The Second Housing Bubble Is Upon Us

The Wall Street Journal is taunting me... It stared back at me in big, bold letters... Record-setting U.S. home equity... The second housing bubble is upon us... A 'no bid' day in one corner of the mortgage industry... Inflation isn't what you think... The proper bear market strategy is about survival...

The Wall Street Journal is taunting me...

I (Dan Ferris) am not saying anyone at the financial publication has ever directed a syllable of their editorial at me. I'm just saying it sure feels like they're taunting me with a recent headline...

In recent Digests, I've pointed out more than once that housing is one of the two great sources of many Americans' wealth. The other, of course, is their investment portfolios.

When housing prices and the value of Americans' portfolios go up in value, folks feel wealthy and spend more. That stimulates the economy (at least the way it's measured nowadays). On the flip side, when both fall in value, folks spend less and the economy slows.

It's called the "wealth effect."

As I noted in last Friday's Digest, soaring home prices have made people feel very wealthy over the past two years. But at the same time, they've also made housing much less affordable.

That's concerning, especially since the stock market is also dealing a major blow to Americans' wealth right now. Falling home prices would be another big punch to the gut.

That brings me back to the Wall Street Journal's taunt...

I opened up my web browser and went to the newspaper's website on Wednesday morning.

On the left side, the top headline talked about the Federal Reserve's plan to bump up the benchmark interest rate by 75 basis points ("bps"). (And later that day, the central bank did that.) The next two headlines mentioned "stock-valuation worries" and falling retail sales.

And then, in the middle of the page, I saw it staring back at me in big, bold letters...

Let me spell that out... U.S. home equity just hit the highest level on record ($27.8 trillion).

It's as if the Wall Street Journal read all my recent essays, knew I would be visiting its website on Wednesday morning, and decided to hit me right in the face as I planned today's Digest.

Regular readers know that financial headlines are notorious for acting as contrarian indicators. So when the Wall Street Journal announces that one of the twin pillars of the wealth effect has reached an all-time high, it gives me that "look out below" feeling.

And with soaring home prices in the mix...

Comparing today to the era before the financial crisis is too irresistible...

Back then, in the wake of the dot-com crash, the Fed cut interest rates. That reduced the cost of owning a home. And the race was on...

Low rates, rising home prices, and Wall Street's growing passion for complex mortgage-backed securities ("MBS") created a perfect storm. It spurred banks to lend money to anyone who could fog a mirror. (And probably one or two who couldn't!)

Folks bought homes like never before. Home ownership soared to an all-time high of 69.2% of American households in late 2004.

It felt wonderful... until it led to the biggest financial crisis since the Great Depression.

Thanks to the COVID-19 pandemic in early 2020, the housing market came alive again...

Short-sighted politicians and corrupt public health officials with direct financial interests in the outcome abandoned every protocol learned about pandemics since the Spanish Flu of 1918 and shut down the global economy.

That devastating economic blow left the Fed with no option other than to cut interest rates to zero (or so its 400 PhD economists would certainly tell you). The federal government piled on and spent – borrowed and effectively created out of thin air – trillions of dollars.

And in turn, home prices soared farther and faster than they did at any previous time in recorded history. They even soared faster than during the housing bubble – excuse me, the first housing bubble.

Aren't you now convinced that we're living through a second housing bubble?

When asset prices go ballistic, they don't usually stop going ballistic by leveling off. They tend to stall out in midair... turn right around... and crash back to Earth.

Housing prices have never gone as ballistic as they are right now...

Look at the chart of the year-over-year changes in the monthly S&P CoreLogic Case-Shiller U.S. National Home Price Index since 1988. The latest reading is the highest level ever...

Just look at the sheer trajectory of U.S. home prices. (Yes, I already showed you that chart a week ago. And I probably will share it another 10 times or more in the months ahead.)

In other words, housing prices in the U.S. have never risen so much, so quickly. They've never gone this ballistic before. So what do you think will happen at some point?

As the chart shows, before this year, the biggest one-year change in U.S. home prices happened in September 2005 – not long before the housing bubble peak. That month, U.S. home prices rose about 14.5% over their September 2004 levels.

The latest reading shows that U.S. home prices rose about 20.6% year over year in March.

That's an all-time high. And as the Wall Street Journal spelled out to me loudly and clearly on Wednesday morning, that means home equity is also at a new high of $27.8 trillion.

Folks can borrow against that $27.8 trillion or receive it as cash if they sell their homes. It's real wealth that can be spent just like the money in your pocket – but it has yet to be spent.

