Real Healing Yet to Begin

 | Jan 25, 2012 | 2:30 PM EST
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Of all of my business responsibilities, the one I enjoy the most is speaking to audiences about the economy.

I enjoy the excitement of attendees as they begin to discover that there are real, easily identifiable guidelines they can follow to understand how the economy works and what it portends for the future. 

One of the guidelines I explain is what I call the "ABCs of Global Macro."

The point of the ABCs is to stress the importance of housing to the health of the US economy and that housing is a leading indicator of economic activity.  If you want to predict what the prospects are for the US economy over the next 12-24 months, you must first determine what the prospects for housing are.

A mental rule to follow to train yourself on the importance of this is to think "housing" everyone you hear the word "economy." It's Pavlovian, but it works.

Housing is still contracting on a national aggregate basis. Home values are still declining and foreclosures continue to increase. The US economy cannot even begin a private sector economic recovery, let alone sustain one, until this is resolved.

The economic rebound since the 2008/9 financial crisis that panicked consumers and investors has been built on monetary and fiscal stimulus and continues to be supported by such. Private sector consumption and job creation are still anemic.

And nobody should expect anything else while home prices and housing activity continue to slide. People are afraid and their fear is warranted, not irrational. 

At the height of the housing crisis, the aggregate homeowner equity was at an all-time high of about 65%, with the other 35% being mortgaged. Today, just six years later, equity declined to a record low of 30%. 

Consumers have yet to fully adjust to the ramifications of this. There is still a sense of denial that has been encouraged by promises of loan modifications and monetary stimulus.

As a result, homeowners and consumers more broadly have not adjusted their consumption habits to the new reality that home prices are not going to rebound.

Because the consumer has continued to spend and the Fed has continued to print, many advisers point out the well-worn advice of "don't bet against the US consumer" and "don't fight the Fed." In normal economic environments that would be good advice. But these are not normal environments. 

What investors and advisers should prudently be anticipating is the emergence of post-traumatic stress disorder being exhibited by home owners and consumers once they begin to come to grips with the reality that the equity that has been wiped out in the past six years isn't coming back anytime in the next several years, maybe decades.                             

Once investors resign themselves to this reality, income will shift away from consumption and toward savings. 

Part of this process is similar to the stages of grief people go through when dealing with the loss of a loved one: denial, recognition, fear, anger/blame, acceptance and finally resignation/resolution.

This process can take years. The resignation/resolution stage can last the rest of someone's life.    

So far, the government promises and monetary stimulus have been precluding this process from running its course and the real healing of the economy from beginning.

"You can fool all the people some of the time, and some of the people all the time, but you cannot fool all the people all the time" is something to keep in mind every time you are told not to fight the Fed or bet against the consumer.

Incremental reductions in home values from this point forward will result in exponential increase in defaults, short sales and foreclosures as home owners finally give up after six years and failed corrective government measures. 

The stocks most at are stake the three money centers with the largest percentages of residential mortgages: Wells Fargo (WFC), Bank of America (BAC) and JPMorgan Chase (JPM). In the last two months WFC and JPM are up about 30%, while BAC is up about 44%, back to where they were last summer.

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