The Bounce in the Housing Market, Interest rates and the Economy

By: Sol Palha | Fri, Sep 18, 2009
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"Science is a first-rate piece of furniture for a man's upper chamber, if it has common sense on the ground floor." ~ Oliver Wendell Holmes 1809-1894, American Author, Wit, Poet

Stories such as the one listed below are going to increase in the months to come; indeed since that story came out in June, we have seen articles of a similar nature advocating that real estate has put in a bottom and that its time to buy. At some point even the most sceptical will feel inclined to believe that the housing sector has put in a bottom.

For June, the Realtors group said its pending home sales index rose 3.6 percent to 94.6, from an upwardly revised reading of 91.3 in May. The last time there were five consecutive monthly gains was July 2003. The results were far better than analysts expected. Economists surveyed by Thomson Reuters expected the index to come in at 91.2. The report tracks signed contracts to purchase previously owned homes and is considered a barometer for future home sales. Typically there is a one- to two- month lag between a sales contract and a completed deal. The jump in pending home sales coincides with other positive trends in the residential real estate market.

For the first time in five years, home resales have risen for three months in a row, increasing almost 4 percent in June. Low prices, attractive mortgage rates and a first-time homebuyer's tax credit of up to $8,000 have kick-started sales. "Because housing is so affordable in today's market, job security and the first-time buyer tax credit are bigger factors in influencing home sales," said Lawrence Yun, the Realtors group's chief economist, in a statement. Also Tuesday, homebuilder D.R. Horton Inc. said its fiscal third-quarter losses shrank from the year-ago period, as it took smaller charges against the falling values of its land and unsold homes. Yun said he expects existing home sales to gradually rise over the balance of the year, with conditions varying around the country. Full Story

Under normal conditions, we would also be inclined to believe that the housing sector has put in a bottom. However, conditions are far from normal, and we would like nothing more than to see the housing sector put in a long term bottom as soon as possible. In life what one wants and what one gets are always different, and as such there are too many factors that suggest a sustainable bottom cannot take hold now.

  1. Some reasons behind the increase demand for homes
  2. First time home buyers are being offered a credit of 8,000 which is fully tax deductible on the purchase of their first home.
  3. Many individuals felt priced out of the market for the last few years and now that prices have fallen considerably they feel that they are getting a bargain.
  4. To add to the allure of buying a house, low interest rates are being promoted and when combined with the above factors it can make for a very convincing story.

Regardless of the rosy picture so many experts are now painting, the factors that provide the foundation for a strong economy and in turn a strong housing sector are not there:

Unemployment numbers continue to rise. In addition the number of individuals who have been looking for a job in excess of 6 months continues to rise.

Salaries are not increasing or keeping up with inflation (do not believe the fake numbers that are put out, all one has to do is look at the cost of many necessities to see that inflationary forces are alive).

Even the post office is now ready to take drastic measures to cut down expenses (possibly closing up to 1000 branches). Almost every state in the US is facing rather large budget deficits, IRS tax receipts are down and while many companies are not firing as many employees as they were a few months ago, they are not aggressively hiring either.

Thus it is hard to imagine how this sector can make a strong come back if the Job market is sour. People spend money when they make money, but if they are not making as much or not making any, then going out and making a large purchase such as home is not an option. Let's not forget that most banks have now placed restrictions on how new loans are approved; gone are the days when you could just walk in and all you had to say was "I want to buy a home" and then scratch your name on the contract and walk out with an approval. The trading desks of many large banks are now accounting for over 50% of their revenue; this illustrates that banks do not think the real estate sector is going to make a come back soon for they would rather risk playing the market than lend money to the consumer.

The one year housing index chart looks very bullish and if one looks just at this chart one would think that the good times are here to stay. From its low in March the index is up almost 100%, by any measure that is a stunning rally. It is now running into resistance and based on the current pattern it will most likely overcome this resistance after a few attempts.

The 3 year chart, however is very revealing and the rally does not look quite as impressive as it does in the 1 year chart. It is still trading a long way of its highs in the 250 plus ranges. We are not trying to throw cold water onto the scene and spoil the party. We would like nothing better than to join the party but cannot find any long term reasons to do so. The housing index could rally significantly higher from its current levels and the long term outlook would still remain bearish. If it manages to trade past 120 for 5 days In a row, the next target becomes 150; a weekly break past 150 and it could trade as high as 180 before resuming its long term downward trend.