During the first housing bubble, home equity peaked at $14.4 trillion in the fourth quarter of 2005 (and again, not long after home-price growth peaked). Then, in the financial crisis, home equity plummeted. It fell around 40% to $8.3 trillion by the first quarter of 2012.

A similar plunge from current levels of home equity would wipe out more than $11 trillion of real wealth. I promise you... If that happens, it would make a lot of Americans feel poorer than they did during the financial crisis.

Signs of stress are already cropping up behind the scenes in the housing market...

Last Friday, the U.S. Department of Labor's latest data showed a higher-than-expected reading on the Consumer Price Index ("CPI") in May. It increased 8.6% year over year – the largest change since December 1981. (That last part is starting to sound familiar, isn't it?)

And according to industry veteran Lou Barnes of Colorado-based lender Cherry Creek Mortgage, folks just don't understand how bad things are in the mortgage market...

Barnes said last Friday's CPI report led to one of the five most painful moments in his 44-year career. As he wrote on his company's website...

Mortgages are covered poorly in the financial press... Today's events still unfolding will take days for good coverage...

The CPI news this morning was so awful that it changed the bond market's view of Fed trajectory, and the weakest sector broke. In bond jargon, MBS went "no-bid." No buyers for MBS. Then a few posted prices beyond borrower demand, not wanting to buy except at penalty prices. Overnight the retail consequence has been a leap from roughly 5.50% to 6.00% for low-fee 30-fixed loans.

"No bid" means exactly what it sounds like... The CPI inflation report was so scary and so unexpected that investors and traders refused to bid on MBS. As Barnes added in his note...

In today's U.S., nobody is prepared to deal with inflation as it has developed in the last 90 days.

The other four painful moments Barnes referred to in his note occurred in 1979, 1994, 2007, and 2008.

In October 1979, the Fed went into full-on inflation-fighting mode. Mortgage rates were 11% on the Friday before Columbus Day and jumped to 13% the following Tuesday, when the markets reopened after the holiday.

If 1994 sounds familiar, that's because you probably heard 1,000 times on Wednesday that the Fed's 75-bps interest-rate hike was the largest since then. Rates were rising as the country emerged from a recession.

In July 2007, subprime and jumbo mortgages failed to attract any bidders – just like MBS did last week. All mortgages were no-bid by July 2008, including government-backed ones.

The government-backed U.S. 30-year mortgage is widely viewed as one of the safest securities in the world. And yet, nobody would even bid on one in July 2008.

That's fear with a capital "F"... And it happened again in the MBS market last week.

That's what it looks like when liquidity evaporates.

We tend to take our modern, large, deep, liquid markets for granted. We always assume we'll find a seller for everything we want to buy and a buyer for everything we want to sell.

Then, one day, buyers essentially go on strike.

The same thing can happen in the stock and bond markets. Any asset can crash. We've seen that recently. But the fact that crashes are rare makes us more vulnerable to them.

Before I go on, I must acknowledge...

When the financial crisis hit in 2008, two aspects of today's housing market weren't relevant...

The first one is inflation.

It's possible that persistent inflation will keep home prices elevated for many years.

The Case-Shiller home-price data that I shared earlier only goes back to 1988. But we can also look at decade-by-decade average home-value data from the U.S. Census Bureau...

The data show that average home prices in the U.S. rose from $17,000 in 1970 to $47,200 in 1980. That represented compound annual growth of 10.8%, compared with average monthly CPI readings throughout the decade of 7.7%.

In other words, home prices didn't merely track inflation. They beat it.

The Fed's home-equity data from 1969 to 1982 show four recessions (the shaded areas in the chart below). Total household equity in real estate only fell significantly one of those times – during the brutal bear market in 1973 and 1974. Take a look...

This chart suggests that inflation can keep home prices rising – and perhaps even at a greater rate than inflation – over the course of several years. And that can happen even as consumers are bludgeoned with higher costs of living, like they were in the 1970s.

Now, let's move on to a second important aspect that wasn't a factor in the first housing bubble...

A new player joined the game – and it's now the market's biggest buyer...

I'm talking about institutions and businesses that buy homes as investments.

They're a bigger force in the home market than ever before. And they've become a much bigger force since the financial crisis...

These investors bought fewer than 20,000 homes per year every quarter from the first quarter of 2008 to the first quarter of 2012. That's around the time U.S. home prices bottomed.

Investor interest climbed from there. And it finally returned to the 2005 high of more than 50,000 homes per quarter in 2017.

Low rates and a slow market during the pandemic brought investors more aggressively back into the market than ever before...

