The first quarter of 2010 is drawing to a close. We made some good calls.
Our article at the end of January turned out to be right. At the time, S&P was at 1070 or so. Since then, it has climbed to around 1170, a 100 points advance, just shy of 10%.
That set our tone for the quarter. Developments in manufacturing, export and retail subsequently reinforced our view that the global economic recovery was firming. For the upside, equities, especially small caps, are the place to be.
Better yet, this is also the time to invest in early cyclicals such as home builders. We did some analyses backed by fundamental research on this sector. In particular, our call on Standard Pacific in several articles turned out to be very profitable. We invested in the stock this year at $3-3.8 range. Along the way, we traded a bit, selling above $5 and buy back in more at below 4.5. It has been quite interesting. Lennar has performed fine too.
We've trimmed some bank stocks. Sold all JPM shares and some WFC shares. New regulations may not be friendly to shareholders. But these large banks should do just fine.
We've been moving into retail stocks. Recently, we picked up SCSS at below $7. It's now at $8. But this is a very volatile stock. It could continue to swing widely.
Energy sector surprised us. It did not perform as well as expected. It could surprise the other way in the next quarter.
REIT sector surprised us on the upside. It's likely not over yet. So we don't think we should short the sector in general.
For the quarter, our fund is up 15% versus S&P's 5%. That's nice. We look forward to the Spring quarter.
Wednesday, March 31, 2010
Monday, March 29, 2010
Retail and Banking: Beginning of a Positive Feedback Loop
(This article has been published on Seeking Alpha: http://seekingalpha.com/article/196282-a-positive-feedback-loop-in-retail-and-banking)
The last credit crisis was extremely dangerous, because the potential collaps of the financial system can create a chain reaction of negative feedback loops in the real economy. Unable to line up financing or refinance existing debts, companies were forced to dramatically cut back and sell assets, just to survive the credit crunch. Many businesses failed because of this, and because their customers suddently found themselves unable to pay, even in the short term. The problems with these businesses in turn hit their bankers or creditors hard.
So both the financial and the real sides of the economy went down together, and their problems feed on each other. Only the government had the power to step in and break the loops.
Now as the financial markets and the real economies stabilize, these same feedback mechanisms have started to turn to the other direction, i.e. the positive feedback loops. We can now readily see it in the retail sector and commercial lending. We discuss a particular example here to illustrate.
Select Comfort (SCSS), a highend bed manufacturer known for its Sleep Number beds, struggled mightily during the credit crisis. It almost went under, and relied on very costly private equity money to survive. Today, the company announced a new credit agreement with Wells Fargo (WFC). The credit agreement, which has a term through June 2012 and provides a commitment of up to $20 million, replaces an existing credit facility with a syndicate of banks.
On the flip side of this agreement, it also signals an increased willingness of a conservative commercial bank to lend to recovering retailers. Many of these large banks have experienced difficulty finding qualified borrowers to lend money to. Now, as consumers return to the mall, retailers have reported improved sales and profitabilities. That will increasingly help these banks find qualified borrowers, putting the banking business on a firmer footing.
And as banking profits improve, their capital positions will be further enhanced, and they'll be able to lend more.
Of course, this positive relationship is dependent on consumers being confident enough to spend. And here, we're waiting to see the mother of all positive feedback loops to start to turn: More jobs and incomes lead to more spending, which in turn leads to more hiring; more hiring leads to more consumer lending and higher purchasing power; etc.
With some luck, we may actually get to see some sign of it this coming Good Friday in the employment report.
The last credit crisis was extremely dangerous, because the potential collaps of the financial system can create a chain reaction of negative feedback loops in the real economy. Unable to line up financing or refinance existing debts, companies were forced to dramatically cut back and sell assets, just to survive the credit crunch. Many businesses failed because of this, and because their customers suddently found themselves unable to pay, even in the short term. The problems with these businesses in turn hit their bankers or creditors hard.
So both the financial and the real sides of the economy went down together, and their problems feed on each other. Only the government had the power to step in and break the loops.
Now as the financial markets and the real economies stabilize, these same feedback mechanisms have started to turn to the other direction, i.e. the positive feedback loops. We can now readily see it in the retail sector and commercial lending. We discuss a particular example here to illustrate.
Select Comfort (SCSS), a highend bed manufacturer known for its Sleep Number beds, struggled mightily during the credit crisis. It almost went under, and relied on very costly private equity money to survive. Today, the company announced a new credit agreement with Wells Fargo (WFC). The credit agreement, which has a term through June 2012 and provides a commitment of up to $20 million, replaces an existing credit facility with a syndicate of banks.
"Our sustained improvement in sales and profit performance – along with increased cash generation, a stronger balance sheet and our positive cash position – have provided us the opportunity to replace our existing facility,” said Jim Raabe, chief financial officer, Select Comfort Corporation. “The new facility significantly lowers the company’s borrowing costs and fees and provides more financial flexibility as compared to the existing agreement.”This is certainly a great news for Select Comfort. The stock went up 10% on the news, which signaled a further easing of credit restriction. At the same time, it also confirms the positive outlook of the company from the credit standpoint.
On the flip side of this agreement, it also signals an increased willingness of a conservative commercial bank to lend to recovering retailers. Many of these large banks have experienced difficulty finding qualified borrowers to lend money to. Now, as consumers return to the mall, retailers have reported improved sales and profitabilities. That will increasingly help these banks find qualified borrowers, putting the banking business on a firmer footing.
And as banking profits improve, their capital positions will be further enhanced, and they'll be able to lend more.
Of course, this positive relationship is dependent on consumers being confident enough to spend. And here, we're waiting to see the mother of all positive feedback loops to start to turn: More jobs and incomes lead to more spending, which in turn leads to more hiring; more hiring leads to more consumer lending and higher purchasing power; etc.
With some luck, we may actually get to see some sign of it this coming Good Friday in the employment report.
Sunday, March 28, 2010
Current housing market according to Lennar
One of my holdings in home builders, Lennar (LEN), has reported its 1Q earnings a few days ago. The CEO's summary of the housing market is worth paying close attention to (my emphases).
... While the new home market and housing in general still faced serious headwinds from current economic and legislative conditions, the market and overall economy appear to be continuing to stabilize and are generally in recovery. As we have expected, at least as it relates to housing, the recovery is not presenting itself as a V shape, return to better times, but instead is proving to be a rocky, stabilizing bottom with visibility obscured by more questions than clear answers.
The overhang of foreclosures and the prospects of additional delinquencies ahead continued to moderate recovery, as shadow inventory continues to be absorbed and then even replenished. Unemployment and a generally sluggish economic bounce back combined to full demand at traditionally low levels. And the prospects of a pullback driven by elimination of legislative and fiscal incentives limit visibility and create pending uncertainties about the immediate future of the strength of the market.
And finally, the debate over whether inflation or deflation lies ahead and the impact of sovereign credit risks add uncertainty to the view ahead of interest rate. Nevertheless, as we reviewed our operations from the field geography-by-geography, there are some common themes that appear to be validating the current trend.
First, prices are not free-falling and in fact in many markets are continuing to stabilize and even recover. In most of our divisions, there continues to be a meaningful reduction in the incentives used and the sales process and that fact is reflecting itself in higher gross margins. For the company overall, incentives were 12.5%, down from 13.2% last quarter and 17.1% last year. And margins improved on a pre-impairment basis to 20.3% from 17.8% last quarter and 14.3% last year. While these trends are vulnerable to the upcoming elimination of the $8,000 tax credit and the elimination of fiscal stimulus to the lending market in the short term, it feels that the momentum provided by consumer confidence and home affordability will likely equalize their impact over a short period of time.
