Been Away For Two Weeks .....

[LuckyOne]

Having been away from the hype and the spin of the UK market for just over two weeks, and having had the chance to watch the implosion that is California and Nevada, four distinct but related themes emerged from watching what is happening "over there" :

1. Prices can diverge from fundamental value over long periods of time. Generally prices exceed values in bull markets / bubbles but it is not impossible for this to happen for short periods of time during bear markets. In fact, counter-trend bear market rallies tend to be more violent than rallies in bull markets albeit over very short peroids of time. We have had a bear market rally in stocks, sterling and house prices (by some measures) in the last few months. This is only relevent to traders as we are still clearly in a complete mess from a fundamental perspective.

2. Cash buyers who spend more than 15% of their net worth on houses are going to get hurt. They need the other 85% of their net worth to protect against a potentially extreme inflationary or deflationary outcome over the next three to five years. No matter how strongly people hold their inflation / deflation view, the simple fact of the matter is that no-one knows what will happen. Buying a house for cash in a deflationary or inflationary environment will probably result in a loss in value in real terms. The only realistic hedge is a diversified portfolio of inflation linked bonds and very high quality stocks. To safely spend £1,000,000 on a house really requires a net worth of £6,666,667.

3. Prices can revert back to those that a cash buyer would be willing to pay. Property in California and Nevada has fallen enough that prices are approaching the level that cash buyers would be interested in buying them at. This is a natural consequence of the fact that borrowing capacity is being withdrawn at such a rapid rate that cash buyers are the only ones left standing. Deleveraged prices are much lower than leveraged prices.

4. Taxes are rising globally. As assets are purchased from after tax income, rising taxes can only serve to lower asset prices (on either a leveraged or an unleveraged basis).

I know that the UK is not the same as California or Nevada. I am also certain that the four bearish themes that I have identified are global rather than local. The bull case has yet to be established. This sharp bear market rally of the last couple of months is going to hurt far more people than it helps by the time the market has completely played itself out.

[LuckyOne]

Hope you had a good break LuckyOne, you have missed all the fun her with the equity market being bumped over the 200 day moving average to try and get the fund managers buying, trouble is they don't have long with the bond looking over their shoulder.

It was good to be away and to be able to reflect on what is happening. A weakness that I suffer from (one of many) is that I sometimes allow my views to be clouded by market noise. Hopefully I am now back on track.

I agree completely with your assessment that the rates at which future cashflows (for all points on the term structure beyond about 6 months) are in the process of rising which will depress asset values.

The bear market rally is close to being over.

The real economy is fücked and still deteriorating. Asset prices have to follow.

My view is that people who did not sell into this little bear market rally are going to regret not having done so when they look back at April / May in Spetember / October.

[Confounded]

Having been away from the hype and the spin of the UK market for just over two weeks, and having had the chance to watch the implosion that is California and Nevada, four distinct but related themes emerged from watching what is happening "over there" :

Hope you had a good break LuckyOne, you have missed all the fun her with the equity market being bumped over the 200 day moving average to try and get the fund managers buying, trouble is they don't have long with the bond looking over their shoulder.

[LuckyOne]

Sure.

And if it props up prices to near Pds.159/160,000 and then dies a death in the summer,

it will be a classic Dead Cat Bounce, serving its purpose to draw in the suckers, and then

destroy their hopes.

Yes.

And we know how things turn out when positions get passed to weak hands during counter-trend moves. Ouch ......

[lowrentyieldmakessense(honest!)]

california gets a mention here

link

Round Two

Most subprime mortgages had teaser rates lasting 2 or 3 years. Alt-A and Option-ARM mortgages usually had teaser rates of 5 to 7 years.

That's why you saw the subprime market implode first.

However, most Option-ARM mortgages had "triggers" in their contracts so that they would automatically amortize once they've reached a certain level of negative equity, usually around 110%. (see this link for a detailed explanation)

The Option-ARM market was overwhelmingly concentrated in the state of California.

Round Three

The Alt-A market is the other ticking timebomb about to explode.

Years before the resetting of Alt-A mortgages has peaked defaults are already skyrocketing. If this trend continues it would easily be the worst mortgage class of them all.

