History Repeats, But Never Quite the Same Way

We are heading for recession, but this time will be different, but yet the same.

There are a number of ways to predict when a recession is coming, when you are in it, and when you are out of it. A recent interview on Marketplace with a member of the government agency responsible for monitoring such things illustrates how difficult it is to predict such things.  Their judgement on recession or lack of recession takes months to process.  By the time they indicated the recession of 2009 had started, it was already several months underway.   Backward-looking statistics are fine and all, but without a time machine, kind of useless, except to historians.

One interesting way to predict a recession, I think, would be to count the number of articles online about recession, using online analytics.   You could even use social media data to see how many people are discussing recession as well.  I think such a system could be predictive, as prior to the meltdown of 2008, there were plenty of articles discussing the "froth" of the overheated housing market.  The signs were there for everyone to see - yet most of us refused to see them.

Markets go in cycles, this much is undisputed.  And the longer a boom cycle goes, the harder the bust will be.   Without Trump's tax cuts (and the goosing of the economy over the last two years) we might already have entered recession territory - a mild recession perhaps.  But over the last two years, companies have been using this windfall money to buy back stocks and do other things that really do not bode well for future productivity, but spell huge short-term gains for people who live and die by share price - such as top executives who are paid in stock options.

Unemployment is at an all-time low, but it was also during the Clinton years in the 1990's.   I remember those times - business was booming and we hired more help to dig our way out of the backlog of work.  Every business was doing just that.  But these last to be hired were the least productive employees for a number of reasons. They had the least amount of training, for starters.  And since unemployment was so low, we were scraping the bottom of the barrel to find people - and paying the highest possible salaries to attract them.

When the economy cooled down, we laid those folks off first.  We realized then that they were the least productive people and in fact, probably cost more in salary and benefits than they generated in additional income for the company.   And I suspect a similar thing is happening today.  There are stories abounding about new hires "ghosting" companies as they take other job offers and don't want to be bothered give any sort of notice.   We saw the same thing in the 1990's, but the term "ghosting" wasn't in the lexicon back then.

The housing market today is overheated - in selected markets.  This is less like the market of 2008 and more like the market in 1989.   In 1989, we saw a lot of overbuilding of office space in some metropolitan markets, along with speculative overbuilding of residential properties in select metropolitan markets.   2008 was a different deal, where everyone, it seemed, refinanced their house and was convinced that they lived above a gold mine that could be mined perpetually for more equity to spend.   Again, in selected markets, such as Florida and Nevada, builders overbuilt, particularly condos, which tended to zoom up in price the fastest, and fall just as quickly.

This time around, it will be the same, yet different.   In addition to a general slowdown in the economy, we have rising interest rates.   I have hammered time and time again in this blog that the price of houses isn't determined by some inherent metric, or the cost of land plus the cost of construction (plus a "reasonable profit" tacked on), but rather by the laws of supply and demand - and how much people can afford in terms of monthly payments - as most folks buy using mortgages.   Today, we are seeing a lot of older, cash buyers, and they are skewing the marketplace.

But even those prices track what the mortgaged buyers can afford in monthly payments.  And when interest rates rise, even 1%, it decreases the amount the borrower can afford to pay.  Assume that Joe Blow can afford to pay $1000 a month for a house in a hypothetical town.   If interest rates are 4%, he can afford to pay about $209,500 for his hypothetical house.  If rates rise to 5%, the amount he can afford to pay - at $1000 per month - drops to $186,300 - a drop of $23,200. 

In the olden days, when we had to put down a 10% down payment (or more) this meant that you maybe lost your down payment amount (at least temporarily) in terms of your equity.   But in 2008 - and indeed, today, this means you may be "upside down" on your loan, for some time.   In 1989, when we bought our first house (at the height of the market) this is exactly what happened to us - but we had put down 10% as a down payment, and at worst, if we had to sell, we would have walked away with nothing, as opposed to walking away owing money to the bank.

And I guess, like a college education, buying a house with borrowed money can be like trading in derivatives - you can end up owing more than you paid!   But this only occurs when you leverage yourself too far or buy in an overheated market.

But getting back to the monthly payment mentality, it is a pretty inflexible rule that people cannot simply afford to pay more money for something, just because prices go up.   Unless wages go up accordingly, Joe Blow is stuck.  If he wants to pay more per month for the house, he has to cut his budget somewhere else.  Maybe this means he doesn't buy that new car he was thinking about, or he cuts back on his cable bill, or cell phone, or buys fewer designer coffee drinks or eats out less.  Regardless of what he chooses to do, each one of these activities (including not buying the house) means that the economy slows further, as Joe consumes less.

And it isn't just interest rates.  As we saw in South Florida, exploding property taxes (in the five figures) and insurance bills (often close to that as well) meant that the amount people could afford to pay to service a mortgage declined.  For condos, increased condo fees and special assessments are also factored in.    Condos topped out in South Florida in 2005 with only half the units sold - sometimes none.   After the first year, the property taxes - based on actual sales prices - skyrocketed.   Condo fees went up after the builder turns over the Condo Association to the owners, who realize the builder was keeping fees artificially low.  Throw in a hurricane or two and rising insurance rates, and suddenly the "affordable" vacation condo costs twice as much per month as what you thought it would.

So you put it on the market - along with half of your fellow owners.   By 2008 you can't give these things away, and a foreclosure crises ensues.

This time around, it will be the same, yet different.   In many parts of this country, housing prices are still somewhat affordable.   There are still people today sitting on houses and condos that are worth less than what they paid for them in 2007.   Still others owe more money than their properties are worth.   How they survived the last decade in these underwater homes is beyond me - just as how Sears survived this long is bewildering.  But another recession and declining housing prices could be the nail in their coffin.

