Jeremy Grantham calls housing a "Classic Echo Bubble"

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Submitted by natesactm on May 12, 2016 - 8:08pm

Lots of good stuff in GMO's quarterly newsletter, especially regarding mean reversion and a thorough take down of "This time is different". In regards to real estate, Grantham says:

"The U.S. housing market, although well below 2006 highs, is nonetheless approaching a one and one- half-sigma level based on its previous history. Given the intensity of the pain we felt so recently, we might expect that such a bubble would be psychologically impossible, but the data in Exhibit 1 speaks for itself. This is a classic echo bubble – i.e., driven partly by the feeling that the substantially higher prices in 2006 (with its three-sigma bubble) somehow justify today’s merely one and one-half-sigma prices."

"Prices have been rising rapidly recently and at this rate will reach one and three-quarters sigma this summer. Thus, unlikely as it may sound, in 12 to 24 months U.S. house prices – much more dangerous than inflated stock prices in my opinion – might beat the U.S. equity market in the race to cause the next financial crisis."

Median House Price/Median Family Income

Link to the GMO's quarterly newsletter here

Submitted by The-Shoveler on May 13, 2016 - 6:16am.

In SoCal At Least it is more a classic housing shortage IMO.

Submitted by spdrun on May 13, 2016 - 7:24pm.

The gyrations of the housing market in the last ~5 years aren't accounted for by population trends, though.

Submitted by moneymaker on May 17, 2016 - 6:43am.

What is the PE for the DOW now compared to then? Unemployment was actually higher in 1982 than right after the BB (bubble burst). Think when everything is considered we are on the precipice of something big, especially when you throw in Trump and government spying/TSA

Submitted by ctr70 on May 17, 2016 - 8:04am.

If house prices are to keep going up or even stay flat, rates must stay in a very low and tight range for a very long time.

Let's be honest with ourselves, probably at least 50% of all the housing price recovery since 2011 has been due to one thing, artificially low mortgage rates manipulated by Fed. Not due to fundamentals in the economy like good jobs and rising incomes. The 50 year average of 30 yr fixed mortgage interest rates is 7-8%, that is where they should be. If they had not been pushed to ridiculously artificially low levels (30 yr fixed in the 3% range are you kidding me?), there is no way prices would be where they are today. Where do you think prices would be in SD if the 30 yr fixed was 7%? So this is all the proof you need this is a Fed engineered housing recovery, not a housing recovery based on real fundamentals.

With that said, rates could still fall further if we get bad economic news or stocks fall. 30 yr fixed rates could fall to 3.00% or in the 2% range, and housing may be stimulated once again. But ask yourself is all this healthy? Is it healthy for economies around the world to get addicted to low rates and QE vs. real growth? Is it healthy for the Fed to keep inflating assets? I mean we are in the 7th year since the end of the recession and rates are basically still at zero! There is something not quite right with that picture.

Submitted by moneymaker on May 17, 2016 - 9:15am.

Maybe zero rates is the first step to getting rid of money all together like on Star Trek ☺ . The big bear hiding in the closet is that these low rates are costing the government money, not exactly sure how but nothing is free, not even artificial low rates. Does it contribute to the national debt?

Submitted by FlyerInHi on May 17, 2016 - 10:13am.

What makes you think that today's rates are artificially low? What is artificial and real?

Money is just a human created means of exchange in commerce. There should be no reason for money to automatically make money on money, such as when rates are high.

Maybe we are just smarter in managing the money supply?

Submitted by ctr70 on May 17, 2016 - 10:48am.

FlyerInHi wrote:
What makes you think that today's rates are artificially low? What is artificial and real?

Money is just a human created means of exchange in commerce. There's should be no reason for money to automatically make money on money, such as when rates are high.

Maybe we are just smarter in managing the money supply?

Rates are artificially low because they are 100% driven by the Fed and not the free market. 95% of all mortgages originated today are Gov't backed. This is far higher % than this has been in most of U.S. history. Do you really think if the mortgage market were more balanced with private investors that these private investors would take the risk for 3.5% return on a 30 yr fixed mortgage? The only reason rates are at 3.5% is because the Fed (aka tax payers) is guaranteeing 95% of all mortgages, and billions in Mortgage Backed Securities were purchased with Gov't printed QE money helping to keep rates down.

It doesn't seem healthy to me that the world economy is driven more and more by central Fed planning, rate manipulation, money printing, and more & more debt vs. true fundamentals, rising incomes, and good jobs.

