[davelj]

Personally, I think it will be more than 15% if we head into a recession because the current estimates are for the S&P to grow earnings both this year and next in the high-single digit to low-double digit range. If we hit a recession earnings will decline as profit margins – which are currently as high as they’ve ever been since recordkeeping began in 1954 – collapse. So, you’ll get a P/E adjustment AND a large earnings adjustment at the same time – a double whammy, if you will, on the valuation front. I think 900 on the S&P 500 and 1800 on the Nasdaq is not at all unrealistic at some point in the next two years, but they could easily stall at 1000 and 2000, respectively. I don’t have a crystal ball, but my bet is that we’re headed into a correction that’s deeper than 15%.

[davelj]

One other thing about the housing bubble… and it’s a point I made as a research analyst back in 2000 regarding the Nasdaq bubble…

The surest gut-level (as opposed to mathematical) indication that there’s a bubble afoot is that too many people with average amounts of human capital are making too much money. [I’m defining human capital as the sum of education, intelligence, experience, instincts, etc.]

During the Nasdaq Bubble – perhaps I should say “last” Nasdaq bubble (as opposed to the current mini-bubble) – every idiot with an internet connection that could spell “Microsoft” was making money in the stock market. Waiters and cab drivers gave out stock tips… day traders were, well, daytrading… It was ridiculous. Total boneheads appeared to be making money hand over fist (“appeared” being the operative word). And people that had merely half a clue – like young venture capital investment bankers three years out of Stanford Business School – were minting money like they were George Soros. Well, markets don’t work that way – they giveth and then they taketh away. I knew that these people weren’t “supposed” to be making that much money and that eventually the market would take most of those “lucky” gains away. And it did. Just like it always does. Sure, some lucky people get out in time and a few actually are brilliant. But the majority, without knowing it, are just waiting to take it in the arse.

This real estate bubble is exactly the same. Think about all these flipper TV shows, all the DVD courses and seminars, all the people who have made “easy” money in real estate over the last five years. Most of these people couldn’t spread a cashflow statement if it was done for them. It’s not meant to be, folks. Again, markets don’t work like that. That’s why, barring all of the statistical data, I know this real estate thing has to end badly. There are too many idiots sitting on too much wealth they shouldn’t have.

[davelj]

I will be shocked if the Nasdaq doesn’t close below 2000 in the next 12-18 months. Other than early-2000 (the year, to be clear) I’ve never seen valuations so high at a time when the fundamentals of both the economy and individual stocks – and particularly tech stocks, where inventories are absolutely through the roof – were deteriorating so rapidly.

We just got what amounts to negative guidance from Dell. I’d expect pre-announcements and negative guidance from at least the following over the next several weeks:

TXN
QCOM
INTC
AMD
RIMM
MOT
AMAT

… and many many others. This is going to be a bloodbath. Why? Everyone’s on the wrong side of the trade… as is the case leading up to all major dislocations…

Look out below, folks.

[davelj]

That’s right 4plexowner. The odds of a two-sigma event (on the right hand tail of the normal distribution – as in a bubble) NOT being representative of a bubble condition (assuming that the calculations were done properly) is around 2.2%. Consequently, there’s is always the chance – obviously quite remote – that we’re not in a property bubble. But it’s a horrible bet. If you consistently bet against Grantham’s methodology you’ll be broke in short order… for what it’s worth.

[davelj]

That’s 28 asset bubbles GLOBALLY over the 70 year period and includes all financial markets – stocks, commodities, bonds, property, etc. I can count a bunch of bubbles in just the last 20 years right off the top of my head: (1) Nasdaq, (2) S&P, (3) late-80s/early-90s CRE, (4) late-80s Japanese stocks, (5) 80s Japanese real estate, (6) Residential real estate late-80s, (7) Emerging markets stocks mid-90s, (8) Asian currencies mid-90s… I could go on…

In fact, I’d say that there’s probably a bubble in some asset market somewhere on earth almost 100% of the time. We’ve just had the misfortune of having several of them at the same time over the last 10 years. (Thanks Alan!!)

There is no bubble in the definition of bubble – two standard deviations is two standard deviations; it’s math.

[davelj]

DesperateBuyer, you are most likely wrong, but I do appreciate dissenting opinions so I’ll take the time to elaborate on why exactly you’re wrong.

First of all, a definitional issue. What is a “bubble” where asset prices are concerned? Here I defer to Jeremy Grantham (of Grantham Mayo Van Otterloo), one of the few true giants of finance from the last quarter century: “While Alan Greenspan may have a difficult time identifying an asset bubble, I do not – it is any market in which prices deviate by more than two standard deviations from their long-term trend.”

