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Stocks, bonds, real estate

By John Schroy, on May 1st, 2010

Reading time: 4 – 6 minutes

I never hesitate to tell a man that I am bullish or bearish. But I do not tell people to buy or sell any particular stock. In a bear market all stocks go down and in a bull market they go up.
Jesse Livermore

Top-down investing: Before buying a particular stock, bond, or piece of real estate, look to see the direction of the market.

Passengers on the RMS Lusitania, could read this warning on the advertisement of the fatal voyage.

On May 7, 1915, the RMS Lusitania was sunk by a German U-boat off the coast of Ireland, with a loss of 1,198 lives.

It was one of the finest and fastest ships in the Cunard line.

Lusitania (and her sister ship Mauretania) possessed the most luxurious interiors afloat.

In common with all major liners of the period, Lusitania’s interiors were decorated with a mélange of historical styles. The first-class dining saloon was the grandest of the ship’s public rooms; arranged over two decks with an open circular well at its centre and crowned by an elaborate dome,

However, the facts about the ship and its lavish fittings were irrelevant in light of the fact that the Imperial German Embassy had issued a warning that there was a state of war and passengers travelled at their own risk.

Today, one wonders why so many ignored this warning. However, the answer had probably something to do with bottom-up decision making.

Anticipation of the pleasures of luxurious dining may have trumped other more general considerations.

Like the Lusitania, investment markets may suddenly sink for reasons that have nothing to do with the merits of particular securities.

On this site, many articles discuss stock, bond, and real estate markets from the top-down, examining macro-factors that explain why prices, in general, are moving this way or that.

Top-down analysis: excerpts

Here are entry points to articles about debt, equity, US stocks, US bonds, and real estate on this blog. Generally, these articles take a top-down approach to these markets, usually based on interpretation of Federal Reserve flow of funds accounts. In each category, most recent articles are shown first.

	US Equities: Articles about the US equity markets, discussing who is buying, who is selling and trends that may effect these patterns.
	US Bonds: Essays on the various segments of US debt markets, such as government bonds, municipals, agency securities, corporate bonds, and various forms of mortgage securities.
	Debt: Opinion and analysis of debt markets in general.
	Equity: Essays on general aspects of equity markets from a capital flow analysis view point.
	Real Estate: Top-down analysis of real estate markets.

Top-down analysis: list of articles

These essays are focused mainly on US stock, bonds, and real estate markets.

