The Proverbial Hits the Fan
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"Bubble bath of doom!" writes Howard Kurtz for the Washington Post in reference to the US housing market: "Will The Housing Bubble Burst?" asks New York's Daily News. "After the Housing Boom," says a Business Week cover story. "Some Economists Warn of Housing Bubble," says The Washington Post. A Time cover story has some experts warning of a bubble inflated by a "psychology of greed." "Are Home Prices Really So Crazy?" Money magazine asks in a 43-page section. The Economist's cover shows a brick, labeled "House Prices," plummeting to earth.
"Five years after most of the media cheered on a stockmarket mania that fell apart with disastrous consequences, journalists seem determined to sound warnings about the overheated real estate market. This time, even as housing prices continue to soar, many are erring on the side of pessimism.
"I do think the press has gone way overboard," says financial commentator James Glassman. "They're scaring people." Just to set the record straight, not all media sat on the sidelines cheering during the technology bubble years. See, for example: "Hubble, bubble, asset-price trouble" from The Economist in September 1999; "Should central banks worry only about consumer-price inflation, or also about the prices of assets, such as equities and property? Mr Greenspan asked this question in December 1996 when he made his famous speech about “irrational exuberance” in the stockmarket. Since then Wall Street has climbed another 70%." Or perhaps the even more timely "Fairy tale" from The Economist in February 2000; "All over the world, the shares that people want to buy are mostly ones that appeal to hope and imagination. How long before reality intrudes?" Answer: about a month, since it was March 2000 that saw the Nasdaq Composite index hit its all-time high
The evidence from Barron's Magazine, another leading financial journal, is more nuanced. Trawling through back issues online, Barron's - with hindsight - looks like something of a bubble booster. Take, for example: "Warren, What's Wrong? Berkshire Hathaway may experience its first annual decline since 1990. Is Warren Buffett's distaste for tech stocks leaving him in the dust?" (December 1999); "Dow.com: Just how internet savvy are the companies in the Dow Jones Industrial Average?" (December 1999); "MCI Worldcom, the nation's No. 2 long-distance carrier, is thriving as an Internet carrier" (September 1999); and, perhaps most bizarrely, "Investors are seeking shelter in technology stocks" (September 1999).
But in the interests of full transparency, Barron's - and particularly writer William Pesek Jr. - deserve credit for bringing to our attention the extraordinary valuation opportunity presented by savings and loan business Washington Mutual in March 2000. To this day WaMu remains the best ever stock tip we have identified from the financial press. So our take on Howard Kurtz's piece - which doesn't appear to offer a definitive verdict on the state of the US housing market - is similarly short on conclusions.
Do the media consciously (or subconsciously) inflate bubbles, or merely report on irrational public behaviour? There were certainly honourable exceptions to the alleged trend of tech stock boostering, and The Economist was among them.
By a telling coincidence, Barron's also runs with the US housing market this week, but the upshot of Sandra Ward's interview with Sy Jacobs, whose hedge fund focuses on financial stocks, is unambiguous: "In a letter to my investors recently, I looked back over the last 10 years and talked a bit about what I expect the next 10 years to be like. In addition to rates being a headwind, I said I suspect, timing aside, the bursting of the housing bubble to be a dominant theme for investing in financial stocks in the next decade. There will be major implications for financial stocks. We have gone through largely 10 years where the credit quality of lenders has been getting better. A lot of that has been driven by rising collateral prices. It's hard to lose when the price of the underlying collateral is going up. A change in the value of the collateral is going to be a second headwind in the face of financial stocks. Also, competition for making loans has increased because everybody feels good about making mortgage loans and real estate loans and it's human nature to loosen credit standards to maintain or grow market share, and that has been going on. During the next 10 years, we are going to be dealing with worsening, perhaps dramatically worsening, credit at some point.As Jacobs observes, housing "feels so much like 1999 and the Nasdaq". And he can't avoid a pop at his former paymasters:
"As I've seen so many times in my Wall Street career, it's a typical case of Wall Street killing the golden goose by creating too much capacity for a business that's really cyclical. In the meantime, volumes are still great and there is business to fight over, so the price war hasn't been too destructive. But if I'm right about short rates going up a little more and the yield curve becoming more flat, the air will come out of the bubble and volumes will go down. The price war will get really ugly and the aggressive underwriting, which has enabled more and more people to own homes, will hurt loan quality at the same time loan volume is going bad and it will be ugly."
We know from the tech stock experience that bubbles can outlast personal solvency (conclusion: market timing can be bad for you). But we also know from the tech stock experience that regression to the mean is a peculiarly powerful market phenomenon (conclusion: patience and discipline can be good for you). The perceived bubble in Anglo-Saxon real estate (which appears to be deflating nicely in the UK) is inexorably linked to the more general bubble in financial asset prices and the extraordinarily and artificially low current level of bond yields. None of these conditions is guaranteed to last. Vulnerable sectors, particularly in the US, include homebuilders, mortgage providers, banks, investment banks and brokerage companies. We happen to believe that the last two are acutely vulnerable to shifts in market dynamics and general confidence. People will always want a home. People will not always want to trade stocks or enter into corporate merger activity of dubious worth, particularly if the proverbial hits the fan.
Tim Price SeniorInvestment StrategisAnsbacher & Co Ltd
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