fsu editorials

A TALE OF TWO BUBBLES
by Jas Jain
May 13, 2006

My prediction of a recession in the US to begin in 2006 is based on a very simple premise � The Housing Bubble contributed far more to the economic growth, in terms of jobs and a source of consumer spending, than the Tech Bubble of 1990s. Not only the so-called �Wealth� Effect is far greater due to housing price and building boom, but also direct jobs related to housing are far greater than in the technology business.

The Asset Inflation (not to be confused with wealth) booms that we are talking about here are the biggest of their kind ever recorded in the US. To assume that when these booms peter out we wouldn�t have a recession is a wishful thinking. The idea that the housing will simply flatten out and there will be no bust is simply not supported by history. It is hard to deny that there was a very strong speculative component to the recent housing boom and all speculative booms do end in a bust.

As to history, I have been told and I have read about housing busts in Southern California during 1970s, 1980s and 1990s. Why would it be different in 2000s? Especially, when the current boom was bigger than any that I am aware of. I am soon going to be heading for a barbecue at a friend�s house in an area called Sky Park (most own a plane, many more than one, and all must have a hanger). It was first built in early 1980s and then the project went bust. There were many empty lots just 4 years ago. The lots that went for 70K in early 1980s, originally, were selling for 45K in 2002 (this friend of mine bought one and has built a big home). If you take inflation into account, the real lot prices were less than a third after 20 years! Soon after my friend bought, the lot prices kept rising and there has been a building boom during 2003-2006 that is absolutely amazing. I have been going to the neighborhood for some 18 years because there is another close friend who bought a home during early 1980s. For years, there was absolutely nothing going on in terms of construction that I could notice.

Now, in order to predict a recession we need to look at some leading indicators. I have already presented the recession forecasts based on the Yield-Curve � the 3-Month to 10-Year US Treasury Yield-Differential (3M-10Y-YD) has already indicated a recession in 2006 with a 50% chance. See, ACCURATE CHARACTERIZATION OF YIELD-CURVE & RECESSION PROBABILITIES.

Today, let us look at another leading indicator, the stock market, or the comparison of the leading stocks for the two booms.

I have chosen Toll Brothers, TOL, as representing the Housing Bubble primarily because the behavior of its top executives in terms of very optimistic forecasts after the stock already started to decline was very similar to the executives of Cisco, CSCO. In both cases, the admission that business wasn�t growing came too late when they couldn't hide the ugly facts anymore.

With reference to Fig. 1, I will summarize the behavior of the two stocks, with appropriate time-shift indicated, as follows:

  1. Both stocks tripled in the 12-month period leading to the peak price. This is the best evidence of the last leg of a highly speculative boom.
  2. CSCO lost half its �value� in 9 months while TOL took only 7 months. This means that we are way past the �correction� in a bull move, i.e., the boom is over for the industry and whatever force was supporting the boom is spent.
  3. The real serious decline for CSCO took place during the second leg and the recession followed in six months after the second leg of the decline began. In six months, CSCO went from $70 to $16 during this decline.
  4. It may be a bit early to say that we have started the second and the serious leg of decline for TOL. Thus, the next few months will be crucial. If TOL breaks $20 then the housing bust is more serious than most people think and IF it cracks $15 then we are talking about a very serious bust in the homebuilding industry.

The most likely beginning of the recession based on the relative behavior of the two stocks is Sep-Dec 2006. The Tale of the Two Bubbles might give us a clue of the Tale of the Two Recessions of 2000s.

I will stop right here. Don't want to be late for that barbecue. (You can bet on spirited debates).

Jas

© 2006 Jas Jain
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Jas Jain

Tehachapi, CA USA
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