The Rude Awakening
Wall Street, New York
Friday, October 6, 2006 ------------------------- - Your round-the-world ticket to the frontline of the
housing markets,
- Breaking down the winners and losers in the Dow's
record breaking charge,
- The Empire coughs up more interest, the secret of
compressed investing and plenty more...
------------------------- From the desk of Dan Denning in Melbourne, Australia... Stop all the clocks, pop your corks, and hosanna in the
highest! The Dow Jones Industrials has reached record-high!
Forgive us if we find this event somewhat underwhelming. As
the succinct analysis of a Daily Reckoning relates:
"Translation: Dow Jones has gone nowhere for six years,
even before taking inflation into account." --And did you know, by the way, that only 10 of the Dow's
30 components are in positive territory for the last six
years? From the Dow's previous high on January 14th, 2000
the best performing Dow stocks are: MO +202%, XOM 158%, CAT
150%, UTX 94%, BA 84%, MMM 46%, JNJ 39%, C 25%, AXP 20%,
and PG 9%. The other twenty stocks are all NEGATIVE for the
last six years, and that includes some shockers: Wal-Mart
(WMT) -24%, INTC -57%, GE -31%, and some not-so-shockers,
GM -58%, MSFT -50%., and HD down 41%. --A back-of-the-envelope analysis of the performance
doesn't yield any obvious thematic conclusions. Oil is up.
Smoking is up. Capital goods from Caterpillar and Boeing
and United Technologies are up. Consumer non-cyclicals from
Procter and Gamble and Johnson and Johnson are up. Yet Wal-
Mart is down, as is capital goods maker DuPont, and home
retail Home Depot. Financials have done respectably while
pharma has languished. What does this tell us about the
next six years? --Not a thing, regrettably. Or maybe it does tell us this:
broad indices are virtually useless in guiding investment
decisions. The difference in performance between firms is
driven by the execution of a good business strategy by a
competent (not corrupt) management in an extremely
competitive world. All these firms competed in the same
environment: rising energy and resource costs, currency
fluctuations, and rising interest rates. Some did better
than others. --There will be some strong sector themes in the future
that can guide your decision making. But our guess is that
from here on out, independent balance sheet and fundamental
analysis is what will make some investors happy and others
insolvent. For our money, the underlying conditions in the
resource markets (demand growing faster than supply) remain
the most compelling investment theme. And with resource
stocks falling with resource prices, we can finally pick up
some great companies at good prices. --"Does anyone care about a housing bubble in Australia, if
there is one?" we asked in our editorial meeting at the Old
Hat Factory yesterday. Granted, there are differences
between America's epic bubble and Australia's junior
version. For one, interest rates in Australia are near the
top of the cycle, or so we're told. House prices have
managed to endure this without collapsing. That, in fact,
may be precisely the problem: for most first-time buyers in
Australia, a new home remains completely out of reach. --It shouldn't have come as too much of a surprise that
August building approvals fell by nearly 13%, according to
the Australian Bureau of Statistics. The real tawdry number
was that permits to build apartments fell 37%. No use in
building more residences if people can't afford them
anyway. The Australian and American property markets are
both struggling for the same reasons: Exotic mortgage
products caused many people to buy more house than they
could genuinely afford. It was this explosion in funny
money that drove up house prices, making them unaffordable. As one of our friends in the industry put it to us
confidentially, the best strategy right now is not to lever
up and buy an investment property and use negative gearing
as a tax benefit, the best strategy is to rent. As renters,
we agree. [Joel's Note: There is plenty going on Down Under to keep a
diligent investor busy. Whether you hail from the Great
Southern Land, or merely want to keep up to date with the
latest goings on in the world's richest commodity region,
you can do so for FREE with the Australian Daily Reckoning
right here: The Aussie Daily Reckoning
http://www.portphillippublishing.com.au/freeservices.html --- Special ---
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diabetes drugs. Learn how you can grab your share of those profits here http://www.isecureonline.com/Reports/VPI/EVPIG945 ---------------------------- Over to Bill Bonner in London... "Lenders gone wild," runs the headline of an article at
MarketWatch: "Bank regulators knew more than a year ago that lenders
were aggressively marketing interest-only and payment-
option adjustable-rate mortgages to consumers who didn't
fully understand what they were buying... Studies show that
a large number of borrowers with simple ARMs don't
understand the terms and underestimate the amount their
mortgage payment could rise. Nontraditional ARMs are even
more complex." That a public spectacle begins as a fraud, progress into
farce and ends in disaster is one of our daily dictums
here. We have spent so much time and so many pages
describing the lies behind the housing bubble that our
readers must be tired of hearing about it. So, now we move
on - to the farce. That too, has been described at length, but at least it is
more entertaining. For here, we move from humor in the
abstract to slapstick...to real life stories of people
whose brains have been turned into suet pudding by the lure
of big money from house-price increases. Nothing was too absurd or preposterous for them to believe,
it seemed. Buyers bought condos before they were built with
every intention to flip, and then they were sold...before
the water was even turned on. Householders believed they
could 'take out' equity from their houses...and never have
to put it back. Hustlers quit their jobs at dotcom start-
ups in order to become mortgage-brokers. Financial
engineers devised new and innovative ways to leverage the
witless homeowner into a house he couldn't afford and could
never hope to pay for. MarketWatch continues: "The housing credit bubble led to the growth of exotic
loans, which, in a vicious spiral, drove prices even
higher, said one observer. In a bubble, 'the financing gets
progressively worse. At the end, you get nuttiness,' said
Dean Baker, an economist for the Center for Economic and
Policy Research, a Washington think-tank. "Finally, prices got so high that 'the only way people
could buy houses was by bending the rules,' said Baker,
who's been warning about the real-estate bubble for years.
