On Economic Troglodytes

One of the things I see on more "populist" forms of financial news commentary is a grave mistrusting of seasonally adjusted data.  For the uninitiated, a seasonal adjustment is a filtering process for volatile data series that have a clear seasonal pattern.  By correcting for the observed historical seasonal patterns, you can get a smoothed look at what the data are without the typical chop.  Good examples of data with significant seasonal oscillations are housing starts (with far more in the spring and summer than in the winter) and employment (with massive amounts of layoffs right after the holiday season and robust hiring in the summer).

However, there is a group of people who don't trust seasonally adjusted data, largely because I don't think that they understand it.  Take this post from Minyanville.  The author boldly dismisses seasonally adjusted jobless claims data as not being "real" and asks that readers look at the non-seasonally adjusted data.  Then, there is a choice quote later:

The actual weekly initial claims data exhibits week to week patterns each year that are consistent, as certain industries tend to add and subtract workers at the same time each year. Rather than smoothing the data to obscure what really happened last week, we can compare the numbers directly with prior years' performance during the same weeks to get an accurate reading of the current trend. Like an optometrist, we can look at small changes and ask whether they are better, worse, or about the same as last year. By carefully evaluating subtle changes, we gain clarity of vision.

As it so happens, that is precisely what the seasonally adjusted data does, however imperfectly.  The reason that, beyond a simply seasonal adjustment, economists like to look at a 4-week moving average for jobless claims is that, even after going through the rigors of a seasonal adjustment, large one-time events can occur like a major corporate bankruptcy, a strike, or a major weather event.  By taking a simple average, you can somewhat smooth this out.  Doing so is, by definition, somewhat backward looking, but it is a tool that you can use if you so choose.  One thing I've learned in my line of work is that there is no one right way to analyze data.  The circumstances may call for a few different ways of looking at it.

What some of the troglodytes like to do is use a 12-month moving average or something like that instead of a seasonally adjusted number, claiming that actually represents the real data.  A neat little trick here is that the 12-month moving averages of the non-seasonally adjusted data and the seasonally adjusted data come out almost exactly the same, which is what you would expect if the seasonal adjustment is worth its salt.  See this below with housing starts data:

However, 12-month moving averages don't capture "real time" changes in the data.  It's for much the same reason that year over year comparisons are useless.  If you had a huge run up in the early months of the 12 month period, the leveled off and are now starting on a downward trend, you won't catch it in the moving average or the year over year numbers for another few months.  Look at the three measures of potentially judging what housing starts were doing during the housing boom and bust of the last decade (CLICK ON PICTURE FOR LARGER IMAGE)

The seasonally adjusted data catches the inflection point earlier and more decisively than either of the other two measures.  In the other two, you can eventually see it, but the seasonally adjusted data provides the much clearer signal.  This is because, with the seasonal filter, you can look at a current month and judge what it means on a "real time" basis rather than being dependent on backward looking measures that take months to provide a signal.  Also, compared to non-seasonally adjusted numbers, which at best rely on a year on year comparison, you can much more easily detect the trend.

This is why, even though seasonally adjusted numbers are not "real" numbers, they do provide the best picture of what is going on of all the data that get presented.  Frankly, people who reject seasonal adjustments as being some statistical creation are nothing but troglodytes.

Calculated Risk: Nominal House Prices May Bottom This Year

Bill McBride at Calculated Risk has made a prediction of house prices, at least in nominal terms, bottoming out this year. I have to agree for a number of reasons that he has enumerated. Price to rent ratios, typically one of the best indicators of the relative valuation of housing, have normalized to the extent that much of a further decline is very unlikely.

This is not to say that housing is a particularly good investment relative to other assets. History teaches us that recoveries from real estate crashes, whether they be Japan in 1990, select U.S. markets in the early 1990s, Hong Kong in 1997, or any number of U.S. markets in the early and mid-1980s, are very slow and painful before they start gaining momentum. As such, expecting any large bounce back in the intermediate term is not a good idea. House prices have declined to reasonable levels rather than undervalued levels.

How do bubbles happen? (A mechanical demonstration)

A lot of skeptics over the existence of bubbles like to believe that just because a market is clearing at a given price that it means that price is an appropriate valuation for that asset. They said this about stocks and they said this about housing. After all, if the price got out of line with what it should be, more supplies would come on line and knock the price down.