These government programs work very well as a kick-start to a free-falling housing market, but it now seems that the free market is positioned to take over in orderly fashion. Second, inventories of new homes remains significantly reduced. While there has been a great deal of talk about potential spec building of new homes to beat the end of the tax credit, we are finding that, that as limited. In most markets, new homes are still being built to order and for the segment of the market that wants a new home, there are limited immediate opportunities to choose from, and that is helping to reduce incentives.
Next, while foreclosures continue to be a significant driver of absorption and pricing, the effect is continuing to decline as the bulk of foreclosure activities is situated in areas that do not compete with new home construction, such as the inner city or the extreme outskirts of markets in which we operate. The better situated foreclosure homes are being absorbed in an orderly fashion and the market is clearly in the inventory overhang in many locations. The $8,000 tax credit has facilitated that clearing process and has helped enable a return to normalcy. In our operating meetings, we found that a number of our markets were no longer effective at all by foreclosure homes as they had already been absorbed. I have noted many times that housing is a localized business and inventories in micro markets, not broad geographic markets are most important in considering demand trends.
Finally, we have heard that unemployment rates in many of our markets is at least stabilizing and in some instances beginning to recover. Accordingly, a general sense of confidence has returned to the consumer and there is a tangible sense that with prices and interest rates low, now is the right time to purchase a home for future security.
This is perhaps the most important element driving the future of the housing markets as the threat of losing one’s job has deterred many from the housing market for some time now. With the ground now firming beneath us, and with solid foundation of our balance sheet, we are able to find new acquisitions of home sites to build new communities where homes can be delivered at responsible profit levels at today’s price level and given zero market appreciation and Rick will give further color on our operations will talk about our acquisitions.
As you can see from our press release this morning, at Lennar, we have continued to position our company to return to fundamental profitability in 2010. We have made meaningful progress in preparing our company for a stabilized and ultimately recovering housing markets. That preparation is primarily reflected in our balance sheet and is now – that is now well positioned for the future. Through the end of last year, we aggressively impaired or disposed of assets that would not add to our profitability in the future. This process enabled us to both clean up our balance sheet, while maximizing the tax benefits derived from the net operating loss carry-back extension that Congress enacted last year.
This in turn has enabled us to move forward with additional liquidity to make strategic purchases and to begin to add back jobs that were lost as the markets deteriorated. In the first quarter, we made meaningful investments that we believe are positioning our company for success. After a rather long four-and-a-half years of mending process, we are pleased to finally be using our cash again to invest for future profitability rather than support impaired property.
Our balance sheet remains fortified with a homebuilding and Rialto debt-to-total cap ratio net of cash of 45.9% and homebuilding cash of approximately 1.15 billion, which includes the 230 [ph] in cash taken in two days after the end of the quarter. The number of joint ventures has fallen to 58 currently and that’s down from 62 last quarter. Many of the remaining ventures are good ventures that have already been reworked and have solid access to the position for the future. We expect to continue to reduce this number as we go forward into 2010. Additionally, we have continued to reduce our maximum recourse debt for the company to $279 million.
Finally, on the opportunity side, we have made our first strategic investments in the Rialto segment of our business. As I noted in prior quarters, we have been preparing to be a significant participant in the distress opportunities that naturally present themselves in down cycles. We have been incubating and operating team of experienced professionals for the past few years. The team is now formed and we have begun the process of actively investing in unique distressed investments. Mid-quarter, we announced the acquisition of over $3 billion of face value of loan in partnership with the FDIC, and we described our progress no our PPIP program with AllianceBernstein.
While I will let Jeff Krasnoff update you on those programs, I will note that we have made meaningful investments that we believe will add significant shareholder value. This is a tough business, but we do it exceptionally well. Yesterday evening, we had our weakly asset managers meeting, and as I reviewed assets with our managers from around the country, I was enthusiastic to see just how comfortably we operate and manage this very unique segment. We are clearly beginning to see more opportunities present themselves in this area and with our unique expertise, we expect to be an active participant in this part of the market recovery, as we feel these investments can add outsized return to our recovering homebuilding operations.
At the end of the day, we are very pleased with the progress that we have made to date and the very exciting position that our company is currently in. Our balance sheet is strong and positioned with adequate liquidity to support investment for our future. Our core homebuilding operations are positioned for success and beginning to grow again, adding communities and leveraging our right-sized overhead. And our Rialto Investments segment is now fully operational and investing capital to create strong returns as we build profitability.
While we have recognized that the current economic environment is fragile at best, we feel today that we are extremely well positioned to navigate the rocky bottom and ultimate recovery that lies ahead.
Friday, March 26, 2010
Why the Crowd Maybe Sheep Again
(This article was later published on Seeking Alpha titled "Pessimistic Investors Are Missing the Boat in 2010, Again.")
There is an abundance of pessimism in the investment crowd. Unemployment, foreclosure waves, federal deficits, enemic home sales, ... there is little wonder why so many commentators dwell on the negative side of every piece of economic data. If you go with the wisdom of this crowd, you should be shorting the market in general.
Yet short sellers have been frustrated so far this year. Nothing seems to work. In particular, the home building sector has been one of the top performers of the year so far (simply check LEN, DHI, SPF, PHM, or XHB). It is truely frustrating for investors who just cannot see any light in the housing sector, and cannot accept the fact that government support is sometimes necessary.
After a disasterous 2008, investors pulled record amount of money out of equities, and put them into bond funds and/or cash. Despite a roaring "V-shape" recovery in the equity market in 2009, narrowed credit spreads and expected rise in the yield curve, investors continued to pour $89 billions into bond funds in the first quarter of 2010.
PIMCO has been the prime beneficiary of this inflow. Its "new normal" thesis has been well-argued and publicized which has also help draw money into bond funds. All this money however may make it extremely hard to keep up with the performance, given the potential inflation and potential rise in rates.
Finally, PIMCO warned that bond funds may have seen best days. They have even started to offer stock funds.
One clearly can see at least two different types of herds here: the avoid-equity-at-all-cost crowd that stampeded into bond funds and the pessimism-dwelling short-selling crowd. One would think that the second crowd may be more sophisticated and better informed, yet they may be just one-year behind the curve after investor like John Paulson has already made his killing in 2007-2008 and went long into financials.
The trait of the investment sheep makes them dwell on one direction for too long. Such sheep showed up in force in the last housing boom. And we may be seeing them again in the abundance of extreme pessimism in 2010.
There is an abundance of pessimism in the investment crowd. Unemployment, foreclosure waves, federal deficits, enemic home sales, ... there is little wonder why so many commentators dwell on the negative side of every piece of economic data. If you go with the wisdom of this crowd, you should be shorting the market in general.
Yet short sellers have been frustrated so far this year. Nothing seems to work. In particular, the home building sector has been one of the top performers of the year so far (simply check LEN, DHI, SPF, PHM, or XHB). It is truely frustrating for investors who just cannot see any light in the housing sector, and cannot accept the fact that government support is sometimes necessary.
After a disasterous 2008, investors pulled record amount of money out of equities, and put them into bond funds and/or cash. Despite a roaring "V-shape" recovery in the equity market in 2009, narrowed credit spreads and expected rise in the yield curve, investors continued to pour $89 billions into bond funds in the first quarter of 2010.
PIMCO has been the prime beneficiary of this inflow. Its "new normal" thesis has been well-argued and publicized which has also help draw money into bond funds. All this money however may make it extremely hard to keep up with the performance, given the potential inflation and potential rise in rates.
Finally, PIMCO warned that bond funds may have seen best days. They have even started to offer stock funds.
