A great but largely unknown resource for investment advisors is the “Monetary Trends” publication by the St Louis Federal Reserve (stlouisfed.org).  Their site is a vast collection of great research and speeches. 

How does this resource help?
At Covert Analytics we adopt a market forecasting and asset allocation approach which is based on simple, easy to understand principles. One of our principles is that an expanding liquidity base and credit creation usually leads to a favorable environment for economic expansion, and in turn a healthy climate for stocks and bonds.  “The rising tide lifts all boats” is an apt metaphor. As most of our readers know, our entire approach to investing is buy when the climate is ripe for appreciation, and sell when the climate is risky. many of the indicators we analyze to evaluate the monetary conditions are distributed by the St Louis Fed. (click here to open publication)

$473 billion in loans set to hit the market?
We were intrigued by a research piece put out by Standard and Poors.  Thanks to Barry Ritholtz at The Big Picture for distributing such an interesting piece.  The most important conclusion of this piece was that approximately $473 billion in loans will eventually need to be liquidated, which amounts to an estimated 1.75 million properties (or about 50% of all the houses available for sale as of December 2009). In other words, it is ugly! The dollar amount is estimated based on their categorization of the loans under analysis into four categories: performing, recently cured, seriously delinquent and REO.  Finally, the tally of $473 billion comprised of seriously delinquent, REO and likely to redefault loans, will need to be liquidated unless met with a substantial pick up in demand.

Why is this important?
This is important because it will likely hang on house prices for a very long time.  No matter how you slice it, Real Estate (technically a component of “tangible assets”) is the most important component of Household Net Worth.

So lets make the assumption that due to the foreclosure estimates from the S&P study, there is a 10% decline in housing prices coming.  This would result in a household contraction of $2.3 trillion. The National Bureau of Economics Research says there is a 10% pass through effect to consumer spending as a result of declines in household net worth. This would be an economic contraction of $230 billion (which represents 1.6% of GDP).

Can excess liquidity help offset this contraction?
The Monetary Trends publication shows some disappointing trends: the velocity of money is sluggish …

 

And bank credit growth is actually contracting!

In other words, it is unlikely that we will see a pickup in demand to offset the foreclosure crunch.  The data definitely does not suggest it, and given still high loan requirement standards, lower credit scores due to inability to meet payments, and deleveraging by banks and consumers, common sense confirms it!

Here is Barry’s post:   http://www.ritholtz.com/blog/2010/02/shadow-inventory-of-troubled-mortgages/

Federal Reserve balance sheet data:  http://www.federalreserve.gov/Releases/Z1/current/z1r-5.pdf 

Thanks for reading!

The Covert Analytics Team

Tags: credit growth, Federal Reserve, foreclosure crisis, household net worth, housing market, Monetary Policy, US economy

This entry was posted on Wednesday, February 17th, 2010 at 1:18 pm and is filed under Monetary Policy, Our Approach. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.