i recall a brief yet opulent conversation with a former roommate in cal about what the next big thing might be in the next few years. being the typical computer engineering student he was, he opined about the rising interests in outer space travel. a year or so, he finished his degree within 2 and a half years and continued his masters at ucla. with new investors surging from different directions about commercial space travel, i have yet to believe that his so-called prophecies were right. he’s still putting more bells and whistles on a software that he’d been working on since highschool. an investor might just make him lucky someday.
and speaking of la, here is a succinct version of greg the stockman‘s dec 04 commentary with some unauthorized plugs on my behalf. it may not be as brief as it may sound, but i tried. more technicalities on the link to his site.
the journal is reporting that a batch of ucla economists had announced that the u.s. and most distinctly cali are beset by a housing ‘bubble.’ the same bubble that hit both nasdaq and silicon valley the hardest by early 2000. despite ongoing proliferation of suburbia in the golden state and a steady climb of histocially low interest rates, the boom in construction may start to dwindle down dramatically for the next years to come. i presume that several americans have read about the rich dad poor dad series; and these economists have got to be right with history repeating itself. they may not have been appointed under bush’s treasury cabinet, but this same group was one of the first to predict the 2001 recession.
verbatim quote to follow.
suffice it to say that I know something about bubbles—about euphoria and overvaluation of an asset class. first, some common sense observations…very unscientific, but quite meaningful if you have learned the hard lessons of investing history as i have. as a stockbroker at merrill lynch in 1999 and 2000, I was a member of an army of 15,000 who was trained to shrug off the notion that we were in a bubble. i had more than quadrupled my little portfolio on the internet, as many did. It seemed everybody knew that technology couldn’t go down. tech ipo’s went up 500% their first day on the market. the most dangerous words in investing are “guaranteed returns” and ‘it’s different this time.’ i bought it, and so did 80 million other americans who happily leapt into the stock market. only a handful of major players called it a bubble… ironically, it was really only those investment advisors tenured long enough to have passed through the energy bubble of the early 1980s or the l.a. housing bubble of the early 1990s. between march 2000 and march 2003, i learned a hard lesson. the nasdaq went from 5100 to just over 1000 in 36 months. being all of 24 years old with two years of above-market returns gave me enough overconfidence to miss some red flags.
red flag #1: historically abnormal returns. californians have been putting their real estate investment caps on with this growing mania. the returns of not making a penny at first until the house is sold, a cash in the bank follows suit as a happy ending. second, most americans have refinanced, cashed out, and spent over 50% of their home equity for the first time since ww2. history doesn’t lie, and robert k was right on the dot… in the bay area of california, local media now reports that over 70% of new loans are adjustable rate mortgages…what happens when all those adjustables ‘adjust’ from 4% on average to their historical average floating rate of 7 or 8%? it’ll eventually smell like big trouble with mortgage payment doubling for homeowners.
r.f. #2: housing costs in bubble areas exceed wage differences. most people in these areas may protest that their wages make up for their costs of living. typically, the national average for a two bedroom condo with 1200 square feet is between $100 and $150 per square foot. yet in the posh zip codes of california, they are paying $550, $650, $750, or even more per square foot on average. with the unanimous chorus of the bond market, the golden state is the less likely to continuously pay its debts with its push to create new businesses, jobs and tax revenue than any other state in the country. the support business programs may sound like good news, but california’s soaring debt, punitive taxes, and anti-business wacko regulations have caused businesses to flee at the rate of 500 to 5,000 small businesses per month, depending on whose numbers you read. who then will be left to sell these $750k condos within the next year? economy.com reported that 30 year fixed mortgage rates should rise from this week’s rate of 5.3% to 6.5% in 2005, then to 7.5% in 2006. greenspan is already in the works of doing that.
r.f. #3: investor and media euphoria. everyone dreams of living in posh houses in the middle of everything. and this is where the inevitable laws of supply and demand come in. i’ve heard a handful of people who have been investing heavily in sin city on every seized opportunity. the average home in vegas went up 54% in the last twelve months, more than 10 times the return on a 10 year us t-bond. greg, however, mused that those types of returns are simply not sustainable and it is only a matter of time until the bubble starts deflating. just like the internet boom, it may deflate painlessly and slowly during the first year, with losses relatively small and not noticeable. and so goes the cliché ‘buy and pray.’ key words: supply and demand.
housing prices are less volatile than stock market indexes. although a house has intrinsic value than stock, these housing prices are not as steady as you might think. long-term us average housing has gone up around 4% to 6% per year since ww2. take out 3% for average inflation, and a bit for property tax, and you can expect a modest 1 to 3% real return annually. in short, most markets will crawl back to average housing appreciation rates. then probably sometime in 2006 or 2007, 30 year fixed rates will rise above the critical 7% and 7.5% thresholds and 70% of those overbaked adjustables trigger an effective doubling of mortgage payments for millions of homeowners.
it has been said that the last year of the bear market is the one that really ravages you. only when it’s too late, the commentators will note the drop in housing prices and suggest that we all run for the exits…just like they all did at the stock market bottom in early 2003. unfortunately, many get out right at the bottom, when the pain is maximized.
cnn: new home sales plunge 12% in november—Steepest Drop in 10 years
wsj, 17 December 2004, “are you living in a bubble?”, 8 dec 04, ‘sizing up the threat of a housing bubble.’
what do you folks make of it? you do the math. it may only be a cali bubble, but these sort of bubbles have tremendous rippling effects.