Bring Forward Demand, Push Back the Consequences

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It’s not May yet. But if you believe in the old Wall Street adage “Sell in May and go away,” you may want to consider getting into May early. From Greece, to valuations, to allegations of corruption at BHP, there would be more than a few reasons.

Speaking of Greece, it ain’t over yet. Dow Jones Newswires reports that, “Concerns over Greece were reignited after Moody’s Investors Service lowered its ratings on the country. The ratings firm noted significant risk that Greece’s debt may only stabilise at a higher and more costly level than previously estimated.”

That was enough to rain on Wall Street’s happy earning parade. But the storm clouds have been building for a while now. U.S. economist John Hussman says at current valuations, the S&P 500 is priced to return about 5.7% a year over the coming ten years. But Hussman thinks a correction is due that will lower that annual return to 2.97% – which is lower than bank interest but with a lot more risk.

In a note to investors Hussman wrote that, “Wholly on the basis of current valuations, stocks are priced to deliver unsatisfactory returns in the coming years – a situation that is worsened by strenuous overbought conditions and upward yield pressures here.”

By the way, the Austrians would have predicted this too. This is yet another example of “bringing forward demand” to try and solve one problem but creating a bigger one down the road. In this case, the rebound in global stocks has been led by financial and banks stocks. But their earnings were largely manufactured by policy.

That is, with low short-term interest rates, banks around the world have been able to borrow short at low rates and lend long at higher rates. The spread between the short – and long-term rates is what delivered fat bank profits in the last two quarters and sucked investors back into speculating on higher house prices.

But “bringing forward demand” for stocks to simulate a recovery in the economy is not the same things as a real recovery in the economy. It’s the opposite. The manipulation of interest rates incentivizes speculative behaviour and leads to false price signals in the market (buy banks stocks!). Real people lose real money when the policy failure is revealed as a sham.

Coming to a stock market near you: the sham revealed!

Hussman thinks the low return for stocks is set in stone. He writes that lower annual returns are, “not dependent on whether or not we observe a second set of credit strains, but is instead baked into the cake as a predictable result of prevailing valuations. The risk of further credit strains simply adds an additional layer of concern here.”

There are “further credit strains” coming down the pike. But one last note on risk chasing. Risk, as we noted earlier in the week, isn’t bad. It’s essential. As John Dickerson wrote in Slate this week, for some high-achieving individuals (in any number of disciplines and pursuits), “risk is the animating and organising principle that drives every day.”

The trouble isn’t failure. That’s also normal and essential in life. You just have to learn to fail quickly. The bad kind of failure is being led into taking a risk you aren’t aware of because of bad (or deliberately misleading) information – and then suffering the consequences. The consequences are so dreadful because they were not part of your calculation when you decided to take action. If you didn’t think it was risky, you’ll be surprised when you get punched in the face. And probably not pleased.

That is the essential problem (and indictment) against rigging interest rates or flooding certain markets with government money – it alters perceptions of risk and shifts time preferences. People end doing things they wouldn’t normally do. And those things end up costing them a lot of money. And it takes time to make back money you’ve lost, or pay back money you owe. It’s not just a financial cost here. It’s a lifetime and lifestyle cost.

Eric Johnston makes just this point in today’s Age, albeit indirectly. He writes that bigger loans and rising interest rates threaten to smash to pieces the personal finances of many new home buyers. “Over the past 18 months, first home owners have flooded the market, enticed by government grants and low mortgage rates. But a comprehensive snapshot of the mortgage market by brokerage JPMorgan and Fujitsu Consulting has shown first home owners are borrowing on average about $280,000. Remarkably, this is the same as established borrowers, who tend to earn more.”

Does getting free money (although government money is never free) cause you to take on bigger and more dangerous risks than if you were making decisions with your own money?

Probably so. JP Morgan analyst Scott Manning writes that “”The higher gearing tolerance of first owners results in greater sensitivity to rising interest rates.” He reckons that if interest rates reach pre-GFC levels, the first home-buyers could be spending as much as half their after-tax income to interest alone.

Ouch.

And speaking of rising interest rates, a research note from Morgan Stanley says you can bank on it. Morgan bond market strategist Jim Caron told the Wall Street Journal that the large supply of U.S. Treasury bonds hitting the market this year would push prices down and U.S. 10-year yields up to at least 5.5%. They’re 3.77% now.

