Jubak's Journal
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Why there is no housing bubble
(Page 2) of 2
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The role of consumer debt
Of course, these are all just projections, and it might be different this time. In fact, those who see a bubble and predict its bursting, argue strongly that it is. The consumer is more indebted now than when mortgage rates climbed in 2003-2004, and thanks to the heavy use of adjustable rate and interest-only mortgages, home buyers are so stretched that even a relatively slight rise in interest rates will be enough to create a cascade of mortgage defaults.
It's certainly true that today's consumer is carrying more debt than the consumers of 10 years ago. But thanks to low interest rates, the monthly burden of that debt is remarkably unchanged over the last few years. The Federal Reserve's DSR ratio, which measures the ratio of disposable income to total mortgage and consumer debt, stood at 11.17 in the fourth quarter of 1994 and at 13.26 in the fourth quarter of 2004. That's an almost 20% increase in the weight of the average family's monthly debt payments in 10 years. But the ratio has been remarkably stable since 2001 and actually shows a slight decline from 13.3 in the fourth quarter of 2001.
To make that monthly debt burden onerous enough to trigger a burst in a housing bubble, you have to look for a big drop in family income so that while monthly debt payments remain the same, they take up a bigger chunk of a diminished family income. That would require not just a further slowdown in economic growth, but an actual recession. Although I think growth will continue to slow this year, I don't think a national recession is in the cards in 2005 or even 2006.
The other trigger would be a big increase in interest rates that would push the monthly debt burden up on average and would strike especially hard at those home buyers who used an adjustable or no-interest mortgage to buy more house than they could really afford.
And that too, oddly, doesn't look like it's in the cards in 2005 for interest rates for 10-year Treasury notes, the part of the bond market that mortgage rates pay attention to. Nobody knows exactly why, but despite eight interest-rate increases that have taken the short-term rate target of the Federal Reserve to 3% now from 1% in June 2004, the yield on the 10-year Treasury has actually tumbled to 3.9% today from 4.7% in June 2004.
Since no one, including Fed chairman Alan Greenspan (who refers to the decline in 10-year yields as a "conundrum") knows why interest rates are behaving this way, it's tough to predict where 10-year rates will be in a year or two. History, however, does show that interest rates usually don't rise when economic growth slows. So if we're headed into even a modest slowdown in growth in 2005 and 2006 from 2004 levels in the United States, Europe and Asia, as now looks likely, then interest rates are unlikely to rise for the 10-year Treasury note in that time period.
Look for refinancing fever -- again
What to me looks most likely to happen now, and I readily admit I didn't expect this in 2005, is another outburst of refinancing fever. At 5.1%, the lowest rates on 30-year fixed mortgages are now about a full percentage point below the average rate on outstanding mortgages. That's a level that, in the past, has produced a wave of refinancing as homeowners figure that the drop in their monthly payments -- about $720 a year on a $100,000 30-year fixed-rate mortgage -- more than offsets the costs and hassle of refinancing.
A refinancing wave, or even a wavelet, would put off any day of reckoning in the real estate market even further.
None of this means that the housing market can go up forever, or that we won't have a day of reckoning someday. And I think any sensible person should use the current drop in interest rates as an opportunity to get his or her own financial house in order. It would be unwise to expect that another, and then another, of these refinancing opportunities will come along in the future.
It's just that those who are predicting a housing bubble and its bursting may have much longer to wait than they expect right now.
In my next column, I'll take a look at why so many predictions -- mine included -- have been so wrong about interest rates in 2005 -- and what that implies for the rest of 2005 and into 2006.
Changes to Jubak's Picks
Buy Groupe Danone
With the decline of the euro against the U.S. dollar, the shares of European food companies, where sales will get a boost from a weaker euro, look more attractive than their U.S. counterparts. So I'm adding Danone Group (DA, news, msgs) to Jubak's Picks as a replacement for U.S.-based Sara Lee (SLE, news, msgs). U.S. consumers know the company for its Dannon yogurt, and the company's fresh dairy division makes up 47% of sales. But the real growth engine -- and a reason that this company may be a buyout target not too far down the road -- is its water business (27% of sales). Groupe Danone is a dominant producer in many European markets -- the company has a 60% market share in France, for example -- but what attracts me is the growth of the company's sales of bottled water in Latin America and Asia. In 2004, the company's bottled-water sales soared 30% in Mexico, for example, and climbed 14% in Asia, where the company's main markets are China and Indonesia. In the first quarter a strong euro knocked about 1.2 percentage points off the company's 5.1% sales growth rate, according to management. A weak euro should turn subtraction into addition for the next quarter or two. I'm adding the shares to Jubak's Picks with a target price of $22 by December 2005. I'd set a stop loss at $15.20.
Sell Sara Lee
The weak dollar had put exchange rates on the side of U.S. food companies selling to overseas customers: the U.S. companies' products got cheaper as the dollar fell against the local currency, and the reported sales and earnings of the U.S. companies climbed when they were translated from stronger local currencies back into U.S. dollars. That wind has shifted, at least for the next quarter of two, and I think European food companies now own this same edge vis--vis their U.S. counterparts. So I'm selling U.S.-based Sara Lee (SLE, news, msgs) so I can add a European food company to Jubak's Picks. Including dividends, I have a 4.4% loss on Sara Lee since I added the shares to Jubak's Picks on March 18, 2005.
New developments on past columns
Time is right for these 7 biotechs
The market certainly reacted to the June 7 news that Cell Genesys (CEGE, news, msgs) would lay off a quarter of its work force and sell off one of its manufacturing facilities and convert another from manufacturing to distribution as bad news. The shares dropped 10.5% that day. But I'd argue that this is actually a sign of progress. The company feels confident enough in the prospects for its lead GVAX cancer programs to concentrate all its resources on bringing them to market. Development of a GVAX vaccine, which is in two Phase 3 studies in hormone-refractory prostate cancer, is reaching that more-expensive but critical stage, where the company must fund bigger trials and then prepare the results for submission to the U.S. Food & Drug Administration. The other GVAX programs to get priority in the restructuring are the company's work in leukemia, pancreatic cancer and bladder cancer. The programs dropped were in the crowded fields of lung cancer and myeloma. The restructuring will allow the company to conserve cash while it still has $40 million in cash on its books as of the end of the March 2005 quarter. As of June 10, I'm keeping my price target of $9 by May 2006. (Full disclosure: I own shares of Cell Genesys.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Cell Genesys. He doesn't own short positions in any stock mentioned in this column.
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