Double Journey

Surprisingly, the market was unchanged on Friday despite major misses by Microsoft and Amazon.  With the market showing some resiliency despite disappointing earnings from these bell-weather stocks, one has to believe that the market is indeed up from here.

But it quite honestly does not make any sense.  We are not in for any type of recovery any time soon.  I think a lot of people are looking at the housing bubble popping like the tech bubble popping.  People believe that recovery is just around the corner and that companies’ earnings will follow.  I just really don’t see that happening.

One just has to look deeper into the numbers to see what is happening.  Most companies are beating expectations because of the bottom line, not the top line.  That is, their revenues are not that strong.  They manage to meet earnings because they have controlled their costs effectively.  This should be a good sign because it will allow companies to use operating leverage if the economy recovers.  Sales will grow faster than the cost structure meaning that companies will be very profitable on their way out.

But this assumes the economy is going to recover soon.  Look at what happened last time.  We came out of the problems we had by creating another asset bubble.  Housing.  By keeping interest rates low and allowing questionable lending practices, the government was  able to paper over the previous problems with brand new problems.  Of course, it took a few years to play out but like all deferred problems, the new ones were much much worse.  Further, the jobs that disappeared with the tech bust never really came back, they just reallocated.  We had a “jobless” recovery last time.  Many of the high paying tech jobs never came back.  Some were replaced by good paying real estate jobs but by all accounts more good jobs were lost than were made.

That is not going to happen here.  I just do not see us able to paper over the problems that we have now created.  They are too big.  The housing bubble will not be re-inflated so what will take its place?  Health care? Another tech bubble?  I honestly don’t see anything even remotely resembling a recovery back to where we were. Companies are being very cautious when it comes to raising their cost.  For most companies, the biggest single cost is headcount and most will not be willing to increase this anytime soon.  Flat is the new up and I think more than a few companies will be willing to forgo higher revenues for a more predictable and low cost structure.

So we will see a long period of cautious companies.  Risk taking will be dampened.  This will mean that we will have an extended period of high unemployment.  This should have the effect of keeping any sort of earnings growth muted because most companies have cut to the bone at this point and will not see any more gains achieved from there.

How much more can it go from here?  Like all other market movements, I have no idea.  The market can stay stupid far longer than anyone can anticipate.

I have been writing often about California lately.  I have done this mostly because there have been many things on my mind, not the least of which has been if it is really worth it to live in California.  For the most part I think it is.  I love most of the things that California has to offer and I have many ties to the area.  My family is here, I went to high school here, and I have a lot of friends in the area.  But I have lived in three of the four corners of the United States and can honestly say that I think I can make it work anywhere I go (with the possible exception of Alaska).

So if I love it here so much why would I consider leaving?  Well, California has been in the news a lot lately, most of it not too good.  There have been several articles wondering if the allure of California is fading.   With the budget crisis the way it is there is little doubt in my mind that a tax hike is around the corner.  Considering how high the tax burden already is, I am in no mood to see even more of my paycheck go out the window.  Unemployment is high and the opportunities for me in the area are somewhat limited.  While I like my current job, I don’t know if I will be there five years from now so I am just planning ahead for what I will do down the road.

Of course one of my biggest problems with California will come to no surprise to my loyal readers.  The cost of housing.  It is still way to high.  Most of the homes in my area are still asking for $500,000.  They are nowhere near worth that.  But even if prices come down another 20%, the housing would still be overpriced.  On the eve of my marriage, I have to look at the situation and ask myself, “Is living in California worth reducing my standard of living?”

I know that I can make just as much salary wise in other parts of the country as I can here.  In fact, in many areas I might even have a distinct advantage given less competition for jobs.  So what is someone like me, a young successful mid-career professional supposed to do?  Do I continue to pay high taxes and live in a small rented apartment?  Or should I consider moving to a state like Texas which has a very low tax burden (no income tax at all) and very affordable housing?  I did a quick search in some of the bigger metropolitan areas like Houston and Austin and there are many houses that I could pay cash for.  For houses in the price range I want to spend, I could easily find a four or five bedroom house for what I could get a condo for here.

