a maximum of $8,000 -- is available to buyers who haven't owned any other primary residence in the U.S. during the three years before the date of purchase.

On the bearish side, rising unemployment has knocked many people out of the housing market and made those who still have jobs skittish. Even those with secure jobs who want to buy can't always get loans on attractive terms because of today's tightened credit standards.

In addition, the supply of bank-owned homes is expected to grow over the next few months because many mortgage companies have ended moratoriums during which they refrained from proceeding with foreclosures. ...

Foreclosures, though far above normal levels in most of the country, are heavily concentrated in a few states, including California, Arizona, Nevada, Florida and Michigan. In areas with large numbers of bank-owned homes, buyers are mainly concentrating on those properties. That leaves ordinary homes languishing as owners generally refuse to slash prices enough to compete with banks. ...

One positive trend is affordability. A family earning the national median pretax income of $52,800 a year needs to spend 25% of that income to buy a median-priced home, down from 44% in mid-2006, according to John Burns, a real-estate consultant in Irvine, Calif. For the Los Angeles metro area, that ratio has dropped to 45% from 102%. In Phoenix, it is down to 19% from 46%.

Critics will contend that the sales merely represent banks blowing out their inventories and the sales do not represent underlying health of the economy.

That misses the point.  Before the economy can really start to improve, banks have to get rid of their inventory.  Clearing out their inventory allows banks to free up capital which then can be used to lend to more profitable endeavors.  The process also facilitates price discovery where home prices clear.  Such activities are building blocks for the eventual recovery.