Guest post - US Equities' Long Term Real Returns

"The three great essentials to achieve anything worth while are: Hard work, Stick-to-itiveness, and Common sense." - Thomas A. Edison 

Courtesy of our good friends at Rcube Global Macro Research, please find enclosed their recent note focusing on US Equities' Long Term Real Returns. Enjoy!

Our research generally focuses on tactical investment horizons (3‐6 months). In this paper, however, we consider long‐term real returns for US equities, for which we have reliable data since 1871.

Nota bene:

By real returns, we mean total returns (i.e. dividend included) divided by the CPI. We chose to analyze the US market as it has longest and most accurate historical data. Our data originates from Shiller’s website: http://www.econ.yale.edu/~shiller/data.htm. Earlier data exists (as early as 1802), but is plagued with survivorship bias.

When we look at price alone (as many observers do), we see no evidence of a long term trend. Rather, we have two distinct 70‐year periods: pre‐WW2: +1.0% annual  price appreciation; and post‐WW2: +7.4% annual price appreciation.

However, as we know, price appreciation is insufficient to quantify returns, especially when we consider long investment periods.

Indeed, a rational long‐term investor should look at (and hope to maximize) real total returns, which take into account dividends and inflation.

When we look at the S and P 500’s real total return, the picture looks very different:

Taking into account dividends and inflation, we can admire the remarkable stationarity of S and P 500’s real returns around a long‐term trend (6.5% per year). Even the 1929 crash and the 1970s’ stagflation represent small deviations from the overall trend. 

A long‐term trend of around 6.5% essentially means that an equity investor’s purchasing power doubles every 11 years, which is in itself the strongest argument for permabulls and buy‐and‐hold proponents. 

That being said, many believe that the 6.5% real return – which is also known as “Siegel’s Constant” – is a historical freak and is unlikely to continue further. 

In a controversial Investment Outlook published last August, Bill Gross compared this 6.5% long‐term real return to long‐term real GDP growth (around 3.5%), and concluded that the stock market was a “Ponzi scheme”, with stockholders having been "skimming 3% off the top each and every year, at the expense of lenders, laborers and the government”. In a comment that reminisced Business Week’s famous 1979 cover, the “Bond King” then proclaimed that the “cult of equity was dying”. 

It appears to us that this analysis is flawed (and indeed, it was immediately rebutted by Dr. Jeremy Siegel, as well as other academics). Although it is true that the market value of equities cannot grow above GDP forever, Bill Gross seems to have ignored the fact that around half of stock returns originate from distribution to shareholders, in the form of dividends and share buybacks. 

There is therefore nothing wrong in the fact that equity real returns are higher than real GDP growth. Even in a zero‐growth economy, companies would still have earnings that can be used to distribute dividends or buy back shares, which would lead to higher than zero real returns for equities.

We’ll return later to the question of the link between equity real returns and economic growth.

Regardless of the sustainability of 6.5% real returns in the future, nobody would dispute that it is hardly a“constant”, especially for short‐term horizons.

If we define 10 years as the lower range of what constitutes a long‐term investment horizon, the standard deviation of forward returns is still fairly wide (around 5.2%). This highlights the need to look for methods of predicting 10‐year forward returns.

One such method, introduced by Robert Shiller in his 2000 book Irrational Exuberance, involves using cyclically adjusted P/E ratios (CAPEs) to predict 10‐year forward returns. CAPEs are P/E ratios that use past 10‐year average earnings in order to smooth out cycles.

The S and P 500’s CAPE is currently around 21, which is substantially higher than its long‐term average (16.5). 

Although bearish observers use these figures as a sign of overvaluation, it is worth noting that 10‐year forward real returns would be around 4.4% according to the above regression equation.

In any case, the CAPE regression only explains around 25% of 10‐year forward returns. Moreover, this analysis is performed in‐sample, whereas an investor operating in real time during the sample period would not have access to the whole dataset.

If we remain in an in‐sample framework, we can obtain R2s that are much better than 25%.

First we can note that corporate profits as a proportion of GDP are one of the most mean‐reverting time series in economics. 

Nota bene:
Although total corporate profits and S and P 500 profits are not the same thing, their growth rate is rather similar over long time periods (3.23% per year for total corporate profits vs. 3.17% for S and P 500 profits between 1947 and 2008):

Low profits as a proportion of GDP lead to business failures, reduced competition, and therefore higher margins further down the road (and vice versa).

