Saturday, September 24, 2011

More Productive Thinking than the Normal Complaining


Rather than pledging up to $400 billion to protect the off-balance-sheet Government Sponsored Agencies (GSEs) Freddie Mac and Fannie Mae…

…why didn’t / doesn’t the government just set up a public REIT and take out-right ownership in the houses???

Put another way, there is ‘closet’ socialized risk in backing the validity of the mortgages in the first place, where the spurious belief is that free markets are therein left alone to work. Yet moral hazard has already taken its toll. That’s why I pose the question: why not just claim the ownership (and risk); protect the nation from future liability matching schemes; keep the national balance sheet in some kind of order (that is actually on the balance sheet); and technically improve the supply-demand dynamics? Keynesian’s would love that policy because that is as direct as federal intervention gets! Plus the government would effectively be able to regulate and administer the benefits to society with genuine accountability.

According to JPMAM, homes make up 25% of the total national assets of $71.9 Trillion…so that is roughly ~$72Trillion x 25% = $18 Trillion. $400 billion is only 2.2% of the aggregate value…a meager and insignificant insurance policy in my opinion. Buying 2% of the worst segments of the market might provide a better ROIC than pulling the rug over an otherwise mess...

I will spare you from graphs here today. Just a thought to ponder, but an even better conversation topic! Be well...  

Monday, September 19, 2011

Bid-ask spreads and rational markets respective to Real Estate


Efficient markets are “rational.” The Efficient Market Hypothesis (EMH) is a concept that most can nod their head in agreement towards regardless of a genuine understanding of the phenomenon. So I have recently been pondering: is the housing market today a rational one? I tend to think negatively, and here is why…

The bid-ask spreads are most revealing: what a willing buyer and seller come to terms on with prices, ignoring all commissions. Generally speaking, narrow(ing) spreads equate to efficient, liquid market environments. Liquid and efficient markets foster trust, faith and stability. Today’s housing market has spreads that easily exceed 10-20-30%! It is not uncommon to purchase a home at discount prices of…well you know what I mean.

So, let’s think about the concept here—a buyer’s market is not a seller’s market, and vice-versa. That is just another way of saying which of the two parties is facing more of the pressure to compress the bid-ask spread: will bids come down or asking prices go up? Today is more on the irrational side because of the psychological bias that sellers more notably are dealing with – denying what willing buyers are willing to pay. 

This is significant because as far as I see it, if spreads continue to remain as wide as they are…it justifies that the housing market needs more time to stabilize itself. Unfortunately, prices tend to stabilize in the downward direction more than upward (funny thought). Much of the dislocation comes as a function of the price-appreciation component of Total Return concept. If homes are perceived to no longer offer greater appreciation than the long-term rate of inflation, 3 percent per year, then that will definitely prove that the pressure should continue to be on sellers to narrow the spread.

Friday, September 16, 2011

Fragmented Housing Market


The above chart is a state-by-state breakdown of home-equity ownership, courtesy of Deutsche Bank research. I think that this graph is powerful; it offers some flavor on the fragmented national housing market. This speaks volumes to the point of tangency which the housing market has arguably reached…

Some observations:
  • It is difficult to talk about housing from a national perspective given the dramatic differences in state demographics and sub-stratified marketplaces.
  • There is no clear trend or difference between states within the 50-99% home equity range; only a small (but still insignificant trend) with the 25-50% equity makeup.
  • What your eyes want to gravitate towards is the penetrating blue ‘negative equity’ slice. Alarming, no? This goes back to the point I made in an earlier blog where I challenged the reader to think whether we are riding a trend or at a transitioning point…
  • These statistics are like when political persons have to reveal their own net worth: very subjective still. How does this graph account for refinancing and in cases where home equity is tapped? Can’t tell from this, too many moving pieces-parts.
Still, this is pretty interesting. More to come, stick around…

Thursday, September 15, 2011

"Total Return"

I hope to make reference to today’s article in the future…

Bill Gross, the legendary and infamous bond guru, and more recently anti-federal-intervention-activist, coined the term “Total Return” back in the early 80’s. He attached the name to his flagship fund: Pimco Total Return

Total Return (TR) is all investors care about—the bottom line is always performance. TR is defined as the sum of price appreciation and income:

            TOTAL RETURN   =          Price Return              +          Income Return

Active investment, such as one’s job, is primarily a function on Income Return – you collect a pay check for services rendered. So the concept really applies to passive investment(ing). When you passively invest in some asset, your returns will come from either selling that respective asset at a higher price and/or collecting a form of dividend. So let’s expand on this formula:

            TOTAL RETURN   =          Price Return              +          Income Return
                                       (Dynamic = change in Earnings & Multiple)  +  (Static = Market Dictates)

Talking points:

- Price Return is dynamic, and where the waters become muddied. When you buy a business, you are acquiring its earnings power. You pay a premium for that—some type of multiple over operating earnings. You receive the dynamic price appreciation as the business increases raw earnings power, or alternatively, from a “multiple expansion,” which is a fancy way of saying: what someone is willing to pay for the business. Hopefully you can see how this can rather easily turn into a matter of opinion…this is what markets try to reconcile.