One clearly can see at least two different types of herds here: the avoid-equity-at-all-cost crowd that stampeded into bond funds and the pessimism-dwelling short-selling crowd. One would think that the second crowd may be more sophisticated and better informed, yet they may be just one-year behind the curve after investor like John Paulson has already made his killing in 2007-2008 and went long into financials.
The trait of the investment sheep makes them dwell on one direction for too long. Such sheep showed up in force in the last housing boom. And we may be seeing them again in the abundance of extreme pessimism in 2010.
Wednesday, March 24, 2010
Rocky Bottom
Home builder Lennar reported good quarterly earnings today. CEO characterized the current housing market as moving along a "rocky bottom."
Major headwind is high unemployment and foreclosures.
Expiration of tax credit does not seem to be a major factor going forward. Buyers are more focused on affordability and the opportunity to own a decent home at a decent location to take advantage of low mortgage rates.
Incentive is down. Average sale price is up. A major factor is in California where certain markets have turned warm. Gross margin is up. Expect profitability in 2010.
A subtantial amount of cash is being put to work. More opportunities in distressed properties are expected. Lennar is in a unique position to work with FDIC and banks and other investors to opportunistically invest and/or co-invest in distress loans.
We get the sense that the housing market is going to be very uneven. Certain home builders who has the flexibility and the ability will be able to take advantage of local conditions better than others.
We like the type that are both aggressive and cautious.
Major headwind is high unemployment and foreclosures.
Expiration of tax credit does not seem to be a major factor going forward. Buyers are more focused on affordability and the opportunity to own a decent home at a decent location to take advantage of low mortgage rates.
Incentive is down. Average sale price is up. A major factor is in California where certain markets have turned warm. Gross margin is up. Expect profitability in 2010.
A subtantial amount of cash is being put to work. More opportunities in distressed properties are expected. Lennar is in a unique position to work with FDIC and banks and other investors to opportunistically invest and/or co-invest in distress loans.
We get the sense that the housing market is going to be very uneven. Certain home builders who has the flexibility and the ability will be able to take advantage of local conditions better than others.
We like the type that are both aggressive and cautious.
Sunday, March 21, 2010
Threats to global economic recovery
U.S. and emerging market economies are the two driving forces in this recovery. One of the biggest concerns a while back was that the Fed withdraws its monetary supports too soon. Looks like the Fed has been methodical and moves in measured pace. Markets appear to have confidence in Bernanke's Fed.
Similarly, since China's enormous stimulus succeeded in pulling the country out of the potential slump caused by rapidly shrinking global demand, another of the biggest concerns was that China ends its stimulus policy too soon. That concern has mostly gone, as inflation is heating up in China and excessive bank lending has caused economists and observers to speculate about the Chinese bubble.
Both countries have been adjusting and rebalancing. We need to trade more, not less. U.S. needs to export more, so does China. Current debates however are so narrowly focused on the Chinese Yuan, the currency itself, that a potential break-out of a trade war has emerged as the biggest threat to the global recovery.
Paul Krugman represents an increasingly confrontational stance that the U.S. Congress and the Administration may come to adopt. Referring to China's long-disputed currency-peg policy, he stated that
All of a sudden, China has become the central culprit for the developed world's economic problem, in particular its inability to stimulate its way out of the recession. I have a feeling that ultra-Keynesian economists like Krugman have run out of ideas, and a convenient way to get some growth is to push China to abolish its long-standing currency policy. And he goes about it in a way quite like how George W Bush went into war with Iraq: we have strong evidence that Hussein was posessing WMD, therefore we must invade, because nothing else would work.
That's very dangerous.
Paul Krugman won his Nobel for his New Trade theory, which tries to explain the trade flows among conntries that do not seem to have distinct comparative advantages. This thoery that examines the implications of economies of scale and monopolistic competitions sometimes yield very different policy implication from the traditional trade theory. We don't really know if that work has colored his views on trade issues with China. If it does, it's unfortunate.
For over the last 30 years or so, China's trade with U.S. was mostly about taking advantage of its vast labor force outside of the cities. This allowed the exporting sector to thrive on razor-thin profit margin, producing goods that ordinary Chinese could not afford or not willing to consume. Most of the margin is made by U.S. multi-nationals. And it came with an enormous costs on the environment. I think the classic comparative advantage argument still applies in this case. If so, the more trade the better. Protectionism can only lead to a worse outcome for all countries.
China ran a trade surplus because the Chinese people consumed less than they produced. U.S. ran a trade deficit because Americans consumed more than they produced. Currency peg has little to do with these results. Many developing countries have their currencies pegged to the US dollar to have an anchor for pricing.
It is in China's interest over the long run to have its currency fully convertible. China will do so only when it thinks it's ready for the change. Just as "shock therapy" would not work 20 or 30 years ago, a currency shock therapy will not work this time. The most likely scenario is as the global economies recover, China will revalue its currency gradually in many steps.
After more than 30 years of development, China is probably ready to float its currency. Some experts (e.g. Goldman Sachs Group's O'Neill ) already think the currency is no longer very under-valued.
Krugman went on to argue that U.S. should not fear China's dumping its 2 trillions plus holding in US Treasuries. Because if China does that, the yield will increase, thereby lowering the value of the holding. In a sense, Krugman thinks that U.S. holds China in hostage because China was stupid enough to lend so much to the U.S. And it's time to take advantgae of that. This is somewhat of a pirate's logic, it seems. Just unbelievable.
China has already been trying to diversify its holding away from the treasuries. It will continue to do so. U.S. will not find it so easy to finance its deficit when China moves substantially away. If interest rates rise suddently, it will hurt U.S. a lot more than it will hurt China. China's holding is the price that it chooses to pay to run the trade game. The holding itself is not been pledged for anything critical.
If long term interest rates rise just 2%, it will put an enormous pressure on the housing market. That'll kill the U.S. recovery. The Fed can always step in to buy up the debt. That will certainly send the US Dollar into a tailspin. Gold price will shoot off the roof in that case. So a logical place for China to park their reserve is gold. What China loses in their US Treasury holding, they can make it up from the gold holding. The loss will be even more limited due to the Fed purchase. If you take this scenario to extreme, that China dumps almost all its UST holding and moves to gold and other forms of precious metal, or oil. The Fed will be forced to step in, blowing up its balance sheet by another 2 trillions or so. That seems like a recipe for another financial crisis. Inflationary expectation will be ignited.
Krugman went so far as to suggest slapping 25% tariff on all Chines imports to the U.S. He meant to use it as a temporary measure to force China's hands. That's a scary thought. This is no blackboard exercise. U.S. consumers will see many everyday items suddently have a price jump. Many factories in China will be forced to close. Trade flow will experience an enormous jolt. For what? If China decides to retaliate, by imposing higher hurddles on U.S. exports, what will U.S. get? Will the world obtain the 1.5% growth that Mr.Krugman imagines it would if only China stops pegging its currency? I think the world will likely get the opposite: a trade war will send the global economy into a double-dip recession and possibly a world-wide stagflation.
Similarly, since China's enormous stimulus succeeded in pulling the country out of the potential slump caused by rapidly shrinking global demand, another of the biggest concerns was that China ends its stimulus policy too soon. That concern has mostly gone, as inflation is heating up in China and excessive bank lending has caused economists and observers to speculate about the Chinese bubble.
Both countries have been adjusting and rebalancing. We need to trade more, not less. U.S. needs to export more, so does China. Current debates however are so narrowly focused on the Chinese Yuan, the currency itself, that a potential break-out of a trade war has emerged as the biggest threat to the global recovery.
