So the last shall be first, and the first last: for many be called, but few chosen.
(Matthew 20:16, King James Bible)
Age of Wisdom, Age of Foolishness has been playing with dates and historical comparisons to try and identify the next tipping point. The year 2013 has been compared with 1913[i]. When all else fails, it’s time for some divine inspiration; so the significance in the numerology of the tipping point reference 2016 will now be examined.
Recent incoming data from the housing market and positioning in the capital markets signals the coexistence of wisdom and foolishness. In the US Treasury Bond market, the banks are “wisely” cutting their direct exposure to this asset class; and replacing it with an indirect exposure by lending to the Treasury via the Fed Balance Sheet[ii]. This process was originally described in Terminal Velocity “Disintermediated”[iii], when the banks replaced their direct exposure to securitised debt with indirect exposure via the Fed. The latest round of risk reduction involves the benchmark US Treasury asset class; and is also combined with the move to raise the risk premium, charged to the Fed by the banks, for increasing the size and scale of “Fed systemic risk” associated with its expanded balance sheet. This was first observed in “Les Miserables”[iv].
CoreLogic’s latest house price data, for October, shows the twentieth month of increases; however there is growing ex post evidence of a deceleration[v].
Those who were last are now first…………
There was also evidence that the velocity in home prices is a statistical phenomenon, being driven by the behaviour of the volatile distressed sector[vi].
The distressed sector came off a low base; therefore its delta is much greater. Housing that is not distressed, has greater price inertia in both directions. As the distressed sector gets closer to its pre-crisis peak datum, the statistical phenomenon shows up as a deceleration. The statistical bias effect has thus been taken out of the picture; leaving pure economic fundamentals (supply and demand) as the driver. There is however an important technical factor in relation to supply, which must also be factored into the equation.
The rally in the distressed sector has been exaggerated by the behaviour of the banks, through the withholding of distressed inventory, in order to boost prices to levels at which they can exit via a normal foreclosure process. The report entitled “Celebrating Mediocrity”[vii] observed that the banks had now achieved their target exit price; and that inventory and foreclosures are rising as a consequence. The banks are therefore seeing the weakness emerging in this sector again. Constrained supply is now becoming abundant supply, as the banks try and clear the market with their inventory at a price level which is just shy of the pre-crisis peak.
A perfect symmetry was also observed by RealtyTrac in relation to the “high end” of the property market. In the “$5 million+” category, foreclosures have jumped 61% since 2012[viii]. It is interesting to observe that the geographical position of this sector directly overlays the position of the distressed sector which the banks are in the process of foreclosing on.
The coexistent “foolishness” was signaled by the latest data on asset class correlations.
Credit risk spreads confirm the perception that everything is back to where it was before the Credit Crunch. Investment Grade corporate bond spreads are now the narrowest that they have been since October 2007[ix]. If everything is allegedly back to normal, as the spreads and correlations imply, presumably the Fed has done its job; and can “Taper” with confidence. The behaviour of the “wise” banks suggests that they have had confidence that the “Taper” was imminent; but have less confidence that it will be executed without causing another crisis.
It seems much more likely that the Fed’s QE to date has caused the correlations and spreads to signal the all clear on “Wall Street”; which is not confirmed with the same performance on “Main Street”. Exactly how Janet Yellen intends to resolve the divergence between “Main Street” and “Wall Street”, whilst adhering to Bernanke’s precedents of transparency and guidance, is going to be one of the most interesting balancing acts going forward. How she performs will determine what happens in 2015, when the Fed allegedly exits QE; and therefore what happens in 2016. The market discounting mechanism, which creates the perceptions of 2016, must occur in the form of real-time daily price action between now and then unfortunately. Superimposed upon this timeline there is also the eternal Presidential Cycle which is converging in a partisan fight, for the rudder that controls the ship of state in 2016.
- End of the Cycle
- Citigroup to BofA Spurn Treasuries for Cash on Taper Risk
- Terminal Velocity (28) “Disintermediated”
- Les Miserables
- Home Price Gains Continue to Slow
- CoreLogic: House Prices up 12.5% Year-over-year in October
- Celebrating Mediocrity
- Foreclosures Skyrocketing for High-Priced Homes
- Taper Defied With Bond Spreads Least Since ’07: Credit Markets
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