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American real estate market crashing - could stagflation be the outcome?

 

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Question:

Can you explain what stagflation means, in particular in regards to the residential real estate market? Who wins and who loses? What will the timeframe be? And what is the likelihood for stagflation?

Answer:


Stagflation is described as sluggish economic growth coupled with a high rate of inflation (rapidly rising consumer prices) and rather high levels of unemployment. Note that the effects of rising inflation and unemployment are particularly hard to counteract for a central bank.

My model in this case–in most cases–are financial microeconomic scenario analyses which take macro events as inputs. I try not to build macro models if I do not have to because they are notoriously difficult to rely upon. I am not inclined to weight the stagflation likelihood more than 20% for this purpose, but that is as much an artifact of the scenario mechanics as the chances that it will happen.

Here are some of the variables (in this model) most affected by macro stagflation:
  1. increasing nominal cost of debt
  2. aggrevated real costs of short debt
  3. dimished and deteriorating consumer purchasing power
  4. increase in the cost of equity (due to valuations)
  5. increased risks associated with debt burdens related to failures/distressed debt
  6. decreasing costs of real wages in the short term related to rising unemployment
  7. PP&E: the P&E portion (plant and equipment) impacted by depreciation effects; more costly to replace depreciation in both nominal and real terms
  8. The P portion (property) unaffected in terms of balance sheet valuations for property held (an accounting artifact), but diminishing as property is disposed of longer-term (but still a gain to book-value for most property) Note, this is exclusively commercial property, not housing

I can only guess about winners and losers…this isn't accounted for in such a specific valuation model.
  • Winner: Larger M&A activity because well capitalized companies will have an opportunity to acquire at smaller premiums. Most of my work is M&A related today, and accelerating.
  • Winner: M&A related lawyers, because more companies will implement poison pills, etc trying to stave off takeovers
  • Winner: Quality VC firms and PE firms as capital havens. Probably more PE activity in M&A space. But, a weeding out of low quality VC/PE
  • Winner/Loser: LBO firms; probably more LBOs (publics taken private) in the short-term, but dying out as debt becomes too costly for the mechanics to work. Note, this is complicated by SOX (Sarbaines Oxley)
  • Winner: Energy companies and many commodities
  • Loser: A ton of hedge funds. (Maybe this is wishful thinking). But at least a real test for HFs
  • Winner: Ultra wealthy individuals who can exploit a lot of the above…these are the guys who are limited partners of quality VCs, investors in PEs, etc.
  • BIGGEST LOSERS: consumers. Stagflation is a terrible draining of wealth out of consumers pockets and very real hardships in terms of unemployment
  • Winner or Loser? The (American) government. There are ood arguments for both directions. The (American) government “won” in the 70s (more tax revenues), lost in the 80s (less tax revenue). But the government is a lot more than economics, so I defer this to greater political discussion (the government got much worse in the 70s, a good bit better in the 80s, in my opinion). Both were stagflation cycles.




Comments:

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2008-03-16, 03:22:50
anonymous  
You did not mention the effect on stagflation on real estate prices
2013-02-09, 23:55:01
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