April Fools 2006
by George Gyftakis. April 2, 2006
It is a wise Wall Street idiom that begs investors to evaluate exactly where they are in the cycle. While times are good and observable problems appear as though a worry of the past, the investment community has the remarkable tendency to essentially become accustomed to the returns of the past and seduced by bullish forecasts for the future. It is especially curious that the many voices sounding from the street are in unison. Implicit confirmation of such cheerleading is evident with a look at the recent Investors Intelligence (InvestorsIntellegence.com) survey of advisors. This appraisal has now set a record streak of more bulls than bears for an unprecedented 180 consecutive weeks. To highlight the importance of this, it is worthy to note that the prior record was 28 weeks less, culminating with the 2000 peak in the US equity market. Thus, we are in effect more bullish today than we were during the apex of the dotcom bubble.
Conspicuously, the parallels between 2000 and 2006 appear to be piling up, or should I say joining up? Merger and acquisition activity has been voracious as of late. Bankers have cleaned up, adhering more than 1 trillion in deals in 05' and the contagion is still charging ahead for this year. Deals closing in 05' registered the third largest ever, behind the back to back dotcom years. There is also evidence that these deals are starting to get bigger, riskier and more ambitious. The issue here is the audacity of the deal making in the face of an uncertain economic and geopolitical climate. The bankers, in typical fashion, insist that everything is in hand but the sense of fearlessness is sobering evidence that the clouds are gathering on the horizon.
This fiscal bravado has made its way from the board rooms of Wall Street to the living rooms of Main Street as exemplified by the overinvestment in real estate. Unfortunately there are too few jobs and insufficient wages for home prices to be commensurate at these lofty levels. Today's homeowner owns much less of his house than any previous generation and these homes were purchased at a historically massive price tag. Consumer appetite for housing has pushed prices so high that approximately 30% of all loans in 05' were interest-only. Cheap credit and perpetual borrowing works while it does, but sooner or later this house of cards will fall. Household real-estate assets as share of GDP are approaching 150% in this country. To put things into perspective, this remarkable number is a higher percentage of GDP than the investments in equities at the height of stock market bubble. In 2000, we had such confidence in our nation's future that we were pleased to throw all of our savings and investment dollars into the market. Perversely, we are willing to do it all over again, using real-estate as the new vehicle.
The only problem here is that real-estate crashes are nastier than your average market crash because of the illiquidity issue. If your stock tanks, you can always trash it with the click of a mouse. Real-estate crashes are a downward spiral of agonizing price slashes and when the vultures begin to circle; your house-sale may seem more like a garage-sale. As soon as speculators do not see the enormous gains of yesteryear continuing, it is estimated that at least 20% of the demand will be removed from the market, virtually overnight. When prices slump, sellers begin flooding the market trying to sell before things take a turn for the worse. Unfortunately, this only exacerbates the problem because now there is dearth of supply and the buyers begin scratching their heads thinking that they should put off buying because prices keep falling. This is not a bold prophesy, it is simply the chain of events that set off a real-estate tumble. Only this time, consider that what was undeniably the largest indulgence in real-estate will result in an equally horrendous correction.
Still more intriguing is to see how the markets react when during the next couple of months home equity loans slow down with rising interest rates. This will of course mean that Mr. and Mrs. Smith will stop using their home as a piggy bank. The mammoth inflows of capital into the US economy, spurred by this re-fi binge, will begin drying up. The collapse of the equity markets during the Go-Go days merely foreshadows the reckoning in store for real-estate, commodities, and all those housing related jobs tied to it.
Even without factoring in the future burden that these high commodity prices will place on our wallets, the evidence suggests the consumer is already quite overextended. Take a look at the numbers for consumer spending: we now spend almost 160% of our wages on goods, services, and expenses in this country. This inauspicious statistic coupled with our paltry savings rate, is certainly a recipe for an extensive, nation-wide business correction. So confident is the average American that we should toss all of our savings toward the purchase of a new home and keep up the credit card spending that we are now left with a saving rate that measures -1.5%. Note that this savings rate was reconstituted in 1999 when the rate fell below zero for the first time. US statisticians then reconfigured the definition of the savings rate to keep it from going into negative territory. Even with Uncle Sam's tweaking we managed to spend ourselves into an even deeper hole.
When it comes to the "buy now, worry later" attitude, we are not the only ones to blame; it is a game of monkey see, monkey do. The government, bearing its twin towers of debt, has neglected its fiduciary obligation and allowed the accounting deficit to grow to about 6% of GDP, larger than it has ever been in our nation's past while the trade shortfall has yawned to almost $625 billion. Throw in a weak dollar and the necessity of foreign nations to continue to support our spendthrift ways, to the tune of $2 billion a day (or 80% of world's net flow of capital) and this economic outlook appears quite bleak indeed.
Taking a survey of the economy only reaffirms this technical correction in the making. We now have a laundry list of active and impending negative catalysts that will begin to beleaguer our markets, most without any signs of fading. Baby Boomers will soon be retiring, many with 401k, IRA, and personal market investments. It would be remarkable to see the markets convalescing during a period when the largest segment of the American population will be making steady withdrawals to fund their living expenses.
While these long-term trends will begin siphoning dollars from the market there is a more immediate motivation to make sure you are aware of the nearest exit. The volatility index or VIX, one of the single best contrarian indicators available, has been flashing a sell warning for equities as it bounces near historic lows indicating calm and complacency in the marketplace. Of corollary importance is the individual investor, who has the uncanny (and ill-fated) ability to identify a market top, has now deemed this an appropriate time to delve back into the world of stock ticks, investing record amounts in the last three months. Undoubtedly the inflows seen by these individual brokerages have helped propel the market to its current stretched valuation. Again, this situation is reminiscent of the months preceding the start of the potent bear market sell off of 2000. Add to the short-term picture the protectionist sentiment gripping Washington with the introduction of almost two dozen bills designed to restrict foreign investment in America and one begins to realize this is not simply a wall of worry the markets will need to climb, but instead an opportune time to track down a few fools willing to accrue this portfolio of holdings that now seem a bit cumbersome.
Statistics compiled from a variety of sources including Elliott Wave International, Investors Intelligence, The Wall Street Journal and Barron's.
© 2006 George Gyftakis
GNG Investments, LLC
New York, NY USA