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The last 12 months have seen monumental shifts in the interest rate and real estate markets. And if I’m right about where things are headed, 2008 should be just as exciting, if not more.
Naturally, I can’t give away the entire store here. More precise forecasts and profitable recommendations are reserved for loyal subscribers to Safe Money Report, who will be getting a potentially lucrative gala outlook issue shortly.
If you’re not a member, I’d like to take this opportunity to extend a very personal holiday invitation. Simply click here now and start your introductory subscription to Safe Money Report with no risk or obligation.
Now, with that said, it’s time to dust off the old crystal ball and share some of my profound insights with you for the next 12 months. Let’s get right to ’em …
Mega-Trend #1: The Housing Downturn Will
Drag On … And On … And On
A few years ago, I started warning that the housing market was a dangerous bubble, destined to pop with devastating consequences.
I highlighted predatory mortgage lending, ridiculous speculation, out-to-lunch regulators, and dramatically overvalued homes as threats to the entire housing system — and told you to expect those problems to come home to roost. Boy, have they ever.
To recap some of the major points …
Sales and construction activity have collapsed: Existing home sales have plunged 31% from their 2005 peak. New home sales are down even more — around 48%. Meanwhile, single family housing construction activity has tanked 55%. And the decline isn’t over: The issuance of new building permits — an indicator of future housing starts — has dropped to its lowest level since 1991.
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The outlook has worsened as empty homes have piled up: An index that measures home builder optimism, buyer traffic, and expected sales has plunged from the 70s during the boom to 19, a record low. And the nationwide home vacancy rate has surged to a near-record 2.7%, a testament to the dramatic glut of empty, depreciating homes sitting on the market.
Mortgage performance has suffered: An alarming 5.6% of the nation’s homeowners have fallen behind on their mortgage payments — up from roughly 4.7% a year earlier and the most since 1986. The percentage of homes in any stage of foreclosure has jumped to 1.7%, the highest since the Mortgage Bankers Association began tracking it in 1972.
According to some estimates, as many as 2.2 million homeowners could lose their houses over the next 24 months!
We’ve already seen the price of an American home lose 6.1% from a year ago, according to the well-respected research group S&P/Case-Shiller. The Census Bureau shows the price of new homes down even more — 13% in October, the sharpest drop in 37 years.
I fully expect more declines in 2008. Home values will likely fall by the mid-single digits nationwide, and more in select markets.
Longer-term, the downturn in construction activity will eventually cut housing inventory to a more manageable level, while lower prices will entice more buyers to step up to the plate.
But it’ll take a good long while to get housing supply and housing demand into better alignment. I don’t expect the overall market to start a gradual recovery until late 2008 at the earliest. More than likely, it will take until 2009.
Mega-Trend #2: Commercial Real Estate Ready
For Its Turn On The Chopping Block
In May, a Moody’s commercial real estate analyst declared …
“Underwriting has gotten so frothy that we have to take a stand … the industry was heading to Niagara Falls.”
But by the time Moody’s took its stand, the frothy underwriting in the commercial sector was too far gone.
As on the residential side, the industry was already plagued by interest-only financing … loans with huge balloon payments … hasty and shoddy due diligence … scrimping on tax, insurance, and maintenance reserves by landlords … little or no equity contribution from purchasers … not to mention loan-to-value ratios of 80%, 90%, even 120%.
Commercial lenders are now attempting to get their arms around the problems. But they waited too long. They’re trying to shut the barn door after the horses are gone. Third-quarter delinquency rates on commercial real estate loans surged to a nine-year high of 1.94%, up from 1.11% a year earlier, and they’re poised to rise even higher in 2008.
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The result: Commercial property values will likely deteriorate in 2008, and commercial foreclosures will escalate. Heck, the process is already underway — as the Wall Street Journal reported on Wednesday:
“For the past few months, the [commercial real estate] sector has been in a state of near-paralysis, as financing has nearly dried up. The number of major properties sold is down by half, and many worry that the market will continue to deteriorate as property sales remain slow, prices continue to drop and deals keep falling apart.”
Earnings prospects for a wide variety of Real Estate Investment Trusts, or REITs, will likely weaken as well, prompting even more REIT investors to jump overboard.
After all, office, industrial, and retail vacancies are starting to rise, and rental growth is never going to live up to the extremely optimistic projections promulgated during the boom.
