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Housing Bubble 2.0

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We’ve written extensively about the stock market bubble blown up by artificially low interest rates and Federal Reserve quantitative easing. But stocks aren’t the only asset bubble out there. In fact, 2017 may go down as the year of the bubbles. And the new housing bubble is one that seems to be floating under the radar.

Financial manager James Stack has noticed it. He predicted the housing crash in 2005, and he told Bloomberg the housing market is flashing red again.

It is 2005 all over again in terms of the valuation extreme, the psychological excess and the denial. People don’t believe housing is in a bubble and don’t want to hear talk about prices being a little bit bubblish.”

Most mainstream analysts see nothing but smooth sailing ahead for the housing sector. Between millennials entering the market and retiring baby boomers getting ready for retirement, they see no end in sight to the housing recovery. Builders are scrambling to get into starter homes to meet the demand of first-time buyers. They have little inventory to choose from after developers focused primarily on high-end homes in the wake of the 2008 crash. Sales in 55 and up communities are booming.

According to Bloomberg,  the S&P 500’s index of homebuilders increased 75% in 2017, about four times as much as the stock market as a whole. A subset that includes just the three largest builders ranked as the best performer of the 158 S&P groups.

So, why is Stack so bearish?

He sees a dynamic not unlike what we saw in the years leading up to the 2008 housing bust. He’s identified a pattern – a steep runup in prices spurred by low interest rates. While it could correct itself gently, Stack told Bloomberg history indicates it will more likely “come down hard” during the next economic downturn.

The last downturn came about when economic growth slowed after a series of rate increases, exposing the ‘rot in the woodwork’ and prompting loan defaults, Stack said. He noted that the Fed has projected three rate increases for this year, and said that ‘raises the risk that today’s highly inflated housing market will again end badly.’ He’s watching homebuilder stocks closely because they’re a leading indicator, peaking in 2005, the year he called the crash — and the year before home prices themselves hit a top.”

Stack also says median home prices are overheating. Typically, they track along with the Consumer Price Index. Last summer, median home prices were as high as 32% above CPI. Just before the housing bust in 2005, they were at 35%.

Housing prices are also overvalued compared to income in many US cities. Two years ago,  housing prices were overvalued compared to income in about 36% of major metro areas. According to CoreLogic, half of the 50 largest metropolitan areas were overvalued in November.

As a result, Stack said a normalization of interest rates will tank the housing market.

If we see mortgage rates at more historical levels, house prices can’t stay where they are.”

The notion that millennials will drive the housing market in the future also seems a bit overoptimistic. Millennials are broke. Their income levels are falling and they are sinking in debt. According to one study, millennials earn approximately $10,000 less than members of Generation X and will likely make around $100,000 less over the course of their careers. On top of that, they are saddled with over $1 trillion in student loan debt. This is one reason the retail sector is struggling. How in the world are these people going to buy homes?

Housing bubble 2.0 may not be as extreme as the first go-around. But it is yet another sign that the central bankers have managed to once again create a world of false prosperity that is eventually going to come crashing back down.

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