Paul Krugman represents an increasingly confrontational stance that the U.S. Congress and the Administration may come to adopt. Referring to China's long-disputed currency-peg policy, he stated that
And it’s a policy that seriously damages the rest of the world. Most of the world’s large economies are stuck in a liquidity trap — deeply depressed, but unable to generate a recovery by cutting interest rates because the relevant rates are already near zero. China, by engineering an unwarranted trade surplus, is in effect imposing an anti-stimulus on these economies, which they can’t offset.
All of a sudden, China has become the central culprit for the developed world's economic problem, in particular its inability to stimulate its way out of the recession. I have a feeling that ultra-Keynesian economists like Krugman have run out of ideas, and a convenient way to get some growth is to push China to abolish its long-standing currency policy. And he goes about it in a way quite like how George W Bush went into war with Iraq: we have strong evidence that Hussein was posessing WMD, therefore we must invade, because nothing else would work.
That's very dangerous.
Paul Krugman won his Nobel for his New Trade theory, which tries to explain the trade flows among conntries that do not seem to have distinct comparative advantages. This thoery that examines the implications of economies of scale and monopolistic competitions sometimes yield very different policy implication from the traditional trade theory. We don't really know if that work has colored his views on trade issues with China. If it does, it's unfortunate.
For over the last 30 years or so, China's trade with U.S. was mostly about taking advantage of its vast labor force outside of the cities. This allowed the exporting sector to thrive on razor-thin profit margin, producing goods that ordinary Chinese could not afford or not willing to consume. Most of the margin is made by U.S. multi-nationals. And it came with an enormous costs on the environment. I think the classic comparative advantage argument still applies in this case. If so, the more trade the better. Protectionism can only lead to a worse outcome for all countries.
China ran a trade surplus because the Chinese people consumed less than they produced. U.S. ran a trade deficit because Americans consumed more than they produced. Currency peg has little to do with these results. Many developing countries have their currencies pegged to the US dollar to have an anchor for pricing.
It is in China's interest over the long run to have its currency fully convertible. China will do so only when it thinks it's ready for the change. Just as "shock therapy" would not work 20 or 30 years ago, a currency shock therapy will not work this time. The most likely scenario is as the global economies recover, China will revalue its currency gradually in many steps.
After more than 30 years of development, China is probably ready to float its currency. Some experts (e.g. Goldman Sachs Group's O'Neill ) already think the currency is no longer very under-valued.
Krugman went on to argue that U.S. should not fear China's dumping its 2 trillions plus holding in US Treasuries. Because if China does that, the yield will increase, thereby lowering the value of the holding. In a sense, Krugman thinks that U.S. holds China in hostage because China was stupid enough to lend so much to the U.S. And it's time to take advantgae of that. This is somewhat of a pirate's logic, it seems. Just unbelievable.
China has already been trying to diversify its holding away from the treasuries. It will continue to do so. U.S. will not find it so easy to finance its deficit when China moves substantially away. If interest rates rise suddently, it will hurt U.S. a lot more than it will hurt China. China's holding is the price that it chooses to pay to run the trade game. The holding itself is not been pledged for anything critical.
If long term interest rates rise just 2%, it will put an enormous pressure on the housing market. That'll kill the U.S. recovery. The Fed can always step in to buy up the debt. That will certainly send the US Dollar into a tailspin. Gold price will shoot off the roof in that case. So a logical place for China to park their reserve is gold. What China loses in their US Treasury holding, they can make it up from the gold holding. The loss will be even more limited due to the Fed purchase. If you take this scenario to extreme, that China dumps almost all its UST holding and moves to gold and other forms of precious metal, or oil. The Fed will be forced to step in, blowing up its balance sheet by another 2 trillions or so. That seems like a recipe for another financial crisis. Inflationary expectation will be ignited.
Krugman went so far as to suggest slapping 25% tariff on all Chines imports to the U.S. He meant to use it as a temporary measure to force China's hands. That's a scary thought. This is no blackboard exercise. U.S. consumers will see many everyday items suddently have a price jump. Many factories in China will be forced to close. Trade flow will experience an enormous jolt. For what? If China decides to retaliate, by imposing higher hurddles on U.S. exports, what will U.S. get? Will the world obtain the 1.5% growth that Mr.Krugman imagines it would if only China stops pegging its currency? I think the world will likely get the opposite: a trade war will send the global economy into a double-dip recession and possibly a world-wide stagflation.
Sunday, March 7, 2010
Anniversary of my family's Hong Kong trip and a year of change (Updated)
This weekend is sunny and warm. Spring is here.
I took my son out playing in the backyard. He is about to turn two, a big boy now. He loves outdoor, but has been staying inside all winter. The record-breaking snow storms are finally behind us. A harsh winter makes you appreciate spring so much more.
As he was roaming around, stepping on wet grass and melting snow-ice, making himself a big mess, I was watching him and reflecting on the year that has just passed.
It was exactly this first March weekend of last year that I took my two daughters on a trip to Hong Kong to join their mother, who was on the academic job market looking for her next postition. The stock market had hit a new and depressing low. U.S. was shedding jobs in the hundreds of thousands each month. The financial crisis was on its full swing and the entire Western financial system was crumbling. State universities were facing big budget cuts, private universities were not much better as their endowments took huge hits. Even the safest part of the academic job market was affected in a big way. Schools were cuting back. Some had withdrawn their positions. No position looked safe.
Universities in Asia seemed to be expanding. We were seriously considering moving our family back to Asia. Who knows, Wall Street as we knew it no longer existed; perhpas it was moving to Hong Kong. The thought of bringing up our kids in a more cosmopolitan multi-cultural environment suddently seemed so appealing. We really did not need to get stuck in the U.S. And after more than 20 years, it would not be so bad to lead our lives back in Asia.
We didn't want to go back to the mainland. We didn't think that we would fit in anymore. China has changed so much since we left in the 80s and early 90s of the last century. Every time I went back and visit Shanghai, Shenzhen or Guangzhou, I was amazed at the huge changes. Some of the changes were exciting, some we would rather not see.
We also din't think our children would be able to fit in easily. Even if they manage to, the single-minded academic study and education wasn't something we'd like them to have. Having gone through that intense process ourselves in our youth, we know that's not the best way to educate kids. The American system is not perfect, but we think it's much better for their development.
Hong Kong and Singapore are different. Their international schools offer many choices for kids like ours. And, we liked the fact that there is a good mix of Chinese teaching and English/American teaching. We do want our kids to have more exposure to the Chinese heritage.
My older daughter was 9, and the younger one was 4. They've never been to Hong Kong. My 9-yr old had classmates who had family ties in HK and had shared interesting experience with her. She was excited about the trip, which had also influenced the 4-yr old's mood in a positive way.
As it turned out, my 4-yr old didn't cause much trouble. Hong Kong was convenient and manageable. We were picked up by a minivan, and headed to HKUST which is situated on the hills over-looking the Clear Water Bay. It was about an hour away from the airport. It was a cloudy day, somewhat humid and cool. It's the climate very similar to Guangdong where I grew up.
As we were passing by the high rises, the driver was kind enough to point to us where the HK Island was and where the rich people live. We were headed to the east side of Kowloon which is a big stretch of pennisula north to HK Island but south to the New Territaries.
As a kid I heard many stories about HK as a land of opportunities. Back then the mainland was so poor that many young men from the villages would swim to HK to try to find a better life. Many of them were sent back, but some managed to stay. One of the middle school classmates took such a calculated risk in early 90s. He was caught and sent back to the mainland.
As we got closer to HKUST, the air became considerably more humid and wet. The university as built right next to a bay with beautiful views. But it's so humid all year round that you need a de-humidifier running at all times. When we arrived at the small on-campus hotel room, my wife told me that she had already collected a bucket full of water from the air since the day before.
Because of the humidity and the salt in the wet air, everything seems to rust quickly.