In a newsletter a couple of years back, Grantham explained that his team of quants had identified 28 bubbles (using his criteria) in asset markets over the previous 70 years. Of those 28, 27 had eventually reverted to their long-term trend line. The only one that didn’t was the S&P’s bubble of the late-90s, although it did decline to within 10% of its long-term trend (in contrast, the Nasdaq bubble did decline to its long-term trend before reversing). Anyhow, Grantham believes that much of the US property market (mainly the big cities on the coasts) is another bubble because, simply, it too has moved to (well) beyond two standard deviations from its mean long-term trend vis-a-vis virtually every metric available for analysis: price-to-rent, price-to-income, price-to-debt service, etc. – you get the picture.

Now, it’s always possible that the “fundamentals” (rents, incomes, etc.) will catch up with prices such that prices merely stall for several years. Interestingly, however, in Grantham’s research he found that in 27 of 28 bubbles, prices ultimately reverted to BELOW the trend line before resuming their upward march. Where SD housing is concerned, that would mean a decline of about 35%-40% from here on a median price/sq.ft. basis (we’re down about 6%-7% or so from the peak as I write).

Now, I don’t know whether the bottom is going to be another 20% down from here or another 35%, but I’m pretty sure of one thing: The decline is gonna be a whopper – and enough of a whopper that anyone with a functioning brain will in hindsight say, “Shit, that was one hell of a bubble that just blew up in our faces.”

One thing that a lot of people lose sight of is that everything important in economics (of which finance is a branch) happens “at the margin.” Which is to say that the most important pricing issues occur with the marginal buyers and sellers, and they do not have to be large in number to have an enormous impact on pricing. For example, the rate of home ownership was 66% in 2000 (after bouncing around between 59% and 66% since WWII) and climbed to 70% in 2005. When the history books are written I think we’ll find that that extra 4% – the marginal buyers – were only able to buy as a result of easy money financing. Once this financing dried up – as it is right now – the marginal buyers turned into marginal sellers and all hell broke loose at the all-important margin. Add in the speculators to this mix and you’ve got a toxic situation brewing at the margin.

Equally important: humans are, well, human. They’re emotional and do stupid things. As prices were increasing over the last few years, otherwise rational people bought property not because of fundamentals but because of the observation that prices were increasing. In other words, price increases – as opposed to similar increases in incomes, rents, etc. – drove people to speculate in properties. Price increases begat price increases. This is how bubbles work. (I should know – I wrote about the Nasdaq bubble in 2000 while working on Wall Street.) Bubbles are social phenomena because people are social animals. The bursting will be the upside in reverse: people will sell because they see prices declining (others selling). But, again, whether we get back to trend quickly or over a period of many years is anyone’s guess… I ain’t that smart.

Having said that, when you write that it “is simply absurd and ignorant to call this a speculative bubble” you reveal a great deal more about yourself than the real estate market about which you proclaim to know so much.

Now, having said all that begs the question… how do YOU define a bubble? And what, specifically, about the SD property market leads you to believe that we’re not in a bubble? (Note: Please use specific numbers, ratios, etc. – data speaks to me.)

[davelj]

I’d say yes, the CFA would definitely help get you a job… but here’s a small rub: In addition to passing the exams, you have to have 3 years of “qualifying work experience” in accounting, finance or economics before your charter is actually granted… but the CFA Institute is pretty generous about how they define such experience. For example, qualifying experience would probably include practicing as a securities lawyer, working as a commercial lender or even mortgage broker… again, they’re pretty liberal about the experience requirement.

Let me put it to you this way… let’s say I’ve gotta hire someone to work for me and I’m looking at two people. They seem pretty much the same from an experience standpoint but one went to Podunk University and got their CFA charter and the other went to Harvard Business School and doesn’t have their CFA charter. Without hesitation I’m going to favor the person with the CFA Charter. Why? Because over 95% of the people that went to HBS graduated, so I really don’t know what that person knows (it’s hard to get in, but you can be a complete dolt and graduate from a top MBA program). Maybe they’re the next Warren Buffett, maybe they’re an idiot. I have no idea. At least I know the person with the CFA Charter knows something tangible – they passed a very rigorous set of exams that a lot of smart people failed and their MINIMUM knowledge level is pretty decent. (Now this person may also turn out to be a dolt, but I’m playing the odds here…)

[davelj]

I’m not going to comment on whether you should move or not. I don’t have an opinion. But, let me share a couple of thoughts/ideas. First, an important poll result. Every couple of years American Lawyer magazine polls a bunch of partners at the top 100 law firms across the nation. And each poll comes back with the same result: Between 70% and 80% of this group of $300K/year (and up to $1 million) partners say they would not go to law school and become a lawyer if they did it all over again. Yup, you read that correctly. Lawyers have notoriously low job satisfaction. My brother is a lawyer and loves his job – but he makes jack shit as a Federal prosecutor… but he does love his job. So, just something to think about.

