This extract from John Mauldin’s Thought’s From The Frontline suggests that the downturn in US housing could be bad for inflation:
Indeed, there may be some concerns that the CPI (Consumer Price Index) number could come under pressure from the housing component. Given that home prices are falling, that may be considered odd by many. But CPI does not measure home prices. It measures something called owner’s equivalent rent. And even as house prices rose by 93% in real terms (per Bob Shiller) in the last decade run-up, rent in real terms did not go up all that much, so the cost of a new home was not reflected in the CPI.
Now, we may have the opposite problem. As more and more people cannot get a mortgage coupled with a very precipitous rise in foreclosures, we are seeing more people who need to rent. Rental property availability in many markets is quite tight, which means that rent prices are increasing. If you go to the Bureau of Labor Statistics and look at the housing rent data, it is not too hard to think that the housing component of CPI could easily rise by more than 4% in the fourth quarter given the current trend.
Since the housing component is about 30% of the total CPI, a 4% inflation in housing could be significant. And oil is over $80 and rising. The dollar is falling, meaning that import prices are going to rise. And should we mention that food costs a lot more than this time last year?
The Carbon Disclosure Project released its fifth Global Corporate Climate Change Report, tracking carbon disclosure and attitudes toward climate change in the world’s largest companies. The CDP this year also launched the Climate Disclosure Leadership Index, an honor roll for companies who are best addressing climate change issues. The launch coincided with the U.N. summit on how to mitigate climate change in which over 80 world leaders taking part. These high profile meetings on climate change illustrate the growing pressure on governments, companies and individuals to act now on carbon emission and climate change issues. The CDP is underpinned by over 315 global institutional investors with more than $41 trillion in assets under management, a collaboration includes some of the largest US and foreign institutional investors, including CalPERS, Merrill Lynch, and Goldman Sachs. The CDP has collected 90 new signatories and almost $10 trillion in assets since last year’s report. Although the CDP5 finds that the gap between awareness and action is shrinking, there is still a huge disconnect between awareness and action on the investor side. The CDP calls on governments to help push investors into using carbon disclosure information in their investment making decisions.
John Mauldin writes convincingly that the Fed is trying to preempt the negative consequences of the housing collapse. However, the players in the market are behaving as if a bail out had occurred. In order for the message to be correctly heard, other signals need to be forthcoming. The problem is that asset markets are not responding to the crisis appropriately. Prices should be down, but they are up … the illusion continues.
Are lower rates going to reduce the chance of recession. Not really. The people that will benefit are those least exposed to the sub-prime problem; those higher up the income ladder. And it won’t encourage a change in behaviour of them either. In fact we will continue to do our supermarket shopping …
Hugh Moore of Guerite Advisors writes:
“Consumer spending accounts for two-thirds of the U.S. economy. Total Household Debt is particularly important in supporting the growth of consumer spending. This indicator includes mortgage debt due to the important role that Home Equity Withdrawal (HEW) has played in sustaining the growth in consumption since the beginning of the decade.
“As shown in the graph below, each time the year-over-year increase in Total Household Debt has dropped more than 40% below its recent peak, a recession (or in the case of 1967, a mini-recession) has occurred. The mid-1980’s slowdown touched this level, but did not exceed it. The current -38.9% level is approaching this boundary and, based on recent credit tightening by financial institutions, is likely to drop significantly below the -40% level.
The European Central Bank left interest rates unchanged at 4% on 7 September, but it is not clear that they will not be increased to 4.25% soon.
The ECB is reacting to the increase in perceived risk in financial markets, catalysed by the sub-prime meltdown. At the same time as the hold on rates increase, the ECB provided another €42 billion to the banking system, whose liquidity has dried up as banks continue to be reluctant to lend to each other, without knowing the scale of losses in the lending markets.
Unfortunately, it will be some months before the scale and scope of the liquidity crisis might be known, and this will make interest rate decisions more difficult. However, I think it unlikely that they will be brought down this year.
This linked article, How We Got into the Subprime Lending Mess (published by my alma mater Wharton), describes the background to the changes in the mortgage industry that contributed to the dislocation between stated risk/return profiles and reality of the loans. The comments following are insightful too.
Oh dear …
Well, it wasn’t as if it wasn’t expected. Futures were pricing a 100% chance of a drop of 0.25% and a 50% chance of a drop of 0.5%. But I still think it was a dangerous mistake. Inflation is pulling at the rein and the speculative dynamic of stock markets continues to undermine fiduciary responsibility and sensible personal wealth management. (For more on these concerns, please see August GRI Equity Review here.)