Yes, I know what the argument against is.  I would have to live in Texas.  But seriously, I’m sure it is not all that bad.  Most of the people I know from the area speak highly of it and would go back if the right opportunity came along.  I’m not saying I’m going to move there or anywhere in the next year, but it is something I would have to consider.  it is something I would have to consider even sooner if California did something stupid like raise taxes yet again.

California’s budget was finally passed last night.  The thing is nobody is happy about it, and that is probably a good thing.

Budgets are hard.  It is not something that most people understand.  I have to deal with this at work all the time.  I have a budget for the department.  I cannot simply spend more than my budget.  No matter how much work there may be I cannot just go hire a new person to do the work.  I have to to be very sure that the benefit of hiring someone, buying a new computer, or sending someone to training outweighs the problems that breaking the budget brings.  If it is not everyone ends up paying for it as the company will miss profit numbers and that results in budget cuts, i.e. layoffs.

This is a classic economics problem.  Economics deals with how to allocate limited resources against unlimited wants.  Nobody in California thinks they should give up their budget.  But California spends money on three major things.  Education,  health care, and law enforcement.  Of course nobody wants to take money away from teachers, nobody wants to turn sick people away, and nobody wants to free prisoners.  So given that, where do you expect California to cut?  When you have a budget gap like California, you cannot make a dent in it if you do not cut from the biggest ticket items.  And this is what California has done.  What else could they do?

As much as I love living here, I have to admit that things are not so great for some.  Unemployment is over 10% in the state.  Housing is still way too expensive.   Taxes are going to have to rise more than they already have (Sales tax is 9.75% in many areas).  So many great reasons to be here.  But for some, especially those in my age group, the negatives are starting to outweigh the positives.

I looked at some housing prices this weekend.  I’m not really in the market but I like to keep tabs on where things are.  I have noticed that there are a lot of new “For Sale” signs going up in and around the Pasadena area.  I think most of this is people getting ready for the summer selling season.  I think a lot of people held off trying to sell in the weak market that we have had in the last year but people can’t wait anymore so here comes the inventory.

But when I look at housing, I think about the saying with regard to the dehydrated man stuck in the middle of the Ocean.  “Water, Water everywhere without a drop to drink.”  While I am interested in housing and there seems to be a lot of inventory, there really is nothing to buy.  How did I come to this conclusion?

I just did the math.  I pay $1700 for my two bedroom apartment.  I admit that it is a pretty good deal when you factor in where I live but I don’t want to be spending way more than that right now.   Doing the math backward, I looked at houses with mortgage if I paid $2000 per month.  That comes out to a $300K mortgage.  Factor in a down payment, and you get a house of around $350K.

My search criteria was simple.  Find me a single family starter home in the $350K range located in Pasadena that has at least 3 bedrooms.  I think there was something like 3 listings.  All the close neighborhoods east are worse as they are even more expensive so there were no listings there.  West in the Burbank area?  Only a handful there too.

No way housing should still be this high.  All I want is a decent starter home and there is nothing within a halfway decent range.  So I’m staying out of the market looking for something to do with all this cash.

I’ve written in the past how I think  my generation is getting screwed in a lot of respects.   Seems like I’m not the only one who thinks so.  I found this article on MSN money about why Generation Y might never retire.   The article explores a behavior and attitude that seems to make my generation risk averse.  Given all the things I have written about in the past about the challenges facing my age group, is it any wonder that we are a little bit risk averse.

It seems that a lot of 20 and 30 somethings are stashing their money in banks accounts rather than in the stock market.  The article attributes the behavior to a fear that my generation has after seeing two major bear markets in the last decade.  You throw in scandals like Enron and Madoff and you have a generation that does not have a lot of faith in the financial system.

I have actually seen this first hand.  Clearly it is not true for someone like myself.  I’ve been pretty risk-loving when it comes to my investment decisions as of late.  That being said, I myself have been somewhat guilty of this.  For the longest time, I’ve been very heavy in my cash holdings.  Most of this is because in my investing lifetime I have not been comfortable with where the markets have been.  I only started investing in the last four or five years and it was pretty clear to me back then the market was too high.  Everything was built on the house of cards that was housing and it didn’t make any sense to me how expensive things were. 

