Lou Barnes’ weekly economic advice for real estate investors

Wow. What was that all about? For one thing, not the U.S. economy. Another thing not about: mortgage rates, just about back where they were before the stock market circus. Take it one piece at a time….

Pay as little attention as possible to the stock market. It enjoyed a one-way rally for three years, and was way overdue for waves of profit-taking — for any reason or no reason at all. But two fundamentals remain unchanged: if you sell your stocks there is nothing useful to do with the money, just safety plays with little or no yield; and second, business conditions and earnings are still good, especially in the U.S.

With those two forces in place it’s hard to get a deep unwind underway. To harm the real economy, stocks have to crash. The real economy may not be accelerating, but it is not slowing in any meaningful way. U.S. manufacturing is very strong, aided by energy costs as little as one-third those of competitors overseas. September industrial production rose 1%.

Job market signals are super-strong but somehow misleading, not pushing wages up. Claims for unemployment insurance fell to 264,000 last week, a level triggering Fed tightening any time in the last 40 years. September retail sales fell .3%, yet another accurate sign of wage weakness. Housing starts are up 9% in nine months, but the whole shebang is apartments, not homes for equity-building.

Where’s the economic fire?

If the U.S. economy is as-was, where’s the fire? Europe. Again. Linkage to markets here are strange but powerful.

The euro experiment has been a disaster because it requires economic changes beyond cultural tolerance. Non-German Europe has never been as productive as Germany. For accounts to balance among 19 nations, the strong must adopt behavior reciprocal to the weak until the weak adopt the productive culture of the strong. For the euro to work, Germany must become consumer-based, inflation tolerant, and an importer. Italy, Spain, and, France must “reform:” shrinking their welfare states, making it easy to hire and fire workers, start and close new businesses.
Ain’t gonna happen. Never is a long time, but never. The European Central Bank (ECB) has bought time. It has given an insolvent euro-banking system enough cash to soak up sovereign debt still flooding from every treasury but Germany’s. Three years ago sovereign bonds all over Europe entered a fire sale, yields soaring. The ECB put out the fire by blustering, saying it would buy these bonds if markets dared to sell against it.

The ECB has not bought a single bond, and markets want to see the cash. The proximate cause of all the market hoo-ah this week has been awful economic news out of Europe, GDPs falling into recession and disinflation turning to deflation. The telltale is bonds, not stocks. Euro-zone bonds have decoupled again: German 10s trade 0.82%, Greek 10s 8.90% (up a full point this week), Spain’s 2.20% and Italy’s 2.56%.
Global markets have caught their breath at week’s end because everyone assumes Europe will try something to save itself. However, markets also assume that so much damage has been done to real economies that nothing will work. This crisis will recur, and on shorter cycle than prior ones.
From Europe outward, effects caromed like a pool-table break. A new European recession is profoundly deflationary for the world, thus intercepting Fed intentions to raise rates. Markets and the Fed itself had adopted “liftoff” to describe the Fed’s initial moves above zero. Now we’re groping for new slang to describe a new Fed predicament: any liftoff will be followed soon by a return to zero. “Crash” is too strong, but “dead stick” is close. James Bullard, St. Louis Fed Prez, for months a big, fluffy hawk this week said quantitative easing (QE) should be reconsidered.
ECB and Fed chatter will lurch markets temporarily, but the global bond rally reflects deep belief that the central banks have shot their wads. Now it’s up to economies themselves, and in Europe the possibility of political exhaustion with the euro experiment. The day it folds will be rough, but global recovery would follow.
10-year T-note, two years back. The run-up to 2.60% last month was in false anticipation of Fed tightening. Although back to 2.20% from 2.00% midday Wednesday (intra-day 1.87%!), the downtrend is intact, and no reason not to test last year’s lows in months (years?) ahead.

10-year T-note just this week. Mortgages touched 3.875% on Wednesday but are right back above 4.00% now.

Oil one year back. A stimulus of sorts here in the US, but not enough to offset poor wages and slowing effects of a rising dollar and incipient deflation everywhere. Oil is invoiced in dollars, thus the strong dollar cancels the overseas benefit of lower nominal price. Everyone hopes the price drop will make miserable the grandiose life of Czar Vladimir. Fatally so, I hope.

Euro in dollars, one year. Currency calculus is weird. The dollar was rocketing (euro down) in market expectation of Fed liftoff. Now the Fed is grounded, so the dollar has canceled some of its ovedone move. Fed or no Fed, more economic weakness overseas and the dollar rocket will re-ignite.

Hard to tell if retail sales have resumed their four-year downtrend in growth rate, or just stabilized. Acceleration is a dream of administration-supporting Lefties and stock salesmen.

What happens if this indication of job-market overheating is real, and wages start to rise at a significant pace? The Fed will tighten. Liftoff, no matter what is going on overseas.

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