Weekend Edition: June 23-24, 2007
Reverse indicators. Do you use them? I use the term to describe someone or something that is more often wrong than right. My favorite example of a reverse indicator, and its use, is found in George Muzea’s The Vital Few Vs. The Trivial Many. In one section of this fantastic book, Muzea talked about his experience as a stockbroker with E.F. Hutton in New York, where he had a client that was “always wrong at decision time.” He recalled, “I used to call him and tell him about a stock I liked. If he liked the idea, I never offered it to my clients, including him. If he did not like the idea, I aggressively marketed the stock. Even the other brokers would ask me to call my reverse indicator to see if he liked their ideas.” Eventually, the client lost his job and had to close his account. The E.F. Hutton brokers threw a party in his honor, and as Muzea remembers, “We were depressed for him and us.”
When trying to figure out where the U.S. economy is headed, I look to the American consumer as one of my favorite reverse indicators. Specifically, I examine what Americans are spending their “hard-earned” dollars on. I’m being sarcastic here, because Americans no longer depend on savings to make a purchase. Instead, items are bought on credit. And who can blame them? The Federal Reserve was more than accommodating in helping U.S. consumers achieve instant gratification by lowering the Federal Funds Target Rate (short-term rate objective of the Fed) all the way down to 1% back in 2003. With interest rates so low, consumers financed purchases, especially when it came to big-ticket items.
So why do I examine what Americans are buying? Because of the correlation between frivolous spending and the top of an economic cycle. And what are some of the more notable non-essential purchases being made by consumers? Glad you asked. My favorites include:
Bottled Water- Americans drank 26 gallons of bottled water per person last year, or $11 billion worth. As the Sierra Club website notes, “It’s an amazing new fad, one of the most successful advertising hypes in recent history. Advertising for bottled water suggests that drinking water in plastic can make you thin, sexy, healthy, affluent, and environmentally responsible. Water bottles have become a fashion accessory.” However, studies don’t agree that it is any safer than tap water. Yet, in the U.S. a sip of bottled water costs on average 1,000 times a sip of water from the tap.
Outdoor Rooms- According to the Wall Street Journal back on June 8, “Outdoor rooms, one of the decade’s most visible symbols of excess, have been a bonanza for manufacturers of everything from $3,700 waterproof pool tables to $130 patio umbrellas that emit a cooling mist. About one million households have outdoor kitchens, with such features as built-in grills and cooktops, outdoor stereos and TVs, refrigerators— even dishwashers.” Surprisingly, homeowners are finding out about the long hours of upkeep and costly repair involved with these expensive backyards. As a result, some are abandoning the “rooms” altogether.
Retirement Homes For Young Adults- Real estate agents and financial planners around the country are increasingly assisting younger buyers with their purchase of retirement homes for themselves in the years ahead, according to a Wall Street Journal article of May 29. These buyers (30-40 somethings) believe that retirement property is a better investment than other traditional assets classes. One buyer, who was 32 when he bought a place for retirement with his spouse, explained, “The house is an asset, so it’s not like we’re throwing away part of our retirement savings.” A young couple from New Jersey said, “We wanted to get in while it was affordable.”
The last time I saw this kind of spending going on was in the late 1990s. I told anyone willing to listen that we were at the top of an economic cycle and headed downhill. Unfortunately, I think we’re at that point again in the U.S. economy, with an even worse ending in store. So, if there’s anyone you know who’s a “reverse indicator,” ask them where they think the U.S. economy is heading. Better yet, you may want to look at what they’re buying these days.
Enjoy the weekend!
Christopher E. Hill
Editor
editor@boom2bust.com
June 24th, 2007 at 1:05 am
Thanks for the information. I am in the money management business specializing in commercial real estate and am based in the San Francisco Bay Area (20 years in the business). I started reading and following this drama unfold about 5 or 6 years ago when it became clear that cap rates on apartment properties were getting ridiculously low, margins squeezed, and the “winning” proformas based on the assumption that the mania would continue forever. (Oh well, it’s other people’s money.) It went on much longer than I ever expected with the apartment flipper turning into the condo converter and with low cap rates starting in major metropolitan areas and then moving to every corner of the U.S. I have seen what has happened first hand (twice! — also in 1991 in SFR) and the bubble is not just in the residential real estate market. Cap rates on commercial properties are still at historic lows and they are very much tied to the fall in the interest rates that has occurred (and that has now reversed). Cap rates have not yet adjusted back to their historical norms, but they are starting to, though they may take some time to get there as prices tend to be sticky and everyone keeps up the wishful thinking.
The market is correcting right now. Small commercial investors and owner-users that rely on financing have and are leaving the market as the higher interest rates are making the purchase prices unworkable. At last year’s prices, those buildings were negative cash flow right out of the box at fully indexed rates, but with an inverted yield curve, the buyer hasn’t been able to compensate with short-term teaser rates and the illusion that he/she will be out of the property with a nice bit of appreciation before the rate fully adjusts. And heretofore, the pricing was so aggressive that the buyer has been purchasing property “fully priced”. This means the pricing presumes any value-added work is already done. The spread for a buyer’s effort and risk in executing a value-added investment are barely compensated for when compared to a NNN investment.
Drives a rational person crazy but there is money to be made by understanding the behaviorial trends as well.