The Treasury will issue US$2.4 trillion in bonds this year to pay for, among other things, this year’s annual deficit of $1.4 trillion. The rest comes from the huge amount of short-term debt the U.S. must roll over. It’s bad when you’re selling new debt to pay off old debt. Ponzi finance?

Now not everyone agrees that the increasing supply of Treasuries will drown demand and lead to spiking global yields. This is, at heart, an inflationary argument (and an argument for gold rising $500 by the end of the year). If you really believed it, you’d have a strong preference for non-paper money.

But what does it mean for Australia? Ten-year government bond yields in Australia are 5.82%. You might then, wonder what would happen to Australian bond yields if Treasury yields went up. Would the rising U.S. yields make the dollar more attractive on a yield basis and lead to a weaker currency?

Over a cup of coffee this morning, we reached the following conclusion: a dollar crisis doesn’t make the dollar more attractive. Yes, it’s a stunning conclusion. But what we mean is that Aussie bond yields might actually go lower in a dollar crisis. That would happen if central banks (other than the Fed) really do flee the Treasury market. They have to go somewhere, and higher yielding currencies like the Aussie might be that place.

But this is not how it played out last time. By “last time” we’re referring to the credit crisis. That drove up everyone’s borrowing costs, destroyed the asset securitisation market, and kicked of a wider credit depression. And if THAT is what happens in a U.S. dollar crisis, it will put a lot of pressure on Aussie banks that source their funding abroad (you know who you are!).

That brings us, finally, to the core of today’s Daily Reckoning: not much has changed since 2008. The core of the problem in the world’s financial system was that too much debt had been used to purchase assets (securities tied to U.S. houses) that fell in value, destroying bank collateral. What’s different today? Have those debts been written off? Or in Austrian terms, have the mal-investments been liquidated?

Not really. Most policy measures then have been polite fictions designed to disguise the ongoing deterioration in bank collateral. Mark to market rules have been suspended. Anecdotal evidence has it that many Americans have simply stopped paying their mortgages. This boosts consumption figures in the GDP accounts (not paying your mortgage is a huge boost to discretionary income). And if the government is modifying some home-owner contracts, surely it sends a signal to otherwise law-abiding home owners that they can ignore contract too?

On the part of U.S. banks, they’re happy to let a home slip well past foreclosure. What else is the option? Writing down the value of the asset and crystallising the loss? No thank you! It’s the old “extend and pretend” strategy…just give it more time and hope that somehow, some way, the housing market recovers and loan portfolios do too.

The result of this refusal to confront reality means that the financial system remains propped up by a handful of accounting tricks, according to Nomura analyst Richard Koo, via ZeroHedge. Koo writes that, “If US authorities were to require banks to mark their commercial real estate loans to market today, lending to this sector would be extinguished, triggering a chain of bankruptcies as borrowers became unable to roll over their debt.”

In a normal crisis, he writes, the banking sector is encouraged to write-off bad loans in order to clean up its balance sheet and unleash credit to fund the recovery. “But during a systemic crisis, when many banks face the same problems, forcing lenders to rush ahead with bad loan disposals (i.e., sales) can trigger a further decline in asset prices, creating more bad loans and sending the economy into a tailspin. I think the Fed’s shift in focus from conventional nonperforming loan disposals to credit crunch prevention is an attempt to avoid this scenario.”

All of this many seem like mostly an American problem. But that’s what it seemed like last time…until the credit tide went out and Australian investors found out just how many firms had business models and balance sheets that depended on cheap funding and the ability to roll it over in a short amount of time.

How much has that changed in the last two years? You’re about to find out. But in the meantime, most of our editors here are using trailing stops to lock in gains accumulated over the last year. And as for finding stocks that are actually undervalued? More on that on Monday.

The discouraging aspect of all this is that so much capital remains tied up in non-performing assets. To save the bankers, we have killed off the future prospects for entrepreneurs. An economy that does that retreats from the frontier, where new productive possibilities emerge, and doesn’t take wealth-creating risks anymore. That’s bad for investors. But it’s not the end of the story either.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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47 Comments on "Bring Forward Demand, Push Back the Consequences"

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Andrew
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It seems to me the USA and Europe now reward the failures and losers of society, the banks are a good example. If you are an entrepreneur you are better off moving to one of the dynamic emerging countries.

