The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

The Parent Company Trap
Fox News is either evil or stupid for not mentioning that Alwaleed bin Talal is News Corp.’s largest shareholder.

Monday August 23, 2010

July New Home Sales were much weaker than expected at an annualized rate of 276k vs the forecast of 330k and is down from a revised 315k in June. The record low remains the 267k level in May. This measure of contract signings is the 3rd month without the benefit of a tax credit. Months supply rose to 9.1 from 8.0. The biggest declines were in the 2 regions with the most competition from foreclosures, the West and South. The median home price fell 4.8% m/o/m. The homebuilding and related stocks are again shrugging off awful housing data and a good sign that the current hangover distorted state of the housing market has been discounted but the banks, still highly exposed to home prices and correspondingly mortgage and HELOC debt, is just a few cents from its lowest of the year as measured by the BKX.

The Upside of 29% Unemployment amongst teens: Cee-Lo Mashups (via Dallas Observer)

Cee-Lo’s Shawshank Redemption from Dallas Observer on Vimeo.

Cee-Lo’s Say Anything

Cee-Lo’s Dirty Dancing from Dallas Observer on Vimeo.

Via Dallas Observer

Yesterday, we discussed the zeitgeist of the moment being bearish.  Try this on for size:

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Recession Porn, anyone?

July Durable Goods orders were not pretty. They rose just .3% m/o/m headline vs an expected gain of 3% and ex transports fell 3.8% vs a forecasted rise of .5%. Non defense capital goods ex aircraft fell 8% after a gain in 4 out of the previous 5 months, led by a 15% drop in machinery orders, a 5.9% drop in electrical equipment and 2.4% fall in computers/electronics. Orders for vehicles/parts rose by 5.3% and are up for a 5th straight month. Shipments, which get plugged into GDP, rose 2.2% and with inventories up by .6%, the inventory to shipments ratio fell to 1.55 from 1.58. Net-net, with the US consumer still on the ropes and Gov’t stimulus coming to its end, cap ex and exports are the 2 remaining key pillars of health and the data shakes the cap ex one in a discouraging way. Yes the data is volatile but the inventory story has run its course and end demand must pick up soon in order to further spur cap spending.

S&P’s one notch credit downgrade to AA- for Ireland is upsetting markets but to compare to the other rating agencies, Fitch downgraded Ireland to AA- in Nov ’09 while Moody’s has it one notch higher. S&P is most worried about the rising cost of their bank bailouts. Irish yields are higher and 5 yr CDS are up by 7 bps to 317 bps. Ireland comes to market tomorrow with debt for sale. In sympathy Greek 2 yr yields are up by almost 30 bps to 11.3% and CDS is up by 34 bps to 932 bps and in response German 10 yr bunds and UK gilts are at fresh record lows and US yields lower too. Being shrugged off was the German IFO business confidence # which rose to the highest since June ’07. With new lows in mortgage rates, the MBA said refi’s rose 5.7% to the most since May ’09. Purchases rose a punk .6%. ABC confidence rose 1 pt to -44, a 6 week high. Only 3 mo’s after riots, the Bank of Thailand raised rates by 25bps for a 2nd month to 1.75%.

I keep finding very poor or misleading reporting on Housing in the US. Some of this is sloppy or lazy reportage; others reflect reporters being suckered by Think Tank spin and political narratives.

Lately, the area seems to be misreported the most is the coverage of the Mortgage Interest Deduction. The misleading impression created by some reports is that this deduction is the result of a specific policy designed to encourage home ownership. That is a false narrative, belied by history of the Federal Income tax.

Let’s take a quick look at facts so that people understand it better.

The first Federal Income tax in the US was passed in 1894, and subsequently struck down by the Supreme Court. This led to the passage of the Sixteenth Amendment (ratified in 1913), that empowered Congress “to lay and collect taxes on incomes, from whatever source derived.”

With this new power, Congress imposed the first taxes. Rates started at 1%, and rose to a whopping 7% for taxpayers with income in excess of $500,000. This applied to relatively few people, with less than 1% of the US population paying any income tax.

As an offset for the taxes, any interest paid (for any reason) was deducted. These were considered business expenses. Indeed, taxes on rents from real estate was a large revenue source. The financing costs of purchasing such rent producing property — a/k/a interest payments — was a ordinary cost of doing business, and hence, deductible.

Keep in mind that during the pre-WW1 period, there was very little interest expenses paid by individuals. Home owners typically owned their houses outright (except for farmers, who either financed or leased the land). There were no credit cards, HELOCs, revolving credit, or student loans.