I'm not smart enough to know how this all works out. Maybe it all works out and fixes itself. But there is no doubt we are in uncharted waters with this global monetary policy experiment that has been going on the past 8 years.

Submitted by mixxalot on May 17, 2016 - 2:45pm.

The real estate prices do not pencil out to average incomes. It is foreign buyers, low inventory and institutional wall street firms jacking up prices.

Submitted by ctr70 on May 17, 2016 - 3:13pm.

mixxalot wrote:
The real estate prices do not pencil out to average incomes. It is foreign buyers, low inventory and institutional wall street firms jacking up prices.

And mortgage rates the last few years being the lowest they have ever been in the 240 year history of the United States.

Super low rates especially juice the prices in expensive coastal areas. 3.5% vs. say 6.5% on a $700k mortgage in CA has a much bigger impact than 3.5% vs. 6.5% on a $100k mortgage in Nebraska.

Submitted by bearishgurl on May 17, 2016 - 3:40pm.

ctr70 wrote:
mixxalot wrote:
The real estate prices do not pencil out to average incomes. It is foreign buyers, low inventory and institutional wall street firms jacking up prices.

And mortgage rates the last few years being the lowest they have ever been in the 240 year history of the United States.

Super low rates especially juice the prices in expensive coastal areas. 3.5% vs. say 6.5% on a $700k mortgage in CA has a much bigger impact than 3.5% vs. 6.5% on a $100k mortgage in Nebraska.

Agree with this except in the most coveted coastal areas (where the majority of buyers pay all cash). Some coastal areas (usually within one mile of the coast) have truly proven to be "bubble-proof" as land on the coastal strip is a finite resource.

And you may be surprised in places like NE (or states with even cheaper RE) it isn't uncommon for a buyer to pay all cash, as well, especially if it is a vacation home or home purchased for relatives to live in. It's also not uncommon for first-time buyer-residents of states with cheaper residential RE to pay off the home within ~5 years of purchasing it. In these areas, mortgage interest rates aren't as sensitive as they would be to purchasers of garden variety tract homes in more expensive locales.

Nice to see you back here posting, ctr70. Are you still living/working up in the PNW?

Submitted by FlyerInHi on May 17, 2016 - 4:29pm.

Ctr70 , I think we will have low rates for a long time because of excess capacity. unlimited things can be produced for cheap.

We need money circulating to soak up capacity, that's why central banks are acting. Not only the Fed, but ECB, China, Japan.

Ideally, governments need to tax and spend and put money in people's pockets. But that's politically hard to do.

I'm watching China's pivot to a consumer economy. The government built a lot of modern infrastructure. They are now building a social safety net to encourage consumers to spend. We will see how it works out in the next few decades

Now is the 50th anniversary of China's cultural revolution. I was reading that, at the time, people were starving and had nothing. The period since then has been the greatest creation of wealth in the history of capitalism.

Submitted by Rich Toscano on May 17, 2016 - 9:14pm.

Thanks OP, glad to see Grantham and GMO getting some attention here. They are as good as it gets when it comes to identifying and analyzing bubbles. FYI - you have to register to access their stuff but it's free and well worth the small effort.

My own version of the graph looks a little different as, unlike US-wide prices, SD prices have been a lot more volatile.

So the US-wide overvaluation is more unusual than the SD level of valuation, for what that's worth.

All due respect to Grantham (who is literally my investing hero -- btw I got to meet him once, it was awesome </fanboy raving>) -- I don't see it so much as an echo bubble, as just a response to low rates. Rates are extremely low and even at these price levels, buying can pencil out. So it's more like high housing prices are a rational response to (irrationally?) high bond prices.

But that's just my feeling on it. When in doubt, listen to Grantham.

(Fortunately, the question of whether the "bubble" label fits or not is not all that important --and I'm sure my man JG would agree with that. The important issue is that housing is expensive, whatever the reason may be, and prospective risk/returns should be evaluated accordingly).

Submitted by Rich Toscano on May 17, 2016 - 9:24pm.

FlyerInHi wrote:
What makes you think that today's rates are artificially low? What is artificial and real?

Money is just a human created means of exchange in commerce. There should be no reason for money to automatically make money on money, such as when rates are high.

Maybe we are just smarter in managing the money supply?

I don't really think your money supply thing explains it. That might explain low inflation, but it doesn't explain why real rates are negative. (I actually think the whole premise is questionable, but even if we allow it, it doesn't explain the negative real rates).

Let's avoid the word "artificial" -- that has a lot of implications. What we can say is that rates are very, very low. Lower than inflation, which has never historically lasted, and with good reason.

