What the iPhone 5 means to Apple's Future

I am an apple maven. I have been for a while. I own an iPad 2, iPhone 4S, iMac and MacBook. I like the hardware design, the operating system and how innovative and cutting edge the company has been - until now.

The release of the iPhone 5 disturbs me. It is apparent that the leap from no phone to the first iPhone and then subsequently to the iPhone 4 were each in their own respect historic moments. Each defined the future of apple and propelled it to become the world's largest company by market cap (depending on the day). Furthermore, the iPhone paved the way for a new breed of communication hardware.

The majority of apple's earnings are determined by iPhone sales and it appears that the iPhone 5 will continue to sell very well. It already has gotten off to an impressive start. What concerns me is the lack of technological improvement from the iPhone 4 to the 5 - in hardware design and software. Despite the current successful sales volume, this lack of improvement means to me that perhaps their competitive advantage is diminishing and the next big innovation is there for the taking - from anyone.

I believe that apple's decline won't be immediate. In my opinion, they will continue to maintain or increase market share over the course of the next 2 to 3 years - especially with the anticipated release of the new inexpensive iPad. However, this iPad is just another repackaging of an existing product - not the creation of something new and different.

The iPhone 5 was apple's moment to demonstrate that it can continue to thrive without Steve Jobs. Although I will continue to be an apple fan for now, I am unfortunately very skeptical about apple's ability to maintain its financial ranking and market cap beyond the immediate future.

The Pros and Cons of a UK Housing Price Decline

I don’t typically like to speak negatively of other people’s comments and/or forecasts but I had to say something about this one.  In the most recent UK Housing article by propertytalk

(http://www.propertytalklive.co.uk/index.php?option=com_content&view=article&id=9993&catid=64&Itemid=85), Assetz House Price Watch not only made a statement today that house prices have increased but that the forecast for UK housing is positive and according to their index, they do not see a double dip recession within the anticipated future.

I am sorry but who is he kidding.  Just two days ago, the Nationwide Building Society released statistics stating otherwise.  They detailed that UK house prices fell in July for the fourth time in five months. Furthermore, the Nationwide House Price Index fell 0.7 per cent in July from June and the index now stands 2.6 per cent below its level of a year ago. Nationwide said the reading was the biggest year-on-year decline since August 2009 when Britain was mired in recession.  House prices are on average 13% down on their 2007 peak.  The good news is that this is better the majority of our European counterparts. 

Just today, JLL released a study, the Residential Eye Report 2012, stating that the “UK Housing industry is facing serious headwinds, both immediate and long-term.”  This doesn’t sound like a promising forecast to me. 

I believe that it is important here to explore the reasons associated with why prices are declining and what impact that this is going to have on residential investment.

Why are house prices dropping?

In my opinion, two reasons:

•         Lack of liquidity
•         Collateral damage from the Euro Crisis

The banks are not lending.  As a result of the last Credit Crisis, the banks have not fully recovered and thus are buyers are not able to obtain the financing required to purchase a home.  It is a perfect storm: lenders are requiring larger deposits and the buyers have less savings to provide as a deposit due to recessionary market conditions.  Stuart makes mention that he does see a double-dip in the cards.  We are in the middle of the double-dip.

However, is it necessarily a bad thing? 

Depends on the investor.

If you own the property, then obviously not.

If you are looking to purchase a property, it depends on your investment objectives and horizon.  If you have a short-term view, I would probably advise veering away from UK residential investments – except for London.  London has proved itself to be very resilient and the UK numbers would be a LOT worse had London not been in the picture.  According to a recent study conducted by UBS, London residential is considered the premier property safe haven city globally.

If you are seeking yield and has a long-term investment horizon, I do agree with Stuart, it could make sense to invest in non-London regions if you have the stomach to endure a possible further drop in house prices.  Due to house prices being low and supply not increasing (resulting from the lack of construction financing) within the foreseeable future, one may be able to purchase residences that offer 7%+ yields.  However, unlike commercial properties, there is the hassle of upkeep, wear and tear, etc. that one must be mindful of when purchasing this type of investment.

If prices drop, the average home purchaser will be able to afford more and the average investor will be able to obtain a higher yield – as long as rents remain or increase.  Due to the lack of rental supply and the fact that the US multi-family model has not made its way to the UK yet, most analysts do not foresee a drop in rents any time soon.

Why This Downturn Is Different

During the 2008 Credit Crisis, many institutional investors turned to emerging economies like China as an alternative and for the most part, it paid off.  From 2008 to 2010, there was an overwhelming sentiment that the Emerging economies had decoupled from the Developed economies. Furthermore, due to China’s increasing consumption, commodity prices and corresponding commodity based economies such as Australia and Brazil were able to piggyback on the perceived decoupled growth. 