From this point of view, buying when earnings are high and selling when earnings are low (as suggested by PE‐based methods) does not seem such a great idea.

Rather than taking the 10‐year earnings average as the denominator, we could therefore use real GDP.

Incidentally, the total market cap / GDP ratio (which is a related concept) is Buffet’s favourite macro measure of value for stocks.

This time, we find a long‐term trend of around 3% for the ratio (i.e. the same 3% that stockholders

supposedly “skim off” at the expense of others, according to Bill Gross).

Although the S and P 500 real return / real GDP ratio looks rather trend‐stationary, it has had rather wild swings around the trend, which indicate potentially interesting opportunities to trade in and out of the market.

Indeed, we obtain a rather nice R2 of 57% when we regress the detrended ratio against 10‐year forward real returns.

Currently, we’re close to fair value, as the overshoot from the 90s (Greenspan’s “irrational exuberance”) finally seems to have been digested. This does not preclude another “undershoot”, such as the one we had in 2008, as investors revise their economic growth assumptions downwards, especially in deleveraging developed economies.

Nota bene:
Although there seems to be a long‐term elasticity of one between equity real returns and realized economic growth, changes in long‐term growth expectations and/or risk premia can have a huge impact on valuations. If we simply look at the Gordon‐Shapiro model and assume a denominator (expected rate of return – expected growth) of around 5%, a 1% decrease in long‐term expected growth decreases the value of equities by 20%. We believe that this explains much of equities’ “excess volatility puzzle”.

Again, this is an in‐sample analysis (just like the CAPE model). Although we still get an R2 of around 40% if we use a running regression instead of a fixed in‐sample regression (and use the first 40 years of the sample as a “learning period”), no one can assert that 3% long‐term returns above real GDP growth are an intangible law of nature.

To conclude, assuming long‐term forward equity real returns to be around 3% plus foreseeable economic growth provides us with a ballpark figure. It avoids making blatantly wrong assumptions about long‐term equity real returns (such as believing that they can be around 10%, like many investors still do).

Additionally, it is important to note that this brief study concerns only the United States, a country that won two world wars and avoided socialist experiments during the last century. It would be interesting to calculate the trend of the real equity return / real GDP ratio for other countries. Unfortunately, reliable data on long‐term real returns is hard to obtain for most countries, as they generally originate in the early 1970s (e.g. MSCI Indices).

We will however try to gather more data on this vast subject, as well as publish additional short studies about long‐term returns of other asset classes.

"Common sense is the most fairly distributed thing in the world, for each one thinks he is so well-endowed with it that even those who are hardest to satisfy in all other matters are not in the habit of desiring more of it than they already have." - Rene Descartes, French philosopher. 

Stay tuned!

Fool me once, shame on you; fool me twice, shame on me...

My thoughts are with all the Japanese people following the ongoing tragedy.
"神さまが守るように"
"kami sama ga mamoru youni"
"May God protect you."

"Japan is a very rich country and has a high savings rate and has the capacity to deal not just with the humanitarian challenge but also the reconstruction challenge they face ahead."

US Treasury Secretary Tim Geithner
Tuesday 15th of March 2011.

Geithner does not believe that there is a risk Japan could sell their US Treasuries to raise cash in order to respond to the damages caused by both the earthquake and the tsunami.

And the reason why according to US Treasury Secretary is that "Japan has a high savings rate":

Japanese getting older = Bad for savings Tim...

Yeah right Tim! Spot on!
This is purely and simply incorrect to stay polite. Get your facts right...I am not surprised to hear this from the man who was in charged of regulating the US banks while at the New-York Federal Reserve Bank from 2003 until 2009.

Are we witnessing at this very moment the demise of the US dollar?

Japan might be finally calling another bluff from the US by dumping in size their US Treasuries to rebuild their economy.

I previously wrote about the Bluff Call of 1971 - the Nixon shock and the collapse of the Gold Standard.

Is it payback time for Japan following the disaster of the 1985 Plaza agreements? (please refer to the post: Analyze this!).
As a reminder from my previous post, another former quote from Tim Geithner:

"On June 1, 2009, during a question-and-answer session following a speech at Peking University, Geithner was asked by a student whether Chinese investments in U.S. Treasury debt were safe. His reply that they were "very safe" drew laughter from the audience."

