Honey, I Shrunk the Net Worth

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"It's
totally different in the real estate market than it is in the
stock market."

~
Thomas Kuntz, CEO, Century 21, February 25, 2005

To
the seasoned investor, four of the most dangerous words in the English
language are "It's different this time." Five years ago,
this country experienced the mania to end all manias for anything
tech-related. Today it seems the public has merely shifted to all
things credit-related.

Manias
share four common characteristics:

  • A feeding
    frenzy sends prices parabolic. In March, 2000 the Nasdaq
    Composite briefly touched 5000, up 44% per year over a five-year
    period. Homebuilding stocks today are up 46% annually in five
    years. The median price of a home is up 8.2% per year over the
    same period. Adjusted for 5-to-1 leverage on a typical mortgage,
    the humble abode has appreciated 41% annually.
  • The
    public jumps in with both feet. During the late 1990s, stock
    ownership climbed to roughly 50% of households. Today "home
    ownership" has passed 70%, a record.
  • Valuations
    detach from economic reality. In 2000 many tech stocks traded
    for over 50 times earnings. Today, in some of the hotter markets
    such as Southern California, home prices command as much as
    50 times their rental incomes.
  • Rationalizations
    abound for why valuations are reasonable and the trend will
    continue. Talk of a "New Economy" has been replaced
    by the politically-sanctioned euphemism "Ownership Society."
    Then, as now, favorable demographics and an accommodative Fed
    were expected to keep the party going.

Admittedly,
there are differences. In 2000 Wall Street underwriters raised equity
for marginal businesses; today they raise debt for marginal consumers.
Five years ago the federal government enjoyed a surplus; today deficits
run as far as the eye can see. In 2000, the dollar was strong, inflation
dead, and commodities weak. In the five years since, the U.S. Dollar
Index dropped 22%, money supply (M3) grew 44%, and the CRB Index
gained 40%.

One
question keeps nagging us. Manias are rare occurrences, gracing
us with their presence every 30 or 40 years. How can a crowd delude
itself twice in just five years? Perhaps at least part of the answer
is that there are actually two crowds at work. The tech mania,
it seems, was primarily driven by testosterone — Ferrari driving
CEOs of dot-com and Silicon Valley startups, napkin-scribbling venture
capitalists, master of the universe investment bankers, and hyperactive
day traders. The present day mania appears to have more balance,
with women playing a greater role. Men are more prone to think in
terms of abstractions and do things like chase technology stocks
into the stratosphere, while a house is tangible and appeals to
both sexes.


 

Tech
Mania, 2000

Credit
Mania, 2005

The severe
Nasdaq bear market of 2000–2002 took the male ego down a few
notches. Wives who were suspicious of the boom, but reluctantly
supported their husbands anyway, knew who to blame when the couple's
finances unraveled. Many refused to adjust their lifestyles to the
new reality. Enter Alan Greenspan offering a cheap and seamless
way to keep up appearances, upgrade the kitchen, and buy that new
home theater system: simply tap into ever-rising home equity. The
wife was able to spruce up her nest, the husband salvaged his marriage,
the finger pointing ended, the house climbed in value, and they
all lived happily ever after.

Predictably,
the residence has become an emotional hot button, making this credit
mania all the more terrifying. Popular mortgage ads feature the
woman in control as lenders line up to provide cheap credit on her
terms. Attention personal bankruptcy specialists, divorce lawyers,
and marriage counselors. Business is about to improve.

March
3, 2005

Kevin
Duffy [send him mail]
is a principal of Bearing Asset Management.

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