When stock markets bubble to record levels, people smell risk and run. When house prices bloat, the homeless moaners come here and blame me. Why?
It’s simple. People expect equity prices to rise and fall. They fear the declines more than they enjoy the gains. And human nature being what it is, when the price of a financial asset plops, the naïve think it could go to zero, so they bail, turning a paper loss into a real one.
But with houses, Canadians now expect only gains. In their minds, every price peak’s just another step on the ladder. The more that people talk about and obsess over houses, the less risk there seems to be. After all, everybody’s doing it. So the government would never dare change the rules, or raise interest rates! The only losers are those who listen to Garth and invest their money instead of getting a mortgage, because now they’ll never be able to buy in (insert city).
It’s classic bubble mentality. Buy now or buy never. Conditions will never change. Trust us.
This is a great lesson in how people totally misunderstand the nature of risk. Their financial lives are built around a single asset on one street, which means they have no diversification or balance. When troubles brew, houses can also turn illiquid. Centring your life around a 30-foot lot with an aging structure on it is unquestionably bizarre. Yet millions are caught up in it.
The main question to ask yourself is this: what do I really care most about? Financial security for my family, or a house? My thesis is the two are not the same. In fact in the years ahead I expect they could be negatively correlated. If I’m remotely correct, there’s a big surprise coming for most people you know.
(a) Buy a house if you can afford it, if it stabilizes your living costs, and represents a reasonable amount of your net worth (ie, 90 – your age = % of net worth dedicated to RE).
(b) If you can’t afford one, don’t go near it at these levels, no matter how cheap mortgages are. Things will change.
(c) Invest in liquid assets with equal fervour. And don’t for a moment think that financial markets pose more risk than, say, a house in suburban Calgary or a condo in Etobicoke.
Thursday was a good example. The Dow shot to the 17,000 level for the first time, taking other markets with it, which was music to realtor ears. “TSE hits record high. Where is @garthturner when we need him to start talking bubble territory!” Tweeted a Toronto condo-flogger. Of course, equity markets advanced for a reason – 288,000 new jobs created in the US in a single month, the fifth consecutive one with at least two hundred thousand extra positions. The jobless rate is now barely above 6%, and falling. America’s recovery continues.
Is this a stock bubble? Maybe. Margin debt is at a record high – meaning lots of investors are borrowing to buy more securities in the belief they’ll gain more. Never a great sign. And stocks are expensive at the same time bonds are dear. In fact, prices for most financial assets are elevated these days.
But compared to Canadian residential real estate – where mortgage debt is now $1.1 trillion, prices relative to incomes and rents are off the chart, and 90% leverage is the norm – equity markets look like benign little puppies. Stock prices expressed as a multiple of corporate earnings are actually about 50% of where they were back in 1987, and far less than during the Tech Bubble or back in pre-crash 2007. In fact, they’re running just slightly higher than the 25-year average.
Of course, the more people with jobs, the more consumer spending that takes place, which breeds profits and plumps stocks. At the same time, the US central bank is on track to eliminate stimulus spending by the end of the year and this week’s boffo jobs numbers will just accelerate things. Now, says strategists at Scotiabank, “the most likely scenario is that the Fed starts raising interest rates in the second half of 2015.” As this approaches, expect bonds to fall and equities to rally – even with a temporary correction now overdue.
Clients are being told to “stay overweight in equities until the early part of the next rate hike cycle.” They’re also being informed that the Fed might well move on rates much sooner, if US economic data continues to be this bullish.
Well, you all know what that means. Govern yourself accordingly.
Meanwhile we’re at the six-month point in 2014. To date this year the 60/40 balanced portfolio that I yak about so often has returned 6.88%, or an annualized 13.76%. The compound annual rate of return for the past four and a half years is 11.28%, which means $100,000 invested at the beginning of 2010 is now worth $150,730.
Real estate? Houses have appreciated an average of 5.9% during this time.
Less return. More risk. The people’s choice.