China is not stupid. I wrote specifically on the fact that China is well aware of what happened to Japan with the Plaza Agreements of 1985: The end of the American Dream, the call for trade barriers and the rise in populism....

Please find enclosed the link to the Chinese view on what happened to Japan following Plaza in 1985:

Revaluation of Japanese Yen, a historical lesson to draw: analysis

Maybe Japan has no choice but to cash in on its holdings to rebuild its country and repatriate Japanese Yens. At least this is what the FX market is betting on, given this evening huge price action and surge in JPY versus the USD from around 80 to an amazing 76 JPY for one USD to now back to 79...Crazy...

Japan selling their US Treasuries would be driving up interest rates.

Prior to the dramatic events happening in Japan, Bill Gross, from PIMCO, the authority on bonds, announced to the world he had dumped all his US Treasuries from his flagship fund: “Yields may have to go higher, maybe even much higher to attract buying interest,”
Yes, Bill Gross expects a sharp increase in interest rates within the next few months. If Japan starts dumping some of its US Treasuries holdings (around 885.9 billions USD as of January 2011), you can be assured Bill's expectations could materialise. China cut its holdings of US treasury bonds by 5.4 billion USD to 1.15 trillion USD in January, reported sina.com.cn, citing the U.S. Department of Treasury.

During the 1995 Kobe earthquake, the Japanese repatriated 30 billion USD worth of U.S. government bonds, equivalent to about 13 per cent of its Treasury holdings at the time.

This time is different?

Dumb and Dumber - QE2 and the risks linked to global rising Yields in 2011

The discussion around the debt ceiling could trigger a sell-off as high as 100bps in US Treasuries, like in 1996. You want to track the TBT ETF in 2011 as a caution (please see below).

Zerohedge goes into the detail of what could happen if we have a 1996 replay in relation to the debt ceiling discussions.

http://www.zerohedge.com/article/can-sovereign-debt-crisis-happen-here-case-study-1995-debt-ceiling-precipitated-government-s
"It is difficult to disentangle the full effect of the 1995-96 debt-ceiling crisis on bond yields since Fed expectations were also changing rapidly during that time. If there is any conclusion to be made, it is the market generally shrugged off the government shutdowns and instead focused on macro developments.

The government reached the debt ceiling in November, and Treasuries generally rallied over the next three months even as the situation in Washington continued to deteriorate. That said, the Fed was also easing monetary policy during this period, having lowered rates by 50bp to 5.25% between December 1995 and January 1996. Nonetheless, reviewing press reports from this period suggests that the market seemed to ignore the debate over the debt ceiling in the early stages, having assumed that politicians would never allow the US to go into default and that a resolution would be brought about quickly. The biggest move occurred in the final days of 1995 when the market was generally optimistic that a resolution would be achieved.

At the start of the New Year, the market realized that negotiations were falling apart with Treasury Secretary Rubin warning sending the 10-year yield 8bp higher. Around mid-February markets began to react negatively to any news related to the budget stand-off; that is until late March when the ceiling was lifted. Treasury yields increased about 80bps in less than a month during this period."

http://www.themarketfinancial.com/marc-faber-on-2011-barron%E2%80%99s-roundtable-why-everyone-will-be-a-billionaire-soon/122361

Marc Faber on 2011 Barron’s Roundtable: Why Everyone Will Be a Billionaire Soon:
Marc Faber and Bill Gross from Pimco had an interesting conversation relating to the state of the US economy and the risks.

Here what Bill Gross had to say:
"I don’t know if the U.S. has reached a desperate point, but it is employing instruments and vehicles and policies that smack of desperation. We are not looking at a default here, but at years of accelerating inflation, which basically robs investors and labor of their real wages and earnings. We are looking at a currency that almost certainly will depreciate relative to other, stronger currencies in developing countries that have lower levels of debt and higher growth potential. And, on the short end of the yield curve, we are looking at creditors receiving negative real interest rates for a long, long time. That, in effect, is a default. Ultimately creditors and investors are at the behest of a central bank and policymakers that will rob them of their money."

This a point Felix Zulauf made:

"There are two worlds—the industrialized world and the emerging world. The industrialized world continues to live in a fiction: that it can afford its current lifestyle by going further and further into debt. At some point, the bond markets will riot against that."

