A Cash Cow No More

Your home won’t bail you out any more.

Homeowners have used home equity loans to support a long-term spending spree, confident that their homes would appreciate and fund their retirement even as families continued to assume higher debt. That strategy worked for those who sold two, three or four years ago. It might work for those who sell in 10 or 15 years. Those in between are, in all likelihood, out of luck.

Home prices will fall, not just in real terms, as inflation outpaces appreciation, but in nominal terms. This process has already started. Floating rates on home equity lines and on all those adjustable mortgages that start out as fixed are moving higher. Construction activity, which powered about two-thirds of gross national product growth over the last five years, is collapsing – which means that employment will follow.

All this will force real estate onto the market, driving down prices and reducing the liquidity of any home for sale. Add to this the unraveling of speculative buying in “hot” real estate markets in the West and we’re facing a decade of personal real estate underperformance on a grand scale. And let’s not even think about the fate of the “investments” people have made by providing deed-of-trust and second-lien financing to those who couldn’t qualify for a regular bank loan.

If you believe – as we do – that the US economy is due for a recession, is subject to a lot of latent inflationary pressure and that, in the long run, growth prospects are probably not as good as they are in some other economies,  then you must conclude – as we have – that consumer behavior needs to change.

Thus to accumulate adequate assets for retirement, households will need to act in unaccustomed ways:

• Work longer hours to earn more.
• Spend less, and recognize that spending on vacation homes, boats and the like is not “investing” but consuming.
• Think very differently about what they invest in and how actively they make investment choices and reallocate their investments.  That is, we continue to think day trading is wacky, but thoughtful reallocation over time is essential.

In this environment, financial assets must give investors some genuine protection against inflation – that is, they must have some component of a claim on “real assets.”  That means that common stocks are a poor hedge against inflation over short to medium horizons. Higher inflation, and the associated higher interest rates, tend to harm their values.

For protection against inflation, investors need to become comfortable with Treasury Inflation Protected Securities (TIPS), commercial real estate funds and commercial REITs, and possibly more exotic vehicles holding commodity pools and timberland. They will need to seek returns in non-US securities, in small-capitalization stocks and perhaps in infrastructure investments such as pipelines and power grids.

They also will have to get comfortable with changing times and the need to change investment strategies to address issues – and opportunities –  that are still emerging.

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This commentary based on information, assumptions and market conditions believed by Contango Capital Advisors to be accurate as of the time this was prepared. It is offered for informational purposes only, and should not be construed as investment or financial advice. Please consult an investment professional concerning your own needs and circumstances and to obtain any specific advice with respect to the topics discussed above.

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