Monday, February 23, 2015
Fundamentally Flawed - Chapter 3.4, US Real Estate and Stock Markets
Sustainable asset prices are generally based upon the growing income (wages and salary) and size of a nations working population in conjunction with corporations earnings and profits. However, over the past two decades the US has twice seen bubbles develop detaching asset prices from the underlying income of the population and size of the working population. The charts below points out these two prior bubbles and then points out today’s real estate and equity values.
The residential real estate chart below shows a general balance between wages / salary and mortgage debt until about ’00. From then on homeowners substitute leverage (mortgage debt) for slowing wage growth and ramping home values. Via the growing reliance on mortgage debt plus ever lower interest rates on the ever larger debt loads, home values are pushed far beyond homeowners incomes. In ’09, the Federal Reserve determines to push this further via QE interest rate suppression to encourage even more debt at even lower interest rates…but to this point, mortgage debt continues declining as consumers are wary of more debt regardless the present record low rates and first time home buyers are at record lows as a percentage of the market. The peaking 25-54 year old US population and workforce in '07/'08 and declines since is strongly correlated to this fall. The current rebound in RE valuation is more to do with foreigners and investors looking for a “safe” substitute to the bond markets that used to offer inflation adjusted positive yields. However, at present valuations, investors are generally having difficulty making the purchases pencil plus foreigners are being hurt by the strong dollar and unlikely to maintain their recent pace.
Salary/Wage Source, US BEA; Real Estate Source, Federal Reserve System, Z.1 Financial Accounts & Mortgage Debt Outstanding
And one last look at residential real estate but adding in the 25-54 year old US population below. The 25-54 year old population peaked in ’07 and has declined since, in tandem with declining outstanding mortgage debt.
Population Source, OECD; Employee Source, US Bureau of Labor Statistics; Salary/Wage Source, US BEA; Real Estate Source, Federal Reserve System, Z.1 Financial Accounts & Mortgage Debt Outstanding
But the real estate bubbles seem tame compared to the current equity values. The below equity chart uses the Wilshire 5000 as the broadest US index tracking all publicly traded US equities, all US employee wages/salaries, all 25-54 year old US employees, and the value of all residential US real estate. The size of today’s mismatched equity values versus the US population’s slowly growing income and the declining jobs market is stunning! Clearly this equity bubble has no match as values are driven by flat earnings but record profits, collapsing corporate tax rates, and financialization…a mixture of record leverage, stock buybacks, free money via interest rate suppression, central bank and sovereign wealth fund purchasing, and an absence of other options for investors to obtain a return.
Employee Source, US Bureau of Labor Statistics; Salary/Wage Source, US BEA; Real Estate Source, Federal Reserve System, Z.1 Financial Accounts; Equity Source, Wilshire Associates
Recessions…and by the way, the US has had 11 recessions in 70 years since 1945, occurring on average every 6.5 years...this would mean the cyclical business cycle is pretty well done and rapidly counting down to the next recession...while the Fed hasn't even begun a "normalization" of its balance sheet or raised rates.