I suppose it's possible that rates stay this low, but I think that people who are depending on that (unprecedented) outcome are taking a huge risk. There's a difference between allowing for it, and depending on it... and many (maybe most) investors seem to be doing the latter as far as I can tell.

Submitted by natesactm on May 18, 2016 - 8:29am.

Rich - Re-reading your "Shambling Towards Affordability, Mid-Year 2015" post, the influence is pretty clear. GMO has been a newer find for me, but have since devoured their free content. So much good stuff in there!

Submitted by The-Shoveler on May 18, 2016 - 8:34am.

IMO it all comes down to lack on wage inflation (in the middle class),

That's what it's all about, they are desperate to create it any way possible.

$15.00 minimum wage, new overtime set to 47K etc...

It's not really about minimum but it's a way to get more into the middle.

Anyway IMO..

Submitted by The-Shoveler on May 18, 2016 - 8:36am.

Wage inflation stagnates the whole economy stagnates.

Submitted by njtosd on May 18, 2016 - 8:54am.

FlyerInHi wrote:

Now is the 50th anniversary of China's cultural revolution. I was reading that, at the time, people were starving and had nothing. The period since then has been the greatest creation of wealth in the history of capitalism.

Maybe because the assets of 60-80 million people (wealthy in particular) thought to have died as a result of the revolution were redistributed to the remaining population.

Submitted by Rich Toscano on May 18, 2016 - 9:38am.

The-Shoveler wrote:
Wage inflation stagnates the whole economy stagnates.

Fortunately wage growth is improving, after having been stagnant for several years:

https://www.frbatlanta.org/chcs/wage-gro...

Submitted by FlyerInHi on May 18, 2016 - 10:00am.

njtosd wrote:
FlyerInHi wrote:

Now is the 50th anniversary of China's cultural revolution. I was reading that, at the time, people were starving and had nothing. The period since then has been the greatest creation of wealth in the history of capitalism.

Maybe because the assets of 60-80 million people (wealthy in particular) thought to have died as a result of the revolution were redistributed to the remaining population.

I streamed the program on my drive to Vegas. 60 to 80 million deaths is rather higher even is you include the Revoltion of 1949, and the following famines.

There was wealth destruction followed by amazing wealth creation in a few short decades.

http://www.npr.org/2016/05/05/476873854/...
DAVIES: Do we know how many people died?

DIKOTTER: Overall? The entire cultural revolution? Probably if you take 1966 to 1976 - in other words a good decade - until the very moment that Chairman Mao dies, you can probably count about 1.5 to 2 million people who were hounded to their deaths.

But the point must be that in comparison to "Mao's Great Famine" which took place earlier from '58 to '62, that appears to be a rather low figure. But the point is that it is not so much death which characterized the Cultural Revolution, it was trauma.

It was the way in which people were pitted against each other, were obliged to denounce family members, colleagues, friends. It was about loss, loss of trust, loss of friendship, loss of faith in other human beings, loss of predictability in social relationships. And that really is the mark that the Cultural Revolution left behind.

Submitted by FlyerInHi on May 18, 2016 - 10:09am.

The-Shoveler wrote:
IMO it all comes down to lack on wage inflation (in the middle class),

That's what it's all about, they are desperate to create it any way possible.

$15.00 minimum wage, new overtime set to 47K etc...

It's not really about minimum but it's a way to get more into the middle.

Anyway IMO..

They are desperate to create wage inflation. Who is they? The people who understand economics.

Yes. Getting money to the masses so they can spend and absorb excess capacity.

Higher rents and house prices can also force employees to successful demand higher wages.

Submitted by The-Shoveler on May 18, 2016 - 11:25am.

MIB

Hahah

No really it is TPTB, yep "they" really exist.

Submitted by spdrun on May 18, 2016 - 1:23pm.

Stagnation is good. Growth is another word for cancer. CO2 output increases during economic growth and shrinks during recessions.

Best hope for Planet Earth would be a long-term recession plus something that massively affects population growth. Maybe Zika was engineered to do that.

I'd say the overtime limit isn't about wage growth. It's about reduction of hours to reasonable levels, which is also a good thing.

Submitted by njtosd on May 18, 2016 - 9:45pm.

FlyerInHi wrote:
njtosd wrote:
FlyerInHi wrote:

Now is the 50th anniversary of China's cultural revolution. I was reading that, at the time, people were starving and had nothing. The period since then has been the greatest creation of wealth in the history of capitalism.

Maybe because the assets of 60-80 million people (wealthy in particular) thought to have died as a result of the revolution were redistributed to the remaining population.

