Thursday, May 24, 2007

Mortgage Problem: hitting harder and faster

The subprime mortgage meltdown has been a shock to industry insiders, but now they say it's hitting harder and faster than expected - even to those who predicted the crisis in the first place.

That was the message Monday from a panel of leading industry executives on the state of the mortgage lending industry at the Mortgage Bankers Association's Expo in New York.

Michael Marriott, director for Credit Suisse, said, "Last October, I predicted the subprime market would collapse and many issuers would go out of business. But the violence and speed of the market sell-off surprised people."

David Lowman, of Chase & Co.'s global mortgage business, said, "35 percent of what once could be done, can no longer be done," referring to mortgage loan products that have effectively been taken off the shelves.

One of the real estate agents he works with had six deals blow up within four days because, "The loan originator told him, 'We're not offering [these products] anymore.'"

According to LeGate, this kind of thing just started to happen in the past month or so.
Allen Hardester, Guaranteed Rate, said many once-common subprime loans products are now almost impossible to find.

"Anything that smacks of no-income and no-documentation is history," he said. "Anything above 85 percent to 90 percent loan-to-value, anything non-owner occupied, anything ludicrous as to value - like someone stepping up from a $1,000 a month payment to a $6,000 a month - is history."


Tuesday, May 22, 2007

Robert Shiller: Houses and the " Bomb"

Robert Shiller is worried about your home's value, and that's not good. A finance and economics professor at Yale, Shiller proved he could see a crash coming with his book "Irrational Exuberance," which forecast the end of the 1990s stock bubble and hit bookstores in March 2000 - almost to the day the Nasdaq started to collapse.

Today, Shiller believes homes are roughly as overvalued as stocks were then and, once again, he's worth listening to.

In short, no one else knows the history - and perhaps the future - of U.S. real estate prices better.

Question: What caused the stock bubble, and why did it end as it did?

Answer: Some sociologists talk about collective consciousness. We humans evolved to be very closely linked, and our minds focus on the same ideas. Those [ideas] get reinforced because we hear them all the time.

Back in the late 1990s, you kept hearing that you had to stake your claim on the Internet or you'd miss out on the future. No one cared about the present. Then something happened around March 2000. There was an acceleration of public talk about doubts. You could no longer declare at a cocktail party that Internet stocks were going up. Such statements had become embarrassing - and just like that, word of mouth changed.

Embarrassment is a powerful emotion.

Question: Is that about to happen in real estate?

Answer: It doesn't seem like we're there quite yet. But this is the biggest boom in housing prices since, well, ever. Nothing seems to explain it, and nobody forecast it. It seems to me...wait a minute. Please don't quote me as forecasting the markets.

Question: Okay. What you're about to say is not a forecast.

Answer: Well, human thinking is built around stories, and the story that has sustained the housing boom is that homes are like stocks. Buy one anywhere and it'll go up. It's the easiest way to get rich.

Question: So how rich can you get on real estate?

Answer: From 1890 through 1990, the return on residential real estate was just about zero after inflation.

Question: Excuse me? That's all? Hasn't it been higher lately?

Answer: Since 1987 it's been 6 percent [or about 3 percent a year after inflation].

Question: So real estate doesn't go up roughly 10 percent a year?

Answer: It can't be true that homes rise 10 percent a year. If they did, in the long run no one would be able to afford a house.

Question: Let me grab a calculator. If real estate really rose 10 percent a year, a $25,000 home in 1957 should be worth roughly $3 million now.

Answer: And that flies in the face of common sense. In fact, I'm inclined to think there's a good chance that the return on real estate will be negative, substantially negative, over the next 10 years because all booms reverse in the end.

Question: All right. We won't call that a forecast either. So how should people think about their home as an asset?

Answer: Avoid concentration of risks. You need a house, but I would avoid a second one - or at least avoid an outsize house. Over-investing in real estate now would be a recipe for disaster.

Question: You also write about the risk to human capital. What's that?