Gary
Guest

@Andrew – Of course they reward the failures and losers. Just look at their politicians. Then again, look at ours. At least Sarkozy packs some nice eye candy on the side and Berlusconi’s ongoing saga is amusing. Ours are just… lame.

chris
Guest

Check out this video of some guy explaining that Australia is in a massive housing bubble:

http://www.ft.com/cms/86a30e34-dfd5-11dc-8073-0000779fd2ac.html?_i_referralObject=15762261&_i_referrer=rss

Brett
Guest

I for one am sick of this whole property BS that I think is stuffing the country socially and economically. A good way to let Ruddy and Co. know how we feel is provided here:

http://www.housingaffordabilitycrisis.com

Biker Pete
Guest
Thanks for the link, Roy. Dear Tanya Plibersek, I am a goldbug and I resent your support for the Australian construction industry. How can my bullion appreciate, if you keep intervening to save Australian jobs, Australian banks and Australia’s third largest industry, construction? Yes, I realise the FHOGs took nearly 200,000 tenant families out of the rental pool, thus freeing up a fifth of a million rentals… and keeping rents low, but it also helped save fiat currencies. This is NOT good for gold investors! We _need_ this crash if we are to prosper, Tanya. Please act immediately to ensure… Read more »
Stillgotshoeson
Guest
Dear Tanya Plibersek I acknowledge the government had the best of intentions when implementing the increased FHOG’s at the start of the GFC crisis and acknowledge that due to the GFC the hundreds of thousands of mortgage holders that were straining under mortgage rates approaching 10%, and fuel bills for their cars at pocket emptying levels of $1.65 per litre.. well with lower interest rates giving people up to $1000 per month they did not have pre crisis levels due to higher interest rates and an average mortgage much lower than is required now due to the increased vendors boost..… Read more »
Biker Pete
Guest

Yep, calling FHOs ‘suckers’ should convince Tanya you have Australians ‘best intentions’ right at the top of your list, Shoes.

Did you send it? Have you received your acknowledgement yet?~

Biker Pete
Guest

You sent Tanya Plibersek an email from Roy’s horse, BP? :)

Biker Pete
Guest

Why, yes, but her response was that he was a neighsayer…

Steve
Guest

“All bubbles pop”

prozak
Guest

using averages doesn’t really tell much of a story

Who here read:

“…first home owners are borrowing on average about $280,000”

And was shocked?

I bet no one. 280k aint that much money.

Biker Pete
Guest

Or, as the Americans would say: “All pop bubbles.”

chris
Guest
Dear Tanya Plibersek, Well yes we know that you had to keep the Australian housing market bubble going on forever, after all, as the media tell us constantly, Australia is LEADING the world out of this downturn. We are the champions my friends. Aint that amazing that a country where most of the people are in debt 150% of their incomes that we are still managing to lead the global charge out of this downturn. Anywho, you also managed to get all the headlines across Australian media to scream “interest rates are at RECORD LOWS!!!”” and then while the masses… Read more »
Biker Pete
Guest

“…there really isn’t much time left for reading financila colums…”

… or dictionaries, apparently… .

Biker Pete
Guest
“…we tease a few more people that they have missed out on buying a house forever…” Or we try to help prepare them for the next dip in prices, so they’re ready when it comes… . Yes, I’d definitely send that one to Tanya, Chris. She does answer them, you know. (Probably a staffer, but its her signature.) Will the bubble pop? All bubbles pop! What will it take to pop the property bubble? Oversupply. That exists in dozens of places around Australia, but most people need to be near their employment, their friends and families. No-one wants to be… Read more »
Steve
Guest

Steve’s quote of the day

“Never EVER be surprised by the sheer stupidity of the Australian mega mortgage mug”

Biker Pete
Guest

Steve: “Steve’s quote of the day: ‘Never EVER be surprised by the sheer stupidity of the Australian mega mortgage mug’

Hardly the quote of the day, Steve. ‘HaHa’ has been using it for nearly six years now.

According to your criteria, Canadians are stupid and Aussies are ‘stupider’.
But you’re brilliant, Steve. _You_ invent new words… .

