from the free page of subscription investment adviser Comstock ...

"Comstock takes a look at the housing bubble and sees a hard landing coming...

The Dot-Coms in 2000 and Housing in 2006

Since the market is rooting for a soft landing and no further rate hikes you would think that the weak existing home sales report on Wednesday would have been just what investors wanted to hear. Instead the market took a dive immediately after the release. Although the bulls can argue that the housing report was already discounted, we think something more is at work here. The FOMC pause in its series of rate hikes most likely signified that the period of rising rates has ended and that the next move will be one of ease. If we are correct in this assumption, it means that we are now in the period between the last rate increase and the first decrease. This has typically been a period where the market collapses as the focus of investors shifts from rising rates to a weakening economy and lower earnings. We think this process is about to begin.

The housing market has now become so obviously weak that we no longer have to quote a myriad of statistics to prove our point. The bad news is now being highlighted not only in the financial media but in the general news and even the tabloids. Suddenly the realization has dawned upon almost everybody (there are still some exceptions) that housing is in for a hard landing—probably a very hard landing. Not only is the current news highly negative, but it will likely get much worse. In this regard we were particularly struck by some numbers we read in last weekend’s Barron’s article by Lon Witter. We quote from the article as follows:

Ø “32.6% of new mortgages and home-equity loans in 2005 were interest only, up from 0.6% in 2000.

Ø 43% of first-time home buyers in 2005 put no money down.

Ø 15.2% of 2005 buyers owe at least 10% more than their home is worth.

Ø 10% of all home owners with mortgages have no equity in their homes.

Ø $2.7 trillion dollars in loans will adjust to higher rates in 2006 and 2007.”

With home prices likely to move lower, a lot of home owners are going to be in real danger of defaulting, meaning that the possibility of widespread foreclosures is a real danger. This is in addition to the coming diminution of mortgage equity withdrawals that have been so pivotal in spurring the recovery from the 2001-2002 recession. The great danger here is the potential unwinding of the massive debt that has built up over the past decade and the accompanying threat of damaging deflation that was averted after 2002 only with the help of the housing boom that is now definitely over.

Investors, however, remain in denial just as they were in 2000 after the dot-com boom came to an end. The S&P 500 peaked in March 2000, dropped by 14%, but by late August had rallied back to where it was only 2% off its top, despite the fact that the dot-coms had already imploded. Investors at that time reasoned that the dot-com bust was an isolated event that would have little effect on the rest of the market or the economy. How wrong they were!

Now here we are in another August, and investors are assuming that the damage to the housing industry and the severe drop in home building stocks will remain isolated events. The housing industry is far more important to the economy than the dot-coms ever were, and the potential negative ramifications for the economy and the market are much greater. In addition there are no other major sectors in which to create a bubble to bail everyone out. In our view we are now in a transitional period that will end soon. Until very recently, the main argument was between those who felt we were headed for a soft landing and those who believed there that would be no landing at all. Now the argument is between those who believe that the landing will be soft and those that think it will be hard. The next shift in thought will probably be toward the realization that the landing will be hard. We have already seen more talk of that in the last few days as the odds of a hard landing continue to rise. "