Finally, we need to mention one of the safer of the mortgage classes - jumbo.

Edited June 2, 2009 by lowrentyieldmakessense(honest!)

[LuckyOne]

california gets a mention here

link

A great summary of everything that has gone wrong (and continues to go wrong).

I may be too simplistic in my view but I think that the US might have had more complicated products than we did but that we share the common problem of freely available debt being drawn down by many who could not hope to ever be able to afford to repay it being used to inflate house prices far above their value.

The crash continues despite a bear market rally.

[LuckyOne]

Good post.

I decent antidote to some of the extreme nonsense being posted here,

and I am getting tired of fighting.

The HOPE is so strong now, you can cut it with a knife.

That is not bullish !

To completely mangle Marie Antoinette's phrase, you cannot eat hope.

[IBlewItLastTime]

If you look at the markets from the perspective of the US or UK (and actually I think we are a California) it all looks knackered.

I am trying to look at this globally and weigh up the influence of the relatively cash rich economies in the East, dominated by a rapidly emerging state-run economy. For them, the end of the world hasn't come, its basically a problem with collapsing foreign markets.

If the bond market goes, then we are all in trouble and the UK in particular is toast. But from a world perspective its not obvious whats happening.

I do subscribe to the weight of money idea, and money will surge to equities in order to get returns it previously got from property or bonds. But it could easily all surge to commodities if things get hairy

[LuckyOne]

Good post.

I decent antidote to some of the extreme nonsense being posted here,

and I am getting tired of fighting.

The HOPE is so strong now, you can cut it with a knife.

That is not bullish !

You did call the counter-trend, technical, bear market rally perfectly.

There is no fundamental reason for this little rally to be anything other than short lived and purely technical.

[grizzly bear]

2. Cash buyers who spend more than 15% of their net worth on houses are going to get hurt. They need the other 85% of their net worth to protect against a potentially extreme inflationary or deflationary outcome over the next three to five years. No matter how strongly people hold their inflation / deflation view, the simple fact of the matter is that no-one knows what will happen. Buying a house for cash in a deflationary or inflationary environment will probably result in a loss in value in real terms. The only realistic hedge is a diversified portfolio of inflation linked bonds and very high quality stocks. To safely spend £1,000,000 on a house really requires a net worth of £6,666,667.

please can you clarify.. presumably you are talking about the very wealthy here? ie do you mean that someone with say a STR fund of £500k should only spend £100k (as a cash purchase) on a house????

[LuckyOne]

please can you clarify.. presumably you are talking about the very wealthy here? ie do you mean that someone with say a STR fund of £500k should only spend £100k (as a cash purchase) on a house????

Good question. I haven't really defined it that well in my own mind.

Part of the problem in this bubble period in the last 12 years or so is that many of us have changed our definition of "wealthy". To my mind, a net worth of £500k is wealthy.

If I had a net worth of £500k and was in my mid 40s, I would not feel that comforable having much more than £100k of my total net worth tied up in a house. If I was completely secure in my job, I might be comfortable carrying a mortgage of something like £250k. That would leave me in a house "worth" something like £350k. If I was really scared about the future, I might not want to have any debt and would choose to spend £100k and no more.

The problem with the bubble is that many people with a net worth of £500k ended up putting down a deposit of £400k and leveraging it up 4 times and living in houses worth £2 million with no room for error if things went wrong.

My example might be too extreme but I think that the rule of thumb of having no more than 15% to 20% of net worth tied up in housing is a reasonable one as it imposes a discipline which will prevent one from "investing" too much in shelter and not keeping enough in reserve against negative outcomes.

I realise that this is an extremely cautious way of looking at the world and is not for everyone but it does help avoid catastrophe if things don't turn out well.

[grizzly bear]

Good question. I haven't really defined it that well in my own mind.

Part of the problem in this bubble period in the last 12 years or so is that many of us have changed our definition of "wealthy". To my mind, a net worth of £500k is wealthy.

If I had a net worth of £500k and was in my mid 40s, I would not feel that comforable having much more than £100k of my total net worth tied up in a house. If I was completely secure in my job, I might be comfortable carrying a mortgage of something like £250k. That would leave me in a house "worth" something like £350k. If I was really scared about the future, I might not want to have any debt and would choose to spend £100k and no more.

