The Case For Housing and the U.S. Economy
By Yours Truly

I was just reading an article, a quite bearish one actually, from TheStreet.com written back in 2004. A few interesting things stood out.

It shows a very bearish outlook. Something that was mainstream at the time. Sentimentally this may have been the reason why the markets couldn’t give yet and why we may be ready just for that now as the mainstream media is currently in denial as to a recession, much more an all out credit bust.

Housing
The fundamental reasons driving speculation of a housing recession are just as prudent if not greater than they were at the time.

  • Rising prices well above the historical averages
  • Historically low interest and mortgage rates
  • Home prices as a percentage of disposable income
  • Increased debt creation
It also mentions how the real slow down would begin with the lenders. This we saw clearly with the implosion of the sub-prime sector. Interestingly enough he also points to an apparent recession in the auto industry, something we know all too well.

Interest Rates, Inflation and Oil
We all know that from 2004 interest rates have surged from 1% to the current 5.25%. Although the economy has not yet collapsed we also have not yet seen the substantial decline in housing that we most definitely will in the future.

At the time real interest rates (Fed Funds rates minus Inflation) was in the negative. The 20 year average for Real Interest Rates was Positive 2.4%. He mentions that rates would thus have to rise to 4.75% to break even.

It would then seem quite proper for the Federal Reserve to pause from tightening while inflation had begun to slow (and Real Rates stayed within margin). However, with Inflation now coming in at 2.75% YoY and the Federal Funds Rate at 5.75%, giving us a Real Interest Rate of 3%, well above the average, we are most probably due for some more raises.

We see an obvious correlation between inflation (primarily costs of producers passed down to consumers) and oil prices. Interestingly enough, rates paused just about the time when oil prices began falling, from their high of $78 down to 52. (Currently trading around the 58-60 area).

There is now a good chance that inflation (due to rising commodity prices), and thus interest rates (higher real rates), will continue their multi-year uptrend.

What this means for investors – Stagflation.
This means that while the economy makes little ground forward, inflation will nevertheless continue to rise. When housing tanks, it will drag along with it higher unemployment (all those no-longer-needed Realtors and investors), rising defaults and a storm in the bond markets, followed by lower earnings, which would inevitably lead to higher price ratios resulting in a sharp sell-off, along with the confidence of the American people and the long awaited for recession.

What you should be buying… Precious Metals, Short-term Cash, Hard Assets and Commodities.

What you should be selling… Stocks, Bonds, Leveraged issues and Financial Assets (and of course any second homes).

Remember… It’s times like these when the key advice is simply not to lose. Forget about beating the market for now. If you stay safe and out of debt that shouldn’t be much of a problem.

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