November 2017 – Monthly Commentary
In 2004, an acquaintance left his job as a banking clerk to become a real estate sales agent. Almost overnight his income doubled as the homes he represented sold briskly. The market was so hot that he was working seven days a week and his income soared well over $200,000. However, in 2006 sales began to slow and buyers were grumbling that home prices had grown out of reach. Builders continued to build new homes, albeit at a diminished pace, and realtors aggressively argued that all was well in the market. The neophyte real estate broker, in an effort to sustain his business added a “click-through” to his website entitled the “anti-bubble argument.” When clicked, a series of charts popped up comparing home prices to a number of measures, concluding that not only was real estate not in a bubble, but the opposite was true. To not buy would be to miss out on the next leg of another profitable run in home prices. His logic was that if he could convince his clients that U.S. home prices were going higher, he’d be able to ensure that his recent uptick in income would continue. Of course, that wasn’t to be and he is now blissfully, though less profitably, operating a boutique organic vegetable farm. I was reminded of his anti-bubble argument as I listened to the parade of investors and traders on the financial news program one recent morning. One after another, the experts agreed that stock prices are expensive and the risk level elevated, but each suggested looking past valuation so as to not miss the next leg up in prices. They are engaging in the same attempt at deception as the real estate agent. The profitability of their employers depends on investors remaining invested in their funds. When pressed on the matter of valuation, the usual retort is to say that they mitigate the downside by focusing on high growth stocks or defensive stocks, or some combination of both. We see many similarities between the current stock market and the 2006 Real Estate market. It impossible to know for how much longer the stock rally will last, but by nearly every measure, stock prices are expensive.
We’ve written on several occasions about our frustration with government reported data and the release of the October consumer price index (CPI) is another stark reminder of why. The Bureau of Labor Statistics reported that headline CPI rose 2.0% year-over-year, decelerating from the 2.2% pace recorded the previous month. Often we’ve said that the muted CPI seems directly at odds with the rising cost of living of the average American. Digging into the details of the report offers a glance as to why and we reference several components to illustrate the point. The first is shelter, which constitutes 33% of the index. The economic profession looks to the Case Shiller national index as the definitive measure of home price inflation and the last reading was a 6.07% rise in home prices year-over-year. That’s far higher than the 3.2% change measured in CPI. Adjusting for the actual change in home prices would add approximately 0.71% to the top line inflation measure. The next items we question are medical care and health insurance, rising 1.9 and 0.2%, respectively. Unlike home prices, there is no definitive data to substitute for these items, but one can attest that when co-pay and co-insurance are factored in the cost of a visit to the doctor, and the staggering annual increase in insurance premiums, health insurance costs are rising far faster than the ridiculous rates suggested by the BLS. Finally, according to the BLS the cost of telephone and internet services fell -7.1% and -1.0% year-over-year, respectively. Regarding those two items, the BLS has said the move to unlimited data earlier this year would result in a falling adjusted price when the additional service is considered. In essence, they’re saying that you’re getting more for your money so that’s deflationary. I can tell you that neither the cost of our phone nor the cost our internet access has fallen. Ever! To solve for the inaccuracies presented by the BLS, we made a number of subjective statistical adjustments that are in no way definitive, but nevertheless, we believe are more reflective of price changes. Based on those adjustments we believe the year over year change in the cost of living is closer to 3.25% rather than the 2.0% report by the BLS. By that measure, the real return on the 10-year Treasury note would be -0.85%.