Editor: Phillip J Anderson / Associate Editor: Callum Newman / Lead Researcher: Terence Duffy

03 June 2015

Ricardos Law

The Unintended Consequence of the Federal

Governments Budget Only You Will See
By: Phillip J Anderson and Callum Newman

In 1921, the President of the United States,

Warren Harding, appointed a man called Andrew
Mellon to be his Treasury Secretary. That
decision would impact the country, indeed the
world, in profound ways that nobody could ever
have expected at the time.

ALSO IN THIS ISSUE

An Effect No One Else Will See
Profit From This Booming Industry
Forecast: Start Putting This Market
on Your Watchlist
Another Signal to Guide Us into 2019

Of the two men, Mellon was actually the more

imposing figure. An industrialist and a financier,
Mellon had stakes or directorships in hundreds
of companies and was one of the richest men in the country.

In her book, All the Presidents Bankers, author Nomi Prims described him like this:
Mellon was an operator. He owned numerous trusts, insurance, railroad and utility
companies, and the Pittsburgh Coal Company, the largest of its kind in the world.
In 1911, Munseys Magazine described him as the J.P. Morgan of the Steel City. On issues
of economics and foreign trade, Mellon was more conservative than Harding. He also believed
in low taxes. Harding promoted Mellons efforts to extend huge tax cuts for the rich and
corporations.

Sowing the Seeds of 1929

Mellon acted true to his beliefs in three different revenue acts in the years 1924, 1926 and
1928. Tax rates dropped for the wealthy from 75% to 25% and middle income earners were
exempted on their first $4,000. That meant by 1928, according to Prims, most Americans
paid no income tax at all.
Sound good?

Well, heres what no one else can show you.

The dramatic savings in income tax were
quickly capitalised into higher land values.

Rent and the

Dysfunctional Economy

This is David Ricardos Theory of Rent in

action. Its a natural law, and cannot be
stopped. It can only be dealt with.

Excellent proof of why tax cuts affect

land values, can be found in Chapter
3 of George Millers book, On Fairness
and Efficiency: the Privatization of
the Public Income over the Past
Millennium

Mellon, of course, didnt know this

would happen.

The result? Those skyrocketing land price

gains provided further collateral for the
banking system to create credit and fuel the
bubble in stocks and housing. The roaring twenties was on.

The price of urban land doubled between 1920 and 1926. Americans got their first taste, en
masse, of unleashing the equity value of their properties into the consumer economy. The
boom times looked like they would last forever.
Of course, everybody knows about the Wall Street boom in the stock market today. But who
remembers the real estate boom times of that era? No one.
This bit of history is important, because...

Nobodys Any the Wiser Today

The Australian Federal Government announced its budget recently.
We would never normally reference it. It means very little in the larger scheme of things and
achieves little.
However, there is one thing you may be guessing by now...
And thats the fact that by 2019 higher rents will eat up the $3.3 billion in small business
cuts announced to considerable fanfare.
Do you see where the higher land prices can come from now, as we continue further into
the cycle?
Note further, that such budgets almost never reference housing affordability. That only
comes if (when) we get to a stage where banks have to be rescued. Then its serious.
Otherwise, the collection of the economic rent will never be toyed with.
Conclusion: Prime real estate can and will go higher in Australia.

The Real Estate Cycle is Moving in America

As ever, we let the property clock guide us. Remember, the US cycle leads the world. We had
the designers take out half the clock to show you the first phase of the real estate cycle.
You can see that here...

It begins with the rise of rents and goes to the mid cycle slowdown we expect to start in or
around 2019. Lets update how this is progressing. We should be seeing rising real estate
values in America.
Are we?
Yes thats exactly whats happening and as forecast. In May the National Association of
Realtors in the US reported that the prices in 148 metro areas are up for the year out of the
174 theyre tracking. 51 of those are showing increases in the double digits. The largest rise
is 33.4% in Texas.
Supply is short, according to analyst at Stanberry Research Paul Mamphilly. He says the
US needs 1.5 million housing starts per year. Thats because the US generates 1.2 million
households every 12 months but 300,000 houses are made obsolescent and abolished in
the same time frame.
In regard to this, Paul points out that the US has been underbuilding homes for at least
seven years. This is perfectly in accord with the real estate cycle.
The downturn in 2007 wiped out a lot of builders and developers. Those that survive face a
tough economy with tight credit and high unemployment. That means the houses they do
build tend to cater for the wealthy, the only market with money and access to credit.
As the population continues to grow, and as the economy slowly improves, it pushes up rents
for establishing buildings. That entices the builders and developers back into the market.
So wed expect to see activity in the construction sector...

