November 2006 MONEY.CNN “BubbleProof Markets” – Ha, Ha

[brian_in_la]

A poster over at calculatedrisk provided a link to a recent money.cnn article about markets that are “ready for a rebound.” It had a lot of unintionally hilarious statements (like Dallas-Fort Worth being cities that avoid boom and bust real-estate cycles.)

Anyway, it reminded me of another brilliant money.cnn article from less than a year ago…an article that provided readers with a list of “bubble-proof” markets.

For example, Los Angeles and San Francisco.

If you haven’t already had your daily cup of schadenfreude, take a gander at conventional wisdom cicra November 2006….

http://money.cnn.com/popups/2006/biz2/newrules_bubbleproof/index.html

Ok, back to work! Slackers!

[bsrsharma]

From an entirely different perspective: Those markets still provide prime real estate investment oppportunity if you want to protect your wealth from $ collapse. If I were to bet between prime real estate in those international port cities and US $, in terms of holding value over the next 10 year period, I would pick the former.

[justdoitstewart]

bsrsharma,

Please expand on your point…I find it very interesting…

[bsrsharma]

These two analyses below by renowned economists will give you the background. Simply put, U.S. $ is in for a massive devaluation in the long run (some think short run, anyway long run includes short run). So, if you have US $ denominated assets like cash/bonds/deposits etc., you will only retain a fraction of the value, say, in about 10 years. So, if you want to protect your wealth from inflation, one method would be to convert your cash equivalents to intenationally valuable assets like prime real estate in major ‘entrepot’ cities in the list. Prime real estate in those cities will retain the value even if rest of the real estate market declines due to international demand. (Remember, when $ collapses, things become cheaper for foreigners to buy).

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http://www.nytimes.com/2007/09/25/opinion/25roach.html

Op-Ed Contributor
Save the Day

By STEPHEN S. ROACH
Published: September 25, 2007
Hong Kong

CURRENCIES are first and foremost relative prices — in essence, they are measures of the intrinsic value of one economy versus another. On that basis, the world has had no compunction in writing down the value of the United States over the past several years. The dollar, relative to the currencies of most of America’s trading partners, is off about 20 percent from its early 2002 peak. Recently it has hit new lows against the euro and a high-flying Canadian currency, likely a harbinger of more weakness to come.

Sadly, none of this is surprising. Because Americans haven’t been saving in sufficient amounts, the United States must import surplus savings from abroad in order to grow. And it has to run record balance of payments and trade deficits in order to attract that foreign capital. The United States current account deficit — the broadest gauge of America’s imbalance in relation to the rest of the world — hit a record 6.2 percent of gross domestic product in 2006 before receding slightly this year. America must still attract some $3 billion of foreign capital each business day in order to keep its economy growing.

Economic science is very clear on the implications of such huge imbalances: foreign lenders need to be compensated for sending scarce capital to any country with a deficit. The bigger the deficit, the greater the compensation. The currency of the deficit nation usually bears the brunt of that compensation. As long as the United States fails to address its saving problem, its large balance of payments deficit will persist and the dollar will keep dropping.

The only silver lining so far has been that these adjustments to the currency have been orderly — declines in the broad dollar index averaging a little less than 4 percent per year since early 2002. Now, however, the possibility of a disorderly correction is rising — with potentially grave consequences for the American and global economy.

A key reason is the mounting risk of a recession in America. The bursting of the sub-prime mortgage bubble — strikingly reminiscent of the dot-com excesses of the 1990s — could well be a tipping point. In both cases, financial markets and policy makers were steeped in denial over the risks. But the lessons of post-bubble adjustments are clear. Just ask economically stagnant Japan. And of course, the United States lapsed into its own post-bubble recession in 2000 and ’01.

Sadly, the endgame could be considerably more treacherous for the United States than it was seven years ago. In large part, that’s because the American consumer is now at risk. Consumption expenditures currently account for a record 72 percent of the gross domestic product — a number unmatched in the annals of modern history for any nation.

This buying binge has been increasingly supported by housing and lending bubbles. Yet home prices are now headed lower — probably for years — and the fallout from the subprime crisis has seriously crimped home mortgage refinancing. With weaker employment growth also putting pressure on income, the days of open-ended American consumption are likely to finally come to an end. That will make it hard to avoid a recession.

Fearful of that possibility, foreign investors are becoming increasingly skittish over buying dollar-based assets. The spillover effects of the subprime crisis into other asset markets — especially mortgage-backed securities and asset-backed commercial paper — underscore these concerns. Foreign appetite for United States financial instruments is likely to be sharply reduced for years to come. That would choke off an important avenue of capital inflows, putting more downward pressure on the dollar.

The political winds are also blowing against the dollar. In Washington, China-bashing is the bipartisan sport du jour. New legislation is likely that would impose trade sanctions on China unless it makes a major adjustment in its currency. Not only would this be an egregious policy blunder — attempting to fix a multilateral deficit with more than 40 nations by forcing an exchange rate adjustment with one country — but it would also amount to Washington taxing one of America’s major foreign lenders.

That would undoubtedly reduce China’s desire for United States assets, and unless another foreign buyer stepped up, the dollar would come under even more pressure. Moreover, the more the Fed under Ben Bernanke follows the easy-money Alan Greenspan script, the greater the risk to the dollar.