The problem with the bubble is that many people with a net worth of £500k ended up putting down a deposit of £400k and leveraging it up 4 times and living in houses worth £2 million with no room for error if things went wrong.

My example might be too extreme but I think that the rule of thumb of having no more than 15% to 20% of net worth tied up in housing is a reasonable one as it imposes a discipline which will prevent one from "investing" too much in shelter and not keeping enough in reserve against negative outcomes.

I realise that this is an extremely cautious way of looking at the world and is not for everyone but it does help avoid catastrophe if things don't turn out well.

going back to the £500k example, you are saying better to have a £250k mortgage and hence £250k in other investments rather than a paid for house no other investments? i can see the point re: diversification BUT if you are subject to tax on income at 40% no point in holding cash, better to have paid mortgage down.

re: spending £100k and no more - well in London that would buy a one bed studio in a crappy area, and i don't see prices falling enough that one could buy a small family house for that.

i am very cautious but don't really want to bring my kids up in a studio flat!

[LuckyOne]

going back to the £500k example, you are saying better to have a £250k mortgage and hence £250k in other investments rather than a paid for house no other investments? i can see the point re: diversification BUT if you are subject to tax on income at 40% no point in holding cash, better to have paid mortgage down.

re: spending £100k and no more - well in London that would buy a one bed studio in a crappy area, and i don't see prices falling enough that one could buy a small family house for that.

i am very cautious but don't really want to bring my kids up in a studio flat!

If you are certain that you will be employed (or employable) for the rest of your natural working life, then paying down a mortgage is the most efficient use of funds from an after tax perspective.

If you worry about large gaps in employment, having cash to hand is very valuable. Even if you are mortgage free, an extended period of unemployment could be catastrophic as it is difficult to source new debt while unemployed even if you have a large value in your house.

As I freely admit, I am very conservative and prefer to rent until I have enough wealth that I can weather just about any storm that life throws at me rather than becoming vulnerable to the impact that debt would have on me if my financial circumstances take a turn for the worse.

Most of my perers think that I am insane for being so conservaitive. They certainly appeared to be right from about 2001 to mid 2007 and wrong from mid 2007 to to-day.

Wealth can be destroyed at least 5 times more quickly than it can be created for most of us.

I always think about how I would feel about losing half my wealth compared to doubling it. When I was younger, the balance was in favour of wealth creation. It is now massively in favour of wealth preservation.

[Confounded]

If you are certain that you will be employed (or employable) for the rest of your natural working life, then paying down a mortgage is the most efficient use of funds from an after tax perspective.

If you worry about large gaps in employment, having cash to hand is very valuable. Even if you are mortgage free, an extended period of unemployment could be catastrophic as it is difficult to source new debt while unemployed even if you have a large value in your house.

As I freely admit, I am very conservative and prefer to rent until I have enough wealth that I can weather just about any storm that life throws at me rather than becoming vulnerable to the impact that debt would have on me if my financial circumstances take a turn for the worse.

Most of my perers think that I am insane for being so conservaitive. They certainly appeared to be right from about 2001 to mid 2007 and wrong from mid 2007 to to-day.

Wealth can be destroyed at least 5 times more quickly than it can be created for most of us.

I always think about how I would feel about losing half my wealth compared to doubling it. When I was younger, the balance was in favour of wealth creation. It is now massively in favour of wealth preservation.

Spot on, but being conservative with your wealth is a lonely camp to be in, even now after being through what we have been through because too many people have been protected from the new financial reality. I am hoping my will to preserve what I have rather than increase it will pay off in the long run. I am relatively young so have plenty of time to repent being careful

[catsick]

If you are certain that you will be employed (or employable) for the rest of your natural working life, then paying down a mortgage is the most efficient use of funds from an after tax perspective.

If you worry about large gaps in employment, having cash to hand is very valuable. Even if you are mortgage free, an extended period of unemployment could be catastrophic as it is difficult to source new debt while unemployed even if you have a large value in your house.

As I freely admit, I am very conservative and prefer to rent until I have enough wealth that I can weather just about any storm that life throws at me rather than becoming vulnerable to the impact that debt would have on me if my financial circumstances take a turn for the worse.

