Sunday, May 14, 2006

The next bursting bubble

The next bubble is about to burst. No, it's not the housing bubble, though it's directly related to it. In my opinion, it's the consumer confidence bubble. And it will start as early as this coming fall or summer.

Personal savings has maintained a persistent streak in the negative, which boggles my mind. I thought that Congress was the only group of people so broadly and reliably irresponsible with money. Apparently though people have been borrowing against the equity on their house, or indirectly using their growth in house equity to offset debts accumulated in other areas or to justify spending money instead of saving for retirement.

Given that consumers power 2/3 of the American economy, there are several indicators that the stock market will feel the pinch from declined consumerism:

  • As housing valuations stagnate and speculators dump unwanted properties on the market, homes will become increasingly difficult to sell at the price that people feel they are entitled to. A feedback loop will fuel this downward spiral, though perhaps not as dramatically as the tech burst.
  • However consumers are already showing signs of lacking confidence in the economy. Producer prices are still high, driving inflation and causing increasing interest rate hikes from the Fed.
  • Demand for Gold is up, often an indicator of cautious investors hedging against inflation.
  • And despite inflation, we are seeing very little improvement in wages or job growth, leading to a situation known as stagflation: stagnation in growth with broadly increasing prices. This has a profound impact on consumerism. And the biggest contributor to rising prices is the cost of oil, which will only get worse during the busy summer travel season, setting us up for a major pinch if this coming winter is less mild than the last.
  • Increasing interest rates usually cause yields on all bonds to rise due to a better rate of return, however we have seen the yields on short-term bonds rising faster than long-term, causing the yield curve to flatten. [Edit:] Since prices on bonds move in the opposite direction as the yields produced, it's important to note that curve has flattened due to high demand for long-term bonds, leading to lower yields on those bonds. (Thanks to reader Detroit Dan for that clarification!)
  • Demand for long-term bonds has been high due to the high interest rates, but once the Fed is done raising interest rates and demand spikes for long-term bonds, the yield will drop further and an inverted yield curve could occur, a frequent indicator of an impending recession caused by widespread pessimism in the health of the economy.
  • Given that the PPI is still high (and increasing with the cost of oil), the only thing that may cause the Fed to stop raising interest rates is a weakened economy, where stagnation is worse than inflation and the Fed can only attempt to fix one. This again reinforces my belief that the yield curve will invert, and that a recession will occur due to widespread pessimism.
  • Carrying this trend further, increasing interest rates are going to hammer home owners that have ARMs. Combined with the inability to sell houses, consumers are going to have to start watching their spending more carefully.
  • Furthermore, the market often softens in the second year of the second term of a president, as the "honeymoon phase" wears off and investors are less hopeful about the prospects of seeing any of the red meat thrown their way as promised the campaigning period. This time should be no exception, as this president has become one of the earliest lame ducks in recent history. The GOP, despite its majority, is increasingly seen as ineffectual. Case in point: Whither privatization of social security?
  • Finally, we are almost 4 years into a Bull market, albeit a weak one. But even weak bulls are usually followed by bear markets, and we're about due for one.
So I believe we're heading straight into a recession, and I've been moving my money accordingly. Let me know if my thinking is awry, I'm new to all this.


Anonymous said...

I believe it was humorist L.M. Boyd who used to punctuate his newspaper column's occasional items on money and investment with the admonishment, "Shut up and eat yer Alpo, Pa. It don't concern you none."

I have no idea if your perceptions are valid, but I'm ever so pleased that you have money to move in response to what you think you see. And now, I'll shut up. It don't concern me.

Texas Hippie said...

And eachur Alpo!

Anonymous said...

You have too much thinky-think in yo blog. All I gotta say is Snoop Double-Dizzle in the LBC with a 9 fendin' to pull a 187, G.

Texas Hippie said...

Looks like my prediction of rising inflation may have been premature or incorrect:

I'll keep my eye on these reports, though I'm betting the market will be really jittery if the Fed does insert a pause in its rate hikes without significant assurance that the pause is based on real monetary policy and not simply a "wait and see" measure.

Texas Hippie said...

Okay, here's the real link.

Anonymous said...

Like inflation I, too, suffer from premature rising

Texas Hippie said...

Heh :)

BTW this CNN article does a better job of making many of the points I was trying to. Thanks for the link, Calculated Risk.

Detroit Dan said...

Texas Hippie, I came over from Calculated Risk, seeing the link you posted there. I like your blog.

You may want to revisit the following:

Since prices on bonds move in the opposite direction as the yields produced, it's important to note that the thing keeping long-term yields high enough to maintain a flat yield curve has been weak demand (and therefore low prices).
Demand for long-term bonds has been weak due to speculation that the Fed is not yet done raising interest rates (and people want to lock in the best rate), so to offset the low demand investors expect a higher yield. Once the Fed is done raising interest rates and demand spikes for long-term bonds, the yield will drop and an inverted yield curve could occur, a frequent indicator of an impending recession caused by widespread pessimism in the health of the economy.

Actually, the demand for long term bonds has been higher than normal. Long term interest rates have stayed low because of high demand. If demand for bonds were low, then lenders would have to offer higher interest rates. Thus we have a flat yield curve.

If the Chinese and Saudis were to stop buying our bonds, which they purchase to recycle their dollars (and keep their currencies undervalued), then long term rates would rise as there would be less demand for bonds. Less demand for bonds => higher interest rates to attract buyers => steeper yield curve. If the value of the dollar is falling, then higher interest rates will be needed to compensate for the loss in value of the dollar vis a vis other currencies...

Texas Hippie said...

Thanks, Detroit Dan, bonds are definitely an area I'm still trying to understand and I get caustion reversed some times. I'll post an update on the front so I don't confuse my vast audience of readers who rely on me for their advice on retirement planning, politics, and poo humor! But truly, thanks for the info and I'll make the correction, to the post and my thinking.

Nikki said...

Hey TX hippie,
Thanks for the kind words over at CR--and the CPI release sure did make you right today!! :)

Texas Hippie said...

Thanks Nikki! I had doubted myself after the PPI report, but the CPI seems to be a more direct indicator of inflation. Things aren't looking so good, unfortunately.