For the entire Barrons January 2011 Roundtable:
http://online.barrons.com/article/SB50001424052970204555504576075983972474462.html

Given current risks on a sell-off on US treasuries, it is important to track the following ETF as mentioned previously, namely the TBT: ProShares UltraShort 20+ Year Trea (ETF) (Public, NYSE:TBT):

ProShares UltraShort Lehman 20+ Year Treasury, seeks daily investment results that correspond to twice (200%) the inverse (opposite) of the daily performance of the Barclays Capital 20+ Year U.S. Treasury Bond Index (the Index).

TBT is already up 9.49% in 3 months and 16.63% in just 3 months. Year to date so far: 5.64% up.

That's the result of a rise in inflation expectations in my book...

Rising global yields is a key issue for 2011.

The excellent Doug Noland in his latest Credit Market Bulletin share the same views:
http://www.atimes.com/atimes/Global_Economy/MA19Dj01.html

"The possibility for a surprising jump in Treasury bond yields is a major 2011 issue. On the one hand, Treasury is not interest-rate sensitive; the marketplace doesn't have to fear much of an issuance impact from a moderate rise in borrowing costs. On the other hand, this dynamic would imply that yields are poised to surprise on the upside when the markets eventually force borrowing restraint. It doesn't take a wild imagination to envisage a market problem leading to an economic problem, to additional "TARP" (the Trooubled Asset Relief Program bailout) more rescues and a jump in borrowing costs - all combining for a dramatic deterioration in our nation's debt position.

That borrowing restraint is being imposed upon US municipal finance is a major 2011 issue. The year has commenced with municipal bond yields adding to Q4's surprising jump. Today, state and local finance is our credit system's weak link."

Doug goes on:

"Here in the US, policymaking has turned simple: run massive deficits, keep rates at zero, and have the Fed monetize debt until the private sector can be trusted to do the heavy lifting. Well, don't hold your breath. So, for Issues 2011, we can assume the Fed stands pat on rates. And while they have little credibility, both congress and the Fed are talking tough against bailing out troubled states across the country. Whether they can stick to this rhetoric is an Issue 2011. The dollar continues to benefit from the capacity of policymakers to inflate credit, a dynamic that will compound our dilemma when the markets turn their sights on disciplining Washington.

I'll posit that each year of massive government marketable debt issuance reduces the likelihood that central bankers will be able to exit their market liquidity backstop operations. History has shown how systems become precariously addicted to inflationary measures and market interventions. The Fed's balance sheet will only move in one direction. And when push comes to shove, they may be forced to buy municipal debt or monetize more Treasuries to help finance bailouts.

For now, the most important issue of 2011 is that serious structural deficiencies ensure that the Federal Reserve errs on the side of liquidity creation. This would seem to ensure a year of even greater monetary disorder, with the risk of heightened instability throughout global fixed-income, currency, commodities and equities markets."

Dumb and Dumber...

The Hurt Locker

Definition: noun. a period of immense, inescapable physical or emotional pain.



The Hurt Locker and the problem of the liquidity trap.

Paul Krugman's definition of the liquidity trap, the Keynesian view:

[a] liquidity trap may be defined as a situation in which conventional monetary policies have become impotent, because nominal interest rates are at or near zero: injecting monetary base into the economy has no effect, because base and bonds are viewed by the private sector as perfect substitutes. By this definition, a liquidity trap could occur in a flexible price, full-employment economy; and although any reasonable model of the United States in the 1930s or Japan in the 1990s must invoke some form of price stickiness, one can think of the unemployment and output slump that occurs under such circumstances as what happens when an economy is trying to have deflation — a deflationary tendency that monetary expansion is powerless to prevent.[29]


Excellent comment this week by R. Glenn Hubbard, dean of the Columbia Business School and former Chairman of the Council of Economic Advisers under President George W. Bush, and Peter Navarro, a professor of economics at the Merage School of Business at the University of California-Irvine:

http://blogs.reuters.com/great-debate/2010/09/10/desperate-times-do-not-always-call-for-desperate-measures/

"The fundamental flaw in Washington’s stimulus logic is the incorrect assumption that America’s current economic woes began with the 2007 recession. In fact, the roots of our slow-growth problem date back at least a full decade.

From 1946 to 1999, GDP grew annually at 3.2 percent, but since then, we’ve only averaged about 2.5%. On a cumulative basis, this seemingly small difference adds up to about 10 million jobs we failed to create.