Well, there's an issue with that. At the end of the day, demand and supply for assets is driven by what the buyers and sellers believe they can get for those assets. That expectation should be reasonably informed by the rational expectation of future earnings (with stocks it is profits and with real estate it is an equivalent level of rent), but as we know it often isn't. When the expectation about future prices becomes detached from rational expectations of underlying fundamentals, the demand and supply curves take on a life of their own.

Click on chart for bigger image

Like all microeconomics exercises, this is crude, but it gets the point out. Demand curves are denoted with "D" and supply curves with "S". The red lines show the market at the starting point. Then, for some reason that could well originally be related to real fundamentals, demand shifts out to D-2. This creates the expectation among holders of the asset that future prices will be higher than current prices and so the prices at which each holder of the asset is willing to part with it increase, shifting the curve in and prices rise further. Skipping ahead a few phases, demand for the asset again shifts out as buyers are trying to race in as their expectations of future prices get wildly out of hand and supply again shifts in as the owners of the asset have their expectations raised as well. 

The problem is that all the while the fundamentals of the pricing of that asset have not changed to support these expectations. At some point, this is realized and both demand and supply shift back to their original locations, causing a fairly huge drop in price.

Now, the exercise above also happens on the downside as well. It happened in March of 2009 in a big way. That was a huge "negative bubble" where expectations about the future prices of assets were irrationally pessimistic. This was partially informed by really bad information about likely future earnings just as the housing bubble was partially informed by, well, lies that the typical return on a house price was between mid-single digits and double digit percentages and that prices could never ever fall. This was so pervasive that it made its way into mathematical models for the pricing of mortgage backed assets.

The point of all of this is that bubbles will always take place in the context of what looks like a properly functioning market. Let's take housing for a moment. A great deal of research suggests that the only factor that really matters for determining the direction and magnitude of change in house prices is the inventory to sales ratio. Housing bulls in mid-2005 said that we couldn't possibly be in a bubble because the inventory to sales ratio was so low (sometimes less than 4 months supply). However, thinking about this in terms of the exercise above, the reason the supply was so low was because the market was withholding supply that would have otherwise been on the market because sellers were holding out for higher prices because their expectations had become similarly warped. The bubble deniers essentially thought that a bubble would only exist if prices were advancing 20%+ in the context of an inventory to sales ratio of 8 or more. Once homeowners and developers began to develop more rational expectations about what they could reasonably expect for their future prices, supplies picked up while demand dropped due to buyers' expectations coming down.

This is all useful to think about when we look at China's housing market and also gold. 

MBA Purchase Index and Early Read on September Home Sales

From Calculated Risk we see a couple of interesting tidbits on housing. First, the weekly MBA purchase index had a rough week, dropping 8.5%. There's apparently a change in FHA standards related to this. Does anybody happen to know what that is?

Then, September home sales seem to have picked up a bit from August. A 4.5 million SAAR will register as a big percentage increase, but in truth that's still a horridly weak number and will leave inventories at the point where price reductions are likely. Inventories much above 8 months of sales usually lead to some measure of price reductions. 

Still, combine this with auto sales that were slightly up and decent retail sales and we at least aren't seeing the relapse in consumer spending many had feared. From the larger perspective, I'm still not seeing the evidence of a double-dip in the broad economy.

August Home Sales and July House Prices

Over from Calculated Risk, we have a preview of existing home sales: http://www.calculatedriskblog.com/2010/09/existing-home-sales-preview.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed:+CalculatedRisk+(Calculated+Risk)

Given that the weekly MBA purchase index has basically not moved in a while and the current levels of pending home sales, the 4.1 million SAAR makes sense.

In terms of what this means for prices, generally inventories over an eight months supply imply moderately to steeply falling prices though the relationship is not ironclad. We did see out of the FHFA today that home prices in July fell 0.5% from June. Given that there is a bit of a lag between when inventory to sales ratios surge and prices drop, we should expect fairly steady small to moderate price declines for many months to come. Currently, a number of forecasts are calling for about a 5-7% decline. Based on some regression work I've done, that seems reasonable.

An interesting consequence of that is that it makes the home-buying decision a little more complicated. The old argument that you want to own instead of rent so that you can build equity doesn't exactly work when your monthly principal payments are going to offset a decline in prices. Just some food for thought.