The deduction on interest was never intended to be a salve to the middle class. It was not designed to encourage home ownership. Indeed, when the interest rate deduction was first considered, home financing was non-existent, and home ownership was not thought of as a public policy. It is not part of any grand scheme of social engineering, as some have called it. It simply has existed since the Federal Income tax came about a century ago.

Indeed, the entire home mortgage deduction is little more than a historical anachronism, a carry over from when all interest payments were deductible.

Now you know . . .

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Previously:
Housing: Still Widely Misunderstood (August 24, 2010)

Source:
History of the U.S. Tax System
http://www.ustreas.gov/education/fact-sheets/taxes/ustax.shtml

See Also:
Who Needs the Mortgage-Interest Deduction?
ROGER LOWENSTEIN
NYT, March 5, 2006
http://www.nytimes.com/2006/03/05/magazine/305deduction.1.html

Defending the Mortgage Interest Deduction
Realator.com
http://www.realtor.org/government_affairs/mortgage_interest_deduction

Today I managed to annoy two billionaires. It wasn’t my intention, it just happened. The first, we’ll save for a future discussion. The second was Mark Cuban.

In this morning’s discussion of sentiment (Celebs’ & Billionaires’ Economic Warnings ?) after dissecting the surprise economic warning from Tony Robbins, I also mentioned Mark Cuban’s “Put your money in a bank” comments.

Mark responded in a comment. He raises valid points I wanted to address, then clarify what I wrote, and respond to his challenge.

First, in the link provided, Cuban published his intro to the book The Number (The Stock Market, Apr 13th 2004).  I am not exaggerating when I say his introduction is marvelous, a devilishly accurate synopsis of the seamy underside of Wall Street. It portrays investing turned into short-term sport, having nothing to do with the fundamentals whatsoever. It is all the more powerful, given his personal experience as a founder of a company that went public, was taken over, etc. There is almost nothing in to I disagree with, other than noting “Ponzi scheme” is the wrong phrase — the “Greater Fool” theorem is more apt. Note that this 2004 discussion is not investment advice, but instead is a warning as to how corrupt the street is.

I can say the same thing about “My Investment advice for 2006” (Jan 2nd 2006). It is not investment advice at all, by rather, is a diatribe against a morally bankrupt Wall Street. We could even call it “anti-investment” advice. Again, I find my self disagreeing with none of it. He raises issues of corruption, under-performance, of self-dealing and of over-compensation. (I cover these in Bailout Nation).  The same can be said for “The Stock Market is for suckers” (Jan 3rd 2006). It is an extended argument against the ways of Wall Street; if you read it, you will find yourself hard pressed to disagree with any of it.

But it is not investment advice.

What I wrote this morning was about sentiment. When high profile people make broad economic or market proclamations, it is note worthy. When they “fall into the category of recession-porn,” that is worth considering too.

What I should have written this morning was the role of Bloomberg in picking up Cuban’s post. In fact, I should have emphasized it. THAT was what made this part of the zeitgeist. Missing that means I was painting with far too overbroad a brush.

I would suggest that Cuban has been remarkably consistent: He has (correctly, in my view) identified structural flaws in the stock market. He has noted repeatedly how the odds are stacked against individual investors, that it’s a sucker’s game. He has repeated that view over time.

This makes his “Put your cash in the bank” not news at all. He has repeated it over time. Hence, any media focus on yet more recession porn, more than what Mark had to say, is what makes this significant.

Beyond the media angle, there is one last issue: It is not my respect for Cuban the entrepreneur, or his execution as a CEO in selling Broadcast.com stock to Yahoo (suckers!), or his acumen as an investor collaring the YHOO shares near their highs. I love what he does running the Mavericks, and running HD Net.

My issue for Mark is:  “What is your edge today looking at markets or the economy?”

Consider Mark’s comments from January 2006:

“If you are going to trade stocks, you just have to follow one rule and remember one thing. That rule is always have a definite knowledge advantage about the company you are trading, and always remember that every stock transaction has a sucker, and you have to know whether its you or the person on the other side of the trade. No one buys a stock from your, or sells one to you knowing they are leaving money on the table.

The bottom line is that unless you plan on making it a full time job to do your research and put yourself in a position to have an advantage, you are going to get your ass kicked at some point by someone who does.”

Hence, this is precisely my point about sentiment: Does Cuban (or Robbins for that matter) have any special insight right now? Was their proclamation the result of this edge? Or was it merely repeating the dominant economic/sentiment meme of the moment?

