Thursday, September 21, 2006

Dan Tiffin’s Newsletter Volume 1.02

From the Desk of Dan The Demographics Man

The Invisible Real Estate Crash

By Dr Mark Skousen, Chairman, Investment U.

• The recent data in real estate is depressing

• New home sales in July are 22% below last year

• In the previously hot Northeast market, new homes sales plunged 43%

• The inventory of unsold new homes hit a new record high at nearly 4 million, up 22%

• Existing home sales are down to 6.3 million in July as opposed to 7 million last year

Lower prices are another indication of a weaker market. The median price of a home last month was up less than 1% compared to the same time a year ago, to $230,000.  It’s the smallest increase since 1995.  That’s a sharp contrast from recent years when the median price of a home shot up by nearly 60% since 2000.

The real estate cycle is well known, and typically lasts 10-15 years but there are seven reasons this particular boom-bust cycle is so severe, with both the upside and the downside.

Real Estate Represents 56% of Financial Wealth

Over the past 10 years real estate assets have increased dramatically, from $8 trillion to $21.6 trillion, representing 56% of financial wealth.  Here are 7 reasons why this happened:

1. The stock market boom:  The ”irrational exuberance“ on Wall Street caused many investors to diversify into other real assets.

2. Favorable demographics:  The baby boomers have a special taste for real estate.

3. Tax advantages:  Real estate investors are taking advantage of the fall in long-term capital gains taxes to 15%, and special tax-free benefits ($500,000 exemption and tax-free exchanges).U.S. only.

4. Terrorist attacks since 2001:  Many scared investors switched out of the stock market into real estate.

5. Cheap financing:  Banks and mortgage companies invented two borrow-friendly underwriting techniques; which included adjustable-rate and interest-only loans.

6. Foreign demand:  Due to the U.S. dollar dropping, American real estate is ”on sale“.  It is estimated that        foreign buyers purchase more than 20% of real estate in Manhattan.

7. Lastly, and most importantly, the Federal Government’s irresponsible low interest rate environment in 2001 to 2004, and pushing short-term rates down to 1%.  This allowed mortgage lenders and bankers to play the spread and virtually print money.

How bad will the Bust be?

Austrian Economics teaches us that easy money and artificially low interest rates create an unsustainable boom and the higher the boom, the greater the bust.  If the housing market were like the bond or stock market, with instant liquidity and low transaction costs, today we would see a real estate crash of unprecedented proportions.

This is an ”invisible crash“ because the real estate market is inherently non-liquid, largely due to high closing costs.  Instead of falling prices, owners try to keep prices as high as possible and wait for a buyer to come along. Therefore, the waiting period expands to months.  In addition, many sellers give up and take their property off the market, waiting for a better environment.

The long term mortgage rates have increased to around 6.7%. However, if mortgage rates rise steeply, the depression in real estate will be disastrous. There’s no question that the real estate boom is over for now and it will take years to recover.

An article in the Investment Executive, Dated 9/13/2006 It states that high Canadian household wealth is to be tested in the coming months. A Scotia Bank reports that despite unprecedented levels, many households may be forced to raise their conventional savings to meet their long-term goals with the return to historically higher interest rates.

As the fast pace of home and equity price depreciation inevitably slows down, it will remove much of the ”strong wealth effect“ that has supported big ticket consumer spending so far this decade.  It would also force many households to raise their conventional level of savings to meet their long-term retirement goals.

We tell our clients that we are heading into the biggest stock market boom ever.   Now, the hot money will start heading into the stock market and finally fulfill our stock market boom predictions. The following points are information gathered that helps support our theory:

• From the Investment Executive, Dated 9/12/2006 American consumers spending in July doubled June figures.   Personal income and disposable income also increased in the month of July.

·• As predicted, spending continues despite what the news is telling us. This in turn will drive the stocks of all companies selling their goods.  Thus;

• In the Investment Executive, Dated 9/13/2006 it also states the S&P 500 is expecting to rally by years end and that ”We expect a broad rally by year end“.  We believe manufacturing, the financial industry and healthcare are the most attractive sectors. We now also see opportunity in the tech sector.

• When you add that fund sales in August were very strong bringing industry assets near record high in the range of $606 billion.  In addition to this, August has traditionally been an unpredictable month during where we see both net sales and net redemptions in the past few years.   This is a strong indicator for the mutual fund industry.

• Interestingly, it was the Sector funds that dominated performance rankings in August of this year.  According to Morningstar Canada, the science and technology sector came in second place, at 4.1% for the month. While our other favorite place to invest for the future being the Nikkei which came in at 4.0% for the month of August.  Finally, everything we have been saying is starting to sprout wings.  Therefore, those that kept their plans we set up in place from the beginning of the biggest stock market boom in history, they will be rewarded for their patience.