Prepare for Apocalyptic Home Sales Numbers

As we have been discussing for a while now, home sales are likely to be quite weak following the expiration of the home buyer tax credit. "How weak?" you might ask? Well, let's just say they could be the lowest in any relevant time span. The expectation of economists is probably way off this time as is being discussed over on Calculated Risk.

If these sorts of sales rates are maintained (if that is the proper word to use here) prices will certainly decline again, which has been our expectation here. What that means is that even now might not have been the best time to buy a house as you will not be building up equity. Of course, it depends on the market, but most will be quite weak.

Now, as for whether or not this will push us into another recession, I don't think so. Existing home sales, which are the bulk of home sales, really aren't that economically productive as they don't reflect the production of new goods. New home sales are really about as low as they can go and were probably actually depressed by the credit pushing more people into existing homes. A decline in prices may make banks a little more skittish, though it would be hard to see how they could be more tight-fisted than they are now.

How Big is the Chinese Property Bubble? Pretty Big

I stumbled across a bunch of charts the other day and this one in particular caught my eye: http://www.businessinsider.com/chinese-land-prices-2010-7#likewise-price-increases-are-killing-income-increases-14 (Credit goes to Jing Wu, Joseph Gyouko and Yongheng Deng at NBER)

What I have said for some time is that despite migration patterns providing a substantial level of support to real estate in China, there is a fundamental problem where price gains have far outstripped income increases. This is also the reason I don't buy the idea that all of these houses are being bought strictly with cash, or at least cash that isn't at some point supported by debt. It just isn't possible.

Just to give you some idea of what a price to income ratio of over 20.0x in Shenzhen means, here in the U.S. California had a price to income ratio of right about 10.0x before prices started plummeting to about half of their all time high. Other markets still had decent sized corrections with price to income ratios of only 4-5x. Generally, much north of 4x is considered to be on the edge of pushing it nationally here while some markets can sustain, over time, more like 5-6x. I've seen some countries that can apparently sustain near 7x, but even for those countries that seems to be the point at which prices stagnate and wait for incomes to catch up.

Returning to China, it is true that there is regional variation, but that has been true in every real estate bubble in history. Here LA, New York, Miami, Las Vegas, Phoenix, Milwaukee, Cleveland, and Detroit all had very different dynamics. In the U.K., London, Liverpool, Manchester, Brighton, and Newcastle had varying degrees of excess. The same applied in Spain in the 2000s and Japan in the 1980s. It's a very non-compelling argument to say the least. What's more is that price to income levels mask another trait of real estate excess which is that those on the bottom end of the income spectrum often get caught up in the frenzy and buy much more house than they can afford in otherwise not particularly overpriced markets such as Atlanta.

It is unclear how much further this has to go, but perhaps Alex can expand with some first hand details on what he saw there.

On Spotting Bubbles: Part 1 of Many

One of the most fascinating phenomena in financial markets is the "bubble". Defining a bubble is somewhat of a tricky art form. I think most people would agree with this quote by Justice Potter Stewart on the issue of obscenity: "I know it when I see it". We all think we know a bubble when we see it, but do we really? I have found myself looking for definitive methods for spotting bubbles before they are clearly out of control and I wanted to share some thoughts on the subject.

Broadly speaking, I would essentially define a financial asset bubble as a case where the price of an asset has far outstripped any reasonable relationship to what it should be priced off of. With stocks, this is the earnings power of a company. With housing, it is the price to rent ratio or a price to income ratio with some adjustments. Asset prices, no matter how much people may want to believe otherwise, must necessarily be constrained by their relationships to their fundamentals over long periods of time. If this was not a constraint, we could all become infinitely wealthy by speculating in financial assets. What these fundamental relationships should be (i.e. a PE of 15x vs 17x or a price to rent ratio of 1.1x 1.0x) are the province of markets to flesh out over any given time, but in the long run, certain reasonable relationships do hold.