Then, the market crashed.  It presents a great buying opportunity so long as you are comfortable with risk.  But imagine you have not been as prudent as I have been and your assets were tied up in your house and in the market.  You have just seen your net worth decrease by 50% in a matter of a few months.  Maybe worse than that if you are now underwater in your house.  Given these beatings, who can blame my generation for wanting to protect the little that we have left?

 I definitely do not agree with all parts of the article.  The second half explains why long term my generation should not be afraid of the market.  It uses the old mantra that the stock market, in the long run, is always a good investment.  While true in the 20th century I am not so sure you can continue to use the past to predict the future.  “Long term” investors in the last decade have gone nowhere. 

So I’m not so sure what my generation really should even do right here.  At these levels, I don’t think stocks are a bad buy but I hesitate to say they are a good buy either.  I could easily see us stay flat from here for the next decade as we work through the excesses we have enjoyed over the last five years.  If we really do stay flat from here, that will make twenty years of no growth right in the prime earning years of my generation.  How is that for screwed?

Economics 101 people.  I just heard a financial reporter, Diana Olick of CNBC, say that housing prices will rise when more people start putting their home on the market.

To give context, the discussion was around the Zillow report saying that over 20% of homehowers are underwater.   The numbers might be even worse than this because there is a large “shadow inventory” of homes.  That is, there are a number of people, over 1/3 of homeowners, who wish to sell their home but have held off over the last few years for fear of owing more than their house is worth.

Olick pointed out that the sales number may be artifically low because the only thing that is selling are foreclosed homes and people who must sell.  She argues that when more of these non-distressed people put their home on the market prices will rise becasue these people will not sell their homes at the low prices.

Umm, no.  Prices are set by a confluence of supply and demand.  Suppliers do not just get to set whatever price they want.  They may wish for prices to be at a certain level, they may certainly not sell at a price they deem too low, but I can promise you prices will not rise because there is MORE supply.  It makes no sense.  I may want to sell my car at $20,000 even though it is worth about $10,000.  I may refuse to sell if I can’t get $20,000 for it.  But that just means my asks will not affect the market even more.  And I promise you my bringing my home to the market will actually depress prices as buyers will feel they have a wealth of choices.

How sad is this as a title?

http://www.usatoday.com/money/economy/housing/2009-04-28-home-prices-february_N.htm

It is kind of like writing, “Only 40 People Die!” or “Stock Market Only Wipes Out 60% of Retirement Savings”.  Perhaps we really have reached a bottom.

In many markets, housing is starting to “rebound” off of disastrous sales numbers.  Many so-called experts are saying that this reversal in sales signals a bottom in the housing market and that now is a great time to buy.

I always have to wonder why people think of housing as some sort of special asset class.  Yeah, yeah.  I know you cannot live in a stock and you do not get a tax write off investing in gold.  But I am talking about housing strictly has an asset class.  If you wish to talk about housing as an investment than you have to look at it as a market not unlike the stock market.  The asset has a price.  There is supply and demand and there is an ask and a bid price.

In no market of investments do prices ever go straight down.  This is always true in both the short and medium term.  Just look at the fluctuation of prices in a given hour.  Even when a company announces horrible news, the stock price does not just go straight down to a new low and stay there.  All along the way, there are people who incorrectly place a bid at a price much higher than where the stock price eventually settles.  Just look at GM’s stock chart.  They and the government have basically announced that the company is going to go into bankruptcy.  At the very least, all the equity is going to be wiped out.  Yet the stock still trades and there are still rallies.  There have probably been no less than four big rallies in that stock over the last year even though the news continuously gets worse.

This is the first time that housing sales have “rebounded” and trended up.  Yet everyone wants to say that we have wished bottom.  There is no doubt that there are several people who have been anxiously waiting to get into the market.  Heck, I am one of these people. They see prices down 25% or even 40% and they want to jump in.   Some of them will and sales will go up.  But that does not mean we have reached the end of a bear market.  There is plenty more downside here as we work through excess inventory and credit standards continue to rise price people out of the market.

So don’t buy the news.  We got plenty more of room on the downside.  If you look at the stock market over the last decade, we are just right back where we started.   And this does not even account for inflation.  Why should housing be any different?  We are still well above pricing levels from a decade ago.  Just in my neighborhood, prices are still almost double what they were a decade ago and this is AFTER a 30% pullback.  What makes anyone think we will not go down even more?