We spent a week there. While my wife was conducting her interviews, I took the kids to visit HK. We were also joined by my mother and my sister who took a bus from my home town. It was a 4-hour trip, and the first time for them. I learned that it's so much easier now to obtain a visit pass for mainlanders who want to visit HK. Swimming in the ocean was no longer required! In fact the financial crisis had hit HK so hard that it was relying on getting more mainland visitors to boost the economy. But that didn't seem work so well, as my mother later told me they were the only travelers on the entire bus which could take hundreds.
We visited many sites, we toured the Victoria Bay. I also took a couple of trips to HK's financial district in Central. Signs of international banks looked familiar. But no one was hiring, except for some mainland asset managers. One of my old colleagues at Berkeley who had joined Lehman Brothers at Tokyo had been transferred to HK after Lehman's Asian operation was bought by Nomura. (Lehman had collapsed only a few months before.) I had an appointment to meet him. Many yrs had passed since we met last time, so I was looking forward to chatting with him. But surprisingly I couldn't get through his cell. I felt that I was stonewalled. The guy clearly did not want to see me. I was a bit disappointed, but then I felt sorry for him.
Another friend who had just moved from NYC to HK to take up a senior position at Citi Group was a lot more honest in telling her experience. Her main point was that her new colleagues in HK were not pleasant to work with. They're not nearly as professional as people in NYC. She strongly advised against moving to HK/China based on her own experience of having actually done it.
From these various contacts, I had a feeling that perhaps HK wasn't ready for the prime time. I didn't have a feeling that Wall Street was moving there.
Headhunters have told me that financial companies had put off hiring... it looked like unless I wanted to work for a mainland outfit, it would be tough for me to find a suitable job in HK within a year after we relocate.
What really put me off is how hard and complicated it would be to arrange for schools for my kids. There are long waiting lists. The tuitions and fees for international schools are astronomical. Education expenses would be on par with housing expense with three kids. And they would have to be on school bus for quite a long trip (45 minutes or longer) from Kindergarten on... that's a big turnoff.
Singapore is not that much better. But some of their universities were willing to offer child education assistance, in addition to housing assistance.
An offer from SMU quickly came through for my wife. It was a good offer. She had a sense that the HK schools would not be able to match.
Going around in the subway system and on streets, we saw many people wearing masks. At first it seems a bit strange. But as we saw more and more dusty air and smog we understood why.
The weather turned bright on our last day. So we took a taxi all the way up to the Victoria peak. We saw the entire bay, and we had a good sense of how smoggy HK had become. Riding the bus down the winding narrow road from the peak, one thought clearly emerged: the richest people who live on the peak may have all the money and the view, but they can hardly escape the lousy air surrounding them.
We heard that Singapore's air is considerably better.
After the HK visit, we had become dis-illusioned. But we thought Singapore may work out for our family. But we didn't have time to visit Singapore. we headed back to the U.S. My wife had not given up on U.S. universities. In fact, we learned later that some schools she had applied to thought she would have better choices and thus did not invited her for visits initially. As she pursued these second opportunities mostly on the East Coast, her Singapore offer was actually quite helpful. By the end of March, she had decided to accept a position in Pennsylvania and I supported her.
We were not willing to give up on America just yet. Deep down, we still believe that U.S. will lead the world in innovations, no matter how hard it's been hit by the credit crisis. Consumers will learn from the crisis, so will the government and the businesses. U.S. will re-orient itself because of the crisis. But th struggle is likely to be difficult, especially for the middle class and the poor.
Where we choose to live is where we'll invest in our family's future. It was a big decision.
We've gone through a nice Summer, a beautiful Autumn, and an awful Winter since we moved to the East Coast. We're starting to enjoy the awakening Spring.
I took my son out playing in the backyard. He is about to turn two, a big boy now. He loves outdoor, but has been staying inside all winter. The record-breaking snow storms are finally behind us. A harsh winter makes you appreciate spring so much more.
As he was roaming around, stepping on wet grass and melting snow-ice, making himself a big mess, I was watching him and reflecting on the year that has just passed.
It was exactly this first March weekend of last year that I took my two daughters on a trip to Hong Kong to join their mother, who was on the academic job market looking for her next postition. The stock market had hit a new and depressing low. U.S. was shedding jobs in the hundreds of thousands each month. The financial crisis was on its full swing and the entire Western financial system was crumbling. State universities were facing big budget cuts, private universities were not much better as their endowments took huge hits. Even the safest part of the academic job market was affected in a big way. Schools were cuting back. Some had withdrawn their positions. No position looked safe.
Universities in Asia seemed to be expanding. We were seriously considering moving our family back to Asia. Who knows, Wall Street as we knew it no longer existed; perhpas it was moving to Hong Kong. The thought of bringing up our kids in a more cosmopolitan multi-cultural environment suddently seemed so appealing. We really did not need to get stuck in the U.S. And after more than 20 years, it would not be so bad to lead our lives back in Asia.
We didn't want to go back to the mainland. We didn't think that we would fit in anymore. China has changed so much since we left in the 80s and early 90s of the last century. Every time I went back and visit Shanghai, Shenzhen or Guangzhou, I was amazed at the huge changes. Some of the changes were exciting, some we would rather not see.
We also din't think our children would be able to fit in easily. Even if they manage to, the single-minded academic study and education wasn't something we'd like them to have. Having gone through that intense process ourselves in our youth, we know that's not the best way to educate kids. The American system is not perfect, but we think it's much better for their development.
Hong Kong and Singapore are different. Their international schools offer many choices for kids like ours. And, we liked the fact that there is a good mix of Chinese teaching and English/American teaching. We do want our kids to have more exposure to the Chinese heritage.
My older daughter was 9, and the younger one was 4. They've never been to Hong Kong. My 9-yr old had classmates who had family ties in HK and had shared interesting experience with her. She was excited about the trip, which had also influenced the 4-yr old's mood in a positive way.
As it turned out, my 4-yr old didn't cause much trouble. Hong Kong was convenient and manageable. We were picked up by a minivan, and headed to HKUST which is situated on the hills over-looking the Clear Water Bay. It was about an hour away from the airport. It was a cloudy day, somewhat humid and cool. It's the climate very similar to Guangdong where I grew up.
As we were passing by the high rises, the driver was kind enough to point to us where the HK Island was and where the rich people live. We were headed to the east side of Kowloon which is a big stretch of pennisula north to HK Island but south to the New Territaries.
As a kid I heard many stories about HK as a land of opportunities. Back then the mainland was so poor that many young men from the villages would swim to HK to try to find a better life. Many of them were sent back, but some managed to stay. One of the middle school classmates took such a calculated risk in early 90s. He was caught and sent back to the mainland.
As we got closer to HKUST, the air became considerably more humid and wet. The university as built right next to a bay with beautiful views. But it's so humid all year round that you need a de-humidifier running at all times. When we arrived at the small on-campus hotel room, my wife told me that she had already collected a bucket full of water from the air since the day before.
Because of the humidity and the salt in the wet air, everything seems to rust quickly.
We spent a week there. While my wife was conducting her interviews, I took the kids to visit HK. We were also joined by my mother and my sister who took a bus from my home town. It was a 4-hour trip, and the first time for them. I learned that it's so much easier now to obtain a visit pass for mainlanders who want to visit HK. Swimming in the ocean was no longer required! In fact the financial crisis had hit HK so hard that it was relying on getting more mainland visitors to boost the economy. But that didn't seem work so well, as my mother later told me they were the only travelers on the entire bus which could take hundreds.
