Category: News

Defaults and a developing deflation go hand-in-hand.

As Robert Prechter’s 2020 edition of Conquer the Crash states:

Near the end of a major expansion, few creditors expect even the weakest borrowers to default, which is why they lend freely. At the same time, few borrowers expect their fortunes to change, which is why they borrow freely. Deflation involves a substantial amount of involuntary debt liquidation because almost no one expects deflation before it starts.

With that in mind, consider this headline and two subheadlines from a Sept. 8 CNBC article:

Most expensive home in America defaults on $165 million in debt, heads for sale

A Los Angeles megamansion once expected to list for $500 million has gone into receivership after the owner defaulted on more than $165 million in loans and debt, according to court filings.

The 105,000-square-foot Bel Air estate, known as “The One,” was placed into receivership and is expected to be relisted at a lower price.

Let’s now transition from news about a “California megamansion” to Elliott Wave International’s analysis of what is going on with the overall U.S. housing market. Here’s a chart and commentary from the September Elliott Wave Financial Forecast:

Two… indicators suggest that a home price peak may be close. The first arrow on the top graph on this chart shows the July 2006 peak in U.S. Median Home Prices. The arrow on the second graph shows the last major peak in pending sales, which came in July 2005, 12 months ahead of the downturn in median home prices. Now observe the arrows on the right side of the chart. A similar divergence is occurring, as it has been 11 months from the latest peak in pending home sales to a June peak in median home prices. The bottom graph is the U.S. National Association of Homebuilders Market Index. Back in 2005, the index peaked in June, one year ahead of home prices. The index registered its latest peak reading ten months ago, with a record high of 90. In December 2005, when the NAHMI was six months into a 43-month decline to January 2009, pundits argued that “housing is simply taking a much-needed breather.” EWFF showed a chart of the seminal decline in the Homebuilders Index in that issue and stated, “The housing market is in the process of falling into an enormous crater.”

China Evergrande Group is the country’s second largest property developer and it’s been selling assets to improve solvency.

In a discussion about the debt-burdened real estate developer, the August Elliott Wave Financial Forecast mentioned that the share price of China Evergrande had plunged 84% (as of August 2) from the peak in October 17.

The publication also mentioned the property developer’s bonds and showed this chart:

The chart shows that the price of Evergrande’s 8¾% dollar bonds crashed in July to 39 cents on the dollar.

Nearly a month later (August 31), Bloomberg published an article headlined “Evergrande Flags Default Risk From Cash Crunch; Bonds Fall.” Here’s an excerpt:

China Evergrande Group warned that it risks defaulting on borrowings if its all-out effort to raise cash falls short, rattling bond investors in the world’s most indebted developer.

“The group has risks of defaults on borrowings and cases of litigation outside of its normal course of business,” the Shenzhen-based company said in an earnings statement on Tuesday. “Shareholders and potential investors are advised to exercise caution when dealing in the securities of the group.”

The company said it’s exploring the sale of interests in its listed electric vehicle and property services units, as well as other assets, and seeking to bring in new investors and renew borrowings. Still, sharp discounts to swiftly offload apartments cut into margins, helping push net income down 29% to 10.5 billion yuan ($1.6 billion) in the first half of the year, in line with an earlier profit warning.

… Evergrande’s bonds sank toward fresh lows as investor confidence in its ability to repay debts continued to erode. While borrowing fell, total liabilities that include bills owing to suppliers edged up to 1.97 trillion yuan, near a record high.

When people turn financially conservative, they tend to spend less and save more.

That’s part of what may be called a “deflationary mindset.”

As the 2020 edition of Robert Prechter’s Conquer the Crash states:

The psychological aspect of deflation and depression cannot be overstated. When the trend of social mood changes from optimism to pessimism, creditors, debtors, investors, producers and consumers all change their primary orientation from expansion to conservation. As creditors become more conservative, they slow their lending. As debtors and potential debtors become more conservative, they borrow less or not at all. As investors become more conservative, they commit less money to debt investments. As producers become more conservative, they reduce expansion plans. As consumers become more conservative, they save more and spend less.

Is “the trend of social mood” now in the process of shifting from optimistic to pessimistic?

Well, read this excerpt from an August 28 Marketwatch article titled “U.S. households and small businesses have stockpiled a mind-blowing record cash pile of almost $17 trillion”:

U.S. households and small businesses have stockpiled a record cash pile of almost $17 trillion — a mind-boggling estimate that exceeds the $16 trillion in fiscal action undertaken by governments around the world to keep the global economy afloat during the pandemic.

That domestic cash hoard has grown exponentially since February 2020 due to three factors: direct government stimulus payments to individuals, shutdown-induced savings from Americans working from home, and small-business decisions to hold onto grants or loans, according to… a Memphis-based manager at fixed-income dealer FHN Financial, which tracks cash flows.

The magnitude of the cash positions being held is surprising considering the tendency of households and businesses to tap their savings during each of the two or three recessions prior to the pandemic era. After the coronavirus pandemic triggered a deep two-month U.S. recession starting in February 2020, what is different this time around is that savings have soared despite the economy reopening. Two reasons have been offered for this: small businesses look to be focused on rebuilding inventories to brace for pent-up demand, while individuals are opting not to spend money on even the more restricted services and experiences that have now become the norm.

This stockpiling of cash suggests the possibility of a developing deflationary psychology.

Cash will be king during a deflationary depression, so it’s a good idea to start storing some away, if you have not already begun doing so.

Let’s return to Conquer the Crash for an example of how the demand for cash soared in recent history:

When access to credit [in Cyprus] was curtailed in 2013, there was a soaring demand for cash — the one thing nobody had. A March 26, 2013 article in The Financial Times reported, “The most immediate problem confronting businesses was a scarcity of cash.” A businessman in Cyprus said, “The market is operating on a cash basis — everybody wants cash.” That was the immediate result of deflation in Cyprus.

Expect a deflation in U.S. home prices just ahead.

Before getting into an explanation as to why, let’s start off with a Wall Street Journal headline from just a month ago (July 22):

U.S. Median Home Price Hit New High in June

More recent news stories have discussed a slowdown in new home sales, yet prices remain elevated according to some local headlines (The Orange County Register, August 18):

Housing market hits record-high price despite signs of leveling off

Southern California’s median home price hit $681,750 in July, rising on average almost $2,000 every week for the past year.

Here’s another example (Austin American-Statesman, August 19):

While prices continue to rise, Austin’s home sales have slowed.

However, according to a key ratio, the rise in home prices is likely headed for a reversal.

This chart and commentary from the August Elliott Wave Financial Forecast provide insight:

This chart of U.S. home prices to rents, courtesy of The Campbell Real Estate Timing Letter, shows another important series of correlations that date back 45 years. Home prices invariably peak when the ratio is high and bottom when it is low. At this point, the ratio has never been higher. The only other reading of more than 100 came as house prices peaked in 2006. [Emphasis added]

If the U.S. government spends and borrows as currently planned, the likely result would be a debt-to-GDP ratio which exceeds the levels following World War II.

Here’s an excerpt from an August 6 Forbes article:

Elliott Wave International’s recently published August Global Market Perspective shows that the debt-to-GDP ratio in 20 advanced economies is already around the percentage levels of World War II. Here’s a chart and commentary: