Housing and the US Economic Outlook

Ok, the US housing market still looks like it is bouncing along the bottom, but does this mean that US consumption spending will remain weak? I suspect the picture is mixed and consumer spending growth will remain weak as a consequence. However, real estate is less important to the US then in, say the UK. Moreover, quantitative easing and economic growth has caused other US Household Assets to rise. There is more to the US economy than housing!


Firstly, this week saw yet more weak data on existing home sales from the National Association of Realtors. You can read the report linked here of which the key conclusion is that the inventory of existing homes is 3.72m. This number is higher than the inventory in 2008 and current existing home sales levels are implying that the months supply of homes is at 9.3 months when the long term average is closer to 6-7months.


Secondly, according to Corelogic report on shadow inventory which is linked here...

In addition to the current shadow inventory supply, there are nearly 2 million current negative equity loans that are more than 50 percent “upside down” that will likely become shadow supply in the near future

...and this implies even more pressure on the housing market.


Real Estate not as Important to US Net Household Wealth Anymore


However, the picture is not so bleak for US consumption growth. I decided to take a look at the portion of net US Household Wealth that is being taken up by real estate...

Real Estate % of Net Worth	1986	1987	1988	1989	1990
	36.8%	37.3%	37.3%	36.9%	37.1%
	1991	1992	1993	1994	1995
	35.0%	34.6%	33.7%	33.9%	31.7%
	1996	1997	1998	1999	2000
	31.0%	29.2%	28.7%	27.7%	31.5%
	2001	2002	2003	2004	2005
	34.9%	39.2%	37.9%	39.0%	40.7%
	2006	2007	2008	2009	2010
	39.0%	36.3%	38.2%	34.8%	32.3%
	Q1 2011
	31.2%

...and it is not hard to see that the percentage of US Household Net Worth held in Real Estate has declined in recent years from the peak in 2005. What is also noticeable is that the ratio declines noticeably in the 1990's and, I suspect, this is largely to do with strong economic growth coupled with rising stock market evaluations. Following the 'dot-com' recession, interest rates were reduced significantly leading to the switch into the next asset class boom.

However, the overall key to economic growth is Net Household Worth and this...

Net Worth (bns)	1986	1987	1988	1989	1990
	15,836	16,902	18,452	20,184	20,516
	1991	1992	1993	1994	1995
	22,076	23,039	24,403	25,193	27,889
	1996	1997	1998	1999	2000
	29,947	33,538	37,483	42,543	42,688
	2001	2002	2003	2004	2005
	42,477	41,232	47,139	52,622	58,936
	2006	2007	2008	2009	2010
	64,147	64,169	51,370	54,084	57,114
	Q1 2011
	58,058

...is still growing. Although, note that it is still below the levels set in 2005!

All of which, leads me to believe that there will be no 'double-dip' but that the growth outlook leaks to be moderate, at best. There is more to the US Economy than housing.

Free Capital Book Review

Free Capital

How 12 Private Investors Made Millions in the Stock Market

Wouldn't life be better if you were free of the daily grind - the conventional job and boss - and instead succeeded or failed purely on the merits of your own investment choices? My new book Free Capital: How 12 Private Investors Made Millions in the Stock Market offers an insight into this life.

Based on a series of interviews, the book profiles 12 highly successful private investors.  How did these people originally get interested in investment? How did the interest progress to the point where they were able to give up their day job? How do they spend their time now?

Around one-third of the interviewees are ex-City professionals; one-third are other degree-educated professionals; and one-third left school at or before 18.  Most gave up all employed work in their 30s or 40s to become full-time investors.

Geographers, surveyors, activists and eclectics

The book presents the investors in four groups.

Geographers have a top-down focus, starting from the overall investment landscape, and focusing first on broad trends and macroeconomic conditions. 

Surveyors have a bottom-up focus, starting from the individual elements of the landscape, focusing first on the idiosyncrasies of particular companies.

Activists seek to influence company managers’ decisions in line with their own views – by dialogue and persuasion, by using the votes on their shares, and if necessary by publicity.  Most investors seek to avoid companies where management changes are required, that is they do not go looking for trouble. The activists are investors who do go looking for trouble.

Eclectics are a residual category. One eclectic is a day trader who trades partly on short-term news flow, and partly on technical analysis.  Another is a fundamental investor who draws on both top-down and bottom-up analysis. 

[could divide into a part II post here, if you want shorter posts. Alternatively, you could remove one or more sections]

How do we know these investors are any good?