Profit From This Booming Industry

We dont have to cite any statistics on this one. The stock market is already telling us.
Note the following stocks that are trading at near or all time new highs in the following list:
Company
American Woodmark
Home Depot
AAON
Masonite International
Smith AO
Mohawk Industries

Market

Gain Since 2011 Lows

Cabinets

349%

Home Improvement

267%

Air Conditioning

249%

Doors

187%

Water Heaters

344%

Carpet & Flooring

358%

These are not recommendations, though you could consider doing some due diligence on
these stocks should you care to. But they highlight the strength of the housing market and
have a bright outlook in general.
Paul Mamphilly suggests a conservative way to gain some exposure to this trend is to
consider the SPDR S&P Homebuilders ETF (XHB).
SPDR S&P Homebuilders ETF (XHB) (AMEX) 1 Day Bar Chart - USD

Source: Market Analyst

Since the beginning of 2012 it has been in a strong uptrend.
The companies within the ETF have exposure to a broad selection of associated industries:
building, furnishings, appliances and home improvement retail.
We expect the strong trends driving this performance to continue. Its also another reason
we dont see America falling into recession anytime soon.

That leads us to a...

Forecast: The Expansion of Banks is Getting Closer

As land values rise in America the natural consequence is that it will require a bigger
mortgage for those wanting to buy in. This is exactly what the banks want to see. More
debt is more profit for them.
For now, mortgage credit is still quite tight and reasonably difficult to get for middle to
lower class borrowers in the US. Thats in contrast to other areas of the economy like auto
and student loans.
On 12 May The Wall Street Journal highlighted the fact that there had been largely no net
change in mortgage debt in the first quarter for the US.

The slow growth in mortgage debt is due to the regulations and fines levied on the big
banks in the wake of the financial crisis.
This will change as credit standards get less strict. History shows after every real estate
cycle the banks do everything they can to get around the regulations.
Its already happening. Back in April the WSJ reported that millennials those born

between 1980 and 1999 are beginning to qualify for mortgages for the first time thanks to
the improving economy.
As the paper reported, Low interest rates and loosening credit qualifications are, in part, fueling
the change. Borrowers can now pay as little as 3% down for government-backed loans, and 10%
or 15% for jumbos, which are loans over $417,000 in most parts of the country.
If the mainstream banks are slow to act, the nonbank lenders will take more and more
market share. They are in fact already moving in to service the market for riskier loans.
One of the nonbank lenders, Quicken Loans, last year took the most market share of loans
insured by the Federal Housing Administration. Their clientele have weaker credit scores
and can get loans for as little as a 3.5% deposit.
This is a trend we will watch closely. Stay tuned.

The Signal That Precedes a Recession

Well keep a close eye on another item as well. While the next move on the clock is going
to see an expansion of banks and credit creation, there are also other initially
seemingly separate things you can keep an eye on to tell you where you are in the cycle
and on the clock.
Have a look at the following chart...

Source: Macrotrends.net
Its a chart of the oil price, log scale, inflation adjusted and shows the US recessions.
Notice anything?

Thats right. The oil price has spiked just prior to the onset of every recession except 1961.
Have you noticed as well, the years ending around 9 and 0 are almost always economic
downturns.
Watch for this to repeat. Prepare for it in fact.
So, if going into 2019 you notice the following...
the economy is really booming
inflation ticks up a little
the oil price spikes just a tad (as it did 30 years prior in 1989)
the worlds tallest, longest, largest, biggest building is opening to great fanfare
and the yield curve is threatening to invert....
Then you will know exactly precisely where you are on the clock.
Watch for it. Its a high probability sequence of events. And if it doesnt happen, then we
wont be seeing much of a mid-cycle-slowdown.
If you watch your chart patterns closely, this is highly tradable information. CT&F will
highlight this for you as we run into 2019.
Stay tuned indeed.
Best wishes,

Phillip J Anderson
Editor

Callum Newman
Associate Editor

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