What these statistics add up to is not a short term cyclical downturn, but rather longer-term trouble driven by four major structural imbalances in America’s GDP “growth driver equation.”


Overconsumption:

From 1946 to 1999, consumption averaged 64 percent of GDP but over the last decade, that share jumped to 70 percent. This increase was fueled not by rising wages, but rather by a housing bubble and a mortgage refinancing wave that turned American homes into ATM machines. This overconsumption has been mirrored in a low saving rate and a second major structural imbalance – underinvestment.

Underinvestment:

Business investment in research and development, technological innovation, and the new productive capacity required for the job creation process has been the single most important missing ingredient in our economic recovery – and for renewed long-term prosperity. Yet the current administration seeks only to raise the regulatory and tax burdens of business.

Chronic trade deficits:

These have been equally destructive. During the 2000s, our current account deficit more than doubled and likely reduced our annual GDP growth rate by a half a percent or more.

Excessive government spending:

This spending has provided some short-term stimulus. However, an overfed Uncle Sam represents the ultimate seed of destruction through upward pressure on taxes and interest rates and a stark future of sharp cuts in defense, education, and infrastructure spending."

"Over the long — and short — term, in implementing any stimulus, we should favor tax cuts to stimulate business investment as the best way to stimulate job creation. Reducing the fiscal burden of entitlement programs is also essential to restoring prosperity."

Federal Government Debt: Total Public Debt



In relation to the raging inflation/deflation debate, Bill Gross at PIMCO has decided to put a wager on it. A 8.1 billion USD wager...quite meaningful (notional value of derivatives position tied to the Consumer Price Index).
They bought inflation floors in size...

"Inflation floors, structured as options on the consumer price index for all urban consumers, are similar to insurance. The buyer of the contract pays a premium at the outset in return for the right to receive a payment after 10 years should the CPI decline during this period."

The bet is that the USA will not be like Japan and are not on a verge of entering a similar lost decade as Japan did.

As I previously discussed in relation to the heated deflation/inflation debate, we are going through a deleveraging period, which meant deflation in some asset prices (real estate, etc.) but inflation in other items, such as food items (up 16% since 2009). In a previous post I argued you could have both deflation and inflation at the same time as currency values are being debased. The latest new record of Gold is of no suprise and the trend is up and up, given we can expect a second round of QE in November in the US.

The rise in food prices are strong inflationary forces at play which is probably creating a lot of headaches for the Bank of England given its inflation target of 2%. You can therefore expect the UK to rise interest rates sooner than expected which will coud increase the risk for a double-dip recession due to the current constraints in household balance sheets. I hope Mervyn King still has plenty of ink in his pen, as he will definitely have more letters to write to the chancellor in the coming months...


http://noir.bloomberg.com/apps/news?pid=20601087&sid=aqqEDrWMDO3w&pos=3

“We think the possibility that the U.S. goes 10 years with stagnant or falling prices is remote,” Mihir Worah, the head of Pimco’s real return portfolio management team, said in an e- mailed response to questions. “The options were priced at rich levels to the underlying” risk, added Worah, whose funds invest in Treasury inflation protected securities."

"Pimco Chief Executive Officer Mohamed El-Erian said last month the chance of deflation in the U.S. is around 25 percent."

Deflation then inflation is still the ongoing theme, which might lead us to Stagflation 70s style.

The latest inflation figure in the UK is of no surprise: August's consumer price inflation came in at 3.1 %. QE is working just fine...I kept saying the results of QE would be more inflation down the line, in April, in March...



http://www.telegraph.co.uk/finance/economics/8003750/UK-inflation-is-uncomfortably-high-says-Bank-of-England-rate-setter-David-Miles.html

"Inflation has been above the central bank's 2pc target since December 2009 although policymakers have argued that it is largely down to one-off factors and should subside over time."

Can the policymakers please specify the time frame? They won't...