Why worry about a weaker dollar? The United States imported $2.2 trillion of goods and services in 2006. A sharp drop in the dollar makes those items considerably more expensive — the functional equivalent of a tax hike on consumers. It could also stoke fears of inflation — driving up long-term interest rates and putting more pressure on financial markets and the economy, exacerbating recession risks. Optimists may draw comfort from the vision of an export-led renewal arising from a more competitive dollar. Yet history is clear: no nation has ever devalued its way into prosperity.

So far, the dollar’s weakness has not been a big deal. That may now be about to change. Relative to the rest of the world, the United States looks painfully subprime. So does its currency.

Stephen S. Roach is the chairman of Morgan Stanley Asia.
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September 20, 2007, 11:26 pm

Is This the Wile E. Coyote Moment?

Lots of buzz suddenly about the possibility of a sharp fall in the dollar. The Canadian dollar is back at parity with the greenback; there are rumors that the Saudis are planning to diversify into euros, and maybe even that the Chinese might break the dollar peg. A nice summary at Barry Ritholtz’s blog The Big Picture.
I could say that I saw this coming; the problem is that I’ve been seeing it coming for several years, and it keeps not arriving (and I don’t know if this is really it, even now.) The argument I and others have made is that the U.S. trade deficit is, fundamentally, not sustainable in the long run, which means that sooner or later the dollar has to decline a lot. But international investors have been buying U.S. bonds at real interest rates barely higher than those offered in euros or yen — in effect, they’ve been betting that the dollar won’t ever decline.
So, according to the story, one of these days there will be a Wile E. Coyote moment for the dollar: the moment when the cartoon character, who has run off a cliff, looks down and realizes that he’s standing on thin air – and plunges. In this case, investors suddenly realize that Stein’s Law applies — “If something cannot go on forever, it will stop” – and they realize they need to get out of dollars, causing the currency to plunge. Maybe the dollar’s Wile E. Coyote moment has arrived – although, again, I’ve been wrong about this so far.
Much more about all this in a thoroughly incomprehensible paper I recently published in the European journal Economic Policy. Don’t bother clicking if you hate funny diagrams and Greek letters.

[surveyor]

cashflow

I’ve found a lot of properties in those “rebound” cities that cash flow pretty well so the article isn’t that far off.

And isn’t cash flow how a lot of people here are saying how properties should be valuated?

[brian_in_la]

Surveyor, totally agree with you that cashflow is the way to go. And if you run the numbers and they look good on a property, then yes, I’d totally agree. If the article was titled “there are still some markets with properties where you can generate positive cashflow” I wouldn’t have ridiculed it. But, the focus still seems to be the capital gain (from the rebound!!!!), not the cash flow. The problem with the bubble is that people stopped worrying about cash flow. This article is more of the same.

[brian_in_la]

bsrsharma, what is your hunch about the degree of currency collapse? I’m not discounting the role of foreign buyers in certain markets like SF, Miami, Manhattan, but do you really think that is going to save the inland empire and san fernando valley? Maybe downtown LA luxery condos….but, really anything else? I just don’t see it.

I agree that if we have Weimar Germany type inflation, housing will be some sort of hedge. If it isn’t burnt down by the angry mobs.

I still stick with housing being massively overpriced and if you are looking for an inflation hedge, there are better options.

[justdoitstewart]

I think everybody agrees that housing is overpriced in California, Phoenix, Vegas, Boston, NYC, FL, etc.

What if you could find a piece of property in an emerging market like Biloxi, MS where the price to rent ratio is pretty good, wouldn’t that be a great hedge against inflation?

[bsrsharma]

Brian,

I was guarded in my comments and limited it to just those cities mentioned in the CNN article. About rest of the markets I am as bearish as any Piggingtonian. (especially Inland Empire – my idea would be for the HUD to take over all distressed properties at some nominal price like $80 – $100/sqft and convert them into public housing and rent it back to the newly “homeless”. Much better than Jim Cramer’s idea of plowing them over) However, for the cash rich (multi-millionaire kind) who want to protect their wealth from the inevitable $ devaluation, prime real estate in those international gateway cities can be a conservative asset. Being international in character protects them from the vagaries of domestic crises.

When it comes to $ collapse, I am not buying the fast “total loss” scenario advocated by some folks (like partypup). I think FED will be smart enough to engineer a gradual devaluation of about 5% per year (on average; peak values may approach up to 10%) over the next 10 – 20 years. Our international linkages, primarily, hordes of Eurodollars, Petrodollars, Sino/Japanese dollars etc., act as a buffer against US $ becoming Mexican Peso. (In Game Theory, this situation is called Prisoners Dilemma. U.S. holds the rest of the world as hostages in a monitory sense. If anybody tries to take advantage as the first mover, everybody will be ruined. That should save us – just like MAD did during cold war!)

Bottom line is, we have to lose at least 50% of the value of $ before we stop becoming a net consumer of global capital. (A rather harsh way of understanding that is – nationally, the average American’s living standard has to fall by half before investors find it doesn’t pay to produce abroad and import for domestic consumption).

[bob007]

i expect cities with net inflow of middle class folks to do well.

sunbelt cities that attract wealthy retires from the northeast

tech centers with moderate cost of living – Austin, Dallas, Raleigh, Portland, Seattle, Boise (some of them will hold. some won’t)

[Author]

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