Debt - Investors move to money market fundsFor the first year since 2001, investors moved back into money market mutual funds in 2005, with net sales of $127 billion.The return of investors to money market funds was clearly the result of the Federal Reserve policy of increasing short-term interest rates, combined with the flattening of the yield curve due to buying pressure on longer-term fixed income securities resulting from the trade deficit.
Equity - Preemptive rights issues for banksIn March 2009, HSBC PLC strengthened its finances by making a preemptive rights offering of new equity. The bank quickly raised $18.5 billion dollars.Unlike Citibank, Bank of America, and other giant US banks, HSBC did not have to sell its soul to the government to stay in business.HSBC had the good fortune to be headquartered in the UK and to have much of its investor base in Europe and other countries where preemptive rights are the law and the customary way to raise capital.
Real Estate - Construction, land costs, and pensionsOver the decade 1995 - 2004, the market value of US residential real estate increased, on average, about 10% a year. The imputed value of land as a percentage of total residential property values, rose from 25% to 38%. The older the city, the greater the burden unionized public servants will be on local property values.State and Local Government liabilities with pension funds (Q3 2005) totaled US$2.7 trillion, and this is probably understated.Whereas citizens cannot escape federal taxes, they can run from state and local taxes by moving to lower-tax areas — 'voting with their feet', as it were.
Real Estate - Home equity beats stocks In 1995, US households held similar amounts of assets in home equity and corporate stocks: US$ 4.3 trillion in stocks and US$ 4.7 trillion in home equity. Over the decade, the situation changed dramatically, so that by 2004, households held US$ 4.8 trillion more in home equity than in corporate stocks.This difference came about because of the crash in the stock market in 2000-2001 and because of the steady increase in home values throughout the decade. Low interest rates and easier terms on home mortgages pushed prices of residential real estate upwards, while individuals favored indirect investment in stocks through mutual funds over direct holdings.
US Bonds - Agency bond issuance recoversAlthough the pace of net new issues of agency bonds was still $79 billion below levels of 2003 — the peak year before the crack-down on Fannie Mae for accounting irregularities — issuance of mortgage bonds by government-sponsored-enterprises recovered to $492 billion in Q1 2006 (annual rates).The three principal buyers of these new agency bonds were foreign investors, commercial banks, and securities brokers and dealers.
US Bonds - Agency bond market dries upIn 2005, net issues of agency and GSE-backed securities were only 7.8% of levels of 2001, when Fannie Mae was in her heyday, aggressively flogging mortgages to the masses.In 2005, net issues of agencies were only $50.7 billion, indicating that this sector had become far less important in the fixed income market than at any time in the last decade.
US Bonds - Bond demand exceeds supply for a decadeOver the decade, 1995-2004, the demand for US bonds of all types has surpassed new bond issues in eight of the last ten years. This is the reason that bond prices have held firm, even in 2003, when net new issues reached almost $1.8 trillion.In most years, buyers had to go to the secondary market to get all the bonds they wanted. On the demand side, steady buying pressure, accounting for about two-thirds of the market, has come from foreign investors, insurance companies, federal, state, and local governments, and banks and savings institutions — each acting for difference reasons.
US Bonds - Corporate bond issues up 18.3%According to statistics published by the Bond Market Association, based on Thomson Financial Securities Data, corporate bond issues for the first five months of 2006, totaled $339 billion.This was an 18.3% increase over the same period in 2005.High rates of new supplies of corporate bonds have exerted pressure on interest rates in the first half of 2006.
US Bonds - Cost of state and local government escalatesFederal Reserve flow of funds table F105 shows that the cost of state and local government to citizens has been steadily escalating over the last five years.Taxes and other receipts of state and local government increased 2.7% in 2002, 5.5% in 2003, 6.2% in 2004, and 6.7% in 2005.Most state and local government are not allowed to run a fiscal deficit and increases in expenses are passed on to citizens as higher taxes and other receipts.The government, in calculating the Consumer Price Index, does not include the cost of increased taxes.
US Bonds - Demand for bonds still strongDespite worries about rising interest rates engineered by the Federal Reserve Bank, demand for corporate and foreign bonds in the US market continued firm through Q1 2006.The principal bond buyers were foreign investors, life insurance companies, and money market funds.Even with firm demand, corporate bond prices weakened in Q1 2006 because a significant increases in new offerings by corporations seeking to finance stock buybacks.
US Bonds - Investment grade corporates hold steadyThe graph suggests that from a long-term perspective, corporate bond yields in recent months have been flattening out to match the reduction in growth of the trade deficit, rather than moving along with Federal Reserve short-term interest rates. Consistent with a leveling of the rate of increase in the US trade deficit in 2006, the price of investment grade corporate bonds has been holding steady.
US Bonds - Life insurers still favor bondsLife insurance companies invest pension and life insurance reserves primarily in bonds, according to Federal Reserve Flow of Funds Table F 117 for Q3 2005. Although favoring agency securities and treasuries in 2002, life insurers quickly returned to their traditional investment behavior of buying mostly corporate bonds.Since 1997, pension funds have become the principal business of life insurance companies, as indicated by the relative size of life insurance and pension funds reserves.
US Bonds - Mortgage borrowing dropsThe rapid withdrawal of borrowers from the home mortgage market, as interest rates rose in Q4 2005, suggests that much of the borrowing over the last year or so was probably opportunistic, stimulated by low interest rates and aggressive marketing (e.g., Ditech.com)Total mortgage borrowing fell 6.6% during Q4 2005, compared to the previous quarter. Mortgage borrowing by households fell even more, down 11.7% compared to Q3 2005.