High UK inflation no conspiracy:
By James Mackintosh

http://www.ft.com/cms/s/0/81dacaae-c038-11df-b77d-00144feab49a.html?ftcamp=rss



Jacques Rueff, a great French economist clearly saw the strategy behind Keynes General Theory of Employment which is currently being used in the UK with QE:

http://www.moneyweek.com/news-and-charts/economics/homage-to-jacques-rueff-88380.aspx

"Keynes came up with a subterfuge. The central bank should cause price inflation during a slump, he proposed. Rising prices for 'things' meant that salaries - in real terms - would go down. That was the greasy scam behind Keynes' General Theory of Employment, Interest and Money: inflation robbed the working class of their wages without them realizing it. The poor schmucks even thank the politicians for picking their pockets: "salary cuts without tears," Rueff called them."

Bill Bonner also adds in his hommage to Jacques Rueff the following:

"Rueff died in 1978. Had he lived, he probably would have been as surprised as we have been by the stamina of the monetary horses. Except for a brief rest while Paul Volcker was managing the stables, they have run from bubble to bubble... delivering more liquidity wherever it would do the most damage. All the while, inflation continued to cut the price of labour. Between 1974 and 1984, real wages fell as much as 30%. Then, more moderate levels of inflation held them down for the next 24 years.

But Rueff’s insight comes with a warning. The faith-based, dollar-dependent monetary system is like a loaded pistol in front of a depressed man. It is too easy for the US to end its financial troubles, Rueff pointed out, just by printing more dollars. Eventually, this “exorbitant privilege” will be “suicidal” for Western economies, he predicted."

Bill Bonner concludes:
"Paul Volcker put the pistol in the drawer. Ben Bernanke has found it. And Jacques Rueff must look on in amusement to see what happens next."

http://www.thedailybell.com/1114/Britain-to-See-Inflation-Risk.html

"Until the 1970s, classic Keynesian economists seem to have believed that it was impossible to have a stagnant economy along with an aggressive monetary stimulus program. In slumps, central banks should print money, and more money, to stimulate via government spending and bank lending. Of course, while such Keynesian solutions may not stimulate the economy much (not with real jobs anyway), they do lead to inflation, and then price inflation, especially in severe slumps. Hence, stagflation..."

http://www.marketoracle.co.uk/Article21501.html

"Krugman's monetary solution to a liquidity trap is sustained inflation, where the central bank reverses fears of future deflation by instead causing an increase in the price level through massive monetary pumping (Krugman estimates this to be in the area of $10 trillion, borrowing the figure from a prior study conducted by Goldman Sachs)."

Housing in the US is still in the hurt locker:

More pain to come unfortunately. There is a huge shadow inventory that needs to be worked through. Banks reposession runs unabated. Housing starts at rock bottom still.

http://www.cnbc.com/id/39175282

"RealtyTrac, an online foreclosure sale site, will release its monthly numbers on Thursday, but sources there confirm the number of repossessions will come in just shy of 100,000 for the month.
That is the highest since the site began tracking in 2005. July's repossession number was the second highest on record. The last highest was 93,777 in May of 2010."

U.S. Home Prices Face Three-Year Drop as Supply Gains:

http://noir.bloomberg.com/apps/news?pid=20601109&sid=aPjDFWbLAdd8&pos=10

“Whether it’s the sidelined, shadow or current inventory, the issue is there’s more supply than demand,” said Oliver Chang, a U.S. housing strategist with Morgan Stanley in San Francisco. “Once you reach a bottom, it will take three or four years for prices to begin to rise 1 or 2 percent a year.”

Gains Versus Inflation

"If the market doesn’t fall to its natural bottom, price gains in the next five to 10 years won’t keep pace with inflation as the difference is made up “on the backend,” said Barry Ritholtz, chief executive officer of FusionIQ, a New York research company. Price increases that fail to at least match inflation are the same as reductions in value, Ritholtz said."

"The Obama administration’s effort to help mortgage holders, the Home Affordable Modification Program, or HAMP, is another source of future inventory as owners with new loan terms re- default, Ritholtz said. About half of the modifications done in 2009 were behind in payments by the first quarter of 2010, according to the Treasury Department."

‘Day of Reckoning’

“The belief has been: if we stimulate sales with a tax credit and delay foreclosures with modifications, the market would stabilize,” said Ritholtz, author of “Bailout Nation.” “We’re just putting off the day of reckoning and drawing out the pain by not letting the housing market hit its bottom.”

Insanity: doing the same thing over and over again and expecting different results. Albert Einstein.

Just the facts on housing in the US:

"Owners of about 11 million homes, or 23 percent of households with a mortgage, owed more than their property was worth as of June 30, according to CoreLogic. Another 2.4 million borrowers had less than 5 percent equity in their houses and probably would lose money on a sale after paying broker fees and closing costs, CoreLogic said Aug 25."

