The Rude Awakening
Laguna Beach, California
Friday, February 16, 2006 ------------------------- - Wealth sinks while stock soar,
- The shaky foundation of housing,
- Debt - not just another evil four-letter word, and more…
------------------------- Eric Fry, reporting from Laguna Beach, California… "Hey, you're gonna love this," a friend remarked recently, "I was looking at Yahoo Finance this morning and I read a headline that said, 'Consumer Spending Powers Dow to Record.' Then right below this headline was another one that said, 'Negative Savings Rate Not So Worrisome.' "So if I understand this correctly," the friend continued, "the stock market is soaring to record highs because consumers are spending money they don't have." "Sounds about right," your editor replied sarcastically. "But there's really nothing new there. American consumers always spend money they don't have; and the stock market always goes up. So what is there to worry about?" "Maybe nothing," the friend reluctantly agreed. "But I'm ust astounded that the eroding financial condition of American households is of so little importance to the stock market." "Get used to it," your editor replied. "The over-indebted American consumer never fails to devise new ways to borrow and spend…So investors have learned to trust that the American consumer never WILL fail to devise ways of borrowing and spending. That grim day will arrive eventually, of course. But who knows when?" "Maybe it's arriving as we speak," the friend suggested. "The falling housing market might deal a deathblow to consumer spending." "That thought has crossed my mind," your editor smiled. Indeed, as faithful Rude Awakening readers will recall, that thought has crossed your editor's mind on numerous occasions. It is crossing his mind again right now. If you'd care to examine any of the prior Rude Awakening columns about the parlous condition of the American consumer check them out here: 11-29-06 The Short View 11-15-06 The Moon Also Rises
8-22-06 The Housing Bust Begins
For a few fresh thoughts on the topic, read on…
--- Urgent Buyout Profit Alert ---
Beat Big Pharma to 3,000% gains on this shocking breakthrough. A small, under-the-radar drug company has brought America's most dreaded disease to its knees. Gains of 30-60 times your money or MORE are all but certain if you're holding shares when Big Pharma buys it out -- and that could happen any day now! Click Here to Learn More: ---------------------------- The Debt that House Built
By Eric J. Fry The American consumer is a modern-day miracle-worker. Possessing assets worth little more than two loaves of bread and five fish - along with a few lines of credit - he manages to feed an $11 trillion economy. The bread and fish do not multiply, of course, but the lines of credit multiply without limit, which means the U.S. economy never misses a meal. But what if, one day, lines of credit failed to multiply? And what if home-equity lines of credit, in particular, disappeared like Egyptian soldiers under the Red Sea? How would the U.S. economy fare? The answer seems rather obvious: Bad things would happen. And yet, nothing bad ever seems to happen to the debt-powered American economy. No financial plagues ever sweep across the land. Therefore, the American economy's recent history of miraculously tranquil, stress-free growth inspires many an economist to predict more of the same. We hope they're right…But we doubt they are. The nearby chart tells the grim tale…or at least most of the tale. Investment in residential construction - also know as homebuilding - is plummeting, as is the growth of personal spending. A careful examination of the chart reveals that the residential construction trend tends to lead the personal spending trend. Thus, since investment in residential construction is plummeting, we should expect a corresponding drop in personal spending, and in overall economic activity. 
