The Words ‘Strong’ and ‘Economy’ Don’t Seem to Quite Fit In

The last few months has seen no-end of theories about what shape the economic recovery and stock market recovery will take.

Will it be ‘V’, ‘W’, ‘L’, ’square-root’ shaped?

Your editor has no idea. What we do know is that things aren’t as rosy as the mainstream media and analysts make it out to be.

Some of the contrary statistics we’ve seen in recent days and weeks make it hard to believe that the economy is heading in a permanently positive direction. In the near term it may give that impression, just as for a while a block of ice will remain intact under a burning sun.

It doesn’t last for long though, and it soon melts away.

Consumer spending up. House prices up. House building down. Job vacancies down. Unemployment up.

We don’t pretend to have all the answers, but the words ’strong’ and ‘economy’ don’t seem to quite fit in.

But out of those things it is the house prices that cause us the most concern. According to RP Data:

“It’s important to note that it has taken just 15 months for values to recover from the February ‘08 peak. I believe these results are encouraging, especially when we take a closer look at other Western markets around the world where prices are mostly in decline,”

Got that? House prices peaked in February 2008, then fell by around 6%, and have now reclaimed that record high, as noted in Monday’s The Age newspaper:

“A five-month surge in Melbourne house prices has undone the damage to the property market wrought by the global financial crisis, pushing the median house price to $469,357 and the median unit price to $377,077 – both record highs.”

Hmmm. We’re nervous, but not surprised. The massive handouts given to first home buyers was always going to prop prices up. As we expected. And of course, we’ve banked on a short term rally evidenced by our tipping of a real estate investment trust in Australian Small Cap Investigator a few months back.

So far, house price action is panning out as we thought it would. We’re now in the rally phase that pushing prices up before the fall.

In fact in the spirit of ‘alphabetonomics,’ we’d say the housing market is forming for an M-Shaped housing crash…

The above chart from ANZ doesn’t include the latest RP Data numbers so it doesn’t show the house prices up to a record high.

Could we be wrong? Could house prices continue to rise on their never-ending advance northward?

Of course anything’s possible. But one thing is inevitable, no asset can possibly increase in value for ever without an appropriate decline at some point. A 6% drop in fifteen months is during a period of low interest rates and government bribes is not a crash.

It’s just postponed the inevitable.

I mean, take a look at the chart above. Even if you’d bought a house with a $100,000 mortgage back in 2005 on a $110,000 house (this is just to illustrate the point by the way), your costs and interest payments would still be more than the 25% appreciation in the house value.

You’d be lucky if you’re breakeven.

Now think about the first home buyers that didn’t buy at $100,000 in 2005, they’ve bought at $125,000 during the last twelve months. They need another 25% increase in house prices in the next four years just to breakeven.

So, is it realistic to see a 25% housing gain in the next four to five years? Maybe, but not from the current prices.

The odds are still in favour of prices sinking back to 2000 levels once the artificial stimulus has been removed from the economy, and interest rates are 2-3 percentage points higher than they are now.

Some Advice from ‘Dr.’ Merv

Oprah has Dr. Phil. Money Morning has ‘Dr.’ Merv.

Following on from yesterday’s Money Morning and our struggle with the ‘Output Gap,’ your editor received the following free counseling:

“This is your problem.

You are trying to make sense of insanity.

When something is quite irrational there is nothing to understand beyond the fact that it is nuts.

Because a mind in good order has difficulty facing insanity, it fights to make sense of it. It is so foreign to its normal state.

Insanity is very hard to face. As one tries to face it, it has the effect of making one feel they are nuts too because that’s what they are looking at and trying to duplicate.

The solution to this kind of situation, once having recognised it for what it is, and that is that it is nutty, is to do no more than label it for what it is, i.e. crazy. Once you do that you can be relaxed about the whole thing and more on to more useful activities. It is no more that a trap put out by the perpetrator to suck in and confuse the unsuspecting. Just an apparency to make one think they have missed something or there is something there they don’t understand.

Don’t get sucked in.

Merv”

With that your editor was calmed and we shall make no further attempt to interpret the “insanity” of the Output Gap.

Other Stuff on the Markets

The S&P/ASX200 fell 2.05% yesterday, while there was better news overnight on Wall Street with the Dow Jones Industrial Average adding 57 points. In Europe the FTSE100 gained 2.15% and the CAC40 added 2.44%.

The price of gold in Australian dollars is trading at $1,164.61, while in US Dollars it trading at $941.70.

The Aussie dollar remained steady versus the US dollar and Japanese Yen, trading at USD$0.8092, and JPY78.12.

Crude oil closed at USD$69.31.

For the biggest movers on the market yesterday click here…