We visited many sites, we toured the Victoria Bay. I also took a couple of trips to HK's financial district in Central. Signs of international banks looked familiar. But no one was hiring, except for some mainland asset managers. One of my old colleagues at Berkeley who had joined Lehman Brothers at Tokyo had been transferred to HK after Lehman's Asian operation was bought by Nomura. (Lehman had collapsed only a few months before.) I had an appointment to meet him. Many yrs had passed since we met last time, so I was looking forward to chatting with him. But surprisingly I couldn't get through his cell. I felt that I was stonewalled. The guy clearly did not want to see me. I was a bit disappointed, but then I felt sorry for him.
Another friend who had just moved from NYC to HK to take up a senior position at Citi Group was a lot more honest in telling her experience. Her main point was that her new colleagues in HK were not pleasant to work with. They're not nearly as professional as people in NYC. She strongly advised against moving to HK/China based on her own experience of having actually done it.
From these various contacts, I had a feeling that perhaps HK wasn't ready for the prime time. I didn't have a feeling that Wall Street was moving there.
Headhunters have told me that financial companies had put off hiring... it looked like unless I wanted to work for a mainland outfit, it would be tough for me to find a suitable job in HK within a year after we relocate.
What really put me off is how hard and complicated it would be to arrange for schools for my kids. There are long waiting lists. The tuitions and fees for international schools are astronomical. Education expenses would be on par with housing expense with three kids. And they would have to be on school bus for quite a long trip (45 minutes or longer) from Kindergarten on... that's a big turnoff.
Singapore is not that much better. But some of their universities were willing to offer child education assistance, in addition to housing assistance.
An offer from SMU quickly came through for my wife. It was a good offer. She had a sense that the HK schools would not be able to match.
Going around in the subway system and on streets, we saw many people wearing masks. At first it seems a bit strange. But as we saw more and more dusty air and smog we understood why.
The weather turned bright on our last day. So we took a taxi all the way up to the Victoria peak. We saw the entire bay, and we had a good sense of how smoggy HK had become. Riding the bus down the winding narrow road from the peak, one thought clearly emerged: the richest people who live on the peak may have all the money and the view, but they can hardly escape the lousy air surrounding them.
We heard that Singapore's air is considerably better.
After the HK visit, we had become dis-illusioned. But we thought Singapore may work out for our family. But we didn't have time to visit Singapore. we headed back to the U.S. My wife had not given up on U.S. universities. In fact, we learned later that some schools she had applied to thought she would have better choices and thus did not invited her for visits initially. As she pursued these second opportunities mostly on the East Coast, her Singapore offer was actually quite helpful. By the end of March, she had decided to accept a position in Pennsylvania and I supported her.
We were not willing to give up on America just yet. Deep down, we still believe that U.S. will lead the world in innovations, no matter how hard it's been hit by the credit crisis. Consumers will learn from the crisis, so will the government and the businesses. U.S. will re-orient itself because of the crisis. But th struggle is likely to be difficult, especially for the middle class and the poor.
Where we choose to live is where we'll invest in our family's future. It was a big decision.
We've gone through a nice Summer, a beautiful Autumn, and an awful Winter since we moved to the East Coast. We're starting to enjoy the awakening Spring.
Thursday, March 4, 2010
Land grab: Housing cycle heading up before hitting bottom
Very good article on Business Week about cash-rich builders buying land again. It's worth quoting the entire article.
New Business March 3, 2010, 8:34PM EST
Housing: Hope on the Horizon
Cash-rich builders are buying land again, betting on a turn in the market for new homes
By Peter Coy and John Gittelsohn
You would think the nation's biggest homebuilders would be writhing in pain right about now. Sales of new single-family homes sank in January to the lowest seasonally adjusted rate in nearly five decades of record keeping and are now off 78% from the housing market's frothy peak in 2005.
Yet in a housing industry as vast and varied as America's, the data often fail to keep up with reality. It turns out that big publicly traded builders, thanks to cost-cutting, asset sales, bond issues, and tax breaks, aren't in grim shape. Their shares have nearly doubled over the past year and they're back in the game of competing for land, reflecting confidence that after years of falling prices, rising foreclosures, and busted dreams, better days are ahead.
The number of lots owned or controlled by a dozen of the biggest builders rose slightly in the second half of 2009 after years of decline as renewed buying offset heavy tax-related selling of unwanted parcels, according to a Bloomberg analysis of company reports. In crash-prone markets such as Southern California and Florida, prices of some construction-ready lots are up 50% or more from their 2009 lows. "There is definitely a shortage of land, and you cannot turn the switch on overnight," says Douglas C. Yearley Jr., executive-vice president of luxury builder Toll Brothers (TOL). "That will cause builders to aggressively buy the land they can."
Land buying began to pick up last year after finished lots hit the market at below the cost of improvements, and housing prices stabilized. Builders could finally turn out homes with some assurance of making a profit, says Scott D. Clark, the CEO of Americap Development Partners, a residential land developer in San Ramon, Calif. Greater affordability and tax incentives should help in the short term. What's more, the big builders believe population growth will eventually require a burst of construction. Warren Buffett agrees. In his Feb. 27 letter to shareholders of Berkshire Hathaway (BRK/A), which owns manufactured-housing maker Clayton Homes, he predicted that "within a year or so residential housing problems should largely be behind us."
Bargain Buying
The builders are staying disciplined for now, selectively scooping up bargains while buying just what they need to meet expected demand for the next few years. "There isn't one public homebuilder that's stupid. They're all well-seasoned. They've shrunk down to the size they need to be, and now they're reacting accordingly" to opportunities for growth, says James T. "Nate" Nathan, the president of Scottsdale (Ariz.)-based land broker Nathan & Associates.
It's tough to say how much land prices have risen because each market is different. Last year, DMB Associates, a developer in Scottsdale, and its partners bought back about 400 lots in DMB's Verrado master-planned community in Buckeye, Ariz., that builders had acquired and then defaulted on. They spent about $15,000 per lot, then quickly resold 300 of the lots to other builders for an average $40,000 per lot. Nationally, though, increases have been considerably smaller than that.
The uptick in prices matters because land is the main factor in real estate's roller-coaster cycle. When housing prices boomed in the middle of the last decade, it wasn't the structures that were suddenly deemed more valuable but the land. Economist Morris A. Davis of the University of Wisconsin-Madison School of Business estimates that the price of U.S. land used for houses and apartments nearly tripled from the beginning of 2000 to the end of 2005. Prices more than tripled over the period in Washington, Miami, Tampa, San Diego, Los Angeles, and Phoenix, and better than quadrupled in two inland California markets, Sacramento and San Bernardino, Davis estimates. He figures that national land prices fell nearly two-thirds through early 2009 before bouncing back more than 20% in the rest of '09. (To calculate the implied value of land, he takes the fluctuating market value of residential properties and subtracts the relatively stable replacement cost of the structures on them.)
The sharp decline in land prices was especially hard on the small builders that account for about 70% of the market. The National Association of Home Builders says its membership has fallen by about 20%, or 45,000. Many that remain have slashed staff. Jerry Howard, CEO of the NAHB, says banks are refusing to extend credit to small builders and stiffening the terms on existing credit.
In contrast, most of the big builders whose shares are publicly traded are battle-hardened and ready to grow again. Writedowns and write-offs by 13 of the largest public builders exceeded $32 billion through December, according to Fitch Ratings. In contrast to small builders, which rely almost entirely on banks for financing, several big builders were able to raise funds by issuing bonds.
Tax-Refund Windfall
An additional boost came last year when Congress passed a law allowing companies to get refunds on past years' tax payments by applying their recent losses to earnings dating back five years. Many sold land at big losses to boost their refunds. The result was a windfall of $2.3 billion for the builders as a group, including $800 million for No. 1 Pulte Homes (PHM).
