Market Sentiment

According to the American Association of Individual Investors, their member survey reports bearishness at its lowest level in years.

When one side of the trade is too crowd, you'd better to be on the other side.

Housing Market Bottomed ?

Look at the Case-Shiller index's bottom after the last housing bust in 1989-90 (as the 20-city index did not exist back then, we used the 10-city index). The index bottomed in September 1993 - more than two years after the U.S. economy had begun to recover - at a value of 75.81. Nominal gross domestic product (GDP) rose by 109% between the third quarter of 1993 and the third quarter of 2009.

However, the population rose by about 20%, so nominal GDP per capita rose by 74%. (Real GDP per capita rose by 27%, a pretty mangy performance over 16 years.) House prices can be expected to inflate about as fast as nominal GDP per capita, in a large country like the United States where space is not yet at a premium.

Thus the Case-Shiller Index this time around might be expected to bottom at 132 (75.81 x 174%). Its current value is 157, so we can expect a further 16% drop, even if you assume the bottom is no lower than after the milder housing downturn of 1989-90. That bottom will probably be reached around the end of 2011 if the 1990-93 post-recession pattern plays out.

Deflation vs. Inflation

Money Flows

Debt Overhang Will Reduce Consumption

In the U.S., consumer spending represents about 70% of GDP. After decades of an inflationary “crack-up” boom, people are stuffed to the gills with consumer debt. But it appears that its long build-up has turned down, which is a message businesses should heed.

Many consumer businesses have already received the new message of our times: Consumers want value for their money. The days of widespread upper-end fashion and lavish dining are largely relics of the past. Don’t believe me? Take a look at charts of bebe Stores (BEBE), Abercrombie & Fitch (ANF), Morton Restaurant Group (MRT) and Ruth’s Hospitality Group (RUTH). Consumers’ changing preferences are reflected in their charts, but we’re most likely only at the forefront of decreased consumption!

A review of the past 30 years of debt/disposable income and debt service payments in the chart below shows that they still remain at elevated levels (courtesy of Gary Shilling’s Insight www.agaryshilling.com). Back in 1982, consumers averaged 60% debt-to-income and debt service payments were only 10.5% of disposable income. We witnessed a substantial rise in debt from 1994 through 2006, but that trend has been in reverse for several years now.

The massive U.S. unemployment numbers also create an interesting dynamic. Typically when one loses a job, debt will initially ramp up as the unemployed use debt to offset the lost income. But for many, the loss of a job becomes a life-changing event: Their attitude towards debt in general and the desire to consume begin to wane. So while there may only be 15 million officially unemployed, there are many more that have gone through the unemployed experience lately, which should dampen their desire to consume for years.

Will we return to the early 80s and early 90s level of debt-to-income ratios? Or will it be even worse this time? Imagine the levels of corporate bankruptcies and job losses that would accompany a decline to below a 60% debt-to-income ratio. That would mean that consumers would reduce their outstanding debt by half. Such a scenario is one of the reasons why we at EWI believe that the current recession is not over yet -- and, in fact, believe that it has only just begun.