Crisis – What Crisis?

Barry Rhitholz had this image of the House Price Index on his blog today:

Wouldn’t you think it would be redder?  Why are there green areas?  How can home prices be rising in 14 states – don’t these people know we are in the middle of a melt-down?  Don’t they watch CNBC?  Didn’t Cramer say no one should buy a home this year on every single NBC/GE station he could get his face on?  Doesn’t GE make a fortune bottom fishing the real estate market and taking over failing financial institutions?  Isn’t GE one of the companies angling to take over the GSE’s now that they are "in trouble" due to a housing crisis and isn’t is Jim Cramer telling you that FRE and FNM are "technically insolvent"?  By the way, I love that his video clip is sponsored by Qatar!

In that same clip Cramer says "We don’t want oil to be down huge because there is too much of the S&P that is now oil."  This is like a doctor saying he doesn’t want to remove a 20-pound cyst because it’s too much a part of you now.  Cramer made these comments with oil at $140 on a day it was coming down from $145…  Cramer is also 100% wrong about BAC as his call for their demise was quickly reversed a week later.

It’s a big country out there and we have a very diverse economy.  There are 45 states in this nation where home prices have dropped less than 10%.  The problem is that the states that have dropped the most, Florida, Nevada, Arizona and California – have a LOT more market investors than every state that is positive except for Texas combined.  When you live in a state that has housing problems, your impression is going to be that the whole country has housing problems. 

Another issue with investors is their unbelievably short time horizons.  Investing used to be something you did over the course of years, not minutes but the mash-up of the Web and the Market have caused "crises" to come and go between breakfast and lunch and corporate news both thrives on the turmoil and steers the viewers towards whatever positions benefit their parent company.  When a crisis can be manufactured that benefits the parent company – so much the better!

Look at the chart above – those are pullbacks off RIDICULOUS prices that got so out of control that people finally stopped buying homes.  I bought my home for $400,000 in 1999 and it was "worth" $1M in 2006.  I told my wife we should sell and live in a hotel for a year as it would be cheaper than staying but we didn’t and we "lost" about $200,000.  The funny thing is, like 95% of all Americans in a similar situation, we are not selling.  We are paying the same $400,000 mortgage we had in 1999.  Yes, there are people who refinanced their homes at the top and "used them as a piggy bank" and those people have serious problems but there are also 35M homes in this country with no mortgage at all, so there is some balance to the system.

The comparisons we are being given now by the media, the "shocking" downturn in housing is by comparison what should have been portrayed as the shocking RISE in housing prices between 2003 and 2006 but was, at that time, cheer leaded by the same media as The Great Housing Boom.  The reality is that, so far, only the homes that were actually purchases at the top, since 2004 are "losing" value, the rest (75% of all homes) are still ahead of where they were bought. 

 You can look at this chart and say perhaps, that it looks like home prices may fall back to $175,000 but then, so what?  Even if we assume 10% of all US homes turn over each year, even getting back to $175,000 would only take us back to 2003 levels.  That means that 60% of the homes in the US are still selling for more than the owners paid for them and 40% have lost roughly 20% of their value.  Total damage to US housing value = 8%.  Now that’s 8% of $25Tn and nothing to sneeze at but it’s also not a reason to expect the entire nation to implode either.  8% of $25Tn is $2Tn and those losses sound massive in all the various ways you can assign them.  If 50% of the people who lose 20% of the value of their homes walk away and stick the banks with them and the banks are forced to sell them at a loss AND the banks lent out 100% of the homes’ value then the banks are looking at $1Tn in losses.

$1,000,000,000,000 is a very big number but those same banks hold mortgages on $25Tn worth of other homes and they are collecting 6% interest and that number is $1,500,000,000,000 EVERY SINGLE YEAR!  Obviously, it’s not all profits but, over the course of the entire mortgage, even $1Tn in losses (and currently it’s just $500Bn and most of those losses are paper ones as actual liquidations have been limited) is an absorbable number. 

Another number that "THEY" have had us panicking over is the GDP.  Last month, the preliminary GDP figure for Q2 came in at "just" 1.9% vs. 2.3% that was expected.  That number hit us on July 31st and dropped the market 200 points in 3 days, down to our August 4th test of 11,200.  While it is both fun and easy to panic over a headline miss, the fact is that the entire "miss" in the GDP was caused by an inventory valuation adjustment (housing again!) that knocked 1.92% off the GDP of 3.82%.  The downward adjustment in inventories masked a lot of very good growth that went on under the radar.  We just went through Q2 earnings and there were relatively few misses there and even guidance was mainly in-line with expectations – not very crisis-like behavior..

Even with this "terrible miss" in the GDP, it was still 1% higher than Q1 and that was 1.1% higher than Q4.  So our past 4 quarters had a GDP of 4.8, -0.2, 0.9 and 1.9, that is an average growth rate of 1.69% for the year – not great but not a crisis by any stretch. 

Government spending makes up 20% of the GDP and was up 3.4% last quarter but, as long as Bush is in charge, we can rely on that to continue at this out of control rate.  We know exports have been strong and we can expect an uptick in the PCE as the stimulus checks filter through the system.  Residential investment (mainly home construction) is falling less after bottoming in Q4 and much of the rest of the numbers depend on oil, which peaked out right at the end of June and if we can make it past this hurricane season, we may be getting the opposite effect as it comes down in Q3 and Q4.

While we’re not throwing caution to the wind, we are doing our bottom fishing as there are many great companies out there being sold as if we are entering another Great Depression.  The only thing that is depressing in this country is the quality of the leadership and there is nothing here that can’t be addressed by some good, solid policy making that starts by addressing the problems that those 100M homeowners are facing.   High oil prices can be curtailed and mortgages can be refinanced but we need leadership and action, not just bickering and empty promises.

We get the GDP numbers at 8:30 tomorrow morning and the markets may make a huge move up if things go well.  I reviewed the Long-Term Virtual Portfolio last week for members and there were many buying opportunities there if you believe America will survive.  If not – there’s always gold and NEM is looking attractive in the low $40s as is ABX under $35.