US Bonds - Mortgage lending continues strongMortgage lending, a major component of the US bond market, continued strong in Q1 2006.The four largest suppliers of mortgage funds continue to be commercial banks, savings institutions, agency mortgage pools, and issuers of asset-backed securities, accounting for 86.8% of the market in Q1 2006.
US Bonds - Non-GSE's rush to mortgage-backed securities After having the market for mortgage securitization virtually to themselves while Fannie Mae was in the regulatory doghouse, issuers of asset-backed securities again face fierce competition as government-sponsored enterprises returned with a vengeance to the market.
US Bonds - Rate sensitivity and bond issuanceThis article describes the factors that influence the four primary US bond markets: Treasuries, Agencies, Municipals, and Corporates.The analysis indicates that a high percentage of the supply side of the bond market is opportunistic and sensitive to interest rates, which explains why long-term interest rates have been relatively stable, despite increasing demand.This analysis also suggests that should the flow of funds from the trade deficit suddenly dry up, the first impact would be a rapid reduction in the size of the residential mortgage market, rather than a sharp increase in interest rates.
US Bonds - Record bond issues push rates higherNet issuance of bonds into the US market in Q1 2006 surpassed prior records, forcing bond prices to fall and rates to rise.The bond market was moved by seasonal factors, the return of Fannie Mae, and corporate demand for funds to finance stock buybacks.Total, annualized net sales for corporate and foreign bonds, agencies, treasuries and municipal bonds reached $2.2 trillion, 70% higher than bond issuance in 2005.
US Bonds - The US bond market's friendOn January 11, 2007, Hugo Chavez Frias was sworn in for a third term as Venezuela's president, promising to expropriate strategic sectors of the economy, specifically public utilities and oil properties and to generally run rough-shod over property rights and the rule of law. This is unadulterated good news for the US domestic bond markets. Perhaps we should light a candle to Saint Jimmy.
US Bonds - World avoids US private debtThe flight to safer investments, which started with the Crash of 2008, has accelerated as the consequences of economic policies of the Obama administration have become evident.There has been a net swing away from certain classes of private debt on the order of USD 1.5 trillion, between 2006 and Q2 2009. This money has gone into US Treasury securities, driving rates to almost zero.
US Equities - Barriers to a bear market recoveryHow long will the rally in US stocks that started in early 2009 last? Remember the 'suckers rally' of 1932-1933 that signaled the end to the Great Depression too early.There are three major barriers to a prolonged recovery in stock prices: a trillion dollars or so of executive stock options; the cost of TARP repayments; and the investment needs of retiring Baby Boomers.
US Equities - Corporations lighten up on tangible assetsFederal Reserve national flow of funds accounts for the years 1995-2004 show that corporate tangible assets, as a percent of total corporate assets, dropped from 56.7% in 1995 to 49.7% in 2004. Tangible corporate assets would have had to been $1.4 trillion greater in 2004 to represent the same percentage of total assets as in 1995.This is an indication of the success of the asset-lite movement and the pervasive flight from "asset-heavy endeavors".
US Equities - Dividend yields drop in 2005Between Q4 2004 and Q4 2005, average dividend yields fell from 4.2% to 1.5%, while long bond rates held steady or rose slightly.The decline in dividend yield was due primarily to a sharp reduction in amounts paid as dividends, rather than to an increase in the market value of equities.The downtrend in dividend yields was constant throughout 2005.
US Equities - Equity closed-end funds more popularBetween December 2003 and December 2005, assets of closed-end funds increased 29%.In 2003, assets of equity funds made up only 24% of the assets of closed-end funds.This increased to 32% in 2004 and 38% in 2005.
US Equities - Foreign stock issues up despite Sarbanes-OxleyDespite unpopular conditions imposed by the Sarbanes-Oxley Act, foreign issuers have continued to sell equities into the US market during Q1 2006. The effect of foreigners on the US equity market has been to dampen the effects of price manipulation driven by buyback-option programs.After 2005 the volume of stock buybacks surpassed prior levels by a substantial margin, dwarfing records set at the peak of the Great Bubble (2000).
US Equities - Foreigners and funds buy US stocksForeign investors and mutual fund shareholders were the primary buyers behind the Bear Market Recovery of 2009. Stock buybacks had disappeared, a significant modification in investor/issuer behavior that had been seen since 1982 and SEC Rule 10b-18.The rally hit a peak in January 2010, reminding many of the saying, "As goes January, so goes the year".
US Equities - GAO favors overly-optimistic projectionsIn a study of the effect of the retirement of Baby Boomers on the price of equities, the GAO assumed that equities will provide real returns of 7% over the next decades. This figure is often cited in Wall Street promotional literature, but has no scientific basis.Baby Boomers whose retirement plans are predicated on a 7% return on equities may find out, too late, that they have been misled by marketing flim-flam.