The result of those balance-sheet heroics? Builders have more than $12 billion in cash they can use to replenish their land inventory. Pulte and D.R. Horton (DHI) each had $1.9 billion in cash and near-term equivalents at the end of December, Toll Brothers had $1.6 billion at the end of January, Lennar (LEN) had $1.3 billion, and KB Home (KBH) had $1.2 billion at the end of November.
Some of that cash is going for parcels that weaker builders lost through default or short sales. On Feb. 25, Starwood Land Ventures of Bradenton, Fla., announced it received "interest from nearly every major homebuilder in Florida" for about 5,400 residential lots it bought in the bankruptcy auction of Hollywood (Fla.)-based TOUSA, one of the few big builders that bit the dust. Lennar was first in line, agreeing with Starwood to acquire or get purchase options on more than 2,700 of the TOUSA lots across Florida. The price wasn't disclosed, but Lennar said it expects to earn gross margins of 20% or better on the deal. In Loveland, Colo., land broker Craig Harrison of Harrison Resource Corp. says he's "in shock and awe" at the amount of interest he's getting from builders and investors for 5,000 acres of land across northern Colorado that recently went on the market for $177 million.
Builders are buying land in part because the parcels they have aren't in the places where they need them. Property on the outer fringes of metro areas is still out of favor, says Daniel Oppenheim, a Credit Suisse (CS) homebuilding analyst. Prices have risen the most for closer-in lots that already have sewer lines, water, electricity, and sidewalks, because builders can throw up houses on them quickly and sign deals by Apr. 30 to qualify for federal homebuyer tax credits. Builders that aren't focused on a quick sales pop are choosing to buy cheaper "paper lots" that lack infrastructure, says Jody Kahn, vice-president of regional markets for Irvine (Calif.)-based John Burns Real Estate Consulting.
Interest in unfinished land usually comes later in the housing cycle, says Thomas E. Lucas, senior vice-president of operations for DMB in Scottsdale. "We didn't think we'd sell raw land for three to four years," Lucas says. That's a striking vote of confidence considering the threats to housing from high unemployment, rising mortgage rates, and foreclosures.
Everything seems to happen faster these days—including the housing cycle, which is heading up before it has hit bottom.
Coy is Bloomberg BusinessWeek's Economics editor. Gittlesohn is a reporter for Bloomberg News.
New Business March 3, 2010, 8:34PM EST
Housing: Hope on the Horizon
Cash-rich builders are buying land again, betting on a turn in the market for new homes
By Peter Coy and John Gittelsohn
You would think the nation's biggest homebuilders would be writhing in pain right about now. Sales of new single-family homes sank in January to the lowest seasonally adjusted rate in nearly five decades of record keeping and are now off 78% from the housing market's frothy peak in 2005.
Yet in a housing industry as vast and varied as America's, the data often fail to keep up with reality. It turns out that big publicly traded builders, thanks to cost-cutting, asset sales, bond issues, and tax breaks, aren't in grim shape. Their shares have nearly doubled over the past year and they're back in the game of competing for land, reflecting confidence that after years of falling prices, rising foreclosures, and busted dreams, better days are ahead.
The number of lots owned or controlled by a dozen of the biggest builders rose slightly in the second half of 2009 after years of decline as renewed buying offset heavy tax-related selling of unwanted parcels, according to a Bloomberg analysis of company reports. In crash-prone markets such as Southern California and Florida, prices of some construction-ready lots are up 50% or more from their 2009 lows. "There is definitely a shortage of land, and you cannot turn the switch on overnight," says Douglas C. Yearley Jr., executive-vice president of luxury builder Toll Brothers (TOL). "That will cause builders to aggressively buy the land they can."
Land buying began to pick up last year after finished lots hit the market at below the cost of improvements, and housing prices stabilized. Builders could finally turn out homes with some assurance of making a profit, says Scott D. Clark, the CEO of Americap Development Partners, a residential land developer in San Ramon, Calif. Greater affordability and tax incentives should help in the short term. What's more, the big builders believe population growth will eventually require a burst of construction. Warren Buffett agrees. In his Feb. 27 letter to shareholders of Berkshire Hathaway (BRK/A), which owns manufactured-housing maker Clayton Homes, he predicted that "within a year or so residential housing problems should largely be behind us."
Bargain Buying
The builders are staying disciplined for now, selectively scooping up bargains while buying just what they need to meet expected demand for the next few years. "There isn't one public homebuilder that's stupid. They're all well-seasoned. They've shrunk down to the size they need to be, and now they're reacting accordingly" to opportunities for growth, says James T. "Nate" Nathan, the president of Scottsdale (Ariz.)-based land broker Nathan & Associates.
It's tough to say how much land prices have risen because each market is different. Last year, DMB Associates, a developer in Scottsdale, and its partners bought back about 400 lots in DMB's Verrado master-planned community in Buckeye, Ariz., that builders had acquired and then defaulted on. They spent about $15,000 per lot, then quickly resold 300 of the lots to other builders for an average $40,000 per lot. Nationally, though, increases have been considerably smaller than that.
The uptick in prices matters because land is the main factor in real estate's roller-coaster cycle. When housing prices boomed in the middle of the last decade, it wasn't the structures that were suddenly deemed more valuable but the land. Economist Morris A. Davis of the University of Wisconsin-Madison School of Business estimates that the price of U.S. land used for houses and apartments nearly tripled from the beginning of 2000 to the end of 2005. Prices more than tripled over the period in Washington, Miami, Tampa, San Diego, Los Angeles, and Phoenix, and better than quadrupled in two inland California markets, Sacramento and San Bernardino, Davis estimates. He figures that national land prices fell nearly two-thirds through early 2009 before bouncing back more than 20% in the rest of '09. (To calculate the implied value of land, he takes the fluctuating market value of residential properties and subtracts the relatively stable replacement cost of the structures on them.)
The sharp decline in land prices was especially hard on the small builders that account for about 70% of the market. The National Association of Home Builders says its membership has fallen by about 20%, or 45,000. Many that remain have slashed staff. Jerry Howard, CEO of the NAHB, says banks are refusing to extend credit to small builders and stiffening the terms on existing credit.
In contrast, most of the big builders whose shares are publicly traded are battle-hardened and ready to grow again. Writedowns and write-offs by 13 of the largest public builders exceeded $32 billion through December, according to Fitch Ratings. In contrast to small builders, which rely almost entirely on banks for financing, several big builders were able to raise funds by issuing bonds.
Tax-Refund Windfall
An additional boost came last year when Congress passed a law allowing companies to get refunds on past years' tax payments by applying their recent losses to earnings dating back five years. Many sold land at big losses to boost their refunds. The result was a windfall of $2.3 billion for the builders as a group, including $800 million for No. 1 Pulte Homes (PHM).
The result of those balance-sheet heroics? Builders have more than $12 billion in cash they can use to replenish their land inventory. Pulte and D.R. Horton (DHI) each had $1.9 billion in cash and near-term equivalents at the end of December, Toll Brothers had $1.6 billion at the end of January, Lennar (LEN) had $1.3 billion, and KB Home (KBH) had $1.2 billion at the end of November.
Some of that cash is going for parcels that weaker builders lost through default or short sales. On Feb. 25, Starwood Land Ventures of Bradenton, Fla., announced it received "interest from nearly every major homebuilder in Florida" for about 5,400 residential lots it bought in the bankruptcy auction of Hollywood (Fla.)-based TOUSA, one of the few big builders that bit the dust. Lennar was first in line, agreeing with Starwood to acquire or get purchase options on more than 2,700 of the TOUSA lots across Florida. The price wasn't disclosed, but Lennar said it expects to earn gross margins of 20% or better on the deal. In Loveland, Colo., land broker Craig Harrison of Harrison Resource Corp. says he's "in shock and awe" at the amount of interest he's getting from builders and investors for 5,000 acres of land across northern Colorado that recently went on the market for $177 million.