In the Orwellian parlance of the mortgage industry, loans
that ignore the true ability of the borrower to pay for the
loan are called 'affordability' products. Most of the
exotic loans have low introductory interest rates that
ultimately adjust to market rates, usually after two years.
Some loans require that only the interest be paid, putting
off the day when the borrower must start to pay down the
principal. Some of the loans allow borrowers to make a
monthly payment that doesn't even cover the interest,
resulting in a negative amortization when the unpaid
interest charges are added to the principal. And most of
such loans sold in the sub-prime market have large
prepayment penalties that make it expensive to refinance." None of this will come as news to our long-suffering
readers. But it is sure to come as a shock to homeowners
who haven't read us. A $200,000 ARM, for example, can rise
from a $643-a-month burden in the first year to a $1,578-a-
month burden in year six...by which time, the principal
would have risen to $214,857, according to a MarketWatch
source. How will the nation's economy hold up as all these loony
mortgages are reset, rescheduled, and regretted? So far,
the masses are betting on more soft landings than at O'Hare
or Heathrow. Yes, a few marginal borrowers will go belly-
up, the optimists admit, but everything else will be okay.
But here at The Daily Reckoning, we don't trust what people
say. Are we right to worry? We don't know...but we spent
yesterday re-reading some of our Daily Reckonings from the
last seven years. We can sum them up for you as follows:
Sometimes right; sometimes wrong; never without an opinion. What we were right about was the tech bubble and the price
of gold. But what we failed to see was how the feds,
working hand in glove with the financial industry, would be
able to keep the bubbles boiling up. We figured that the
central lie of central banking - that you can create
'wealth' simply by putting more liquidity into the system -
would have caught up to them by now. But no, not at all. People still have faith in stocks,
bonds, and the dollar. We saw what looked to us like a great top-out of the stock
market in January of 2000. Sell the Dow; buy gold, we said.
Since then, stocks have gone down...but the Dow has gone
right back up. Still, you would have done well to sell the
Dow six and a half years ago. If you'd bought gold,
instead, you'd be up about 140%. And even if you'd just put
the money into 91-day T-bills, you'd be ahead of the game. Altogether, since January 2000, if you had held the 30 Dow
stocks, reinvesting the dividends, you'd be up only 12.7%.
Adjust that number for inflation and you'd actually be down
nearly 10%. A money market fund, by contrast, would have
put you ahead by 20% in nominal terms and less than 2% in
real terms. Stocks were no place to be, post-2000. And we are not so
sure they will be a great place to be post-2006. Are we right to worry about the over-extended American
consumer and his counterpart, the clueless American
investor? We don't know...but now comes the discouraging
word that U.S. payments to its overseas creditors were now
greater than its receipts from overseas investments. For
several years, the country has been in the strange position
of having a very, very negative net foreign investment
position...but a positive balance in its net annual
external investment account payments. 
That is, for some reason never fully explained, Americans
owed more to foreigners than was owed to them by
foreigners...the yanks got the better of the payment flow -
that is, until the 2nd quarter of this year. Two weeks ago,
the whole thing went bad...after 90 years, the United
States has now got on the wrong side of its capital service
payments as well as its capital holdings. And now, because Americans do not save enough money, the
country has to go abroad to borrow the money...to pay the
interest on the money it borrowed before. And, since Japan
is the country with the most U.S. debt...and China is the
country most eager to lend of late, the United States must
borrow from China in order to pay Japan. Thus do the mighty, as well as the humble, fall into the
same debt trap. The marginal homeowner must borrow to pay
his mortgage and credit card debt. The marginal "empire of
debt" must borrow to pay interest on its T-bonds. [Joel's Note: "To own your own home" – The great Australian
dream...or is it the great American dream? We would bet
they have an English version of this for Bill's neighbors
in London...and France, no doubt. It seems folk all over
the world are striving towards, at least, one common goal.
We here at the Rude Awakening would like to know exactly
how you feel about the climate in which you are trying to
attain this goal. Is your local market drying up...or
driving forward? Are sales and prices headed skywards...or
turning backwards? We'd like to know what is happening on
the front-line of the housing market. Please send you "boots-on-the-ground" response to your
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