The deficits are simply too high and the U.S. instead of putting the money, they print to good use (if there is such a thing as they don't really own the money in the 1st place), the government is instead spending money at an unsustainable rate. One does not rehabilitate a drunk by substituting cheap beer for expensive cognac; the only way to rehabilitate this chap is to cut his supply of booze and offer him treatment. The U.S. seems to think that the answer to our debt problems is taking on more debt.

Let's assume for some strange reason (one that we have missed or cannot locate) the real estate market actually recovers and starts a new long term up trend. The massive amount of money the Fed is creating is going to result in foreigners demanding significantly higher rates for the risks they are taking in purchasing US debt. The national deficit is at a stunning 11.68 trillion and rising. The year is not even over, and we have already added 1.4 trillion dollars to it, next year, we are going to add a minimum of another 1.2 trillion dollars and that's assuming things don't get worse. These figures do not include unfunded liabilities such as Social security, which is set to run out of money by 2029. The debt has continued to increase at an average rate of 3.96 billion dollars every single day since Sept 2007; the keyword is average for clearly we are running well above average this year.

Initial projections now are for the deficit to increase by an additional 9.3 trillion in 10 years; at the rate we are going, it's going to occur at a much faster pace. Soon annual deficits will account for 4% of the overall economy; a figure that history has proven to be unsustainable. In less than 10 years the total deficit will most likely exceed 82% of the overall economy and from there it there would be very little time left before the US crumbles. The big question going forward is how are we going to be able to pay the interest on this deficit, plus all the other unfunded programs that need capital, the biggest of which is Social security without going bankrupt?

Since 1969 Congress has spent more money than its income and people wonder why the average Americans spends more than he makes; the leaders are saying its okay to do so. Now for the kicker, the interest paid on the national debt is the third largest expense in the Federal budget. Defence is still the number one but one wonders how long it will hold this position. In 2006 interest payments totalled 405 billion, for 2007, they came in at 429 billion, for 2008 the figure was 451 billion and as of June 2009, total interest payment are 320 billion dollars. In comparison the budget at NASA is 14 billion, the education budget is 61 billion and Dept of transportation has a budget of 56 billion only. It makes one wonder what the government is thinking. One would think that congress would start spending less but as each year passes, they spend more. We are soon going to arrive at a point where the interest payment alone will exceed 1 trillion dollars; many nations' economies do not even account for half of this amount, and yet they remain solvent. The US with the world's largest economy cannot live within its means. Given the current rate at which the US is printing money, the unthinkable might just become a reality. The U.S might be pushed into bankruptcy. History is a wonderful subject, it provides a clear guideline of not only what was done but will occur again. History always repeats itself.

The U.S. has two options, declare bankruptcy, or start to implement massive budget cuts and raises taxes; there are no other options. The cuts will have to be huge for they will wait until the end to implement them; every administration wants to look good and simply passes the buck to the next administration.

We do not know how the things will unfold exactly, but any person with simple common sense understands that something will have to give otherwise the whole system will fall apart. The debt is now 11.68 trillion, in a few years it will hit 15 trillion, and in less than 10 years it could be well over 19 trillion. Overseas investors are already questioning the logic of investing in a nation that has no regard for its currency whatsoever; how long will they continue to buy this debt when interest rates are so low? They are going to start screaming for higher rates and as the US creates more money, they will demand even higher rates and so a vicious cycle will unfold. Rates could eventually hit the 20-25 percent mark.

This is why we find it very hard to believe that the real estate sector has put in a long term bottom, for the top players are doing everything in their power to debase the US currency. Real Estate does not perform well in a high interest rate environment.


The housing sector and the financial sectors are the back bones of this country's economy and if both are still in trouble, it becomes very hard to make a good argument for a long term bounce in the real estate sector. This does not mean that the real estate sector cannot experience a pretty strong bounce in the short term time frames, but it does mean that this bounce is not sustainable.

The interest payments on our national debt are staggering and anyone with a bit of common sense can see that this trend is not sustainable. The government bickers when it has provide extra funding to local programs but they have no problems almost spending close to half a trillion dollars annually on the interest that is due on our national debt.

The world at large has entered into the phase of extremes; the situation is either very good or very bad. Look when the markets were crashing early this year they crashed hard, when they started to rally, they mounted an incredibly strong rally. There is no in between stage; the same trend is pushed to the limit until it is completely unsustainable and the correction or the move upwards is usually extremely explosive. These movements are reflective of the world we will live in today.