"Ah", you might say, "You said in the 'long run'. What about the short run where I actually live?" Indeed, and this is the problem. Over short (3-5 year time spans) any particular asset class can become wildly overpriced. How wildly? Well, let's look at the NASDAQ in the span of 1996-2000:

As you can see, up until 1999, the NASDAQ held more or less in line with the S&P 500 before wildly departing and going absolutely bonkers (technical term). What's more is that the S&P 500 in this time frame was also overvalued quite considerably, though I will discuss that finer point in detail in later post. Earnings growth during this time span was good, especially for the technology-heavy NASDAQ, but not anywhere near that good. It's much like how ordering pasta at a high-end Italian restaurant may be worth $15.00 a plate, but not $30.00. At $30.00, you are just being irrational.

This takes me to a brief digression on economists. Many economists, particularly those with significant classical leanings (no, they don't sit around and listen to the finest works of Handel, though they might) feel that consumers and investors are always rational and they justify this point with a bit of twisted logic. This is that because an investor bought an asset at a certain price and expects to receive more for it in the future, they are being rational. Only if they bought an asset with the expectation that they would lose money in the future would they be irrational. If this definition of rationality strikes you as absurd, it should. If I were insane and kept drinking six cans of Dr. Pepper everyday under the expectation that would be good for my health, would that be rational? Well, it might be if I were poorly informed, but I would already have to be irrational to believe such a thing.

This brings me to how to, qualitatively, spot a bubble. You do not do so by saying "Oh, the stock market is up 50% over the past twelve months so that must be a bubble" because the market has done that plenty of times and not looked back ever again. Similarly, in individual sectors, a rapid advance does not necessarily mean that people are not in league with their senses. Steel production in the United States in the late 19th century increased many thousands of percent and did not constitute a bubble. Similarly, PC sales from 1985 to 1995 increased by such a large percent that most people wouldn't believe it if you printed it. As such, a simple quantitative rule such as "x% increase necessarily equates a bubble" is not useful.

The basic qualitative framework for assessing the likelihood of a bubble is trying to determine the amount of reliable information (broadly construed) available in a market and then assess to what extent that information is being employed rationally. There is a third variable that is unfortunately quantitative, but is easily enough assessed which is whether the asset or whole asset class in question present offer greater than typical rates of return. Bubbles do not form in assets or asset classes where there is not a truly better than typical fundamental story going on. For example, the U.S. housing bubble formed during a time of low inventories and high affordability due to low interest rates. The NASDAQ bubble occurred in the sector of the economy seeing the fastest growth.

So, to put succinctly:
1. Is the asset or asset class in question fundamentally more attractive than other alternatives?
2. Is there either little information available or is the information corrupted in some way?
3. Are market actors incorporating available information or are they doing so in a rational way?

As I hope to show in later posts, this basic framework can be used to assess not only the presence of bubbles, but also to determine the differential effects of bubbles within an asset class. Incidentally, these criteria can be used to assess what I call "fear bubbles" such as what existed in March 2009.

On Bad Analysis and the Chinese Real Estate Market

It's amazing how some lines of logic will never die. I saw this article from Bloomberg about the likelihood of a collapse in real estate prices in China. In it was this absolutely awful line of reasoning from Stephen Roach:

"Rogoff’s view clashes with that of Stephen Roach, chairman of Morgan Stanley Asia Ltd., who said last month the property boom isn’t a bubble. While portions of the market such as high- end apartments are overheating, residential demand will remain robust as rural Chinese migrate to cities, he said in a radio interview in Hong Kong with Tom Keene on Bloomberg Surveillance."


Well, this actually sounds familiar. I seem to recall discussions about how the U.S. faced "pockets" of overvalued real estate, though when you added up the pockets they amounted to half the entire real estate market. Also, there were discussions about the growing demographic demand for real estate as well as the fact that inventories were temporarily lean. While not discussed much in this article, the same logic has been used to defend Chinese property prices.


At the end of the day, however, the problem is that average and median sales prices here far outstripped incomes, whatever temporary supply bottlenecks existed to support prices for an instant. In China, many central city areas, from what I have read, are priced at 14x median incomes. California, at the peak, was about 8-10x before declining approximately 40%. It may still decline further. Housing prices must necessarily be a function of incomes in the long run, whatever short term trends may distort them. This is similar to how stock prices must conform to earnings eventually as they are supposed to represent the value of a company. Asset prices cannot remain entirely detached from their underlying determinants for long ("long" meaning more than several years). 


