BEING STREET SMART
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Sy Harding
BUBBLE 1 – BUBBLE 2 – BUBBLE 3! September 14, 2007.
In 1999 I made the unpopular forecast that the stock market was in a bubble that was setting it up for the worst bear market since that of 1929. The forecast was met with skepticism to say the least. The popular book of the day was Dow 36,000. Didn’t I realize it was a new era; that a technological revolution of automation and computerization was underway that would keep corporate earnings growing uninterrupted for another decade at least. Did I not realize that the modern Federal Reserve had learned how to control the economy to prevent events like recessions and bear markets?
In a matter of months the severe 2000-2002 bear market began, in which the S&P 500 lost 50% of its value. The Nasdaq lost 78% of its value. The 2001 recession took place. It was seven years, until July of this year, before the S&P was able to return to its level of 2000, and it has fallen back from that level since July. It was a serious bear market.
Early in 2005, I made the equally unpopular prediction that the real estate sector had entered an unsustainable bubble, the bursting of which would cause at least as much trouble as the bursting of the stock market bubble before it was over. I was told I was wrong. It was different this time. Interest rates were low. The economy was strong. The population was growing, and government and the lending industry were making it possible for all Americans to eventually own their own home. Therefore it would be many years before overbuilding would be a problem. Meanwhile, the strong demand justified the rising prices. As late as mid-2005, national home-builder Toll Brothers was projecting its sales would increase another 10% in 2006.
However, just a few months later Toll, one of the first to warn, warned that its sales were ‘softening’. A couple of months later the company reported its orders had plunged a huge 29% in the December, 2005 quarter. By that time, I was saying in this column (February 10, 2006) that “The bursting of the real estate bubble has begun, and remains the biggest problem lurking around the corner for the economy.”
And it’s certainly been a steep slide down for the real estate industry since.
Now, I’m hearing Wall Street and Washington claim that no one could have foreseen the problems in the banking sector that are resulting in the current ‘credit crunch’.
However, more than a year ago I began forecasting that yet another bubble had formed, and would be the next to burst, calling it the ‘debt/credit’ bubble.
Some excerpts from my May 17, 2006 column:
“. . . . banks due to have problems again, the problems this time evolving from high risk loans to hedge funds, trading and investing for their own accounts in high risk derivatives, and their contribution to the creation of the real estate bubble. It wouldn’t be the first time that excessive greed by banks led to excessive risk-taking, which in turn required bailouts by U.S. tax-payers to prevent a collapse of the U.S. banking system. . . . . . . . And the banking industry has set itself up to be the center of another serious financial problem, also perhaps the next scandal regarding treatment of customers and investors. . . . We have a real estate bubble in which buyers purchased homes using ‘creative financing’ that leaves them little to no equity in their homes to cushion any decline in home prices. They will see large increases in monthly expenses as their adjustable rate mortgages are reset to require real monthly payments. Studies project that 1.4 million households face a jump of 50% or more in their monthly mortgage payments in 2006 and 2007. . . . . Banks say they are not at risk because these days they don’t keep the mortgages on their books. They sell them to mortgage packagers who in turn sell them to investors. . . . . Providing high-risk adjustable-rate loans they would not normally make if they had to hold the paper themselves, in many cases without making it clear to the home-buyers that they can’t afford the purchase, and then selling the potential bad loans to hedge funds and other investors, would seem to contain the seeds for potential investigations down the road if borrowers [home-buyers], and investors in mortgage-backed securities, take a bath.”
That is pretty much how that bubble has been bursting this summer, a year later.
So maybe I’m overdue to be wrong.
But my forecast of recent months has been that the Fed is behind the curve and we are headed into another recession. It’s enough that the bursting of the real estate bubble and the debt/credit bubble are both still underway, and will be for some time. (The National Association of Realtors now projects that home sales will continue to decline the rest of this year, and another 8% next year).
Now two more supports seem to be collapsing from under the economy. It had been hoped that employment would remain strong, and that would allow consumers to continue to spend and provide support for the economy.
However, last week’s unexpectedly dismal employment report, and this week’s disappointing retail sales report have economists reversing course in increasing numbers, more of them also beginning to see a recession coming.
The puzzling part is that the stock market doesn’t seem to care all that much. Yet there has never been a recession that was not accompanied by, or preceded by a stock market correction. So maybe I am wrong about a recession. At least that’s what the stock market is saying.
Sy Harding is president of Asset Management Research Corp., publishes the Street Smart Report newsletter, and a free daily Internet blog at www.SyHardingblog.com. He also authored the 1999 book Riding The Bear – How To Prosper In the Coming Bear Market.
