Barristas, Potters, Yoga Instructors and Depression Economics

Brad de Long has a great introduction to Depression Economics here. Can't wait for lecture 3.

Real Estate as an Investment?

The lastest US new home sales numbers hit new record lows in July and am amazed how long this downcycle is. Inventory numbers are close to the lows of 40 years ago when population and household numbers were much lower but no sign of a rebound in sales.
Calculated risk has the analysis and the charts as usual:





The Baseline Scenario ponders why so many believe real estate is such a good investment after all. Looking at this long term chart nothing to be too excited about. Exclude bubble years and real real estate prices in the US have barely moved over longer time periods:

They argue:
"Housing is generally a worse investment than either stocks or simple U.S. Treasury bonds. Then why do so many people think it’s such a great investment?

1. Leverage. Let’s say inflation is 2% and housing returns 3% (1% real return). If you put 10% down, now your house is returning 30%, or a 28% real return; subtract a 6% fixed-rate mortgage, and you’re making about 22%–or twenty-two times the real return of the underlying asset. Of course, we all know the dangers of leverage.
2. Price illusion. People remember the nominal price they paid for their houses. When they sell them thirty years later, they look at the difference between the nominal purchase and sale prices and think they made a ton of money. This is especially true of the generation that bought houses in the 1960s and early 1970s before inflation hit; they saw their home prices go up by a factor of ten and thought it was due to high real returns.
3. Bubbles and optimism bias. Every now and then we have a huge bubble like the one at the right-hand end of the chart above. For a while, people think that’s the new normal. For a while after that, they continue to think it’s the new normal, because they are biased toward optimistic expectations about the world. (Note that during the first half of the decade that I was advising friends that housing was a bad investment, housing was actually a great investment, assuming you could get out in time.)"

Druckenmiller Quits

One of the hedge fund great is retiring. Bloomberg has the story with some interesting infos on the man who broke the ERM.
From the article:
"He made some of his biggest trades working with Soros, including one that cemented Soros’s reputation as a preeminent speculator: A $10 billion bet in September 1992 that the Bank of England would be forced to devalue the pound.

Breaking the Bank

By August of that year, Druckenmiller said he had initiated a $1.5 billion trade that would profit if the German mark rose versus sterling. He expected Europe’s exchange-rate mechanism, in which the currencies moved against each other within a limited band, to come under pressure as Germany raised interest rates to prevent inflation after reunification. Germany’s move forced the United Kingdom and other members of the ERM to decide whether to increase rates, which could damage their already troubled economies, or devalue their currencies and fall out of the ERM.

Druckenmiller said he calculated that the Bank of England didn’t have enough reserves to prop up the currency, and it couldn’t afford to raise rates. He was right, and selling by the Soros fund is credited with pushing the pound out of the ERM.

“He was so proud because until that point Soros had never made $1 billion on a bet,” said Roger Entress, a Pittsburgh surgeon and early Duquesne investor, who was golfing with Druckenmiller at the National Golf Links of America in Southampton, New York, the weekend before the devaluation."

A Bond Bubble?

Prof Paul Krugman does not think so. Using a simplified Taylor Rule and projections for employment and inflation from the CBO he derives a predicted fed fund rate which looks like this:



Low rates for years to come!!!
He adds: "That’s right: four years of near-zero short-term interest rates. Does a 10-year rate of 2.6 percent still sound so unreasonable? And bear in mind that I’m not using some doomsayer’s forecast; I’m using the staid folks at the CBO.

And just for the heck of it, I asked what interest rate on a 10-year security would yield the same present value as investing in short-term debt at the predicted rates, and rolling it over each year. (Actually, I cheated slightly, because I was getting tired; I considered a bond in which there are no payments along the way, just repayment of accumulated interest and principal in year 10; but I’m pretty sure it doesn’t make much difference).

And the implied interest rate was … 2.6 percent.

Here’s what I think is going on: aside from the obviously intense desire of some of the bond bubble folks to see a fiscal crisis — they’ve been planning for it, and they’re not going to take no for an answer — my sense is that a lot of people just can’t bring themselves to face the reality that we’re likely to be in a zero-interest world for a long time. They just keep assuming that the Fed is going to raise rates soon, even though there is absolutely nothing about the macro situation that would justify such a rate increase."

If no bubble and the bond market is right expect some dismal economic prospects for much longer. Bu hao!

Market Update

Econbrowser has a great analysis of where we stand market valuation wise. Using Prof Shiller's data he posts the following charts:
(1) 17% downside to be back to average

(2) A chart comparing PE and the following 10 year nominal returns of the S&P500. At the current PE do not expect much in the next years if history is any guide



(3) And among others a chart comparing the dividend yields vs tips' and bond yields.
While equities do not strike as bargains they still compare favourably to bonds.


He concludes: "A buyer of stocks today is usually getting a higher immediate yield than on TIPS, in addition to prospects of future dividend growth. Just as they did in the 19th century, stocks as priced today should give you a significantly better return than bonds"

Dividend Aristocrats 2010

Here is the list of the 42 companies from the S&P500 that have raised their dividends for 25 years in a row or more. In the past they have outperformed the S&P500 substantially.

3M Co	MMM
AFLAC Inc	AFL
Abbott Laboratories	ABT
Air Products & Chemicals Inc	APD
Archer-Daniels-Midland Co	ADM
Automatic Data Processing	ADP
Bard, C.R. Inc	BCR
Becton, Dickinson & Co	BDX
Bemis Co Inc	BMS
Brown-Forman Corp B	BF/B
CenturyLink Inc	CTL
Chubb Corp	CB
Cincinnati Financial Corp	CINF
Cintas Corp	CTAS
Clorox Co	CLX
Coca-Cola Co	KO
Consolidated Edison Inc	ED
Dover Corp	DOV
Emerson Electric Co	EMR
Exxon Mobil Corp	XOM
Family Dollar Stores Inc	FDO
Grainger, W.W. Inc	GWW
Integrys Energy Group Inc	TEG
Johnson & Johnson	JNJ
Kimberly-Clark	KMB
Leggett & Platt	LEG
Lilly, Eli & Co	LLY
Lowe's Cos Inc	LOW
McDonald's Corp	MCD
McGraw-Hill Cos Inc	MHP
PPG Industries Inc	PPG
PepsiCo Inc	PEP
Pitney Bowes Inc	PBI
Procter & Gamble	PG
Sherwin-Williams Co	SHW
Sigma-Aldrich Corp	SIAL
Stanley Black & Decker	SWK
Supervalu Inc	SVU
Target Corp	TGT
VF Corp	VFC
Wal-Mart Stores	WMT
Walgreen Co	WAG