Deep sea fishing: Housing starts still at rock bottom



From the excellent Calculated Risk blog:

http://www.calculatedriskblog.com/2010/09/two-key-housing-problems.html

"The excess supply is keeping pressure on residential investment, and therefore on employment and economic growth. As new households are formed, the excess supply will be absorbed - but this is happening very slowly."

"It takes jobs to create households, and usually housing is the key driver for employment growth in the early stages of a recovery. So this is a trap: the excess supply means weak employment growth, leading to few new households, so the excess supply is absorbed slowly - putting off more robust employment growth.







The excess supply is also pushing down house prices (prices are just starting to fall again). Lower prices will eventually help clear the market, however lower prices will push more homeowners into negative equity."

"Negative equity frequently leads to distressed sales (short sales or foreclosures), and losses for lenders."

It will take a long time to clear the mess in US housing. A long, painful process to clear the excesses of the housing bubble.

The importance of branding in economy in general and what it really means in particular

Branding Definition: "Entire process involved in creating a unique name and image for a product (good or service) in the consumers' mind, through advertising campaigns with a consistent theme. Branding aims to establish a significant and differentiated presence in the market that attracts and retains loyal customers."

Branding Definition in Economy as per this blog: "Entire process in creating a unique term for an economic policy or financial product in the consumers' mind, through consistent communication in the news." The best example to mind comes when you think about High Yield bonds, which should really be called Junk bonds, or more recently "Quantitative Easing" which should really be called printing money out of thin air...

Here is the link to Wikipedia about QE (Quantitative Easing):

http://en.wikipedia.org/wiki/Quantitative_easing

"Risks"
"Quantitative easing is seen as a risky strategy that could trigger higher inflation than desired or even hyperinflation if it is improperly used and too much money is created.

Some economists argue that there is less risk of such an outcome when a central bank employs quantitative easing strictly to ease credit markets (e.g. by buying commercial paper), whereas hyperinflation is more likely to be triggered when money is created for the purpose of buying up government debts (i.e. treasury securities) which in turn can create a political temptation for governments and legislatures to habitually spend more than their revenues without either raising taxes or risking default on financial obligations."

MV=PT as per Irving Fisher's equation. The Bank of England bought 200 Billions worth of long dated Gilts with QE. The BOE by pumping M (M4) is expecting T to rise and it is not really happening...
As a reminder: MV = PT. M is the stock of money in the economy,V is the velocity of circulation or the speed at which money flows around the economy. P is the price level and T the value of transactions, or gross domestic product (GDP). Hence by
increasing ‘M’, QE aims to increase ‘T’.

The main risk of QE was that the money pumped into the system would not result in higher
spending and economic activity. Banks are currently using all these additional funds to help repair balance sheets. Increased availability of credit is not resulting in more lending. Many companies and individuals do not want to increase borrowing during a period of economic uncertainty and this is the reason why savings are going up and people are trying to repay their debt.

Therefore the initial MV = PT equation means that a rise in ‘M’ leads in reality to a fall in ‘V’ leaving no net benefit.

As per my previous blog post in February, first we are seeing deflation then comes the big risk of hyperinflation which explains why so many famous hedge fund managers like Tudor, Soros, Paulson and others have fallen to the gold bug and have as well increased recently their holdings in Gold in size...

The results of QE will be an increase in inflation down the line.

This also bring us to the recent violent currency movements we have seen in the markets and particularly on GBP. The United Kingdom faces massive headwinds and with the risk of a hung parliament with the upcoming election, the prospect for GBP currency could not be bleaker. GBP will probably come under significant pressure and I can easily see GBP at parity with the Euro, not to mention that the coveted AAA of the UK is threatened.

Bill Gross from PIMCO in his latest market comment talks as well of the sovereign risks ahead of us:

http://europe.pimco.com/LeftNav/Featured+Market+Commentary/IO/2010/Investment+Outlook+March+2010+Bill+Gross+Dont+Care.htm

The importance of looking at the Macro picture has never been more important than today.

You should look at safe harbors such as Australia, Canada, and developing countries like China, India, etc.

I also agree with Bill Gross comments:

"An investor’s motto should be, “Don’t trust any government and verify before you invest”."