Most of my perers think that I am insane for being so conservaitive. They certainly appeared to be right from about 2001 to mid 2007 and wrong from mid 2007 to to-day.

Wealth can be destroyed at least 5 times more quickly than it can be created for most of us.

I always think about how I would feel about losing half my wealth compared to doubling it. When I was younger, the balance was in favour of wealth creation. It is now massively in favour of wealth preservation.

As you say I think it very much relates to the age you are and what your family needs are , when I was 22 I had zero net worth and took out a 5 times sallary mortgage and crossed my fingers, that was the right thing to do at the time , last year at 40 , I did as you suggested and bought a place to live in for about 15% of net worth, but that just happened to be where me and the wife wanted to be living and was also the right thing to do . If you are young and have money in the bank and live in crappy accomodation you are going to have to suck it up and spend all your money or be miserable .... trying to time the market is ok over a 1-3 year horizon but at the end of the day living in the studio for 10 years is going to ruin your life and your family will leave you ....

[dances with sheeple]

Good thread, some realism for a change.

[Confounded]

As you say I think it very much relates to the age you are and what your family needs are , when I was 22 I had zero net worth and took out a 5 times sallary mortgage and crossed my fingers, that was the right thing to do at the time , last year at 40 , I did as you suggested and bought a place to live in for about 15% of net worth, but that just happened to be where me and the wife wanted to be living and was also the right thing to do . If you are young and have money in the bank and live in crappy accomodation you are going to have to suck it up and spend all your money or be miserable .... trying to time the market is ok over a 1-3 year horizon but at the end of the day living in the studio for 10 years is going to ruin your life and your family will leave you ....

If you are young and have money in the bank you are far from trapped in a studio, where I live I can rent a 5 bed farmhouse with land (1-2 acres) for less than some of our friends are paying out on mortgages (at these rates!) for a far smaller place even after they have had a good chunk of purchase cost covered by a parental donation.

I rent a place that at peak I could have bought 2 of for cash, I chose to rent it because its location is ideal even if a little extra space would be handy (growing family). It is also cheap due to it being a friends house (I have lived in two rentals since selling and both have been through friends at a good rate, it is amazing how many people are stuck with a property atm and are just happy to have a good hassle free tenant).

I get fed up with people scaring people out of rented accommodation because it is small and your wife will leave you, absolutely rubbish just move to a bigger place if it becomes a problem. I see far harder times for my friends and peers who chucked the kitchen sink into buying at the absurdly ridiculous prices of 07, many of which are not ideal for a family of 4 which mine is. At current prices people going in now will not find it much easier. I have no problem with renting and although I would enjoying buying our next family home in this climate there is no way I am tying up my capital into a house at these prices, it would need to be a bargain and possibly even provide a livable income. As Luckyone says it is not sensible to have all your net worth tied in a house (something you have clearly deduced for yourself). With the job uncertainty I may prefer to use the money to start/buy a business and earn a living from the capital rather than just living in it with no income!

[grizzly bear]

If you are certain that you will be employed (or employable) for the rest of your natural working life, then paying down a mortgage is the most efficient use of funds from an after tax perspective.

If you worry about large gaps in employment, having cash to hand is very valuable. Even if you are mortgage free, an extended period of unemployment could be catastrophic as it is difficult to source new debt while unemployed even if you have a large value in your house.

As I freely admit, I am very conservative and prefer to rent until I have enough wealth that I can weather just about any storm that life throws at me rather than becoming vulnerable to the impact that debt would have on me if my financial circumstances take a turn for the worse.

Most of my perers think that I am insane for being so conservaitive. They certainly appeared to be right from about 2001 to mid 2007 and wrong from mid 2007 to to-day.

Wealth can be destroyed at least 5 times more quickly than it can be created for most of us.

I always think about how I would feel about losing half my wealth compared to doubling it. When I was younger, the balance was in favour of wealth creation. It is now massively in favour of wealth preservation.

I think it depends on what your wealth is in relation to your salary - and also would be easier to find a new job (on same salary) if you earned £50k than if you earn £250k.

As you say I look at my friends who are living in houses costing 3 or more times their net wealth, (eg LTV of 25% and not other significant assets) and I would not be comfortable with that, although I can see that they have had little choice but to live this way.