- Income returns are “static” in that rates are locked in; like the background character in any screenplay, you know what you are getting. Knowing how much money you will collect is nice, and sometimes that is all one can ask for. However, thinking about the risks of inflation, credit, and all of those subtle and often unquantifiable threats can make this income return look not so great.

- How do you know what is prudent, do I want price return, income return, or both? If both, how much of each should I want? Obviously we just begun a conversation on dictating what you require out of your investments. From here, we can keep walking backwards while looking forward, and try to answer the questions of “what constitutes an investment?” and “what risks come with the returns that I am trying to obtain?”

I guess we will have to pick up this conversation…or better yet…use this theoretical backdrop in context. Because after all…people only care about real-life and the bottom line: Total Return.












































































Wednesday, September 14, 2011

Some Insights & a (controversial) Conversation Topic

I was part of a discussion last week where someone told me that the ‘capitalization rate’ on some of the top, in-demand office building in NYC is no greater than 4%.

No, I did not know that. I didn’t realize that you were being compensated a mere 2% of premium, with leverage, default risk, and business risk over the U.S. 10-year treasury (also backed-up with long dated debt, ha), which is hovering around 2% these days. Boy, is it difficult to make sense of what we see going out in the world today! It is hard to provide recommendations when the concept of “fair value” might have shifted right under our feet.

I did know that nations such as England, Canada and Australia do not have the interest-rate deduction policy written in their tax code. What I did not know was that, unlike the U.S., these nations have markedly higher average home asset prices and ownership per capita! That is all the deduction (pun intended) that government stimulation—via asset inflation—might seriously be both unwarranted and non-justifiable. That was a contentious political statement right there…

…but give me the benefit of the doubt to make the claim: how will we begin to know how to make judgments, given a set of data, until we know who bears the risks? Nobody as far as I can tell knows who is bearing those risks, so I air on the side of caution that personal responsibility is a minimum standard. I believe that there will be a generational shift towards responsibility, which is inevitable given the choices we have available to us today. Be very conscious about the decisions you make, and know who you can trust.

Tuesday, September 13, 2011

A Primer on Fancy Economic Statistics



Economic statistics are only as good insofar as they have predictive power. It is either fantastic or very troubling that the marketplace offers us nothing short of a ton of statistics! Dr. David Kelly of JP Morgan is one economist whose opinion I trust because he (at the very least) presents his materials in an objective format. If you are into economic data, make it a point to check out the quarterly “Market Insights,” found at JPMorgan’s website.

Ok, so what is going on in these charts (above)? There are some counter-intuitive and hard to decipher information here. Let’s take an inventory of facts before we try to draw conclusions:
1.      Home prices, measured across the entire nation, remain markedly lower than the ’06-‘07 highs.
2.      Home-equity, in proportion to home market prices, remains off the highs as well.
3.      Home inventories remain low, below normalized averages.
4.      Affordability is at levels not seen in a generation.
5.      Over 40% of the CPI index is tied to housing, and therefore has a significant impact on monetary policy initiatives.

Recall the opening sentence where I made the claim that statistics are only as good as their predictive power. Unfortunately, we will not and cannot offer zealous conclusions (this isn’t a get-rich-quick subscription), but we will go so far to make the following inferences:

-       There is little evidence that a trough is discovered with prices. Like many market environments, the conclusion becomes a matter of perception: if you are the type of person that follows trends and technical’s, recognize that there has been sustainable downward pressure in place for over five years now; or, if you are a type of contrarian, you might be making the case that we are closer to the apex today than the trending data would suggest. Contrarians go on to build a thesis on why value isn’t recognized by the common marketplace; dislocation might be a great thing!

-        Fiscal intervention has been the catalyst in driving affordability— homes tend to be the singular largest asset, and consequentially liability for most American families. Intervention has come in the form of falling interest rates and organized re-fi programs. There is much controversy surrounding the government sponsored agencies Freddie Mac and Fannie Mae: how much risk is ultimately borne by the taxpayer anymore? To the degree you have confidence in the federal government’s intervention should be proportional to your belief that this transfer of wealth will have a multiplication effect on the economy.

-        It is difficult to make sense of inventory levels. Do you justify the compression on the basis that expansion was too quick, or make the case that the operating cycle needs to pick back up??

-        How can economic statistics reconcile for the intangibles in life? People are motivated by a lot more than equity accumulation. Could you imagine explaining to your children that you need to enact an austerity program on household budgeting because their after-school programs are a drag on your net worth? Owning a home, after all, is a dominant form of signaling and social hubris in our society. I would be so bold here to proclaim that there may be a bias in place whereby economists might often look to model correlation metrics for the sake of causation conclusions…and political agenda’s…

I’m going to leave this feed open-ended. You will have to come back to see which statistics we pay attention to!