Sometimes, I think analysts forget that asset prices cannot rise independent of their determinants in the long run. This is why they fall victim to bubbles so frequently. This is part of the reason that asset managers do not truly "create" wealth. In the end, it works out to be closer to a wealth transfer. In the case of China, incomes are rising, people are moving toward the cities, and financing has been plentiful. Against the backdrop of squeezed supplies, yes, prices can rise exponentially in the short run. However, the high prices will bring more supply onto the market and they will also sap demand. In time, financing too will ease as overlending will lead to higher default rates. At that juncture, prices will drop to a level more supported by the fundamentals. 


It is odd that a man generally as bearish as Stephen Roach is would fall victim to the sort of arguments that the National Association of Realtors used back in 2005. It could be that he is talking the book of Morgan Stanley in China, but I don't want to make that accusation without evidence. In any case, this bears watching.

Economic Data Summary: Week Ended July 2nd, 2010

To finally play catch up, here we are. This was once again somewhat of a mixed week for economic data, though with a downward bias to be sure. It seems to be somewhat of a theme lately and one that indicates a sudden slowing of economic growth. As I discussed in another post, I don't think this signifies a double-dip, but it has come on unexpectedly fast for something that has no apparent proximate cause.

June Non-farm Payrolls

Most of the financial press called this a "mixed report", but I disagree. It was a deeply disappointing report. Of course, beneath the headline of -125,000 jobs (entirely due to Census layoffs) was the somewhat increased private sector hiring compared to May, though at less than 100,000 it was weak. I guess it's better than the job loss recovery (yes, I used job loss rather than jobless) from the 2001 recession, but that was so much shallower of a recession than what we went through. As some have indicated this is a typical recovery path from a financial panic induced recession.

More worrisome to me was that aggregate weekly hours turned down as did aggregate payrolls with declines in both hours worked and hourly incomes. Much more of this sort of performance would get me truly concerned. One little nugget in the report was that those unemployed 27-weeks or more turned down while the numbers increased down the scale a little bit. That was an interesting development and might bear watching to see if it is repeated. Down the scale makes sense from laid off Census workers, but those out 27-weeks or more should be continuing to increase. It might have just been a statistical burp.

June ISM and Chicago PMI Surveys 


Neither report was what I would call "weak" in the sense that they indicate contraction. The Chicago PMI, at 59.1, is firmly in expansion territory, indicating continued solid growth in industrial production. Granted, there is some slowing in new orders, but production actually hit new highs. In fact, the overall rate of growth was barely off from May at all.

The national ISM figures showed modest slowing, but still a broad based expansion in manufacturing activity. All major indexes are north of 55, which indicates the likelihood of average to slightly above average conditions in the manufacturing sector in the near term. Next week watch for the regional Fed surveys to get a better sense of what July might look like. If the slowing trend rapidly accelerates into a real downdraft, there is real cause for concern.

April Case Shiller House Price Index

Economic Data Summary: Week Ended June 25th, 2010

This is belated on my part and for that I apologize. Two weeks ago, we had a fairly rough raft of economic data and that situation actually only intensified the next week as we all saw. I will whip through these as gingerly as possible to keep us flowing.

May Existing Home Sales and May New Home Sales


These reports were gross and grosser. Existing home sales dropped 2.2% to 5.66 million at an annual rate from April to May, which was well well well below expectations of 6.2 million. Inventory to sales ratios have ballooned out to over 8 months again. There was almost nothing good to say here so I will not even attempt to. I fully expect that sales will be horrid in June as well as throughout the summer before beginning to pick up again, at a seasonally adjusted rate anyway, toward the end of the year. Any improvement then will be slow.

New home sales were catastrophic (watch until about the 0:30 mark for the proper visual of this report). The consensus was for a 400,000 annual rate and they came in at 300,000. I've rarely seen a miss quite that bad in any report. Inventories once again surged to over 8 months, which is a level consistent with price declines in the future. The expiration of the tax credits has had a massively negative impact on home sales. Going forward it will be hard to piece together what the real estate market is looking like, but suffice it to say that it will not be positive for some time to come.

May Durable Goods Orders

This is one of the most volatile economic numbers and it did not disappoint in that regard in May. The headline number was down 1.1% while ex-transportation they were up 0.9%. Most categories actually increased, but airplane orders caused the volatility here. For the best comparison, here is non-defense capital goods ex-aircraft:

As you can see, we are having a much more rapid recovery in business spending in this recession than in the prior recession. In this category, the fall was not actually much worse either. This is one of the very encouraging aspects of this recovery for all of the disappointments.

