The Reality of It All
Monday, July 31st, 2006
By Michael Lombardi, MBA for Profit Confidential
Readers have been e-mailing and writing me lately asking why my tone, about financial matters, is always so negative. I can only respond that, after following the investment game for almost 25 years and as a macro economist, it’s my job to tell you the reality of what I see unfolding around us. And, right now that reality is negative.
Interest rates have gone up, hurting consumer spending in the U.S. There’s no escaping this reality. And while interest rates might stop rising soon, they cannot fall further either because the U.S. dollar is so fragile.
Why is the U.S. dollar so weak against other world currencies? It all has to do with a huge American trade deficit, record high debt levels at the consumer and government level, and a currency no longer backed by gold.
The next reality is the stock market. Why haven’t stocks moved above the price high they made in late 1999, early 2000? Simply because the stock market is a leading indicator and it sees a slowing economy ahead. If the Dow Jones Industrial Average was to jump to a new record high such an event would signify that better economic times lie ahead. We must face the facts: America’s best economic times are behind it.
Onto the biggest and worst reality American consumers need to face: The run-up in home prices is over. This is a very important, and very significant, event. When interest rates drooped to their lowest level in over a generation–with the Federal Funds Rate hitting 1% in the late spring of 2004–American consumers borrowed heavily to buy bigger homes or even second and third homes. (It has been said 40% of Americans have a second home now.)
But all that home buying came with borrowed money. In total, 75% of Americans have a mortgage on their home-and at least one-third of those mortgages are variable rate or adjustable rate which means monthly payments eventually go up as interest rates rise.
The unfortunate reality in the housing market: Oversupply will lead to lower prices. How would you feel if you had a big mortgage on your house and the value of your home started falling? Not a comfortable position. The price action of American’s biggest new-home builder stocks (they are down almost 50% in the past 12 months) is an indication of huge problems ahead in the housing industry. As time passes, we may see the reality in the American housing market turn into a home- grown catastrophe.