US Equities - GAO pooh-poohs a Boomer bustIn July 2006, the Government Accounting Office issued a report saying that the retirement of the Baby Boomers should not have a negative effect on stock prices.This article reviews the GAO reasoning and concludes that the government's 'Don't worry, be happy' conclusion is not credible.The Woodstock kids will soon have to think about assisted living costs.
US Equities - Households save and invest in equitiesGovernment economic stimulus programs that have sent money directly to US households have resulted in more saving and less spending.Low interest rates have encouraged individuals to move from debt instruments into equities.Should extreme government spending programs lead to inflation, as expected, the 2009 recovery in equity prices may prove unsustainable.
US Equities - How long will the 2009 stock rally last?The US stock market rally of 2009 revealed flow of funds patterns not seen for over a generation. The rise in prices does not seem to be based on fundamentals. There are barriers to continued recovery.Does 2009 represent a paradigm shift in the market of US equities?Or is this simply a signal of a fleeting bubble, like the rally of 1932?
US Equities - Individual investors avoid equitiesFederal Reserve flow of funds accounts for Q1 2006 show the degree to which equity investments have fallen out of favor with individual investors.In the year 2000, about 80% of the money that flowed to mutual funds was directed to the equity market.After the crash, by 2002 less than 20% of net mutual fund sales were allocated to the stock market.
US Equities - Intermediaries control corporate AmericaThe percentage of equities belonging to households and nonprofit corporations increased from 42.8% to 55.4% between December 1995 and December 2004.Over 55% of the equity shares of US corporations which belong, in the final analysis, to US households and nonprofit organizations, are held indirectly through intermediaries, such as life insurance companies, private pension funds, government retirement funds, and mutual funds.
US Equities - Record issues of equity ETFsAccording to the Investment Company Institute, the number of ETFs increased from 151 in December 2004 to 201 in December 2005.In December 2005, domestic equity index funds made up 73% of ETFs, international equity index funds were 24% of the total, and 3% were bond index funds.Issues of equity-based exchange traded funds totaled $121.7 billion in Q4 2005 (annualized basis), according to Federal Reserve Flow of Funds table F123.
US Equities - Sarbanes-Oxley and the shortage of equitiesThe Sarbanes-Oxley Act of 2002, by discouraging companies to go public, will exacerbate the shortage of equities, with a negative effect on the US stock market, although this was not the intent of its authors. Poorly drafted, ill-conceived, and unfair this law does little to protect investors.
US Equities - Stocks surge on spurious earningsFASB Rule 123 vastly understates the real cost of stock options. The accounting for massive stock buyback/option programs by issuers of traded securities over the last generation may be in accordance with GAAP, but is likely to have severely distorted the P&L statements of hundreds of companies.With this in mind, claims that 'better numbers' have driven the stock market in Q2 2009 deserve a healthy dose of skepticism.
US Equities - US corporations still in recovery modeThe Federal Reserve flow of funds accounts provide a general view of the financial situation of US corporations as of Q4 2009. The question that I would like to address is simply this: To what degree have US corporations been able to improve their financial liquidity since the Crash of 2008? Whereas behavior of US households indicates a shift to more conservative financial positions — with far higher levels of saving than prior to 2008 — corporations do not seem to have taken a similar course.
US Equities - US equities in peril; dividends slashed!Over the last five quarters, the annual rate of dividends paid by US non-financial corporations has fallen by two-thirds, from $462.2 billion to $160.5 billion.The apparent reason for this negative trend is the intent of corporate management to radically increase stock buybacks in order to boost the value of executive options.
US Equities - Who is holding America's stock proxies?Over 55% of corporate stock that belongs to US Households and Nonprofit Organizations is held indirectly through intermediaries who have the power to vote these shares.The major holders of these voting powers are pension plans and mutual funds.This means that it is not shareholder-owners that control most US public corporations, but hired intermediaries, each of which have conflicts of interest.