Richmond Fed and Kansas City Fed June Manufacturing Surveys 


Mixed bag here, but it does reflect that the manufacturing recovery might be slightly running out of gas, at least for a brief period. The Richmond Fed survey showed what still look to be solid numbers indicating a decent clip of growth. They noted that optimism is waning a bit, but I would not characterize this as a weak report.

Kansas City barely showed any growth at all, though you often have to put several of these months together to get a proper idea. It bares watching a few weeks from now when these reports come out again. If they show further deterioration, I will begin to get somewhat more nervous. Patchy regional growth is somewhat worrisome as we had seen such strong synchronized growth for a few months in a row. Still, if you look at the history of these indicators you will see a lot of chop in them. The chop only gets troubling when it coincides with other signs of weakness just as a pain in your chest may be nothing, but if your arm goes numb and you become lightheaded, then it might be time to worry.

And the rest....


GDP was revised down to a 2.7% growth rate in the first quarter. There's not much to say there except that international trade is once again becoming a persistent drain on GDP growth. China's currency manipulation along with a rebound in oil prices have done some damage.

Jobless claims for that week edged down from an earlier spike, but that has been a back and forth motion for some time now. It is very difficult to read much into these figures for now. They have been translating into weaker than expected employment reports lately so that relationship might be making sense again.

The weekly retail sales reports for that week were soft, indicating a slightly weak June, though nothing cataclysmic. I will be curious what the retailers say this coming week as they report their monthly sales. They might give us a hint into July.

Finally, MBA indicated that purchase applications and refinancings remain soft. This is no surprise, though with the recent plunge in long term bond rates, look for both of these to start increasing again some time in the future. If they don't, then consumers have really and truly turtled up.

A Housing Relapse?

There's a fairly good post over at Calculated Risk about the uptick in inventories shown in recent home sales reports. Additionally, as I have mentioned in the weekly economic updates, the temporary boost that the plethora of government programs has provided to the housing market appears to be giving way with some new price declines possibly setting in.

I would say, as does Bill McBride at Calculated Risk, that a new series of price declines would not be as catastrophic as they were previously. However, they will have a deleterious effect on economic activity and possibly make banks more unwilling to lend. Will it be enough to entirely derail recovery? I don't believe so, but it certainly bears watching.

Further, there is the possibility of synchronized declines with other major markets around the world such as Australia, which appears badly overvalued, and China, as has been previously mentioned. Australia is not a large enough housing market to sink the world, but when the bubble there starts bursting, it will cause some pressure that, if it occurs at the wrong time, could make life difficult.

Anyway, those are just my two-cents.

Economic Data Summary: Week Ended June 18th, 2010

This was a decidedly mixed week of economic data. Industrial production was quite strong, but housing starts and the Philly Fed were fairly weak.

May Industrial Production 

This was the highlight of the week. 1.2% on the headline number, 0.9% on manufacturing, 1.3% on business equipment, construction equipment up 0.8%, and so on. There was not a weak component in the entire report except for mining, which is always quite volatile. Just to make the point about the strength of the recovery in manufacturing, here is a comparison of the past three recessions:

There is a V-shaped recovery, but it is only in manufacturing. Still, I consider industrial production one of the very best coincident indicators so this is an encouraging sight.

May Housing Starts and Building Permits

If everything about industrial production was good, everything about housing starts was bad. Starts were down 10.0% and permits were down by 5.9%, indicating future weakness in starts. Weakness was widespread and should be expected to continue going forward as the distorting effects of the tax credit wane. I expect there to be many mixed signals in the next few months on housing and don't expect there to be a definitive up-trend until either the end of the year or well into next year. A potential full on relapse in housing with prices and sales falling on a sustained basis is not out of the question, though the magnitudes would be much less if for no other reason that there is not much room on the downside.

A Nervous Eye Toward the (Far) East

Technically Europe is a closer east than Asia is, but I will conform to the conventional parlance on this one. In any case, while the concerns around Europe are well known, I have been more closely tracking the troubling developments in the property markets in both mainland China as well as Hong Kong, and I don't like what I see. 