The first sign that the rate cut wasn’t appropriate was the bounce in the stock markets. After the decision was announced all three major US indexes were up more than 1%.. The Dow Jones industrial average was up 1.37% at 13,587.54, the S&P 500 Index was up 1.87% at 1,504.29, and the Nasdaq was up 1.60% at 2,622.95. As of this writing markets are still open, and up.
There will be a speculative rush for a few weeks until the reality that interest rates are not the problem sinks in. Perhaps on a positive note, they could be increased again if inflation accelerates too soon.
The most unnerving conclusion, however, is that the Fed is not able to give the tough love the markets need, or, even worse, emotions and personal interests got in the way of the decision.
The lower rate will encourage another bout of gorging on debt and further extension of an unsustainable mountain of credit. Consumer behaviour needs encouragement to change, to become more practical. The sooner the better.
(And here’s another discussion of the Fed’s Irresponsible Move published in BusinessWeek.)
As we expected, there appear to be more money than deals in clean-tech.
New Energy Finance reports: 2006 was another record year for Venture Capital and Private Equity investment in the clean energy sector, with $18.1 billion invested in companies and projects. This represented a 67% increase on 2005 ($10.8 billion), and beat New Energy Finance’s original forecast. However, this rapid growth in VC & PE investment only tells half the story: a significant amount of money ($2 billion) resides in funds and has yet to be invested. During 2006 clean energy VCs invested only 73% of the total money available to them – a symptom of a competitive market where demand for deals is outweighing supply, thereby driving up company valuations.
Cleaning Up 2007: Growth in VC/PE Investment in Clean Energy Technologies, Companies & Projects by NEF
Since Autumn 2006 attention to the sector rose as various reports came out: The Stern Report, various IPCC reports, the movie The Inconvenient Truth and so on. Private equity managers all rushed to get in on the game because they saw it as an easy way to raise money and thought that the fundamental economic drivers had suddenly changed. As is always the case with too much money chasing too few deals it is likely that many over paid. It is also likely that few had expertise or an understanding of the emerging economic dynamics of the enlightened consumer. Money will be lost.
The good result however is that more attention is being paid to this area, especially aspects like alternative energy.
The better managers are those that can also look beyond clean tech and make the connection with the growing LOHAS consumer profile as well.
The ninth annual survey of the Dow Jones Sustainability Indexes is available.
More information about the report, as well as selected downloads about each industry leader and regional rankings, are available at http://www.sustainability-indexes.com.
Anatole Galetsky presents GaveKal’s perspective in Here Comes the Whale that Northern Rock is the large problem that needs bailing out in order to pass through the financial liquidity imbalance that has accrued during the past few years.
… on past experience, the long-awaited appearance of the whale – Continental Illinois, Chrysler, Brazil, Drexel Burnham, Kidder Peabody, Mexico, LTCM/Russia, Enron/MCI/Argentina – would announce the beginning of the end of the liquidity crunch. …
… because we started thinking in the middle of 2006 that our whale was overdue for an appearance, but it never quite turned up. In February we finally realised what species of a fish we were looking out for – a mortgage lender, with a specialty in high-risk loans – but still the damn creature refused to show. But this weekend, a whale finally surfaced, though somewhere totally unexpected. Until last week, almost nobody in the markets had heard of Northern Rock PLC. And even on Friday – when Britain’s fifth-biggest mortgage lender was officially “rescued” by the Bank of England in its first lender-of-last-resort operation for 34 years – most people in the markets saw this event as “a little local difficulty” compared with the mess in the US sub-prime market or German state banks.
Time will tell how history views these events and and Northern Rock’s place in history, but other “whales” where well known and media savvy before the crisis, this one was not. It can be said, however, that Northern Rock is contributing to the evidence that a rebalancing of the price of liquidity is taking place.
The FT describes how Norway’s sovereign fund management sets the standard. Government Pension Fund-Global, part of Norges Bank, was set up by the Norwegian government in 1990 and manages about €235 billion. It has worked with authorities in Kazakhstan, East Timor, Bolivia, the Faroe Islands and several African countries among others.
“We make no strategic investments,” said Martin Skancke, director-general of the fund at the Ministry of Finance. “We invest in individual companies and sec tors. We are invested in between 3,000 and 4,000 companies in 40 countries and average ownership of a company is below 1 per cent. We do not feel that this distorts markets.”
Investment decisions are either made by individuals at the fund with specific investment mandates or are contracted out to external asset managers. At the end of 2006, 22 per cent of the fund was managed by 50 external managers with 80 different mandates.
Transparency is paramount. The ministry receives advice on the investment guidelines from the Central Bank of Norway. Consultants are also employed to help with this work as well as to judge performance and the management of costs.
Ethical Guidelines for the Government Pension Fund – Global Norwegian Ministry of Finance
Principles for Corporate Governance and the Protection of Financial Assets