REAL ESTATE: the good, the better and the best

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The benefits of owning a home are well known but taken for granted. I just want to remind everyone that in spite of the recent downturn in real estate prices, the unprecedented bull run we’ve experienced the past few years has contributed to raising many homeowners’ standard of living by helping many families improve their lifestyle, pay for their children’s education, allow some people to borrow against their equity to pay for medical expenses; others paid down their credit card debt at lower rates ( I know you’re thinking some used the equity in their homes to buy depreciating assets, but let’s just stay focused on all the positives of owning a home); the stability that a home provides to children cannot be measured, but it is a fact that it does contribute to reducing stress and improving self esteem, better school grades and staying in school longer.

First of all, I still like real estate in spite of all the negative news. If prices drop some more, then maybe (if you can) this may be a good time to purchase an income property. I believe that home prices will drop some more in the short term driven by higher interest rates. I’ve said for some time now that the Fed’s position is a difficult one: raising interest rates could drive home prices lower but dropping rates or leaving them level would cause the US Dollar to be less competitive on world markets. The Euro is up against the US Dollar more than 10% so far this year alone and unless the Fed intervenes and raises interest rates, demand for the US Dollar will continue to wane in favor of the Euro or the British Pound.

There are times of plenty and times when one needs to tighten his/her belt. This is a time for the latter and this too shall pass sooner than we think. After all, the US is still by far the largest economy in the world with California’s economy alone exceeding the economies of many nations around the world. Our real estate is prized because of our political and economic stability – yes, in spite of all the negative news. It’s only a matter of time before we get back to the status-quo, namely relatively prosperous times. If we can manage to stick to the basics, the rest will take care of itself.

And the basics are Shelter and Security                                                                                  

Savings and Investments (Security): according to the Bureau of Economic Analysis, Americans actually went from a negative savings rate (which comes from borrowing or from liquidating assets) to a positive savings rate (derived from disposable personal income). Another point to keep in mind is that the Bureau does not take into account monies set aside in IRA’s and pension plans. That figure alone would dramatically alter the savings rate.

I also get a lot of questions on where the stock market is heading. Here’s my personal opinion: I believe that we’ll see new highs in the indexes driven by commodity stocks. The oil industry has seen unheard of profits in the last few years and I expect that companies that are commodities intensive will continue to fare well in the next few years for the simple reason that worldwide growth driven by strong economies particularly in Asia will continue to fuel demand for all basic goods from foodstuffs to energies and of course precious and industrial metals. So I have to admit that I am still bullish on both commodities and stocks.

Real Estate (Shelter): probably still many families’ largest asset. Baby boomers often rely on the equity accrued in their homes to pay for their children’s education, medical bills, emergencies, business startups, finance credit card debt at lower rates with the benefit of tax deductibility and of course to purchase depreciating assets such as cars and boats. As working folks approach retirement, their homes should be paid off or at the very least should have low mortgage payments (assuming they purchased their homes 20 to 30 years ago at much lower than current valuations). So real estate may be suffering today but not for long. The problem with our society is that we have “short-termitis” a disease that won’t let us look beyond instant gratification.

Last quarter, the US GDP grew at 3.4%, the fastest pace in the past 12 months. Not bad… Also the IMF recently stated that its forecast for global economic growth would be higher placing it at 5.2% with China, India and Russia leading the way.

Finally I’d like to point out that the S&P 500 has had 6 corrections ranging from 6.4% to 8.6%. The recent pullback was well within this range, so I see it as a correction (overdue) in a bull trend. One overlooked detail is that the price-to-earnings ratio in the S&P 500 is very attractive at current levels. 

Which brings us to today’s recommendation. Being bullish commodities and stocks, I expect investors to concentrate most of their risk capital in these investment vehicles rather than Treasuries. The recent bounce higher we’ve seen in the debt instruments (30 YR Bonds, 10 YR Treasuries and 5 YR Notes) was driven by the stock’s market’s decline (not uncommon this time of year and all the way to October) triggered mainly by the sub-prime crisis (real and not temporary). The Fed will have to take a hard stance and act to prevent a disaster. Simply stated the cost of borrowing will have to go up. The Fed will have to raise interest rates. Higher interest rates will send bonds lower. Keep in mind that I am looking at a long term position which could take us into the end of the year and beyond.

Let’s look at the chart below which is the Sept. Bonds continuous contract with the US Dollar overlaid in blue.

Daily ZBU7  (Bond Futures) continuous/DXU7 (Dollar Index Futures) continuous

We can clearly see that as the price of Bonds went up (interest rates went down) the value of the US Dollar dropped. As a matter of fact looking at the same monthly chart below, the correlation is quite obvious.

Past performance is not indicative of future results. There is a risk of loss in futures trading.

As I said before, I believe that interest rates will start going higher, not at the next meeting but possibly at the following one. I won’t venture as to how high but 6% would be a realistic target in the short term and should support the US Dollar back towards the 90.00 mark or higher.

STRATEGY: Sell Sept US Bonds at 110’090 with an initial target of 109’020 and a stop at 111’220. If reached the next target is at 107’270 with a 1% trailing stop. If profitable, hold those positions as long as possible. We could see Bond prices go much lower possibly towards the 106’000 area.

Good Trading,

Chad Geraigiri

chad@optimusfutures.com

Optimus Trading Group

1-800-771-6748

Tags: bond+futures