Since 1948, observes Chris Puplava of financialsense.com, "whenever residential fixed investment falls to or below a -10% year-over-year rate of change, we have seen a recession, with only two exceptions: 1951 and 1967. Residential fixed investment is currently at a negative 12.6% year-over-year rate, marking only the eleventh time this has happened in more than five decades…"The "why" of this relationship between falling residential investment and recession is fairly intuitive: Item #1: Residential fixed income falls only during times when home prices are soft. Item #2: Home equity represents more than half of household net worth - and close to 75% of middle class household net worth. If, therefore, residential investment is falling, home prices must also be falling. And if home prices are falling, most Americans, especially middle class Americans are feeling poorer. (Falling home prices also eliminate the opportunity to obtain a "cash out" home mortgage.) If, therefore, Americans are feeling poorer, and cannot gain access to fresh lines of credit, will they not curtail discretionary spending…at least to some extent? "Private households in the United States embarked on their greatest borrowing binge of all time, fostered and facilitated by the rampant house price inflation and a most aggressive financial system," observes Dr. Kurt Richebacher, editor of the Richebacher Letter. "Over the five recovery years since the end of 2001, their overall indebtedness surged by 66%. This compares with a much slower debt increase in the prior recovery years from 1995-2000 by 43.9%." Household debt has been soaring, he explains, because home values have also been soaring, thereby enabling homeowners to "extract equity" from their homes. "Homeowners used the sharply rising market values to embark on their greatest borrowing-and-spending binge of all time," Richebacher explains, "thereby financing higher consumer spending through soaring equity withdrawals, even though personal savings are negative in the aggregate. "Therefore, what has been happening on the balance sheets of private households," he continues, "has been a race between booming 'wealth creation' through rising house prices and soaring indebtedness." So far, housing-driven wealth creation has been winning. The net worth of private households -comparing the aggregate rise in house values with the simultaneous rise in indebtedness - soared 40% between 2002-late 2006. But the housing-market hare is starting to lag behind the liabilities tortoise…which is why the vibrancy of the U.S. economy may be faltering before our eyes. "The growth rate of real U.S. GDP has been steadily falling," Richebacher notes, "from an annualized rate of 5.6% in the first quarter of 2006 to 2.6% in the second and further down to 2.0% in the third quarter." And most early economic indications from 2007 imply that the new year may not be a happy one. Overall industrial production decreased 0.5 percent in January, while output in the manufacturing sector dropped 0.7 percent. "All major market groups recorded decreases in January," the Federal
Reserve announced yesterday, "[while] the factory operating rate, at 79.6 percent, was the lowest manufacturing utilization rate since October 2005." The housing slump may not deserve all the blame for America's weakening economy…just most of the blame."Housing and its importance as a major contributing factor in GDP…has turned from a tailwind into a headwind, as residential fixed investment has contracted," observes Chris Puplava of financialsence.com. The slump in housing deepened during the final three months of last year with sales falling in 40 out of 50 states. Not surprisingly, therefore, housing-related employment is tumbling from coast to coast. "Loan officers, mortgage agents, real estate employees, development executives and construction workers are among the array of people who have lost jobs in the East Bay or are wondering when the ax might fall," Northern California's Contra Costa Times reports. "And directly or indirectly, those job losses are tied to a drastic slump in the sales, construction and financing of new homes…Now, a slowdown has arrived and relief has yet to arrive on the horizon." "It's a whole new world," one mortgage lender told the Times. "We're hunkered down for a cold winter. We're not sure when spring will arrive." The chill of winter has also descended upon the retail sector. Retail trade employment recently turned negative. Clearly, the coincident declines in both real estate employment and retail employment imply a commensurate decline in overall economic activity. "Housing played a considerable role in the recent economic expansion," Puplava concludes, "as homeowners borrowed against their increasing real estate assets and withdrew equity to finance their spending needs and wants. This practice however ended quite clearly in the third quarter of 2005 with mortgage equity withdrawal (MEW) cresting at $1.02 trillion dollars; that's quite the ATM! 
Since peaking, MEW has fallen to $730 billion in the third quarter of 2006, still a sizable number, though it's the rate of change that is important…As MEW is seeing a negative rate of change, it is contributing negatively to consumer spending. This can be seen above with the change in retail sales contracting almost in lock-step fashion with MEW. Both have been trending closely since 2000 though not prior to this point, illustrating housing's dominant role in the economic expansion since the last recession… "But even if consumers completely stop borrowing more debt," Puplava warns, "their financial obligations are likely to continue climbing ever higher as their net worth decreases due to falling home prices and their debt burdens rise from ARMs resetting at higher interest rates." Woe to the American consumer…and to America's consumer-driven economy. Joel's Note: To the casual observer it may seem likely that a minor correction is due in the financial markets. After all, this borrowing can't go on forever, can it? Dr. Richebacher, however, is not what you might call a "casual observer." His intense, life-long scrutiny of the markets led him to call the plummeting of the Greenback, the collapse of the housing market and the implosion of
personal savings long before people had fully entrenched themselves in debt. If you tend to err on the side of caution, or imagine something slightly more than a minor correction ahead, you might like to check out Dr. Richebacher's newsletter here: The Richebacher Letter
--- The Best Two Investments Of 2007 ---
"The Only Two Investment Strategies I'll Follow This Year…" The world's most respected market analyst just revealed the two best investments for 2007… and the ONLY two money moves he intends to make over the next 12 months… He almost never shares his personal strategy. But right now and for as long as he'll let me, I'm going to GIVE away both these strategies… Plus a full year of membership in his sought-after market analysis service… and a chance to join the ranks of the world's most elite investors… absolutely FREE, just as soon as you're ready. Click Here For The Full Report
| 