Biker Pete
Guest

‘stupider’ ! Classic. Ping me, Steve. Oh, I see you have…!~ :)

Steve
Guest

HaHa as in I will get the last laugh

Biker Pete
Guest

Well, you’ll certainly outlive me, Steve!~ ;)

Biker Pete
Guest

The sound of Steven’s laughter: Steve, 26 April 2010:

“…those who have invested in property have knowingly made me and my fellow Australians WORRSE OFF thats why I dont give a Sh!t about them… thats why I hate them…”

Yep, that’s laughter all right… .

nv
Guest

Meet the world’s largest landowner.
Pure scum really.
http://www.whoownstheworld.com/about-the-book/largest-landowner/

prozak
Guest

Nv,
Yeah right.
the queen ain’t even the largest land owner in the UK.
pure and utter bollocks to try and sell a book and conspiracy theory.

nv
Guest

by prozak;
“the queen ain’t even the largest land owner in the UK.
pure and utter bollocks to try and sell a book and conspiracy theory”.

Oh reeaaally? Crown land? Have you not heard about it? Hmmm?
Crown Land. That’s right, crown land. All freehold property is on crown land, you own nothing. You have a tenure to freehold land because all is on crown land.
Dirty filthy murderous scum of a monarchy.

prozak
Guest

NV,

The term still exists.

George III handed over the crown estate to parliament in return for a civil list payment. The monarchy now owns the land and is managed independently. The ruling monarch cannot sell the land nor does the income belong to them. the estate reports to parliament.

in Australia crown land is owned by each state or the commonwealth and makes up only 12.5% of all land. in addition there is allodial title that was not from crown grant.

in short…. anyone who buys into this conspiracy theory is an idiot.

nv
Guest
“Crown land is land that is owned and managed by State Government. It accounts for over half of all land in New South Wales”. “Crown lands managed by the LPMA should not be confused with other forms of Crown or State owned lands such as National Parks, State Forests, State Rail property etc”. http://www.lpma.nsw.gov.au/land_titles/land_ownership/crown_land TOTAL LANDS CATEGORY (1993 data) Public: 23% Private: 62.75% Please Note: Of 62.75% Private Land, 20.6% is ‘Freehold’ and 42.1% is CROWN LEASEHOLD. Aboriginal: 14.25% So we have 23+42 = 65% crown land + 14 aboriginal = 79% + say 21% private = 100. http://www.ga.gov.au/education/geoscience-basics/land-tenure.jsp Your… Read more »
nv
Guest

“Crown land is land that is owned and managed by State Government. It accounts for over half of all land in New South Wales”.
“Crown lands managed by the LPMA should not be confused with other forms of Crown or State owned lands such as National Parks, State Forests, State Rail property etc”.
http://www.lpma.nsw.gov.au/land_titles/land_ownership/crown_land

nv
Guest

TOTAL LANDS CATEGORY (1993 data)

Public: 23%
Private: 62.75% Please Note: Of 62.75% Private Land, 20.6% is ‘Freehold’ and 42.1% is CROWN LEASEHOLD.
Aboriginal: 14.25%

So we have 23+42 = 65% crown land + 14 aboriginal = 79% + say 21% private = 100.
http://www.ga.gov.au/education/geoscience-basics/land-tenure.jsp

Your comment “makes up only 12.5% of all land” is right out of wikipedia which makes you the idiot.

nv
Guest

idiot

Biker Pete
Guest
And now to Oz, where it’s all bubbling happily away… . PerthNow, 29/04/2010: “Melbourne’s house prices jumped 27 per cent over the past 12 months, double that of Sydney, where house prices increased by 14.7 per cent. Brisbane …is… up 9.1 per cent for the year to a median of $451,388. In Perth, house prices rose 1.1 per cent for the quarter and 9.4 per cent for the year to a median of $519,526, according to APM. The rapid recovery of the top end of the residential market, which is less sensitive to interest rates, is dragging up median prices…”… Read more »
prozak
Guest

Wow didn’t someone get all wound up like a little toy….

Regardless of the amount of crown land your own quotes prove your conspiracy wrong.

I’m sure that won’t stop you believing the conspiracy though.

Have a nice day, but be careful the queen is also leader of the illuminati and has eyes everywhere and will have you killed and fed to the giant squid on which our planet rests.

