The Fed hiked interest rates again by another quarter point to 5.25%. No surprise there.
But the post-meeting statement was a lot tamer than I expected. Sure, they warned high energy prices could keep the heat on. But in the same breath they took it all back by saying the economy is slowing.
Typical Fed double-talk.
The knee-jerk reaction? A big rally in stocks and bonds.
But has anything changed? No! The Fed still isn’t taking a tough stance on inflation. And guess what: Just as the Fed was releasing its statement yesterday, the price of crude oil — which is driving inflation — surged to within a couple of dollars of its highest level in history.
We’ve Seen This Movie Before and
We’re Destined to See It Again
Martin and I are watching this situation together and we see eye to eye. But in some ways, he and I couldn’t be more different.
I’m 30. He’s almost 60.
I’m a Boston University grad. He studied at Columbia in New York.
I like nothing more than downing an ice cold beer while I cook up a batch of turkey burgers on my Weber grill. He eats only health food and would never even touch a Coke.
And we cut our teeth in entirely different financial markets, too.
Martin was shaped by his experiences in the 1970s. He saw: Runaway inflation … a stagnant economy … double-digit interest rates, which crushed stocks and bonds. And Martin saw what can happen when the Fed lets the inflation genie out of the bottle, and is too tame to confront it.
He can remember the last time gold traded above $700 an ounce. He can tell you, in vivid detail, about the brutal bond market rout of 1980, when the U.S. government practically couldn’t borrow money.
In contrast, I started following the markets in the mid-1990s. I saw:
A booming economy …
Soaring dot-com stocks …
And falling inflation.
Consequently, investors in my age bracket came to accept the Fed as practically omnipotent. Indeed, the late 1990s was true economic and market nirvana.
I had no trouble finding work right out of Boston University at an Internet firm called Bankrate.com.
And let me tell you, I wasn’t worried one bit about an Internet bubble. Neither were many others in my generation. Greenspan and his Fed cohorts assured us that surging productivity and rising corporate investment in technology made all the bubble talk meaningless.
Meanwhile, stocks were going virtually straight up. And when they did go down, they didn’t stay down. The Asian currency crisis in 1997? The Long-Term Capital Management hedge fund meltdown in 1998? Nothing more than flesh wounds. Greenspan smoothed things over with more easy money, and before you could say “Buy the dip,†the Dow was making new highs.
Housing was cheap. My wife and I bought a great starter home here in Palm Beach County, Florida for a song. Heck, we were even able to finance the purchase with a short 15-year mortgage thanks to low interest rates and a low price tag.
On top of that, quiescent inflation and stable living expenses translated into great, “real†salary and wage gains. Dollars went a heck of a long way.
Remember: At one point, gasoline dipped below $1 per gallon — and crude went as low as $10 a barrel! But …
Now, The Good
Times Have Ended
It was hard at first — really hard sometimes — to accept and understand what happened starting in 2000.
How could stocks plunge so far, for so long? How could bonds sell off for an extended period of time, and then sell off some more? How could the Fed be forced to cut short-term rates to 45-year lows, then hike them 17 straight times without absolutely crushing the markets and economy?
But the more I’ve studied, and the more I’ve talked with Martin and the rest of the team here, the more I’ve learned.
I saw that, no, the Fed isn’t omnipotent. In fact, its record on everything from Internet stocks to oil prices to adjustable rate mortgages is downright awful.
I realized that monetary policy isn’t really “tight†when interest rates fail to rise as fast (or faster) than underlying inflation.
It became very apparent to me that you really, really have to consider the “risk†side of the risk/reward equation when making investment decisions. And I opened my eyes to all kinds of investments designed to make money during the times when stocks and bonds go down.
So what’s foremost on my mind right now?
Trouble Brewing in Residential
And Commercial Real Estate
My specialty in the interest rate world is mortgages and housing. Before I joined Weiss Research, I covered the market from several angles at Bankrate.com. And I’ve been scouring just about every wonkish study on those topics ever since.
Based upon the reckless lending I saw, the dot-com-like rampant speculation in housing, the threat of rising interest rates, and the utterly ridiculous overvaluation of homes from one end of the country to the other, I started warning that a real estate bust was coming more than a year ago.
I was too early. And I looked pretty stupid for a while when sales and prices kept on booming for a bit.
Not any more. In a recent press release, even the National Association of Realtors was reduced to practically begging the Fed for mercy.
They’re effectively saying: “Please, stop raising interest rates. Please, please don’t make the downturn even worse than it already is!â€
I’ve talked about home-building stocks plenty. Now, I’m increasingly focused on the fall-out, the “second round†effects, if you will.
I’m looking at the sorry state of the construction suppliers, the mortgage lenders, the regional banks. At the same time, I’m paying more and more attention to the massive overvaluation and frenzied deal-making I’m seeing in the commercial real estate market.
I have to tell you, what I’m finding isn’t encouraging. The amount of exposure to a real estate downturn in the financial industry is frightening. Here are a few troubling things I’ve uncovered:
- Construction and development lending surged a whopping 34.6% year over year in the first quarter, according to the Federal Deposit Insurance Corp.
- Real estate construction and development loans, multifamily residential loans, and loans secured by commercial real estate properties totaled more than 42% of all loans at institutions with less than $1 billion in assets. That’s a huge increase from 28% just six years ago.
- Banks with $100 million to $1 billion in assets have a stunning 400% of their capital tied up in real estate loans. That’s twice the level at the end of the 1980s and early 1990s, when the banking and savings and loan industries imploded due to massive real estate losses.
Don’t get me wrong: Right now, apartment and office rents are rising and everything looks peachy. I’m talking about longer-term issues that won’t explode on the front pages of the Wall Street Journal right away. But with interest rates rising, liquidity showing tentative signs of tightening, and the economy poised to slow down the road, I think real trouble is coming.
Lenders with high-risk condo construction and conversion loans will take a bath …
Developers who paid sky-high prices for land will get whacked when returns don’t measure up to expectations …
And commercial investors, who have been snapping up office buildings and retail property based on wildly optimistic estimates for rent growth and appreciation, will have serious losses.
My take: If you’ve got too much money tied up in this area, it’s time you lighten up. Yesterday’s weak-kneed Fed action only prolongs the agony of rising interest rates.
One last important note: Larry just called, and he wanted me to tell you that the price of crude oil has crossed through the $72.32 upside level that he outlined in “Your Roadmap for the Dow, Gold, and Oil.†He considers this a very bullish sign, and says gold is also moving toward its upside level.
Until next time,
Mike
For more information and archived issues, visit http://legacy.weissinc.com
About MONEY AND MARKETS
MONEY AND MARKETS (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Sean Brodrick, Larry Edelson, Michael Larson, Nilus Mattive, and Tony Sagami. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Regular contributors and staff include John Burke, Colleen Collins, Amber Dakar, Ekaterina Evseeva, Monica Lewman-Garcia, Wendy Montes de Oca, Jennifer Moran, Red Morgan, and Julie Trudeau.
Attention editors and publishers! Money and Markets issues can be republished. Republished issues MUST include attribution of the author(s) and the following short blurb: This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://legacy.weissinc.com
© 2006 by Weiss Research, Inc. All rights reserved.
15430 Endeavour Drive, Jupiter, FL 33478