While the West has suffered, China’s reported GDP annual growth rate has ranged between 9.2% and 10.4%.  The perception of decoupling has held so far but I have concerns that the global economy is going to experience a shift that may surprise many.  China, despite its attempts to maintain an image of constant double-digit growth, is currently experiencing a soft landing and consequently, it appears that many of the industries and countries that piggybacked on their growth are experiencing likewise.  

“A rising tide lifts all boats” and unfortunately, the opposite rings true as well.

China is not as decoupled as the global economy had hoped.  China’s forecasted growth is 8.2% for 2012 and most analysts don’t perceive any rebound in the near future.  The reason for this is because the current Euro Crisis has demonstrated that China is not as self-reliant as many hoped. 

The question is what impact will this have on the global investment environment? 

This is yet another reason for why there is currently a global flight to safety which means that everyone is seeking what they perceive as the safest means of capital preservation.  Investors are currently paying the German, Dutch, Austrian, Finnish and Danish governments for the privilege of placing their funds with each respective treasury and it appears that UK may be joining the club.  UK yields on 2-year government bonds appear likely to turn negative as investor demand for low-risk investments continue to increase. 

This means that investors are willing to incur a guaranteed nominal loss in lieu of making an investment that could go either way and bear the uncertainty associated with such investment.  This is unprecedented.

Just yesterday, the VIX (Volatility) Index, which many refer to as to the “Fear Index” was at its highest all year.  The VIX is a gauge of investor sentiment.  Warren Buffett has said time and time again “Be fearful when others are greedy and be greedy when others are fearful.”  According to Buffett, now would technically be the time to invest. 

Is it?

In my opinion, for the most part, it isn’t.  And here’s why:

-       The Euro Crisis is going to resolve itself any time in the near future and will most likely get worse before getting better

-       The libor scandal will have far–reaching implications and will most likely negatively impact the profitability of the banking sector.  Consequently, this will eventually further tighten an already struggling borrowing market

Yet, in my opinion, gold has had its run, defensive equities are overvalued and treasuries cannot be priced any cheaper. 

Where should a savvy investor invest their hard earned capital without bearing unnecessary risk?

Good question.  Let’s revisit the topic in a few days and I will provide you with my thoughts.

The Facts Vs Sam Zell and George W

Created on March 5, 2008

On February 27^th in an interview with CNBC, Sam Zell announced that he believed the housing sector would recognize a turnaround as early as spring of this year. Shortly thereafter, on February 28^th, 2008, the Chief Commander of the United States, George W. Bush, made a public announcement to the nation that the economy is softening but “not heading for a recession.” Despite my personal and the firm’s vested interests for our domestic economy to quickly recover; in my humble opinion, I have two predominant issues with the statements that have been made:

1. Both of these individuals, like myself, have a great interest in the market to recover and as a result will perceive the statistics and data in a manner that will most likely be skewed and
2. Every bit of data and statistical analysis states otherwise
   

One of the challenges that the conventional reader is commonly faced with is that the majority of content one is frequently exposed to is filtered through those that have conflicting interests.The media will regularly have a strong tendency to sensationalize negative data and on the other hand, in the area of real estate, realtors, mortgage brokers and developers have the general tendency of doing just the opposite. In most cases, much like all things in life, the truth typically falls somewhere in the middle. Unfortunately, in this case, my personal outlook, based on all of the available data, is that the media may be right – things are going to get a lot worse before they get better.

Although it is impossible to predict the future, there are simple methods and philosophies with which one can utilize to assess the reality of the present and based on this reality, assess the repercussions and outcome of present conditions to foresee the future. What are these methods/philosophies?

Historical Analysis

I am not referring to conventional references made about historical analysis which entail staring at a graph illustrating the historical performance of a stock, industry and/or sector and based on the graph’s short-term trend, assuming that the graph will continue to perform in the direction it has performed for the previous five to ten years (which in my belief is a very lazy and assumptive method of analyzing data). I am referring to the fact that over the course of a century or more, especially in developed countries such as the United States, the economy and its sectors have a tendency of experiencing cycles. Based on these cycles, history has a tendency of repeating itself.

As an example, per the graph below, over the course of the past 40 years, the United States has experienced a total of six recessions – some larger than others. As the graph illustrates, there is a direct relationship between housing starts and recessions. In the majority of the instances that the country has experienced a decline in housing starts, shortly thereafter, the country has experienced a decline in economic conditions. However, even more profound is the following:the greater the decline in starts, the longer the recession. The unfortunate outcome of this data is that in the event history repeats itself again, as it has over the course of the past forty years, it appears that based on the drop in housing that we have experienced, the recession we are experiencing today should be similar to those experienced in 1974 and 1982. According to the Census (http://www.census.gov/const/newresconst.pdf), in January 2006, there were approximately 1,800,000 housing starts. In January 2008, there were approximately 1,004,000 – a 44.3% decline in housing starts in as little as two years and the greater challenge is that statistics are pointing to the fact that it will get worse.

