Today’s rate cut of 3/4% came sooner than expected—but is still not enough.
 
With the 2 yr note now down to 2.05%—the Fed will now need to get down to 2%–or lower.
 
The question is–how–and how soon—as well as—will they ever get ahead of the curve will all of its implications.
 
The cut today—just 8 days before the next scheduled meeting—automatically guarantees AT LEAST another 1/2 pt cut next week to 3%. With any luck, the Fed will cut 1 full pt to 2.5%—setting the stage to “catch” the market by March with an inter-meeting cut in Feb before the March  meeting. I now see the fed needing to get to 1.5% by May. No one believed me before–believe me now.
 
What is interesting about all of this is that while you see an economic capitulation due to the FED being too restrictive for too long—this downturn, started and caused by higher rates which caused the worst housing downturn since  the Great Depression—is actually starting to see the first signs of life. Let me explain–
 
While all of the pundits have been pondering whether or not the US would go into a recession–it was clear to me from the beginning that the recession started Aug 10th–just after the capital markets froze. There is little doubt that we were heading that way–but the seizing of the markets accelerated the decline. The Fed’s response to this was–and has proven to be–anemic as they stay consistently behind the curve, and noticeably above the 2 yr bond. They have continued to mis-read the unemployment levels—due to the fact that a huge amount of people have lost their jobs–but these people were not employed, they were independent contractors! They were real estate agents and brokers, mortgage brokers and bankers, appraisers and pest control companies, movers, plumbers, electricians,  carpenters, etc. You get the drift.
 
Against this backdrop of a worldwide stock market decline and clear capitulation of panic selling—–has come the first glimmers of spring with the first signs of life in the housing market—the very market that led the downturn. How do I say this?
 
We started to see the first signs of life when searches for real estate turned the corner December 26th—when all of a sudden, our budgets in certain markets were not enough to satisfy the demand for people looking for homes. We continued to see this starting Jan 3rd when real estate leads—those people who either contact us because they want more information on a home or an appointment  to see them–simply exploded. This has been starting to be reinforcing by the number of people who have not only contacted us–but want to see homes NOW. Up to this point, the attitude by prospective home buyers has been–I’d like to see the home–maybe in a week or two–”I’m kinda busy.” This has dramatically shifted.
 
As you know, housing tends to lead a market into a recession—but it is also the leading indicator for an economic revival and tends to pick up midway thru the recession. Since postwar recessions tend to last 10 months–midway would be Feb 10th—and we’re not too far from that. While it would be very easy to say that this is not a normal credit-led downturn by any means [and I completely agree] this must be held against these important facts—that the Fed started lowering rates immediately following Aug 9th’s debacle [rather than waiting for the economic fall-out to be more widespread before finally acting]—and that they actually started to reflate the economy starting last May when they embarked on a policy of increasing M 3 by a 15.3% annual rate. These two VERY important factors will get us out of this sooner than the consensus feels. Additionally, I now expect real estate prices to be HIGHER at the end of the year and a huge number of transactions to occur due to these sharply lower interest rates. I feel that today’s emergency interest rate cut not only says that they are going to be cutting much more than people expected—but it will accelerate the home buying process and recovery—since we have three years of pent-up demand to go along with these sharply lower interest rates.

While the newspapers and pundits continue to discuss and hypothesize on whether we could go in to a recession—-we not only already IN a recession, but probably mid-way through the recession. Typically, recessions are reported after they are finished and are backwards-looking. I believe that when the capital markets froze mid-August, that they economy quickly declerated into at least 2 quarters of declining growth. It’s that simple.
 
The residential real estate market’s decline will have brought about the recession, and the residential real estate market will bring us out—as it ALWAYS does. The typical post-war recession is 10 months, and if this one started on/about August 15th, then typically it would be finished June 15th. The housing market normally picks up MID-WAY thru the recession [due to lower interest rates and the affordability] and that would be expected to be Jan 15th.
 
We have some unusual things going on now that seems to be escaping the media who loves to write about”gloom and doom”—but seems reluctant to write about the news.

Simple fact—housing inventory has now declined across the United States 4 months in a row! In some areas–the decline in inventory has been 10% or more–in only the last month.

While the Federal Reserve was keeping tight on interest rates, they were quietly expanding the money supply at a great rate–and have increased the M3 by approximately 15% in the last 12 months. This is huge— will play a great role in housing’s recovery—-and will bring a general econimc recovery sooner rather than later.

Since we operate a national real estate business, I can tell you that leads for buying have exploded since the first of the year.
 
As you all know, I have been expecting the real estate market to begin its recovery in March–led by an increase in transactions. Getting leads in January should lead to transactions in March. I also expect prices on homes to begin to turn north ahead of everyone else—either in the fall of this year, or the spring of next year at the latest. With inventory declining, and transactions expected to be picking up soon, it won’t be long until the media reports the upturn, and then people will return to the real estate market in droves [3 years of pent-up demand by people waiting until it’s “safe” to buy.] Once the inventory bulge is taken out of the market, prices will start to recover.
Classic economics–classic people investor’s psychology.
 
Bernanke’s speech sets the tone for a 3/4 % rate reduction on Jan 30th to 3.5%, and clears the way for a reduction to 3% mid-March. The 2 year treasury is now near 2.5%—so expect Fed funds to get near to the 2-2.5% range, and we could be at 2.5% at the May meeting!. I don’t think they will need to go lower because the Fed increased the money supply much earlier into the slowdown than people realize—and because/since they did—the housing market will show stronger positives this spring than people expect—which will lower the need for the Fed to lower the rates, and because I expect the decline in bond yields to be over sooner than later since the bond market will begin to see this upturn before the Fed and everyone else. Over the next 6 months you will see parts of the economy declining—and the housing market start to recover.
 
Let’s look at the housing inventory decline…

The change in the number of homes for sale at the end of December compared to a month earlier–
 
Boston - 13.3%
Chicago - 8.6%
Dallas - 8.2%
Los Angeles - 8.5%
Minneapolis - 9.8%
Orange County, CA - 10.2%
San Francisco Bay -11.3%
Seattle -10.7%
San Diego - 8.8%
Washington DC area - 8.4%
etc.
 
Fact is—-when you look at the numbers, and remember that this is the 4th consecutive month of inventory decline—the numbers are startling—-especially since all we keep hearing about are foreclosures causing inventory to swell. Maybe news reporters ought to report the REAL news on this. Once they do–the recovery will be well under way!
 
The Wall Street Journal had this to say yesterday-

“market performance is ugliest before and in the early days of a recession as investors panic about the effects of a downturn on earnings. In the three recessions between 1980-1991, stocks turned positive before the recession ended, leading to runaway gains in the months after the downturn. Stocks on the whole rose modestly during those recessions”

This leading me to believe that the worst of the downturn is probably here—and we have experienced a small up-move in stocks after the recent correction although it is way too early to call an end to the decline in equities. However, due to declining rates, expectations of large decreases coming soon, and the ease that corporate earnings will be able to beat year-over-year comparisons–especially in the financial and housing sectors—this portends a strong advance in stocks.