Now, if you decide for whatever reason that you don’t want to go the legal route (I just know too many miserable lawyers not to recommend running from that field like a banshee on fire) and that finance might interest you, I have a suggestion. Do NOT go to business school for your MBA. Instead, sit for and pass the Chartered Financial Analyst exams. Assuming you pass all three exams (the first exam is offered twice a year, the third and fourth exams are offered once a year, so it takes a minimum of two years to pass all three assuming you don’t fail one), then you’ll have something of value. Practically every asshole in business and finance (including me) has an MBA from a noted program. But a much smaller percentage has obtained their CFA charter as only about 15%-20% of those that sit for the first exam end up receiving their charter. So, you’ll have “scarcity value” when you’re done. Also, you don’t have to take any time off from work (although you’ll have to spend a good portion of the three months prior to each exam studying). And finally, the cost for each exam after paying for the exam fee and the study materials, etc. is maybe $2K-$3K (but that’s a ballpark, I haven’t looked in a while). Personally, if I could go back in time and do it all over again I wouldn’t have bothered with business school – complete waste of time and money. 95% of my class graduated (like most programs) and a third of them still couldn’t read a fricken’ balance sheet by graduation date (again, like most programs). The CFA charter, however, has served me well, particularly relative to the time and investment required.

Now if you have no interest in finance or business disregard what I just wrote… but still think long and hard about law school which I think is the surest path to professional misery.

[davelj]

Also, we must not forget that this is probably the tip of the iceberg. While this may be one of the larger scams of its kind perpetrated by one group, there are many other similar scams that have been perpetrated on a smaller scale by plenty of fraudsters. And they’re all going to unravel over the next couple of years. To quote Borat, ” Niiiice.”

[davelj]

Whoa Daddy. If even half of the 5,000 homes in question end up going into foreclosure by the end of this year (as opposed to “the next several months”) that will be an unmitigated disaster for SD/Riverside home prices, as it appears that the majority of the homes involved in this fraud are in SD and Riverside Counties. I’ll say it again, Whoa Daddy.

[davelj]

Wealth can only be discussed in relative terms; in a vacuum it’s a virtually meaningless term. You are incredibly wealthy in Ghana if you earn $1,000 per month; here in the U.S. you are near the poverty level. If you live in Shreveport, Louisiana and earn $75,000 per year you’re relatively wealthy; here in San Diego you’re firmly entrenched in the middle class. Consequently, any discussion about wealth must include a reference point for comparison.

Personally my minimum definition of “wealthy” would be an income of $300K/year and a minimum liquid net worth (that is, stocks, bonds, cash, easily saleable real estate or business interests, excluding primary residence) of $5 million and maximum leverage of 25%.

But that’s just me.

The problem, of course, is that there are a LOT of people, particularly here in SoCal, that have a big income and big net worth but they spend almost all of that income and that big net worth is highly leveraged such that they are one recession away from extreme financial duress and bankruptcy. It’s only when the tide goes out that you find out who’s been swimming naked, and here in SoCal there are a lot of folks swimming without bathing suits… we just don’t know who they are… yet.

[davelj]

I was the one – although perhaps there were others – that mentioned here that MP would likely run into problems at some point. I don’t have time at the moment, but I’ll show you why MP’s principals will still make out like bandits even if several of these projects end up underwater. First clue: most are financed by different banks and are structured as separate entities that aren’t tied together. As long as MP puts up its 20%-25% equity into the deal generally the lender won’t ask for personal guarantees or additional corporate guarantees. But I gotta run for now…

[davelj]

The odds of the S&P or Nasdaq’s earnings growing at greater than low single digits this year are not materially greater than zero. And I wouldn’t be at all surprised if they declined this year or next. There’s too much debt on the balance sheets, tech valuations are ridiculous (even if earnings don’t fall), we’re likely headed into a major slowdown if not outright recession, and I bet we see a large divergence between GAAP earnings and “reported operating earnings” (that is, “earnings before bad stuff”) either this year or next, much as we saw in 2000/2001. The only good news is that rates are low and unemployment is low (for now), but that ain’t enough to keep this leaky boat afloat. Right now the market is partying (almost) like it’s 1999. The only reason it isn’t going to fall like in 2000 is that valuations are lower… but they’re still well above what the fundamentals justify. An economic slowdown will have the pleasure of changing all that.

[davelj]

This stock market is operating on a set of fundamentals that I’m just not seeing. I think we’ll officially be in a recession by the second half of the year and this market’s going to start really f(l)ailing.

[davelj]

sdrealtor, what are your assumptions about MSFT’s dividend growth rate over the next 20 years? I’m curious as to how you’ll get to six figures in dividend income.

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