Six of the investors are ‘ISA millionaires’ who have accumulated over £1m in PEPs and ISAs. Four of these – including Financial Times ‘My Portfolio’ columnist John Lee – had reached the £1m milestone by 2003 or earlier, and another two in 2005 and 2006.  Given the inability to borrow, and low contribution limits in PEPs and ISAs, these results are arithmetically impossible without exceptional investment returns.

For some of the investors, the regulatory requirement to declare publicly any major shareholdings above 3% of a quoted company gives further evidence of their substantial wealth. For example the Swedish micro-cap investor Peter Gyllenhammar – profiled in chapter 10 of the book – is named in many major shareholding announcements every year.

Characteristics of the free capitalists

The final chapter of the book identifies similarities and differences between the 12 investors’ stories. Some of the similarities are as follows.

Future time perspective Time perspective is a psychological concept which describes how an individual parcels consciousness into a past, present and future, and how much attention they give to each. The investors have a future time perspective. Their habitual focus on the future is not a duty or a chore – they seem to prefer perceiving the world through this perspective.

It is unsurprising that investors should focus mainly on the future when thinking about investments. But it was more interesting to see signs that they had had this perspective from a young age, well before they ever thought about investing.  Individuals with a present time perspective – those who focus more on living for the moment – may tend to spend rather than save any increase in income, and so never get started as investors.

No overnight success Most interviewees initially spent several years following the typical pattern of a novice investor – neither making any real money, nor losing enough to put them out the game.  This pattern did not seem to be inconsistent with eventual success as an investor.

Mainly smaller companies Most interviewees invest mainly in smaller companies. They rarely hold shares in the FTSE350 index. In other words, they ignore the top 90% of the stock market by market capitalisation.

Low appetite for leverage Most of the investors use little leverage or debt of any kind in their investments. Some had spread bet accounts, but this appeared to be motivated mainly by tax considerations rather than a desire for leverage.

Money for freedom, not for spending The interviewees appear to live modest lifestyles relative to their accumulated wealth. Investment for them represents first and foremost a source of quiet freedom, rather than a source of ostentatious spending power.

Not team players The investors all work alone.  They make their own decisions, and they appear to be little influenced by any form of group affiliation.

A craft, not a science The investors use relatively simple analysis and heuristics.  None relies on modern portfolio theory as understood in the academic world (“like learning Physics to play snooker” said one interviewee), or on any other sophisticated quantitative analysis. This is despite the fact that several do have strong quantitative or business school backgrounds.

Guy Thomas

The contents and first chapter of Free Capital are available FREE here. 
The book is available (usually priced around £10) as a paperback or e-book from Amazon, the publishers Harriman House and many other booksellers.
All author royalties will go to charity.

Recent Weakness a Mid Cycle Slowdown?

According to the media we are seeing hard evidence of a global slowdown. Now, Global equity markets have been weak so I’m wonderingly out loud whether this is another case of the media fitting the ‘facts’ to the story? Are we seeing the beginnings of a global slowdown or is this a typical mid cycle moderation in growth?

From my perspective, I’m market neutral, so the most important thing to me is to identify the outperforming trends and themes rather than making an overriding decision about markets direction.  Nevertheless, a key aspect of this is taking a view on where the global macro economy is going.

I suspect that the answer to the question in the first paragraph is that this is a mid-cycle moderation with some special circumstances.

Firstly, the short term data on employment indicates that the current situation remains positive. You can access the American Staffing Association data here and it is indicating ongoing employment gains.

Secondly, the Association of American Railroads is reporting steady weekly rail traffic here

So, no collapse just yet.

Thirdly, I suspect that the tightening attempts within emerging markets seem to have caused a moderation in inflation with commodities...

This should be good news for lower income consumers who have been feeling the pinch recently. Indeed, this recovery has been characterised by the weakness in discretionary spending power of the lower income groups. We can see all of this in the latest US retailer’s monthly sales figures. The high end companies like Nordstrom, Saks, Coach and Macy’s reported good numbers whilst the lower end companies like Costco or Limited Brands gave disappointing numbers.

However, given moderating commodity prices and increased employment gains it is highly likely that some of the stocks set to outperform expectations will come in the kind of beaten up lower end discretionary space in the US. In addition, this increased spending power should encourage some spending which will create growth longer term.

So, in summary this looks like a mid-cycle moderation which creates opportunities for stock pickers exposed to the right sectors. Global manufacturing has had a great growth run but this is largely due to the base effect caused by severe capacity cutbacks in the recession. Investment in Machinery and Equipment (IME) fell off a cliff in the recession but has come back strongly in the recovery. I suspect know it is time for the growth leaders to shift to more mass consumer discretionary names.

Indeed, the latets JP Morgan Global Manufacturing and Services Report found here  says a similar thing, albeit wth some expected slowdown in manufacturing due to Japan.