I streamed the program on my drive to Vegas. 60 to 80 million deaths is rather higher even is you include the Revoltion of 1949, and the following famines.

There was wealth destruction followed by amazing wealth creation in a few short decades.

http://www.npr.org/2016/05/05/476873854/...
DAVIES: Do we know how many people died?

DIKOTTER: Overall? The entire cultural revolution? Probably if you take 1966 to 1976 - in other words a good decade - until the very moment that Chairman Mao dies, you can probably count about 1.5 to 2 million people who were hounded to their deaths.

But the point must be that in comparison to "Mao's Great Famine" which took place earlier from '58 to '62, that appears to be a rather low figure. But the point is that it is not so much death which characterized the Cultural Revolution, it was trauma.

It was the way in which people were pitted against each other, were obliged to denounce family members, colleagues, friends. It was about loss, loss of trust, loss of friendship, loss of faith in other human beings, loss of predictability in social relationships. And that really is the mark that the Cultural Revolution left behind.

Ok - tomato tomahto. According to Dikotter it was 45 million between 58 and 62.
I realize that was before - maybe I should just say Chairman Mao. After the black plague in Europe the remaining people did very well temporarily. I saw statistics saying that 82% of the land that was "vacated" was claimed by others (usually younger people who survived the plague better) within a year. Fewer people, more land and more resources per person. Not a great way to achieve that result.

Submitted by FlyerInHi on May 19, 2016 - 1:01pm.

njtosd wrote:
Fewer people, more land and more resources per person. Not a great way to achieve that result.

Actually the wealth creation in China was after Mao's death. They put educated, competent people in charge. Although a communist country in name, they created the greatest amount of wealth in the history of capitalism. Quite a feat given all the challenges.

I believe we are successful in America because our politicians generally listen to academics and educated experts.

Mao was an uneducated pitchfork peasant. And we don't want people like that running things. Venezuela is a good example.

About the growth conundrum, after the 2008 crisis, our politicians and politicians around the world ignored the advice of economists and failed to enact growth indulding policies. The central banks, as independent institutions, were left to act on their own.

Submitted by XBoxBoy on May 19, 2016 - 1:59pm.

FlyerInHi wrote:
Mao was an uneducated pitchfork peasant.

Sorry, but that's just not true. Mao was the son of a wealthy farmer (read land owner) and much better educated than the vast majority of Chinese of his age.

Submitted by FlyerInHi on May 19, 2016 - 2:38pm.

Ok. Leaving aside Mao's education and knowledge of economics, China's intelligentsia was undoubtedly decimated under Mao. In the 80s, educated were allowed to serve again.

There are very good reasons central banks, as independent instructions, acted to prop up economies. Leave aside the period before, the Fed acted beautifully after 2008. The ECB, more beholden to politics, didn't do such a good job.

I believe the problem of low rates, low growth, stagnant wages and high asset prices is because fiscal policy didn't keep up with monetary policy.

Submitted by Rich Toscano on May 19, 2016 - 4:24pm.

FlyerInHi wrote:
Leave aside the period before, the Fed acted beautifully after 2008.

You could have said the same thing in 2005 -- and many did. Until the Fed has successfully normalized policy*, it's too early to declare victory.

* - BTW - That's the hard part.

Submitted by FlyerInHi on May 20, 2016 - 8:45am.

spdrun wrote:
Stagnation is good. Growth is another word for cancer. CO2 output increases during economic growth and shrinks during recessions.

Best hope for Planet Earth would be a long-term recession plus something that massively affects population growth. Maybe Zika was engineered to do that.

I'd say the overtime limit isn't about wage growth. It's about reduction of hours to reasonable levels, which is also a good thing.

Be careful what you wish for. We have a preview in Japan and Europe
Population decrease is bad for small towns and villages. You can live cheap in a small town but nobody wants that.
I guess you may argue that reverting to nature is a good thing.

http://www.slate.com/blogs/the_slatest/2...

Submitted by spdrun on May 20, 2016 - 9:19am.

What's wrong with Europe? Being on the bleeding edge of tech isn't everything.

Who gives a crap about small villages? Towns and villages have become ghost towns since before Pompeii. If a few villages dry up and blow away, so what? Nothing is immortal.

Submitted by FlyerInHi on May 20, 2016 - 10:29am.

So what?
Housing in depopulated areas will become worthless.

The bleeding edge of tech, or large metro areas, is where people make money to buy what they want. Even people are complaining their kids can't find well paying jobs in San Diego so they have to leave.

Sure, that's nothing in the scheme of the universe.

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