From this Bloomberg article on Hong Kong: 
"Home prices have risen 41 percent since the end of 2008, prompting the government to tighten down-payment requirements for luxury homes in October to curtail speculation after record- low interest rates fueled the surge. Financial Secretary John Tsang on May 12 pledged to keep boosting land supply."


Home prices up 41% in 16 months? That's worrisome to say the least. Considering that in the long run home prices are a function of incomes, I find that a little odd. I suspect that there are some at the upper ends of the income strata in Hong Kong that have seen even greater than 41% income growth and that is probably what is propelling prices higher at the margins. However, just as in California five years ago, the super rich are never enough to support a large real estate market (and despite being only one city, Hong Kong is a large market). Eventually, California reached a point where 88% of the population could not afford the median house. Yes, that is just as silly as it sounds. Hong Kong is at a similar juncture right now. Prices will have to correct, the question is when.

Embrace the Stability of... Toll Brothers???

This is not intended to be an endorsement of buying Toll Brothers (TOL) for your portfolio, but rather as a post demonstrating the utterly bizarre nature of the stock market at times.

In this instance, Toll Brothers, one of the companies most at the center of the housing boom as a luxury homebuilder, has proved to be one of the most stable stocks out there since the real estate crisis started in earnest in mid-2007. For most of the last 2 years and nine months, it has basically hugged relatively closely to where it started the period:

Compare this to many other companies so directly tied to the fall of the housing boom and you would be forgiven for thinking that Toll Brothers must be involved in something other than real estate. Of course, it did have a large fall between mid 2005 and mid 2007, which proved to be a solid leading indicator of the crisis. However, since then it has relatively consistently held up better than the broad market even as housing construction has imploded.

Just goes to show that simplistic analysis does not do one's investments justice.

Economic Data Summary: Week Ending May 28th, 2010

We've finally gotten to a point where I think all data series have had some level of explanation or are at least straightforward enough that we can cut right through them. In any case, the data this week were somewhat of a mixed bag, though still show that the economic recovery remains intact. Without further ado:

April New and Existing Home Sales


As expected both new and existing home sales had very strong months in April. New home sales were up 14.8% at an annual rate and existing home sales were up 7.6%. However, this was largely due to the homebuyer tax credit. As we have discussed previously, that is likely to distort the data going forward for some time to come. How much the distortion will be has yet to be seen, but my guess is that it will be significant. The depressed home sales in the coming months will probably weigh on prices that have otherwise firmed recently, which takes us to our next data...

March S&P Case Shiller House Price Index


Sputtering. That is the appropriate word to use for what had been some decent house price increases in mid through late 2009. Seasonally adjusted, house prices did edge up somewhat in March in the markets followed by the 10-city index, but the broader 20-city index fell slightly from 146.0 to 145.93. Not a huge decline, but still it does indicate that house prices are likely to remain moribund for some time to come.

Economic Data Summary: Week Ending May 21st, 2010

The data released in the past week were mixed, the first week in a while where that was true, however there does not seem to be much of a change in the overall trend of steady, moderate economic growth.

April Consumer Price Index (CPI)

This is the measure of prices paid by consumers for a pre-determined basket of market goods. Along with the PCE deflator, it is one of the two primary methods for determining the rate of inflation for consumers.

In April, the headline number fell 0.1% and is up 2.2% year on year. The April decline was driven by lower energy prices and that trend will probably continue for a couple more months with the recent decline in crude oil prices as well as gasoline and natural gas prices. The core rate, less food and energy, was flat for the month and is up 0.9% year on year. Inflation is very modest and there are few signs that it will accelerate soon in any meaningful way.

April Producer Price Index (PPI)

This is essentially the CPI for businesses, focusing on manufacturers in particular. There's really not much more to say about it except to say that, along with the CPI, these releases can move markets when there are concerns about Federal Reserve interest rate moves. This is because when markets are on edge fearing rate hikes, strong inflation numbers will change interest rate expectations to the upside and hurt equity and bond prices.

Like the CPI, the headline number was down 0.1% month on month, driven by energy. Year on year, the finished goods index was up 5.5%, which would look scary under most circumstances. However, as recently as July of last year the PPI was down 6.9% year on year so the comparisons are somewhat skewed. PPI is subject to much more wild swings than CPI because changes in raw materials prices are felt more rapidly and are not moderated by the fact that not all price increases are passed on to consumers.

April Housing Starts