Predictions are hard, especially about the Future

One of my favorite books ever is the book Dune by Frank Herbert.  He built a universe with a complex religious, economic and political framework that transports you to a completely different world.  It is not a dry technical read about an alternate reality but a compelling and rich story with an amazing tapestry behind it. 

I will stop gushing over the man, but I want you to watch this video and remember the respect I have for this man and his capabilities.  It's short at around 4 minutes.  He explains his natural curiosity and his broad skill set that created the situation for him to write the book series.  However even Mr. Herbert gets the end of fossil fuel prediction VERY wrong. 

When you extrapolate out the current state too far into the future one will come up with very wrong results.  The world is extremely dynamic.  Humans are very clever.  New technologies and innovations which were too expensive drop in price enough to totally transform the dynamics of a system, rendering your prediction invalid.

In this 1977 interview he states we will run out of fossil fuels in 40 years.  We are 3 years past that deadline.  Even brilliant people can be wrong on occasion.

Another attempt at a Dune movie is near release. I hope it's better than the last one.

Jim Chanos - Easier to Find Short Ideas as Bull Market Goes On

I've mentioned Jim Chanos before in this blog, and he's out again with some telling examples of late stage 'exuberance'

While Mr. Chanos is almost never perfectly timed with the market's current mood, he is rarely wrong longer term.

http://www.bloomberg.com/news/videos/2016-06-15/chanos-easier-to-find-short-ideas-as-bull-market-goes-on

Inflation expectations and QE(infinity)

I have posted before regarding inflation expectations in the US treasury market and I need to give you an update, especially so considering the recent round of QE as announced by the Federal Reserve.

A refreshed chart from the Fed of the inflation expectation spread (10 year nominal yield minus 10 year TIPS yield) teases out some interesting items to consider.

10 year nominal Treasuries minus 10 year TIPS (source: Federal Reserve) 

Note how we have recently broke above the 2.5%  Since the GFC it has rarely breached this mark and did not stay there for long.

Now look at when previous QE's were initiated. A graph by dshort.com does the job.

While they are not to the same scale, you will notice the first round of QE was initiated during the deep dark days of the financial crisis.  The inflation expectation spread was near its low of the series and the world looked bleak.

QE2 was discussed mid 2010 and also coincided with an interim dip in the inflation spread at around 1.5%

QE(infinity) was just announced and our inflation expectation spread is already near the highs of the entire series.  

While the Fed and other market participants have their own flavor of inflation expectations they look at this series is near its highs. Before the GFC this spread didn't venture much higher and the Fed thinks they can get it higher now? The future is subject to change (of course) but unless we get some serious wage growth it appears to me the Fed is pushing up against a long term inflation expectation wall.  

As an example here's nominal Personal Consumption Expenditures.  It has been on a secular decline since the inflation days of the 80's and also notice how it recently peaked and appears to be rolling over again (ahem)

Nominal PCE - Source Federal Reserve

For some additional context here's the 10 year nominal and TIPS yield since 2004. Notice how now 10 year TIPS are now going for a negative real yield.

Disclosure: Considering selling/shortening duration on some TIPS positions

Will we run out of storage for Natural Gas?

The price of natural gas has been falling throughout 2012 and is making multi year lows.  You have to go a long way back to find sub $2 natural gas and considering the price of oil is near nominal highs this is unusual.  (Yes I know there's not of much a substitution effect between NatGas and Oil but work with me here.) 

Natural Gas spot price
source: stockcharts.com

So what's driving this drop in gas prices? Some of it can be attributed to a warmer winter but the development of shale gas and fracking technology has opened up whole new geographic areas which were previously thought to be uneconomic to drill for natural gas and oil. (EIA article on the topic) This has increased production (sorry, but peak natural gas has not occurred yet)

This additional production has increased inventories and driven down prices. How much is impressive when you look at long term natural gas inventory figures.

It appears inventory bottomed around March 9, 2012 at 2369 Bcf (Billion cubic feet) where the recent seasonal minimum is around 1600 Bcf. Over the entire data series natural gas has never bottomed with so much already in storage.  This has hit prices. Hard.

One would presume that with spot prices so low, production would be curtailed and bring the supply and demand back into balance. This may not happen fast enough.  Even with very low spot prices production is still higher than last year. Couple this with already higher than average inventory numbers inventory and you have falling spot prices.

Nat gas production still high
source: EIA

Could we run out of storage for natural gas before the winter drawdown?  It's going to be a race between declining production (if any) compared to already bloated inventory figures.  I quantify the challenge below.  Each yearly line shows the injection rate needed to fill inventories to capacity each year. Consider it a "glide path" of how much you'd need to produce each day until the peak inventory day (around the middle of November) The injection rates are not linear throughout the year but comparing the curves is instructive. As one can see in 2012 the hurdle is very low.


Right now the injection rate for 2012 can be ~33% lower than previous years to completely fill up inventory by the middle of November.  

IF you see the 2012 line continue to drop as time progresses and remain well underneath the 2009 line storage may very will fill up.  We have another 200 or so days to go; I'll be updating you over the summer.

