The S&P 500 finished the week almost unchanged. Almost, because it technically inched higher by 0.1% on very weak volume. Volatility slipped 4% back down to multi-year lows, lows usually associated with extreme complacency. And risk complacency, along with bullishness about prices, is certainly dominating the markets and the media.
While the US economy struggles (remember, it actually contracted last quarter), and much of the rest of the world is in outright recession, equity markets have continued to climb higher, ignoring all signs of fundamental weakness.
The risk markets are also ignoring signs of corporate slowdown. Sales are not climbing, on average, as the have over the last three years, and earnings are most certainly disappointing….across the board.
Markets are also ignoring event risks, whether it’s the US federal spending cutbacks that will hit in two weeks, or the threat of a credit event in Europe, or the threat of a financial crisis in Japan, or any other of the dozens of geo-political risks that we all know about.
Today, players in risk markets believe that nothing much can go wrong. This time IS different.
And that’s what makes them especially dangerous. Because in such extreme states, when everyone is on one side of the boat, it doesn’t take much of a disturbance to create a disaster. In the meantime, the party rages on.
US macro news last week was mostly disappointing. Small business optimism missed expectations. Business inventories also missed. Initial jobless claims beat expectations, but only because the BLS ‘estimated’ the results for several KEY states. Almost always, when the actual counts come in, the subsequent claims figures shoot higher (worse). Although the Empire State manufacturing survey beat expectations, industrial production missed badly—it fell when it was supposed to rise.
Residential real estate, according to the media and the realtors and the banks, has finally passed the bottom and has started its long-awaited recovery.
But is this really so?
Well, according to the Case Shiller index (perhaps the most respected national and regional house price index), yes median home prices have been rising—on a year over year basis—since the spring of 2012.
But is this it? Does this mean that the bursting of one of the greatest bubbles in US history is over. and a durable recovery is in effect, as the housing proponents claim?
Very possibly, the so-called recovery is only temporary.
On the supply side, Fed-backed too-big-to-fail banks have been restricting the amount of inventory (from foreclosures) hitting the market. This has created significant upward price pressure over the last two years.
On the demand side, the Fed-suppressed interest rates have allowed organic buyers and pools of investors to borrow very cheap money (near historic low levels) that allows them to bid up prices and still be able to afford the properties.
So the question is—-can this demand and supply manipulation continue indefinitely, to create a self-sustaining recovery in housing prices?
The answer is most certainly not. And the Fed has publicly said so, by stating that its extraordinary measures (to support banks and to suppress rates) will not continue forever. And when these Fed programs subside, inventory may creep higher (the pool of foreclosed homes is nowhere close to being cleared in the market) and higher rates will mean that potential buyers will be paying more, much more, in mortgage rates.
In both cases, the end result is that median home prices will come under pressure again. The good news is that if they keep rising for another year or two, then the subsequent declines will begin by taking away the recently built up gains, and that it may take several years just to go back down to the lows hit in early 2012.
In any case, it’s certainly not clear that the ultimate bottom (especially in real prices) has been established. So buyer beware.