Wednesday, July 05, 2006

Welcome Back!

Sorry for the slow posting over the past few weeks. Back in some of my earliest posts I described how the combination of rising rates, inflation, a weaken US dollar, falling real estate prices, a tapped out consumer and the weak job growth since 2001 were setting the stage for a financial market instability in the US in 2006 - 2008.

This thesis has continued to play out in rapid succession over the past 7 weeks. While we have had the occassional rally here and there to stem the downward slide the bias has clearly been negative as of late.

So please excuse the lengthy welcome back post, but I thought it might make sense to revisit some of these issues as they are becoming increasingly important for investors (and ulitmately consumers).

Rising Rates - Bernake is in no man's land. He needs/wants to stop raising rates, but the data keeps telling him to push on. I'm leaning toward one more hike followed by a pause of 2-3 meetings. I think this is a flawed strategy, but to be frank I don't have a better option. The markets might go crazy when the Fed says it's done. Seriously, we could be up 5-10% in the blink of an eye, but I view that as the last hurrah and a perfect entry point for long-dated market puts.

Inflation - I really wish these gov't nerds that keep preaching there is no core inflation would actually try to go buy something. As long as you don't have to buy any construction material, healthcare supplies or services, anything related to higher education, gas, food, real estate, etc, etc, I'm sure you would view the world as having little inflation, but for the rest of us inflation is here in a real way. Inflation has two causes increased demand or increased production cost. Thus, far production cost has been the primary driver, but I fear that by the time the fed figures out that Inflation is real - production costs will be falling and demand might be falling off a cliff (consider housing for example). Thus the Fed might start fighting a battle which is long over causing more damage to our economy.

Real Estate - Well, the word is finally out. The great Real Estate Boom is over. But here's the problem - this asset class is still in serious flux. Rising rates will pinch hundreds of thousands of new homeowners in 2006-08, just as the homebuilders flood the market with new inventory. If you are one of the few, the proud, the debt free homeowners of America stand up and take a bow, you are unlikely to be affected. If you plan on owning your home for another 20 years you too will also be spared. If you bought your house pre-2005 in Upstate NY, the damage should be minimal. However, if you bought a 4 bdrm colonial in Westchester in 2005 for $1.5 million with an adjustable rate mortgage - ouch.

I've said it before, but I think it is worth repeating the financial risks many families have undertaken in the pursuit of larger homes than they can afford (the standard # is that your fixed monthly debts - cars, credit cards, mortgage, student loans - should not exceed 25% of your net income) has the potential to shake the entire financial foundation of our country. When this gets really bad think of everyone in the real estate food chain that will have less $$$ to spend - Real Estate Agents, Mortgage brokers, electricians, carpenters, painters, plumbers, Home Depot employees, etc, etc.....

The world isn't coming to an end, but I'm a bit concerned about the near-term financial health of our nation. I would not want to be President in 2008. That person is going to have some very, very hard spending cuts/tax increase decisions to make.

No comments: