Monday, April 28, 2014

Fake it, 'til you make it...

I joked with someone the other day that every company I see seems to have embraced the "fake it, 'til you make it" mantra.  In essence, this means just act like everything is going perfectly - you are selling out of every item you stock, your customers are demanding that you expand, investors are beating down your door, etc, even if none of it is true.

This is similar to what has happened in the equity markets for the past 6 mths.  Companies continue to post adequate earnings, but increasingly they are falling short on the sales side.  They tell us to ignore sales misses and focus on the earnings (cost controls and reduced investment allow earnings to grow faster than revenues).  Fake it, 'til you make it.

However, there is one real gauge of the economy that is hard to fake - housing.  Many people want to point to the resurgent US housing market as a sign of strength in the economy.  However, I'll take a contrary view by offering this example of the sort of buying that has gone on in the past 4 years.

1) 50 houses are available for sale.
2) There are 20 buyers looking in this market.
3) 3 of the buyers are all-cash investors managing billions of liquid capital.
4) The large buyers quickly buy 35 of the homes drastically shrinking supply to 15 houses.
5) Now Realtors start moving prices up b/c the on the market supply has declined (even though total supply hasn't really changed).
6) The buyers start to panic and start overpaying.
7) The investors slowly leak out a few properties to keep demand and prices high.

This is the DeBeers (the diamond company) strategy for keeping prices inflated.  The problem is that it is entirely dependent on the small buyer stepping up to buy.  Lately, as interest rates have ticked up and the real economy has stagnated, real buyers have hesitated.  The risk is that we could see one investor start to panic and dump massive amounts of inventory into the market.  This would lead others to follow and soon housing could fall into a massive correction again.

The players are different from 2007 this time (Canada's housing bubble is much more like the US in 2007), but the set-up for a housing correction remains the same.  Stay nimble, my friends.

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