Statistical Analysis

In addition to analyzing historical patterns, one can obtain a fairly clear idea of the overall direction of a sector and/or economy by analyzing key fundamental indicators and much of this form of analysis is composed of utilizing common sense. Based on the data illustrated above, one would impulsively assume that the quick fix to the dilemma is creating government programs to encourage and stimulate additional housing starts. The challenge is that a decline in housing starts is not the cause of the recession – it is one of the repercussions of a declining economy.

The reason why housing starts domestically have declined is due to a sequence of factors.According to the Census, between May 1999 and 2004, the mean new one-family house sales price appreciated from $185,100 to $256,700 – 38.2% appreciation in as little as five years. In response to these market conditions, national sales of new one-family houses increased from 888,000 in 1999 to 1,369,000 in May 2004 – a 54.1% increase. 

What caused this sudden increase in price and sales? Investors. Real estate is a consumer product. At some point or another, the sales price associated with the respective real estate holding will be tied to how much one is willing to pay to purchase or rent the unit. What most failed to recognize during this craze is that what one is willing to pay is determined by the number of options available to them – dictated by the number of homes listed for sale/rent at any given time. In response to prices and sales increasing, the investment community turned to real estate as an alternative to the stock market in light of the high-tech crash in the late 1990’s and invested large amounts of capital in new construction assuming that the development of new homes would provide one with the ability to leverage one’s participation in the 38.2% of appreciation. Housing starts increased from 1,676,000 in May 1999 to 2,077,000 in 2004 – a 23.9% increase yet the nation did not need 23.9% of new homes. The US population increased by approximately 5% which means that the construction community built far more homes that the market could absorb.

In addition to the oversupply of new homes, the 54.1% increase in home price assumes that the average consumer can afford to purchase a home that is 54.1% more expensive than they did five years prior – based on an increase in income and decrease in cost (interest rates, property taxes, HOA’s, etc.). In spite of the fact that the Bank Prime Rate had dropped from 7.75% in May 1999 to 4% May 2004 (which now is at 6%), two predominant factors prevailed: the national income levels did not increase 54.1% and yet the number of homes to chose from increased significantly. 

Where are we today?

Notwithstanding the conditions articulated above and the fact that home sales nationally have dropped from 1,106,000 in January 2004 to 588,000 in January 2008, a 46.9% decline (the most recent Census data), home prices still have not dropped. To the contrary, despite all of the negative media, according to the most recent Census records, home prices have appreciated from $258,600 in January 2004 to $276,600 in January 2008 – a 6.9% increase. In addition, the Bank Prime Rate is currently 6% - 2% higher than May 2004. 

Until such time that the cost of ownership drops via the decrease in interest rates and/or the drop in new home sale prices, it is very difficult to justify an increase in housing absorption.Due to the recent credit crisis and the fact that sub-prime resets are projected to be far higher in 2008 than 2007, lenders have universally tightened lending requirements reducing the amount of capital and liquidity available to the general public. As a result of the reduction in the general public’s access to debt, consumption has and will most likely continue to decline.This inevitably impacts earnings associated with US companies that depend on US consumption. Lower earnings means lower stock prices which typically forces companies to cut costs to maintain profitability – one of the highest costs being labor. This has and may continue to lead to increased unemployment which further reduces national consumption levels and unfortunately, in a worst case scenario, may create a downward spiral that repeats the sequence of negative events articulated above. 

Although the Federal Reserve’s decrease in interest rates may soften the blow to some degree, until such time trust is re-established with global lending community and access to debt is reverted back to what it once was, it is likely that the US Economy will need significant pruning until such time that the economy is stabilized.

The Future

What does it mean to be stabilized? For an economy and a culture that is immersed in consumerism whereby consumption levels and earnings are dictated by the amount of credit available as opposed to the amount of income one generates, stabilization for the time being may mean the following: national consumption associated with consumer products reducing to a level that is dictated by what one can afford as opposed to the amount of credit one has access to and home prices continuing to drop to a level that is congruent with what the average consumer can afford. It means that we as a nation down-size for the time being – to weather the storm. Yes, this does unfortunately mean greater unemployment and increased foreclosures; which is the price we pay for over-consumption and attempting to live beyond our means for too long. We were all keeping up with the Jones’ not realizing that the Jones’ were maxed out all along, also living beyond their means.

However, we are a great nation. This too shall pass and much like the past six recessions we experienced, our economy and nation will endure this recession with the same resilience, creativity and unity as we have in the past. The United States is home to the world’s greatest companies, universities and minds. We are the foundation of the world economy which is why when the US Economy suffers; the rest of the world suffers and vice-versa. For this reason, despite the fact that times may get tough(er), history illustrates that in every scenario, our country has eventually rebounded and in most cases, the pruning was necessary.

Eric Jafari