For the past couple of years, market bulls have been roaring great hope and wildly optimistic expectations. Their upbeat forecasts were based on common themes: world economies would decouple from a US slowdown, real estate prices around the world would only have to correct a modest -5% in order to rebound and continue their ascent, and subprime mortgage problems would be small and contained.
In the past few months we have seen that world economies are slowing pretty much in concert, world stock markets are once again highly coupled in their descent, and Real estate prices in the US have already fallen 8% over 12 months ended November 2007. See latest Case/Schiller index. Oh yes, and subprime has been contained alright, at least to planet earth.
But even though a decline of 8% in real estate to November was the worst in many decades, by all indications prices are getting much cheaper by the day. The WSJ cites more evidence of this yesterday in Homes in Bubble regions remain Wildly Optimistic. :
“…even after a year of misery and falling prices, homes in many of these regions still aren't cheap. They remain wildly overvalued compared to average personal incomes. There is a strong long-term correlation between the two figures. And in many regions, house prices would still have to fall a very long way to get back into line.
How far? Try around a third in Florida and Arizona — and closer to 40% in California… Even if house prices stabilized, it would take a decade or more for rising incomes to catch up.”
In many areas, prices could reasonably fall another 20 or 30% over coming months. I just returned from speaking in Phoenix where housing has been particularly overbuilt and is now violently correcting, already down by up to 50% in some areas before buyers can be found.
AND REMEMBER WHY WE CARE about the housing market. The bulk of the economic expansion since 2002 was on the back of Mortgage Equity Withdrawals (MEWS). Without the dramatic ascent of real estate prices and the consequent ability of consumers to refinance and spend, the US and much of the western world would have experienced recessionary growth for the whole of 2001 and 2002 rather than a couple of quarters in 2001. And growth would also have been decidely sub-par even in the '03-'07 period. See the chart GDP Growth: With and without Mortgage Equity Withdrawals. Whether the ongoing real estate contraction happens fast and furious or follows a long slow grind down over the next few years, we will not see record earnings and growth like we have seen for some time to come.
And here is the kicker– this means stock prices are also wildly overvalued at this point, even with their sell-off over the past few months.
For all the optimistic souls who still insist that commodities and raw goods are now shipped to China and India more than the western world. I am sorry to point this out, but the demand at the back door of Chindia has been driven by demand at their front door for finished products and manufactured goods shipped to western consumers.
Western consumers paid for the bulk of their demand through debt and MEWs that they can no longer access. Be wary of optimistic forecasters who site recent corrections as buying opportunities in real estate and equities. A decline of 8%-20% is a start, but it will be little comfort if prices follow their likely path significantly downward from here. As always, the price we pay is our greatest risk.
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