Disclosure: short UNG

A housing update -- at best a flat market

Over the last few years during conversations with clients I've frequently been asked my opinion about the housing market and whether now is a good time to buy.  Home prices are naturally a point of conversation as they are a large part of most people's net worth and the loss of equity is preventing some people from moving up or refinancing.  So the question of whether we are at the bottom of home prices is an important one.  Unfortunately I don't think we are at the absolute bottom of home prices and we will most likely continue to see a slow decline in prices in the near future.  My non-prediction for 2012 is we will not see a rebound in home prices; at best we'll see a flat to slightly down market.

Home prices have strong local factors so this conversation is about national trends, your local market will vary.

Unfortunately right now home prices are continuing their decline nationwide:

Home prices still dropping - (Source: Paper Money)

Outstanding mortgages still contracting

Mortgage loan balance still declining
There are several headwinds the housing market needs to overcome before it is fully healed. This chart shows the change in mortgage values outstanding since 1975 (Source: Federal Reserve) Looking at loan balances to predict home prices may seem counter intuitive but remember a rising total national loan balance means there are more buyers (and borrowers) entering the market.  Some interesting aspects of this chart are how even during other previous recessions (shown in gray) the value of outstanding mortgages continued to rise on a year over year basis; until our most recent recession in 2008/2009.  This was the first time during this entire data series when the total value of all mortgages outstanding declined on a year over year basis. One would not be engaging in hyperbole to call our current decline in home prices exceptional.

An overhang of foreclosed homes
While it appears the primary wave of home foreclosures is past us there still is a large backlog of homes in the foreclosure process. Until this backlog is completely cleared and returns to more 'normal' levels, the amount of housing coming on the market by 3rd parties (not the person who currently lives/owns the home) will put downward pressure on prices.

Single family delinquency rate (Source: CalculatedRisk)

Another negative factor is the hidden inventory of homes out there from people who want to move up or out but are waiting until home prices stabilize before putting the place on the market. I personally know of a few people who are accidental landlords and are hoping and waiting until prices stabilize before putting their rentals on the market.  While this is purely anecdotal I'm sure its not just a local or isolated phenomenon.

Renting versus Owning coming into balance
Fortunately there are some positive factors which should mitigate a continued decline in home prices.  Home prices and mortgage rates have declined to the point where a mortgage now equal to rent.

Rent versus Owning (Source: Soberlook)

As you can see for a very long time it was cheaper to rent versus own. We are approaching a point where this may invert and owning a home would be cheaper than renting. There are other upkeep and time costs associated with home ownership (as a homeowner I can assure you there are many!) but the primary costs are approaching parity.  

Clearing the excess inventory
The number of unsold homes is beginning to stabilize as a percentage of US population.  The hidden inventory is of course hard to measure but at least we are getting closer to 'normal' for this data series

Unsold homes as % of population - (Source: Sober Look)

The long decline in construction spending does appear to be finally over which will help the building trade and stop being a drag on overall GDP growth.

Construction finally bottoming? (Source: Federal Reserve)

Even though the housing market decline appears to be slowing forecasting when we finally reach bottom is not something I'm willing to predict right now. I believe the worst of the declines are behind us so if you are looking for a home now would be a good time to start looking but be picky and drive a hard bargain! There is going to be lots of supply coming on the market over the next few years.

One aspect of the crushing decline in home prices is it has popped the speculative mindset so very prevalent in American thinking a few years ago. (I'll admit to falling a little under that spell myself)  Take your time and find a house to live in, not one for profit.

Additional reading:
http://www.calculatedriskblog.com/2012/01/fannie-mae-serious-delinquency-rate.html
http://soberlook.com/2012/01/two-data-points-on-us-housing.html
http://paper-money.blogspot.com/2012/01/new-home-sales-december-2011.html
http://soberlook.com/2012/01/five-reasons-2012-will-be-start-of-us.html
http://paper-money.blogspot.com/2012/01/radar-watching-november-2011.html
http://paper-money.blogspot.com/2012/01/fhfa-monthly-home-prices-november-2011.html
http://paper-money.blogspot.com/2012/01/radar-watching-november-2011.html
http://pragcap.com/why-home-prices-have-much-further-to-fall
http://www.tilsonfunds.com/JohnBurnshousing.pdf
http://research.stlouisfed.org/fred2/graph/?graph_id=62720&category_id=4082
http://research.stlouisfed.org/fred2/graph/?graph_id=64527&category_id=4082
Calculated Risk calls a housing bottom
http://www.calculatedriskblog.com/2012/02/housing-bottom-is-here.html

Home prices going up? Not until you show me the money.

Are home prices going up in a sustained manner anytime soon? No

A recent presentation by Australian Professor Steve Keen inspired me to search for a similar American data series. One exists and it does not predict any sort of sustained bounce in American home prices. (I am simplifying Mr. Keen's presentation as he looks primarily at the 2nd derivative of loan levels but the level of destruction in American mortgages outstanding is epic)

As Mr. Keen states, it is not people who buy homes, it's people with money who buy homes.  Just to show you the magnitude of the home devastation we are experiencing here's the entire home loan series:

For the entire data series, going back to the mid 50's we've never seen a year over year decline in the total value of home loans outstanding.  Yes, some of this decline is due to homes being foreclosed and the loans vaporizing as a result, but that also eliminates yet another person who cannot trade up from their current home to something larger as their equity and credit score head towards zero.

Until we see year over year growth in mortgages outstanding we will not see a sustained nationwide rise in home prices. We will of course see localized variation in this with some pockets of growth but nothings happening until You show me the money.



Disclosure: The author is short some housing related stocks.