Thursday, November 10, 2005

Snap, Crackle and Pop... Not the Rice Krispies Characters

In the 90’s we saw a bubble in tech. Inflationary concerns have led to the Fed increasing fed funds rate, perhaps a bit too much. Imbalances have caused some to be very concerned, while others touted that tech will change everything and that their valuations should reflect this outlook. Smart money got out as many suffered the effects of a bubble popping. The slowdown in the economy had led the Fed to start lowering the fed funds rate in order to pump some confidence in the markets. Instead of going into a major recession, the money had shifted to real estate as these assets currently remain extremely inflated in certain hot markets. What have people learned from these experiences?

The real estate market isn’t liquid as stocks, but we’ve seen that real estate is more liquid than many have thought. Property flippers have come into the market like traders and contributed to the rising artificial price of properties. I’ve seen many people jump into this home purchasing bandwagon (mainly fueled by cheap credit). One of the problems we saw during the rise of the tech bubble was the use of leverage in the form of margin purchases. As the stock market headed southward, many began to receive margin calls, which may have accelerated the bubble burst.

I can’t help but notice the similarities between these two leveraged purchasing patterns. In both circumstances, many have used borrowed money to chase these rising assets – in many cases without fully understanding the risks they have bore. In some cases, those who have learned from the stock bubble have realized their profits from their real estate plays and have been laughing all the way to their banks. However, there still are others who are in a potentially serious problem. These people are those who have bought their properties during the peak using interest-only financing.

When I ask some of these people why they would do such a thing, they tell me it’s because they couldn’t afford a fixed financing, and that it’s ok since they plan on selling the property in a couple of years. They have bought into the idea that these prices will keep going up, just as those who thought the stock market will rise infinitely. Once again, we have “irrational exuberance,” but this time in the real estate market.

Relative to the real estate market, stocks look cheap. However, the US economy remains uncertain. Our principal at RW Wentworth, Tom Au, believes a lackluster future waits in the next coming quarters for our economy. You can read a brief highlight of his interview with The Wall Street Transcript (TWST). Where will the money flow next? Perhaps towards some value stock plays or maybe even toward international markets.


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