Mega-Trend #3: The Party’s Over For
The Financial Sector
The finance industry generated hundreds of billions of dollars in profit in the past few years. Originating, bundling, buying, selling, and trading residential mortgages, corporate debt, leveraged buyout loans and more was a humongous cash cow.
And don’t even get me started on the explosion in the packaging and trading of complex, hard-to-understand derivatives.
Suffice it to say that the notional, or face value of global over-the-counter derivatives soared to a stunning $516.4 TRILLION in the first half of 2007! That was up 40% in a year and up almost six-fold since the turn of the century, according to the Bank for International Settlements.
Unfortunately for many financial firms, that business model is now shot. Complex debt securities are blowing up. The risk of parties to derivatives transactions actually failing to meet their obligations — known as “counterparty risk” — is rising fast. And the origination and packaging of all kinds of debt is grinding to a halt.
A couple key examples …
Commercial real estate bond issuance plunged to $4.9 billion in October from a peak of $26.9 billion in August.
Bottom line: The decline in all these businesses will crimp sector earnings. Loss rates on previously originated loans are also poised to rise sharply. That makes most financial stocks a high-risk bet.
Mega-Trend #4: Election Year Politics
Will Spur Epic Bailout Efforts
The 2008 election process is starting to kick into high gear. This will be one of the most pivotal presidential election years in decades — not only because no incumbent is running but also because the hottest days of the campaign are likely to coincide with some of the worst shocks of the housing bust.
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| The race is on among democratic presidential hopefuls to bailout homeowners in 2008. |
I can think of nothing that could be a more riveting, baseball-and-apple-pie issue for politicians than the prospect of millions of voters losing their home. It’s the American Dream turned into the American Nightmare.
Result: Unprecedented pressure on Washington officials and politicians — whether coming, going or staying — to keep voters happy and the government bailout machine in overdrive.
Already …
- The White House has announced an “FHASecure” reform plan designed to make it easier for troubled borrowers to refinance with a government-backed mortgage.
- In December, we also got the much-heralded “Paulson Plan” — a separate program to freeze interest rates for certain borrowers.
- Democratic politicians are pushing even more aggressive plans. Hillary Clinton, for example, wants to institute a 90-day moratorium on foreclosures. Connecticut Senator Chris Dodd, who is also Chairman of the Senate Banking Committee, recently spearheaded an effort to go further down the path of FHA reform.
Meanwhile, on the monetary policy front, the Fed is jumping into the game with both feet. Late in 2007, it cut the federal funds rate … slashed the discount rate … and made other sweeping changes to the way it channels funds to the banking system, as I detailed last week.
You can expect policymakers to continue competing for bailout supremacy on the monetary policy and legislative fronts. We could even see additional tax bills targeted at stressed consumers and borrowers.
While these efforts will help some marginal borrowers and banks, they won’t be enough to offset the economic forces aligned against residential and commercial real estate. Indeed …
Mega-Trend #5: Despite All This Money Pumping,
The U.S. Has A Date With Recession
When an iceberg pierced the hull of the Titanic nearly a century ago, nothing could keep the 46,000-ton ship afloat. Likewise, once the credit crunch began piercing the U.S. economy in 2007, there was nothing on the foreseeable horizon that could prevent a recession.
Never forget that lenders provide the lifeblood of an economic expansion.
Companies borrow money to build factories. Developers take out loans to put up apartment complexes and strip malls. Consumers use credit cards and home equity loans to finance their spending. But now, that flow of credit is being squeezed everywhere.
It’s also getting tougher and tougher for businesses to obtain commercial and industrial loans. In fact, half the lenders recently polled by the Fed say they’re tightening standards on commercial real estate loans.
That’s double the level a year ago, and the highest reading since 1990, when the Savings & Loan crisis was crippling the banking system.
With the “housing ATM” spitting out fewer and fewer dollars … and standards tightening across a wide range of loan products … the economy is starting to roll over.
Consequently, it looks like 2007 could end up being the auto industry’s worst sales year since 1998, and the just-completed holiday shopping season was a real disappointment.
It’s clear that the federal government and the Federal Reserve will do everything they can to fight the recession threat. But they will likely fail, with the economy shrinking for at least part of 2008.
Keep these five mega-trends in mind. I believe they will affect everything from stocks … to interest rates … to the bottom-line performance of your own portfolio.
And by all means, have a great New Year’s holiday!
Until next time,
Mike
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