I'm going directly to the source now. Let's bring in wages. It's ultimately all about jobs, jobs, jobs, and jobs.
I've used the average ratio to generate the trend line in the following chart.
The replacement-cost value of durable goods have clearly been tied to wages. So let's attempt to tie the market value of real estate to wages and see what we get.
We've been continually sold the idea that the real estate market could appreciate faster than our ability to pay for it. Let that idea represent the upwardly sloping linear trend line in the chart above.
The reality of the situation is that we can only afford what we can afford. Let that idea be represented by the flat "average" ratio in the chart above. If you make X amount of money per year, then you can afford to buy a house that is X times some constant. In this case, that constant might be 2.15.
Now let's use that 2.15 constant to create the trend line in the following chart.
In my opinion, real estate is still overpriced. There is some risk that we will actually dip below the red trend line. You can't exactly have an average if you don't spend as much time below the average as you do above it.
We can speak of extremely low interest rates all we want. If real sustainable jobs don't appear soon, watch out below. That's especially true if the price of oil cannot be contained.
As a side note, I have no more interest in investing in the stock market now than I did when I exited it in 2004. It is trying to price in a return to normal. In my opinion, the return to normal is still in the other direction though.
This is my theory and I'm sticking to it.
See Also:
A Grand Unified Theory of Malinvestment
A Grand Unified Theory of Small Business Malinvestment
A Grand Unified Theory of Stock Market Malinvestment
A Grand Unified Theory of Real Estate Malinvestment
Trend Line Disclaimer
Source Data:
FRB: Flow of Funds
Jobs are old news, this is the NEW economy!
ReplyDeleteGYSC,
ReplyDeleteThat's the problem.
The NEW economy is much like NEW Coke. ;)
New Coke
The American public's reaction to the change was poor, and the new cola was a major marketing failure.
I love that story so much. What a flop.
ReplyDeleteI did some lawn repair this weekend and I used Scotts Seeding soil for the patch work. I have been buying this stuff for two years because it works so well. As I was using it I found a whole crap load of wood chip fille rin the mix; this was not the case the past two years. Either they changed the ingredient list or they are using wood chips to make the weight of the bag using less good material. Weird. Its like those huge boxes of cereal bu they are only 1/4 of the way full!
Wood chips? Seriously? Good grief. I have a solution though.
ReplyDeleteYou just need to add fertilizer to your fertilizer.
wood chips as mulch?
Someone told me to work some lawn fertilizer into the wood chips.
Mark - good job. Yes, the fundamental ratio is between incomes and prices. Specifically, the buy-in incomes have to support the entire weight of the pricing structure above.
ReplyDeleteDurable goods purchases vary with incomes due to economic utility functions. For example, see this graph from the consumer expenditure survey.
http://www.bls.gov/cex/chart_02.png
Notice that as the price of oil and gas went up in recent years, the purchases of vehicles dropped.
Most consumer goods are utility goods, and spending on each type of function (shelter, food, transportation, medical care) generally has to be somewhat balanced. You can't spend 50% of your income on your house mortgage, taxes, and insurance if you don't have the money to get to work or eat.
The more fundamental the utility the stronger its share of the total will remain. So purchases of discretionary/somewhat discretionary goods compress when fundamental costs go up.
MaxedOutMama,
ReplyDeleteThat's a great chart. It shows just how much damage rising oil prices can do to our "resilient" economy.
There might be some good news here.
When I drive, I tend to think in terms of 50 cents per mile total operating costs. I think most people tend to think in terms of 10 cents per mile gasoline.
If one drives half as much because gasoline doubles in price, that could actually mean that the person saves a lot of money. Over the long-term, that money could be spent on other things.
Just a thought.