According to a new report from real estate company Redfin, institutions and businesses bought a record 93,260 homes in the third quarter of 2021. They followed that up with 87,910 purchases in the fourth quarter of 2021 and 77,829 in the first quarter of this year.

The most recent number is about 17% below the record high for this metric. But it still made its own record... It represented 20% of all the homes sold in that quarter.

Individuals and institutions are both buying fewer homes this year. But individuals have been hit harder, which is allowing institutions to garner a record share of home purchases.

Both groups are buying fewer homes this year for the same reason – higher home prices and interest rates make it more expensive. Investors tend to make more cash offers than the folks who will live in the houses they buy, but they still often fund offers with debt.

My point is... investors respond to higher prices and rates the same way individual households do – their buying as a group slows down.

My idea about the tendency for ballistic price charts to crash might apply here, too...

The ballistic rise in investor home purchases of 2021 is already 17% off its record high.

I believe it's more likely to drop off quickly, like most ballistic movements, rather than gradually. And it could wind up bottoming out well below where it was just prior to liftoff.

The whole situation feels way too bubbly.

And as we discussed above, the stress of high, totally unanticipated inflation has already generated one of the five most panic-ridden days of the past 43 years in the mortgage market.

Are we really supposed to believe that's the end of the trouble in the housing market – and not the beginning of the trouble? The Mortgage Bankers Association reported last week that mortgage applications were down 16% year over year. And the industry group said refinance applications fell 76% over the same period. That's serious damage.

Many investors keep believing in "peak inflation" and that everything will be just peachy now. And I continue to believe that's simply absurd.

I'm more worried and more bearish than I was a year ago, a month ago, and heck, even a week ago.

At some point, further declines will make the end of the bear market more likely. But for now, every decline pulls another leg of support from under the most expensive market in history. And that makes more declines likely from here.

Perhaps my single biggest worry for investors today is that too many of them don't understand what inflation really is – and why it tends to be so persistent when it shows up...

Inflation isn't what you think it is...

It looks like an increase in the price of "things." So right away, when it appears, we hear excuses...

At first, inflation was a "transitory" effect of all the stimulus that governments and central banks used to counteract the insane massive global economic lockdowns.

Then, it had the same cause – but it was no longer transitory.

Then, it was made worse by Russian President Vladimir Putin's invasion of Ukraine. Economic illiterates like Senator Elizabeth Warren of Massachusetts would have us believe that it's caused – or at least exacerbated – by greedy grocers, meat packers, and oil companies.

It's all nonsense.

Inflation is one thing – and one thing only. This definition is true in all times and places. And it isn't higher prices for goods and services. Higher prices are the result of inflation.

In actuality, inflation is a decline in the value of money. It is "always and everywhere a monetary phenomenon," as economist Milton Friedman famously put it.

Reducing the value of money is one of the biggest tricks governments try to pull off...

It's one of their most often used techniques throughout recorded history to try to deliver on undeliverable promises they make as they seek to gain greater power over you.

And importantly, it has never worked out well. So watching it play out today just makes everyone who won't acknowledge it look like an idiot or a liar (or both, in the case of most of the political class).

It's easy to see why inflation tends to hang around longer than anybody anticipates...

Governments are in the business of maintaining and expanding the reach of their monopoly. They don't have any incentive to do what's really best for their people – which is to get out of their way and leave them alone.

So governments won't really do anything about inflation.

The central banks that do take inflation seriously will raise interest rates until millions of people are suffering under a deeper-than-expected recession. If you don't believe me, consider the horrendous one that then-Fed Chair Paul Volcker caused in the early 1980s when he sent interest rates into orbit.

Pundits often say the stock market looks forward. But maybe a new crystal ball is needed...

The market clearly didn't expect what the CPI report showed last Friday.

That's why the MBS market went "no bid" a week ago. And then, on Monday, the stock market capped off one of the worst three-day sell-offs in history...

Everything fell that day. Everything. Investors went on a mad scramble to raise cash as every major asset's price got crushed. (My colleague Corey McLaughlin covered it well.)

Until a week ago, almost nobody was talking about a 75-bps rate hike from the Fed. And then, when it happened on Wednesday, the stock market went haywire.

Stock prices gesticulated wildly as Fed Chair Jerome Powell delivered the news. Then, stocks cratered hard yesterday... The S&P 500 Index fell more than 3%. The tech-heavy Nasdaq Composite Index dropped 4%. And the small-cap-focused Russell 2000 Index plunged as much as 5.2% during the day before finishing down about 4.7%.

And as I explained earlier, the Wall Street Journal taunted me as everything unfolded...

Wednesday's headline about record home equity of $27.8 trillion made me think all over again about how awful it would be if a big chunk of all that wealth suddenly got wiped out.

No matter what you and I think we know about the future, we know nothing. But all the returns for the investments we're holding today will eventually arrive in that unknowable future.

That truth – brought to light again by this week's events – is why I always urge you to...

Prepare, don't predict.

I've counseled holding plenty of cash too many times to count.

Sure, cash suffers from inflation. But as I've said before, the proper bear market strategy is about survival. And having a lot of cash on hand is the essence of survival at the end of a bear market. It's how you recover from those dark days when the sun shines again.

But unfortunately, I fear that day is a year – or more – into our future.

Doc's 'Playoff Beard' Is Still Going

In the April 14 Digest, we told you about our colleague Dr. David "Doc" Eifrig's streak of 100-plus winning trades in Retirement Trader. It's nearing a new franchise record.

And as part of the charge to a new record, Doc isn't cutting his "playoff beard" until the streak ends. Two months later, we can report that Doc's beard is still growing...

Today, Doc closed a pair of winning trades. That extended his win streak to 118 in a row and helped him inch closer to his all-time-high streak of 136. Even better, the trades captured annualized gains of around 20%. That's great when you consider that the S&P 500 is down 9% over the span of these trades.

Once again, Doc continues to show how his options strategy in Retirement Trader can give subscribers more downside protection than regular buy-and-hold strategies. Plus, you can collect "instant" cash with this strategy as well.

If you're interested in learning more, watch Doc's latest presentation. In it, he shares exactly how the strategy works... and why it's great to use in today's fear-filled market.

New 52-week highs (as of 6/16/22): None.

Before we get to the mailbag, we need to pass along a couple of housekeeping notes...

First, the markets and our offices will be closed on Monday for the Juneteenth federal holiday. Following this weekend's Masters Series, we'll pick things back up on Tuesday – with some special guest content...

That's because Digest editor Corey McLaughlin is taking a few well-deserved days off next week. On Tuesday, you'll hear from our international editor Kim Iskyan. We'll share a pair of guest essays from our editors on Wednesday and Thursday before closing out the week with our regular Friday Digest from yours truly.

In today's mailbag, you'll see additional commentary from a subscriber about the Federal Reserve. Plus, we need to note a mix-up that we made in yesterday's Digest. What's on your mind? As always, e-mail us at feedback@stansberryresearch.com.

"The 3.5% Fed rate [the central bank's projected benchmark lending rate target for the end of the year] can only affect peoples' borrowing/spending. It can't directly affect supply-chain matters or the until-just-now seller's market in hiring. It will take a lot to get the economy back on track." – Paid-up subscriber Randy B.

"The author messed up [below] the chart showing only 17% of the NYSE stocks were trading ABOVE their 200-DMAs... He says below the graph that the stocks [were] trading BELOW their 200-DMA in two different sentences. He means ABOVE, not BELOW." – Paid-up subscriber Chris N.

Corey McLaughlin comment: Thanks for bringing this point up, Chris. As you've noted, the chart was correct. And those two spots in the essay just below the chart were wrong.

As of yesterday, only 17% of New York Stock Exchange ("NYSE") stocks were trading above their 200-day moving averages ("200-DMAs"). And as of today, it's actually worse (or better, if you're waiting to "back up the truck" to buy stocks at the bottom)... Following yesterday's sell-off and as of this morning's open, the number of NYSE-listed stocks trading above their 200-DMAs has dropped to roughly 15%.

I hope that you and the majority of readers still got the meaning of yesterday's Digest despite the mix-up. It sounds like you did, since you still knew what I meant. The point is...

We're near a bottom, but we're not there yet.

"Hello Corey, a very good column tonight. Simplification is refreshing in the market, and the advance/decline line is a well-known, but still overlooked indicator, in terms of its importance.

"One comment: I think you meant to say that 'the number of stocks trading ABOVE (not below) their 200-day moving average was 17%. I realize I'm probably not the first reader to mention this, but just in case!

"That was a great statistic on the three-day routs leading to a positive market 86% of the time. It will be interesting to see if another down leg develops after a possible relief rally in the coming days. I think so, but the market will probably try to trick as many people as possible." – Paid-up subscriber Kevin L.

McLaughlin comment: Yes, thanks to you as well for the note about the mix-up, Kevin. And for the record... we've corrected the online version of yesterday's Digest right here.

Good investing,

Dan Ferris
Eagle Point, Oregon
June 17, 2022