I saw a post on CNBC today and had to laugh.  It was an article written by their real estate reporter declaring that not all real estate investors are irresponsible.  Here is a brief excerpt from the end of the post that gives her point:

Mr. Obama, it is not wrong, irresponsible or even negligent to purchase an investment property. Not every American can afford a home; we’ve learned that the hard way. There is no shame in renting. But a rental home is not always an apartment in a building owned by a large developer. It is often a single family home or a condo, owned by another American who purchased an investment property, legally, responsibly and ethically. Why exactly are we penalizing these homeowners? You might consider the fact that when these properties go into foreclosures, the responsible renters are out on the street as well.

Now I agree that there are many investors who acted responsibly.  But why should I help those guys out any more than I should help out the people who lost money investing in the stock market (of which I am one)?  How is not helping real estate investors “penalizing” them?  Seems like everyone feels entitled to a handout these days huh?  This is the exact type of language someone would use if they feel entitled to something.  If they do not get it, it is not fair because everyone else got it too.  Give me a break.  Seriously, I do not care one iota if every investor loses their home.  Would it be an economic calamity?  Sure, but that is why it is called “investing”.  Investing has risks associated with it.

This is also why I do not want to help most people out now, even the “responsible” ones.  They too took a gamble.  Now you could argue, that many people did not buy a house for an “investment” reason.   They just happen to be the happy beneficiaries of a rising asset.  In that case I propose the following plan since government seems to want to protect homeowners, but not investors, and make the rest of us pay for it.

When you buy a residence, you must declare if it is for you to live in or for you to have an investment.  If you declare it is for you to live in, great.  You will get all the benefits that exists today.  You get to deduct the interest on your mortgage.  And if what happens today, the price of your home drops, the government will protect you so you can stay living in your home.  HOWEVER.   Let us say you are going to sell your home.  You should not reap any of the profits of you selling your home.  The government should get part of your windfall.  You after all were not in it for the money and the government was protecting your losses.  They, and by that I mean all of us, should reap the benefit of protecting your home.

The inverse would be true for any house you declare an “investment”.  That is, you should not get any protection or benefit from the government of any kind.  You should not be able to deduct the mortgage and you should not get any assistance if your house becomes worth less than what you paid.  However, if you sell it, you get all the profit.

This is a simple idea really.  Why should we have privatized gains and socialized losses, the exact scenario we are in now?  We need to get back to a system of private gains and private losses & social gains and social losses.

Today, Obama announced his housing rescue plan.  It basically boiled down helping out “responsible” home builders by giving them access to low cost financing so long as they are not too underwater on their mortgage.  It also created some incentives for lenders to modify loans for “at risk” homeowners who are in danger of defaulting.

All of this will be in vain.  I really just do not understand how others, supposedly smarter people do not understand this.   Let me try to explain in very small words.

Rising housing prices is bad.  If housing rises faster than incomes, then you are pricing out a class of people, new homeowners.  People who get happy when the price of their primary residence rises are foolish.  It does absolutely nothing for you if everyone’s house is rising in price as fast as yours.  If you sell your house, you are going to buy another one.  Rising housing prices will in fact hurt you because you pay taxes as a percentage of your house’s value.  You also pay closing cost and other real estate fees when you sell your house as a percentage of the sale.  So you are paying more and more for each of these transactions.

Now, this may be just fine if you are in housing already.  You can swap houses with other homeowners and pay more and more for that asset. But at some point, for the asset to really be worth more, you need outside money to come in and buy the asset from you.  For you to “move up” you have to get someone to buy your starter home.  How is this going to happen if your price is too high for the average person to afford?  It won’t.

This is a simple economic fact.  Housing prices will not stabilize until an average family can afford the average house and we are still far away from that.  Anything that attempts to prevent the housing price correction, such as this plan, is only stalling the inevitable.  This plan does not and cannot create demand at the bottom.  It actually does the exact opposite by keeping demand artificially low by keeping prices artificially high.  The government can throw however many billions or trillions they want at the problem.  Until someone addresses the question of how the average American can become a homeowner, prices are either coming down or we are staying flat for another dozen years.