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Today's Market WrapUp  01.17.2003  Mon  Tue  Wed  Thu  Fri  Hartman Archive

Bloomberg Follies
BY MIKE HARTMAN

A quick pass through today’s Bloomberg Newswire Headlines tells the story for most of what has happened this week. “U.S. consumer confidence unexpectedly fell in January and industrial production dropped in December, evidence the economy is struggling to gain traction. The University of Michigan’s preliminary sentiment index dropped to 83.7 this month from 86.7 in December.” The number was expected to come in at 87.0. “U.S. stocks fell after Microsoft and IBM said a recovery in demand for software and computers isn’t imminent.” “The dollar fell for a fourth day against the euro as a drop in stocks, lower consumer confidence and a wider trade deficit fueled concern the world’s largest economy will expand slower than expected.” “U.S. Treasuries headed to their first weekly gain in three after private and government reports showed declines in consumer confidence and industrial production.” Stocks are down, dollar down, treasury bonds up, and gold, oil, natural gas, and CRB Commodity Index is up.

Stock Market Rolling Over

The Dow lost 2.3% for the week to close at 8586, the NASDAQ dropped by 4.9% to finish the week at 1376, and the S&P 500 was down 26 points or 2.8% to close just above the psychological barrier of 900.  It sure looks like the stock market is ready to roll over as the bear market forces begin to reassert themselves once again. If you take a look at the three-year graph of the S&P500 above, you can see that the equity bulls are facing formidable resistance. So far in January the index has not been able to break above the short-term consolidation resistance (blue lines) around 940. After that, you can see the three-year downtrend line (red), and finally the neckline of the five-year head and shoulders pattern at roughly 960 (green). Technically speaking, it won’t be easy for stocks moving forward. From a fundamental perspective it’s going to be choppy at best as we work through fourth quarter earnings and continue to hear of lower guidance and layoffs for 2003. A close below 875 should accelerate the decline in the S&P 500 Index.

Even if we can muddle through earnings, the war worries and weak dollar should contain stock market gains in the near term. The financial markets do not like uncertainty and nobody knows what will happen when the bombs start to drop. One thing that crosses my mind is the fact that Al Quaeda has openly stated that they intend to attack our economy. It only seems logical that if we strike Iraq, that they will fight back with some kind of terrorist attack. Just look at the carnage in the airline and travel industries since the attacks of 9-11. To speculate on what, when, and where could waste a lot of time, but it seems probable to me that they will take their best shot. If there are any significant surprises to the stock market, I would expect a greater likelihood that any news would have a negative bias. Expect the unexpected.

Tangible Assets vs. Tangible Assets

For the regular readers of Financial Sense Online, you know that we have been pounding the table that “paper” is going down and “things” are going up. When I was working with one of my clients this week we got into a long-winded conversation on real estate as protection from financial upheaval—after all, real estate IS a tangible asset, right? As I got to thinking about it, people are buying real estate because it can’t evaporate to nothing like stocks that go bankrupt and bonds that go into default. People are buying physical gold for the very same reason! While property and gold are both tangible assets, they are in fact very different. Take a look at the data in the following table and let’s see if we can discern some of the differences between gold and real estate as tangible assets.

The most glaring observation is the fact that average household incomes have risen by 39% since 1982, while during the same period home prices have gone up a staggering 268%. Note that I used data for the San Diego area since that is where I live, while the income numbers are national. This trend would not have been possible without the dramatic decline in mortgage rates and lenient lending practices from banks and mortgage companies. Can you even imagine what your monthly budget would look like if mortgage rates went back up to 13%? How many new buyers would be eliminated if they actually had to make a down payment of 20%? Without those buyers, demand would be significantly lower, which would soften prices.

Most people believe that real estate prices will continue to rise ad-infinitum…it just doesn’t happen that way. Look at the period from 1990 to 1995. The average home price dropped from $193,210 to $171,600, or roughly 11% during the period. The mini-recession that we had in 1990-91 put a drag on housing for the next four or five years. If the recession of 1991 eventually knocked housing down by 11%, I would expect the current economic downturn to impact the housing market by at least 20%. The high-end homes are already taking a hit, and the lower priced homes are taking longer to sell.

In my mind the biggest factor that has created the upward movement in real estate prices has been the constant lowering of mortgage rates—it sure wasn’t because of a proportionate rise in incomes! People aren’t so much looking at how much a house costs, but rather if they can afford the monthly payments. We are now at near forty-year lows on interest rates with very little room to go any lower. When interest rates begin to rise in earnest, prices will have to decline as very few households will be able to afford the payments. The only alternative is to have incomes rise sharply relative to home prices. With increasing unemployment, it will be difficult to justify higher wages.

Buy Real Estate With Gold Now let’s take a look at the average price of gold for the last twenty years. Look at the period from 1982 to 1996. There were only three years that gold exceeded $400 per ounce. As a rule for the period it appears that gold was pegged to not go above $400. Then the following period from 1997 to last year where it appears that gold was pegged to stay under $300 per ounce. The strong dollar policy of the Clinton Administration which included a cap on gold prices, an increase in the money supply, and a lowering of interest rates has had much to do in the relationship of real estate prices, to interest rates, to the price of gold. Back in the early eighties you could buy the average house in San Diego for about 300 ounces of gold. Today the same house would cost four times that amount or roughly 1200 ounces of gold. Another interesting thing to note is that for the 14 years from 1982 to 1996 home prices increased 70%, but in the most recent six years from 1996 to present prices have gone up 117%. It was half the amount of time and a much bigger increase in prices. Over the next few years I would expect the numbers to come back more in line where a home would cost somewhere around 400-500 ounces of gold (reversion to the mean). If housing sees a 20% decline and gold goes to $700 per ounce it would mean that our $370,000 home is now about $300,000 and could be purchased with roughly 430 ounces of gold. The only other scenario that I can envision is where home prices are stagnant for the next few years and gold goes up substantially, which would have the same net effect. I sold a rental property and used every penny to buy gold bullion. In a few years the gold will hopefully buy a much nicer property. I would have sold our primary residence and bought gold with the equity, but I like being married, so I had to ditch the plan!

In the final analysis, be cautious when you think of real estate as a tangible asset. It is a hard asset, but usually with debt attached and subject to interest rate exposure, which dictates how expensive that debt will be to carry. When interest rates go up it will be tough to find buyers who can afford the payments at today’s prices. If you are looking to buy a second property it might be a good idea to be patient and wait a while. Better yet, get the loan now while money is cheap, use it to buy gold, and in a few years convert the gold to the mansion of your dreams! Good luck and good investing to all.

Copyright © 2003 Mike Hartman 
January 17, 2003

Chart courtesy of www.stockcharts.com 

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Mike Hartman
Puplava Securities, Inc.
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