Answer: What you're trying to do is to invest in skills that somebody else will want to pay you for. Let's say you want to work at Bethlehem Steel. That would have been a good idea in the 1950s, not so good by the 1970s. The world went the wrong way on you.

Question: How are you investing now?

Answer: I'm probably a little over 60 percent in stocks, almost all of it outside the U.S. I have a lot of cash. And I've been reducing my exposure to real estate. It may be at the end of a cycle.

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Monday, May 14, 2007

Stocks and the Bull Market

The 50% Principle states that following an extended rise in the Dow, if a following decline retains at least half of the Dow's preceding gains, the primary trend is taken to remain bullish. I want to emphasize that the advance must be extended in both duration and extent. The 50% Principle cannot be applied to advances of a few months or so.

All right, now let's look at the market picture. The Dow had advanced from 759 at its 1980 lows to 11722 at its 2000 high. That was a bull market rise of 10963 Dow points. Half of that is 5481, so adding 5481 to the 759 low gives us a halfway or 50% level of 6240. Again, remember that the 50% Principle states that as long as the Dow remains ABOVE the halfway level of its preceding extended rise, the primary trend remains bullish.

The Dow started down from its January 2000 high and continued down to a low in October 2002. At its October 9, 2002 low, the Dow closed at 7286.27 -- this was far above the 50% level of 6240. Thus, under the 50% Principle, the primary trend of the market remained bullish.

Further proof that the 2000-2002 decline was a reaction in a continuing bull market rather than a bear market decline was seen via a test of values. I went back in my archives (you can do this too) and noted that at the October 2002 low, the yield on the widely-followed S&P Composite was a micro 1.79%, while at the same time the S&P was selling at 33.07 times earnings. The Dow was priced slightly better, but on either count, stock values were nothing like what one might expect at a true bear market bottom.

Thus, based on both the 50% Principle and on values, the "collapse" of 2000 to 2002 was a bull market correction, not a bear market decline.

I think what threw me off more than anything else was the astounding decline in the NASDAQ, which lost 78% of its total value. The NASDAQ collapse was comparable to the 1929-1932 decline in the Dow, at which time the Dow lost an incredible 89% of its total value. On top of that the S&P during the 2000-2002 lost almost half its value.

During 2000-2002 the whole nation was keyed in on the NASDAQ and the tech stocks. The disastrous smash of the NASDAQ helped to convince me that the primary trend had turned down. Sure, the bear market almost destroyed the NASDAQ, but it was the action of the Dow that I should have trusted. The 30 Dow stocks represent the "backbone" of US economy. The NASDAQ was, to a large extent, made up of wildly speculative tech stocks, few of which paid any dividends at all. As a matter of fact, this is still the case. The NASDAQ does not represent the US economy -- the Dow does.

So the lesson is this -- for the direction of the great primary trend of the market and the economy, use the D-J Industrial Average for your guide. Use the 50% Principle together with your study of values. At the 2002 lows, the 50% Principle applied to the Dow told us that the great primary trend of the market remained bullish. At the 2002 lows, values told us that this was NOT a bear market bottom -- quite the opposite, stocks at the 2002 lows were still overvalued and characteristic of an ongoing bull market.

Happily or maybe luckily, I zeroed in on the utilities following the 2002 lows. At the 2002 lows, many or even most of the utility stocks were providing "juicy" dividend yields of 6% or more. Since I always emphasize dividends I repeatedly advised buying the utility stocks. At the October 9, 2002 low, the D-J Utility Average stood at 167.57. The D-J Utility Average closed last Friday at 526.54. That means that the utility advance from the 2002 lows amounted to a rise of 215 percent.

Compare that to the Dow which rose from its 2002 low of 7286 to last Friday's close of Dow 13326. Thus, the Dow from its 2002 low has risen 82.9 percent, far less than the rise in the "conservative" Utility Average. Subscribers who bought the Utility stocks have done better, percentage-wise, than those who bought the Dow stocks. From: **DowTheoySubscription**