Which brings me back to my original point: How much of what we hear today is late cycle momentum calls  and/or The Recency Effect? And how much is genuine informed insight?

What’s your edge?

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Tonite I will be on Fast Money on CNBC at 5:30pm discussing the Housing market, as you may have noticed the past two days here, here and here lately.

The key housing takeaways:

• Housing over the past century managed to just outpace inflation by 1.1%;

• The bond bull market that starting in 1980 drove mortgage rates down from the peak by as much as two/thirds — as high as 15% down to ~5%.

• Post WWII growth of suburbs and the subsequent baby-boom demographic surge created a massive demand for Housing (unlikely to be repeated soon)

• Decreasing credit costs also drove Real Estate appreciation (1980-2005);

• Bull Markets end with blowoff tops, pulling forward a decade or more of future returns;

• Home prices remain 5-15% overvalued nationally; Resolved via a big drop tomorrow, or 7-15 year period of no appreciation (depending upon inflation and wage gains);

• Housing has problems with both too much supply and not enough demand. .

Should be fun!

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With the S&P’s closing near where they were just before the awful home sale figure was released, the action is a clear message that the market knows the housing data before and after the tax credit deadline is completely distorted and thus a worthless take on the state of the market. We know things are soft but the measurement of that extent is still cloudy because of the amount of demand that the tax credit pulled forward and the subsequent hangover. Yes the home building and related stocks are trading well today having priced in the bad state of things for now in terms of activity and ignoring the Existing Home Sale # but the BKX index has broken to the lowest since the first day of trading 2010 and maybe is reflecting the new reality that home prices (collateral backing a lot of still large bank exposure) are about to take another leg down after the Spring bounce.

I have to point to two very odd MSM pieces — one on the front page of the NYT today, the other in the OpEd page of the WSJ in March 2009. Each shows a misunderstanding of Housing that I think is significant.

Lets start with today’s NYT. Front page, top left corner, second paragraph:

“Mr. Cuomo was housing secretary at a critical moment for the nation, just as its subprime mortgage fever was beginning to spike. It was during his tenure that the banking industry began to embrace predatory loans, and these creations led to a housing bubble that badly damaged America’s banks and nearly toppled its financial system.” (emphasis added)

That is a big WTF moment for a front page article of a major paper. And it is, of course, wildly incorrect. Cuomo was at HUD until Clinton left office (1997-January 2001);   His tenure at HUD ended before the rate cutting at the Fed began in 2001.  The sub-prime fever did not begin until years later, and did not peak  until years after that. (Note that I don’t care at all about Cuomo — it is the housing timeline I want to see portrayed accurately).

The St. Louis fed noted in a research piece (The Evolution of the Subprime Mortgage Market) that the big spike in Sub-Prime loan origination began from 2002 to 2003, when “LoanPerformance data show a 62 percent increase and the Inside Mortgage Finance data show a 56 percent increase in originations.”

As the chart below shows, subprime blew up in 2004-06; the Times got the time-line completely wrong in a front page story.

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Source: Joint Center for Housing Studies of Harvard University STATE OF THE NATION’S HOUSING 2008

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The Times partly acquits itself with following paragraph:

“The record shows that the mortgages bought by Fannie and Freddie during Mr. Cuomo’s tenure had low default rates. More broadly, if Mr. Cuomo was less prescient and gutsy than he now claims, no one seriously argues he deserves some outsize share of the blame for the subsequent collapse. Far more powerful actors, including the finance industry, its various regulators, two presidents and Congress, helped create the environment and wrote the policies that caused it.” (emphasis added)

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Next up: My Caribbean cruising buddy Gary Shilling, in the WSJ OpEd pages last year. (hat tip).

I am in agreement with Gary about an Immigration solution to Housing — (I have mentioned this in the past) But I have to take issue with his statement “the 1996-2005 housing bubble.”

I have been arguing since 2005 that we had a credit bubble, not a housing bubble. But even if you ignore the credit argument, and think of it as a pure Housing bubble, how does one get 1996? Home prices This exploded in 2003-04, and peaked in 2006-07.

See the Ned Davis Charts:

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Sources:
As HUD Chief, Cuomo Earns a Mixed Score
DAVID M. HALBFINGER and MICHAEL POWELL
NYT, August 23, 2010
http://www.nytimes.com/2010/08/24/nyregion/24hud.html

Immigrants Can Help Fix the Housing Bubble
RICHARD S. LEFRAK and A. GARY SHILLING
WSJ, MARCH 17, 2009
http://online.wsj.com/article/NA_WSJ_PUB:SB123725421857750565.html