Biker Pete
Guest
Some time back, someone here suggested at the rate Australian property is rising, that even if Keen is correct (that there will _eventually_ be a 40% crash) the price of Australian housing will have risen to such a level that it will easily exceed the ‘values’ he said would crash. At the time, I remember dismissing that comment as interesting, but a little irrelevant. Considering the annual figures for Sydney (14.7%) and Melbourne (27%) we’d have to concede that two more years of that ‘growth’ would render even a 50% crash of lesser consequence, unless one bought at the top… Read more »
nv
Guest

oh poor prozac, better go and bow to your queen to make you feel good who then bows to the danish queen who then bows to the jew banksters.
history nor convoluted legalities are your forte so have a good life bowing.

Stillgotshoeson
Guest
That “27%” figure is a little distorted though BP. The real average growth for Melbourne is probably closer to 10 to 12 percent. Quite a few areas that were “expensive” suffered 30 or more percent drops at the height of the GFC. Mainly due to owners of these “million dollar + ” properties drawing on equity of the homes and purchasing a portfolio of shares.. then under the advice of advisors/friends/neighbours they then took out margin loans against their share portfolios, the share market crashed and they were forced to sell homes quickly.. Brighton, Kew, South Yarra, Toorak, Bulleen and… Read more »
Don
Guest

Soon the wait will be over and we get an idea of what the government has in store for us – Sunday bloody Sunday :)

Stillgotshoeson
Guest
Further to above.. http://www.theage.com.au/business/property/housing-bubble-to-burst-history-says-yes-20100430-txcc.html#poll The Poll results are interesting.. Poll: Do you think the property bubble will burst, or are we really the lucky country? Poll form 1. Please select an answer. Prices are sure to fall 2. Prices will flatten out 3. Prices will keep rising 4. View results Prices are sure to fall 42% Prices will flatten out 42% Prices will keep rising 16% Total votes: 1406. Means a large majority of those that voted think the growth is going to end in the near term.. If they do not “correct” and merely stagnate for a number of… Read more »
Stillgotshoeson
Guest
Comment by Don on 30 April 2010: Soon the wait will be over and we get an idea of what the government has in store for us – Sunday bloody Sunday :) I can’t believe the news today Oh, I can’t close my eyes and make it go away How long, how long must we sing this song? … … And the battle’s just begun There’s many lost but tell me who has won The trench is dug within our hearts And mothers, children, brothers, sisters torn apart … … And it’s true we are immune when fact is fiction… Read more »
Davo
Guest
Not sure where these median house price increases come from. I sold a house, 3 bedroom, 2 bathroom, double storey brick (typical 70’s house)in Stafford Heights last October. Stafford Heights is about 8kms to the Brisbane CBD. Sold it for $503K to a couple of first home buyers via an agent acquaintance of ours. My wife spoke to the agent yesterday, and she said we sold at the right time, as she would really struggle to get more than $450K for it today. A month before that, we sold our own house, and again she said we would be lucky… Read more »
Biker Pete
Guest

“And it’s true we are immune when fact is fiction and TV reality
And today the millions cry
We eat and drink while tomorrow they die ”

And gold takes no prisoners(?)

It’s a jungle out there… :)

Biker Pete
Guest

It’s wonderful that you have so much trust in realtors, Davo.
Not everyone believes their pitch… .

You should definitely stay with that one! ;)

rick e
Guest

Since my dr email is not in yet this a nice read
The Mogambo Guru
http://dailyreckoning.com/the-bittersweet-memories-of-commercial-property-ownership/ is this like cdos again?

rick e
Guest

one more

Rising Federal Debt Found to Cause Intestinal Alien Syndrome
The Mogambo Guru

Steve
Guest

Steve’s quote of the day

“The only way you can have affordable housing is if house prices correct”

Biker Pete
Guest

“Steve’s quote of the day: “The only way you can have affordable housing is if house prices correct”

Uh, let me guess. Steve Keen, 2006, right?!~

Steve
Guest

Unless Kevin Rudd gets rid of Negative gearing in the tax review on Sunday
I will not be voting for anyone in the house of reps next election

Stillgotshoeson
Guest

Different figures for the last 12 months property market in Melbourne…

http://www.theage.com.au/national/hot-property-puts-melbourne-into-the-forefront-20100430-tzi9.html

As bank lending to housing investors accelerated sharply in March, real estate monitor RP Data-Rismark says Melbourne prices have climbed 18.7 per cent in the past year. The median house price soared $71,000 to $452,000, leaving thousands of would-be home owners unable to compete.

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