Fed funds rate is trading at multi decade lows; this market has been in a bear market for almost 27 years. This is a very very long time and thus once a new trend starts, one can expect it to last for a very long time; it's just a matter of time before this market experiences a trend change as it is now trading at a very extreme point. Extreme conditions never last forever. From a long term perspective, one has to start preparing for a high interest rate environment.

The bond market has rallied towards super bubble proportions, and it is therefore, destined to mount an equally strong correction. A foretaste of what lies in store was seen this Jan when the bond market mounted a very strong correction. From its high to its recent low in the middle of June the bond market experienced a 20% correction. This is a very large move considering that it took place in just a span of 6 months.

Interest rates will probably test their lows once more and bonds, on the other hand will test their highs one more time before putting in a multi year top formation. Interest rates are at historic lows, and as such they cannot stay at these levels forever, especially when the Fed is printing new money at a mind boggling rate.

Additional negative developments

Consumers cut down debt levels by a whopping 21.6 billion in July; this amounts to annual decline of 10%. Economists were expecting credit to drop by 4 billion. For an economy that only expands when more debt is taken on (76% of our GDP is based on consumer spending) the long term growth prospects appear to be rather dim.

The story below also highlights how this economic down turn is affecting the entire world. Under normal conditions such a massive drop in real estate prices coupled with a weak dollar would attract droves of overseas investors but instead the opposite has occurred.

Interest in U.S. real estate by international buyers declined due to the worldwide recession and severe credit crunch, according to the 2009 National Association of Realtors® Profile of International Home Buying Activity.

The share of Realtor® clientele who are foreign buyers is smaller than in previous years, but among those purchasing nearly half paid all cash - bypassing the mortgage process. Twenty-three percent of survey respondents served at least one international client in the 12-month period between the end of May 2008 and the end of May 2009, down from 26 percent in the 2008 study. During this period an estimated 154,000 homes were sold to foreign nationals, which is down from approximately 170,000 international transactions during the previous 12 months. Full Story

Finally, a very funny thing occurred in Zimbabwe before hyperinflation struck that nation. Individuals started to purchase treasuries driving yields (interest rates) lower and then out of no where they were hit with inflationary forces which later morphed into hyperinflation. Is not the exact same thing taking place in the United States? From Nov to Dec 08, individuals poured money into the bond market even though their rate of return when adjusted when adjusted for inflation was zero at best and negative at worst. History sadly always repeats itself. In 1980 one Zimbabwe dollar was roughly equivalent to one US dollar; today it takes almost 6 trillion Zimbabwe dollars to buy 1 USD.

No market can remain in a bullish or a bearish phase forever; at some point, the trend will change. Investors who are still holding onto adjustable rate mortgages or who have fixed rate mortgages that were obtained at much higher rates should re finance and lock in these low rates now. If you can sell for a profit or break even, then your best bet would be to get out now as prices are destined to fall much more in the years to come.

Use Strong pull backs in the Gold, Silver and Palladium markets to add to your bullion positions. Individuals willing to take on a bit more risk can purchase a basket of stocks connected to the commodity's sector; use strong pull backs to open up new positions or add to your current ones.

"One pound of learning requires ten pounds of common sense to apply it." ~ Persian Proverbs, Sayings of Persian Origin



Sol Palha

Author: Sol Palha

Sol Palha

Sol Palha is a market analyst and educator who uses Mass Psychology, Technical Analysis and Esoteric Cycles to keep you on the right side of the market. He and his partners are on the web at

The information contained herein is deemed reliable but no guarantee is made about its completeness or accuracy. The reader accepts this information on the condition that errors or omissions shall not be made the basis for any claim, demand or cause for action. Any statements non-factual in nature constitute only current opinions, which are subject to change. The author/publisher may or may not have a position in the securities and/or options relating thereto, & may make purchases and/or sales of these securities relating thereto from time to time in the open market or otherwise. Neither the information, nor opinions expressed, shall be construed as a solicitation to buy or sell any stock, futures or options contract mentioned herein. The author/publisher of this letter is not a qualified financial advisor & is not acting as such in this publication. Investors are urged to obtain the advice of a qualified financial & investment advisor before entering any financial transaction.

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