Builders are buying land in part because the parcels they have aren't in the places where they need them. Property on the outer fringes of metro areas is still out of favor, says Daniel Oppenheim, a Credit Suisse (CS) homebuilding analyst. Prices have risen the most for closer-in lots that already have sewer lines, water, electricity, and sidewalks, because builders can throw up houses on them quickly and sign deals by Apr. 30 to qualify for federal homebuyer tax credits. Builders that aren't focused on a quick sales pop are choosing to buy cheaper "paper lots" that lack infrastructure, says Jody Kahn, vice-president of regional markets for Irvine (Calif.)-based John Burns Real Estate Consulting.
Interest in unfinished land usually comes later in the housing cycle, says Thomas E. Lucas, senior vice-president of operations for DMB in Scottsdale. "We didn't think we'd sell raw land for three to four years," Lucas says. That's a striking vote of confidence considering the threats to housing from high unemployment, rising mortgage rates, and foreclosures.
Everything seems to happen faster these days—including the housing cycle, which is heading up before it has hit bottom.
Coy is Bloomberg BusinessWeek's Economics editor. Gittlesohn is a reporter for Bloomberg News.
Tuesday, March 2, 2010
Will U.S. manufacturing lead job creation?
So far the US economic recovery has been jobless. But unemployment is a lagging indicator. Employers won’t add permanent jobs until they see rubust demands for their products. They’ll increase hours per worker first, then add temp workers, before they hire new ones. This Friday’s employment report will again be a critical one for the market.
Yet arguably a better way to look at job creation is in the leading sectors. US manufactoring has been expanding in recent months. It’s one of the potential leading sectors for job creation, besides technology, healthcare and governments. The just-released Institute of Supply Management (ISM) report for Feburary is worth a close look.
The table below gives a snap shot of manufacturing in February. Click to enlarge.
The PMI came in at 56.5, still expanding but at a slower pace compared to January’s 58.4. This is the 7th month of consecutive expansion. Much of this expansion has been discussed or associated with replenishing business inventories. But notice how it coincides with the continuing expansions in both export and import.
And both surging export and inventory restocking was the main factors behind 4Q GDP’s 5.9% growth. Many commentators and economists are worried that the “one-time” inventory effect will not last long. Yet, looking at the ISM report, Customers’ Inventory index is still too low, even though it registered one of the highest increase in February. One can make a case that the inventory push may still have some way to go towards contributing to GDP growth in 2010.
The most important trend to focus on is the Manufactoring Employment index, which has recovered dramatically since the depth of the great recession and is now in its 3rd month of expansion. Manufacturers appear to be hiring for real to produce goods that go to replenishing inventories and to export. This trend is certainly helped by the weak dollar, notwithstanding the recent strength due to Euro-zone turmoil. It’s also helped by the abundant supply of labor.
The strength in export will most likely continue because emerging market consumers are now consuming more than that by US consumers, according to JP Morgan’s recent estimate.
Much of the strength may ultimately depend on US consumers. Here we run into a loop. For US consumers to step up their consumption, there has to be more jobs. But to create more jobs, US businesses need the consumers to step up spending. There is no circularity of logic here, it’s a feedback loop that can go either way. On the way leading to contraction, the loop went negative until it hit a bottom. Now, on the way to recovery, we believe that this feedback loop has become a positive one: More consumer spending will lead to more jobs and more jobs will lead to more consumer spending. The initial trigger for this positive loop was probably the inventory rebuild and external demand.
We leave governments outside of this picture, because public spending and financial stabilization were critical but are not part of the normal forces that the economy can count on.
CalculatedRisk shows an interesting regression result on ISM employment index on changes in BLS employment, and stated:
“Although there is significant variability, the current level of 56.1 percent in February suggests around a 22,000 gain for manufacturing jobs.” Click to enlarge.
Obviously, US will need a lot more than 22,000 jobs per month from manufacturing if it is going to lead the job creation. Let us say 88,000. Using the slope CalculatedRisk computed, that level of job creation would imply a reading of 74.4 for the ISM employment index. Such a high level is off the chart, as can be seen from the index series above for the recent decades. In fact, the highest reading in the ISM series went back to the Feburary of 1951 when it registered a 73.7 reading. We all know the history of US manufacturing since then, especially in the 1990s and 2000s. Many manufacturing jobs have gone overseas to low-cost producers such as China and India.
Certainly the competitive envornment has changed since the 1990s. Wages have increased in these development nations. Energy costs have increased dramatically, along with the costs of raw materials. With high unemployment and a favorable monetary policy, US does have a fighting chance, provided the healthcare costs can be brought under control.
The challenge is huge.
Yet arguably a better way to look at job creation is in the leading sectors. US manufactoring has been expanding in recent months. It’s one of the potential leading sectors for job creation, besides technology, healthcare and governments. The just-released Institute of Supply Management (ISM) report for Feburary is worth a close look.
The table below gives a snap shot of manufacturing in February. Click to enlarge.
And both surging export and inventory restocking was the main factors behind 4Q GDP’s 5.9% growth. Many commentators and economists are worried that the “one-time” inventory effect will not last long. Yet, looking at the ISM report, Customers’ Inventory index is still too low, even though it registered one of the highest increase in February. One can make a case that the inventory push may still have some way to go towards contributing to GDP growth in 2010.
The most important trend to focus on is the Manufactoring Employment index, which has recovered dramatically since the depth of the great recession and is now in its 3rd month of expansion. Manufacturers appear to be hiring for real to produce goods that go to replenishing inventories and to export. This trend is certainly helped by the weak dollar, notwithstanding the recent strength due to Euro-zone turmoil. It’s also helped by the abundant supply of labor.
The strength in export will most likely continue because emerging market consumers are now consuming more than that by US consumers, according to JP Morgan’s recent estimate.
Much of the strength may ultimately depend on US consumers. Here we run into a loop. For US consumers to step up their consumption, there has to be more jobs. But to create more jobs, US businesses need the consumers to step up spending. There is no circularity of logic here, it’s a feedback loop that can go either way. On the way leading to contraction, the loop went negative until it hit a bottom. Now, on the way to recovery, we believe that this feedback loop has become a positive one: More consumer spending will lead to more jobs and more jobs will lead to more consumer spending. The initial trigger for this positive loop was probably the inventory rebuild and external demand.
We leave governments outside of this picture, because public spending and financial stabilization were critical but are not part of the normal forces that the economy can count on.
CalculatedRisk shows an interesting regression result on ISM employment index on changes in BLS employment, and stated:
“Although there is significant variability, the current level of 56.1 percent in February suggests around a 22,000 gain for manufacturing jobs.” Click to enlarge.
Obviously, US will need a lot more than 22,000 jobs per month from manufacturing if it is going to lead the job creation. Let us say 88,000. Using the slope CalculatedRisk computed, that level of job creation would imply a reading of 74.4 for the ISM employment index. Such a high level is off the chart, as can be seen from the index series above for the recent decades. In fact, the highest reading in the ISM series went back to the Feburary of 1951 when it registered a 73.7 reading. We all know the history of US manufacturing since then, especially in the 1990s and 2000s. Many manufacturing jobs have gone overseas to low-cost producers such as China and India.
Certainly the competitive envornment has changed since the 1990s. Wages have increased in these development nations. Energy costs have increased dramatically, along with the costs of raw materials. With high unemployment and a favorable monetary policy, US does have a fighting chance, provided the healthcare costs can be brought under control.
The challenge is huge.
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