I will feel comfortable spending all STR money on a house, with a (small) mortgage - (def less 2x joint) - as I am confident that either me or husband will have job, and we will be significantly more secure than most other people. We are not buying now as I don't want to loose STR on house price drops but there will come a point where I am happy to do this.

[LuckyOne]

I think it depends on what your wealth is in relation to your salary - and also would be easier to find a new job (on same salary) if you earned £50k than if you earn £250k.

As you say I look at my friends who are living in houses costing 3 or more times their net wealth, (eg LTV of 25% and not other significant assets) and I would not be comfortable with that, although I can see that they have had little choice but to live this way.

I will feel comfortable spending all STR money on a house, with a (small) mortgage - (def less 2x joint) - as I am confident that either me or husband will have job, and we will be significantly more secure than most other people. We are not buying now as I don't want to loose STR on house price drops but there will come a point where I am happy to do this.

Being disciplined about your entry point into the market certainly gives you a lot of protection against the risk of having too high a proportion of your net worth tied up in property.

As you correctly point out, having two incomes from jobs in non-correlated businesses also allows you to be less conservative than I have suggested.

I met two couples recently in California who have gone from "lifestyles of the rich and famous" to broke in the last year because they did not understand that spending all of your money on a house when one is an estate agent and the other is an interior designer in one case and a title guarantor in the other case is not a good idea.

[abharrisson]

Having been away from the hype and the spin of the UK market for just over two weeks, and having had the chance to watch the implosion that is California and Nevada, four distinct but related themes emerged from watching what is happening "over there" :

1. Prices can diverge from fundamental value over long periods of time. Generally prices exceed values in bull markets / bubbles but it is not impossible for this to happen for short periods of time during bear markets. In fact, counter-trend bear market rallies tend to be more violent than rallies in bull markets albeit over very short peroids of time. We have had a bear market rally in stocks, sterling and house prices (by some measures) in the last few months. This is only relevent to traders as we are still clearly in a complete mess from a fundamental perspective.

2. Cash buyers who spend more than 15% of their net worth on houses are going to get hurt. They need the other 85% of their net worth to protect against a potentially extreme inflationary or deflationary outcome over the next three to five years. No matter how strongly people hold their inflation / deflation view, the simple fact of the matter is that no-one knows what will happen. Buying a house for cash in a deflationary or inflationary environment will probably result in a loss in value in real terms. The only realistic hedge is a diversified portfolio of inflation linked bonds and very high quality stocks. To safely spend £1,000,000 on a house really requires a net worth of £6,666,667.

3. Prices can revert back to those that a cash buyer would be willing to pay. Property in California and Nevada has fallen enough that prices are approaching the level that cash buyers would be interested in buying them at. This is a natural consequence of the fact that borrowing capacity is being withdrawn at such a rapid rate that cash buyers are the only ones left standing. Deleveraged prices are much lower than leveraged prices.

4. Taxes are rising globally. As assets are purchased from after tax income, rising taxes can only serve to lower asset prices (on either a leveraged or an unleveraged basis).

I know that the UK is not the same as California or Nevada. I am also certain that the four bearish themes that I have identified are global rather than local. The bull case has yet to be established. This sharp bear market rally of the last couple of months is going to hurt far more people than it helps by the time the market has completely played itself out.

Whatever you were smoking in california must surely be illegal over here.

[grizzly bear]

Being disciplined about your entry point into the market certainly gives you a lot of protection against the risk of having too high a proportion of your net worth tied up in property.

As you correctly point out, having two incomes from jobs in non-correlated businesses also allows you to be less conservative than I have suggested.

I met two couples recently in California who have gone from "lifestyles of the rich and famous" to broke in the last year because they did not understand that spending all of your money on a house when one is an estate agent and the other is an interior designer in one case and a title guarantor in the other case is not a good idea.

presumbly you don't just mean "spending all of your money" but mean instead, spending all your money AND mortgaging all your future money on a house.

if one bought a house for cash even if it was 100% net wealth, then provided if they lost their jobs they were confident about finding another to cover basic living costs (eg food, utilities, etc) they they wouldn't be broke.

i guess its about living within ones means.