Speaking of Sears, there is a lot of chatter on financial pages about how mall owners are being creative in coming up with new uses for old malls - everything from pop-up stores, to retirement communities (Mall Walkers!) to even homeless shelters.  This sounds like good news, but it actually is the last dying gasp of these properties, many of which are decades old.  And most of these types of buildings have a design life of 20-30 years or so, and are very hard to adapt to other uses.  Most will be torn down, I expect.    If you have a lot of money tied up in REITs (Real Estate Investment Trusts), I hope it isn't too highly leveraged in malls.

Rising interest rates will harm other industries.  Ford had banner years in 2015 and 2016.  But lately, as interest rates rise, sales are slowing down.   Prices are also edging up, as the cost of materials (thanks, Trump tariffs!) jumps dramatically.  The new F150 has a body made entirely of aluminum, and the cost of aluminum has jumped.   It is not like you can switch to alternative metals on a whim, either - you have to redesign the whole truck.   But rising interest rates mean, once again, that monthly payments go up.  So Joe Blow can't afford to pay more for a new car or truck.   He either buys a cheaper model, or decides not to buy at all.

These are not gloom-and-doom predictions, just ordinary cycles in the marketplace.   And just like in 2008, or 1989, or indeed, 1929, the market will turn around again, and people will go back to work, and industries will recover over time.   In fact, a remarkably short period of time.   Most share prices recovered from the nadir of March 2009 within a year or so.   Granted, this meant some companies that were leveraged too far went bust.  It also meant that some individuals who were leveraged too far, went bust as well.

And sadly, the last time around, a lot of people made foolish decisions which only made things worse.  One retiree I met here on our island told me he sold all of his investments in March of 2009 and invested in Gold and government bonds, essentially locking-in a 50% loss in his portfolio.    Others did stupid things like cashing in a 401(k) and paying huge taxes and tax penalties, in order to "hang on" to an underwater house.  They sold off their retirement account - which is and asset protected in bankruptcy, to make monthly mortgage payments on a house, which usually is not.  And the house never recovered in value, and when they were done frittering away their life's savings on interest payments to a bank, the bank foreclosed anyway, leaving them with nothing.

Panic is not the answer.  Trying to "hang on" to bad deals is not the answer, either.  Cashing in your retirement is the dumbest answer of all.

A reader writes that the net result of the last recession was that those who had money made a whole lot more.  Those who had less, usually lost it all, or a substantial portion, anyway.   That does seem to be a pattern in these things, and some folks argue that folks on the Right like to see these volatile market swings (which are increasing in frequency and intensity) as it allows a few select people to make a whole lot of money in a short period of time.   Stable markets are not profitable markets, which was the major gripe of Republicans during the slow-but-stable growth era of the Obama administration.

But again, these larger forces at work do not entirely negate free will or the individual actions of the actors in the marketplace.   In other words, what you do in your own life has far more of an impact on your life than these nefarious actors and world events.

If a house seems unaffordable, maybe that is a good sign that it is.  Maybe the market is overheated, if you are spending a huge portion of your income on housing.   And maybe waiting for a better market - or searching elsewhere - is a better idea.  Or maybe just not buying into such a market at all is a good idea.   Rents are high, but you can't lose your shirt on renting an apartment, in most cases.

Whatever the outcome of the next recession will be, the person with the least amount of debt and the most amount of savings will likely do better than the opposite.   Of course, there are always the folks who are leveraged in debt up to their eyeballs and have no savings whatsoever - and who are crafty enough to walk away from the over-leveraged house two hours before the Sheriff shows up to evict them.   Or worse yet, somehow manage to convince the government to "bail them out" of an underwater mortgage (although history has shown that most people who get a "mortgage adjustment" usually end up losing their houses, just at a later time).

Myself, I have not done anything dramatic to prepare for this next recession.  I have sold off a lot of stocks and bonds over the last year or so, and thus have a lot of cash on hand.   But since I am retired, I need this cash to live on, so it makes sense to have it in the bank, and not tied up in stocks.  Later on, when I need the cash, I don't have to make the painful decision to sell at a loss at a time not of my choosing.

And a funny thing, too.  If I had left that money in stocks and bonds, today it would be worth exactly the same as a year ago, as the euphoria over the "Trump Bump" has worn off.   I managed to ride the first part of this bump in 2017, but got off the ride before it peaked in 2018.   Better to get off before the peak than to try to time it and get off too late - a lesson I learned back in 2005 when I sold out of the real estate market before it went South.

In March of 2019, I had no cash to invest (and still had a lot of debt).  I had $750 in my trading account and bough Avis stock for 74 cents a share.  It went up several thousand percent in price since then, and that $750 investment made me well over $10,000 in capital gains.   Sadly, I was not able to buy more stock (and other bets, such as Fannie Mae, didn't pan out).   This time around, I hope to be the guy with cash-in-hand, when it all goes South.

Well, I can hope, anyway.  Trying to time markets is nearly impossible to do, even when all the warning signs are there.

UPDATE:  A reader provides this helpful link to a Washington Post (our motto:  "Trump is a sad and lonely man, and we consider that a news story!") article that talks about google searches on "recession".

I am guessing that someone far smarter than you and I has already figured this out and is trading stocks based on social media data and google analytics.   If enough people are searching on "should I sell my stocks?" and "Is a recession coming?" or "should I buy gold?" you can make trades based on that data and make a fortune.

Or worse yet, you can use a troll farm to "prime the pump" and get people to panic or act against their own self interest.  Sort of like how Russia nudged us in the 2016 election.