Wall Street May Seem Fine, But There's an Economic Sinkhole Below

I celebrated my 59th birthday last week. Time has given me some perspective on life and the markets. Like most, however, I am still trying to figure out a few things. One belief I have become more confident around by the year is Twain’s observation around history not necessarily repeating but rhyming in many cases.

When I first moved back down to Miami in 2003 after a few years in New York City, it was already evident the Magic City was already in a housing boom. By 2006 it was also quite evident that the city had a major housing bubble on its hands. In many neighborhoods, it cost half as much to rent than to buy the same place. From the perch of the balcony of my apartment in Miami Beach I could count over 50 huge cranes putting up different 30- to 50-story condo buildings.

The bust that followed was beyond epic, but at least I thought everyone learned a valuable lesson that would stick with them throughout their lifetimes. I was wrong. There are currently over 90 large buildings going up between Coconut Grove and Mid-Town. Most are for skyscrapers between 60 to 90 stories this time around. And unfortunately, a few cuts to mortgage rates aren’t going to stave off the inevitable.

There are many newer construction one-bedroom apartments in downtown that can be had for less than $500,000. The problem is the cost for home-owner association fees, taxes and insurance run $1,500 to $2,500 a month before factoring in the interest and principal payment. Given the median household income in Miami is just over $75,000 annually, that is an intractable problem. This will lead to a major bust as more supply comes online. I expect single family homes to fall at least 20% from their peaks and condo prices to drop 40% in most major metros across Florida before this bust completely plays out. Many other regions like Denver, Phoenix, and Las Vegas are in the same boat. Can’t happen? It already has in another former hotspot in the form of Austin, Texas. Many cities like Cape Coral, Sarasota and Fort Myers in Florida have already experienced 20% declines in condo prices from their peaks with no bottom in sight.

Investors are also ignoring deepening cracks in other parts of the economy. This is being papered over thanks to some solid economic readings including recent strong retail sales reports. Remember, however, the top 10% of households by income, not only own 87% of stock wealth, they also drive nearly half of all consumer spending. Most of the rest of the country feels like it is navigating a recession-like environment. The faltering job market just raises that angst and is a key reason consumer sentiment is in the dumpster despite decent gross domestic product growth.

The default rate on sub-prime auto loans is now higher than their peak during the Great Financial Crisis. Tricolor Auto Holdings, a significant operator of used-car dealerships and a major subprime auto lender, has just filed for Chapter 7 bankruptcy. It is largest bankruptcy in the subprime auto loan space in years as is a sign of the growing stress in this niche of consumer finance.

Then we have the train wreck that the student loan market is fast becoming. One would think giving loan holders a nearly four-year taxpayer-financed holiday from payments would have allowed plenty of time for these debtors to get their financial houses in order. Unfortunately, that is not how things have played out. Since loan payments were restarted earlier this year, nearly six million of the nearly 42 million student loan holders are 90 days or more past due.

I feel we have seen this movie before. With markets at all-time highs and selling at levels by many metrics not seen since the end of the Internet Boom, investors are ignoring these economic tea leaves at their peril.

At the time of publication, Jensen had no position in any security mentioned.