Contrarian signs of trouble in the housing market
The current market rally shows signs of maturity. Is it due to die of old age, or will this rally last forever?
Most people who speculate in financial markets lose money, and most of them fail to recognize their “safe investments” are actually risky speculative bets. The housing bubble was a speculative mania, and despite the wild rise in prices during the final two years, most buyers late to the rally lost money — often a great deal of money on what they believed was a can’t-miss deal of a lifetime.
The basic problem is emotional. Once people take a position in a financial market, their emotions immediately impact their behavior. They begin combing financial media sites for confirmation of the “rightness” of their buying decision, and they filter out messages and signals that don’t meet their preconceived bias. They tell others of their great investment and encourage them to join the party.
If their investment increases in value, they naturally seek to gain more. The speculator succumbs to greed, and they often increase their exposure by purchasing more of whatever it is that rewarded them so handsomely. For example, during the housing bubble, people commonly borrowed against the increased value of one property to obtain others. And during the tech bubble in stocks, many “investors” maxed out their margin, borrowing money to buy even more stock.
The most risk adverse people wait until the end of a long price rally before participating because they want assurance that the rally is durable. Unfortunately, the longer a price rally goes on, the less likely it will continue, so the most risk adverse people are the most likely to buy in late when the party is already over.
These emotional reactions prevent speculators from booking profits. When they could sell for a profit, greed induces them to buy more. It isn’t until prices fall that speculators consider selling. Once the rally starts to falter, the risk adverse participants who entered late are the most fearful, and they sell quickly for a loss. As these weak hands sell, prices fall further, the rally loses momentum, and speculator psychology changes. The stream of greater fools runs dry.
At first, most speculators lapse into denial. Through a feedback loop of emotional rewards, they trained their mind to ignore bad news and focus on the positive. The first signs of a deteriorating market are dismissed as an aberration. The greater the degree of emotional conditioning, the lesser the chances that the speculator will correctly interpret the signs and act appropriately.
As prices fall further, fear invades a speculator’s subconscious. Nagging feelings of doubt that were easily dismissed at first become stronger and harder to suppress. The internal battle between greed and fear rages well past the breakeven point where the speculator could have closed the position without losing any money.
The more prices decline, the more emotional pain a speculator endures. The natural reaction to pain is to seek relief, and in a declining financial market, denial loses effect, so a speculator’s only relief is the sale of the asset they previously coveted so dearly. Unfortunately, this relief only comes after the speculator already lost a great deal of money.
A speculator’s emotions always conspire against them. When the asset is rising in price they want more of it, and when it is falling in price they want less. This natural reaction is the cause of all losses in speculative markets and the reason most speculators fail.
It’s not all hopeless. For those lucky few who recognize this process, the signs of mass delusion and mania can be played for opposite effect. A wise man buys when a fool sells and sells when a fool buys. This is the essence of contrarian investment.
Of course, contrarian investment isn’t easy because the peer pressure of the herd and the conventional wisdom will vehemently oppose good contrarian ideas. For example, many were shocked and dimayed when I wrote in 2010 that everyone should Buy Las Vegas real estate — as much of it as they could. Most people thought I was crazy:
Well, I’ve been to one world fair, a picnic, and a rodeo, and that’s the stupidest thing I ever heard come from the IHB. – lowrydr310
Las Vegas? Come on – absolutely no point to owning anything out there. No intrinsic value to the occasional tourist at all. – AZDavidPhx
AZDavidPhx was so unimpressed with my idea that he created a parody cartoon I still use today — as an affirmation.
I would be very careful. There is still excess supply, so renters may not be readily available, and that will also put downward pressure on rents. Plus with buying so attractive, why would people rent? The recently foreclosed? Is that the best group to count on? – winstongator
I’ll echo the concerns on gaming coming back – I have to think that alot of the HELOC withdrawals profiled here daily fueled splurges at the Bellagio and those just aren’t going to come back. I can see some stabilization and maybe modest recovery from where we are now, but don’t think we will get back to say 2007 peak levels anytime soon. – scottinnj
Is the rental market strong enough in Las Vegas to ensure enough positive cashflow to make the investment worth it? If it’s better to own than rent, why would people rent your property? Seems a bit self-defeating to me because the cheap prices will either:
a. Dry up the rental pool.
b. Drive rental prices low enough so that cash flow isn’t too much of a benefit.
I would buy out there as a “vacation” home but I don’t know if I would want to be a Desert Land Baron / Overlord. – irvine_home_owner
Did someone hack into your account again? – ?
As you can see, I was not greeted with resounding cheers and affirmation for my idea. Yet, it was an excellent contrarian play.
Another problem with contrarian investing is that the signs are rarely clear. The two articles I share today are a strong contrarian signal, but other signs point to a different conclusion. I will let you decide.
Orange Countians have a bad habit of spending too much in good times, then failing to pay bills – especially property-related ones – when the economy turns lean.
My Big O’s Banker Index gives me no reason for concern. It scored 98.11 percent in the third quarter – theoretically, the share of bills being paid locally. That’s up from a 91.5 percent low set midrecession in 2009 and a new high topping the 2005 pinnacle.
The fact that this index is back at 2005 levels is exactly why it’s a cause for concern.
So we can choose to pat ourselves on the wallet for the accomplishment.
Or we can recall the last time we paid bills like this: 2005.
That was during the last throes of the great surge of the real estate bubble. Now before you gulp too hard – fearing history may repeat itself with another bubble bursting – remember the key financial stimulant in the last cycle: Wacky risk-taking by mortgage makers is nowhere to be found today.
As I said, the signs are rarely clear.
Big money is flooding the Southern California homeselling business, resulting in the biggest industry expansion since the recession hit eight years ago.
As a result, more agents are getting real estate licenses, brokerages are opening offices, mortgage banking is on the rise and title insurance companies are expanding.
Rising home prices are behind this growth, fueled by near-record-low mortgage rates.
In Orange County, this year’s dollar volume generated by combined home sales hit $18.9 billion as of September, the highest volume in at least 12 years, according to figures from the California Regional Multiple Listing Service, an industry group that maintains a database of homes for sale.
That’s an increase of $9 billion, or 83 percent, from the bottom of the housing market downturn in 2009.
An increase in real estate agents is an excellent contrarian indicator.
Remember this ad from 2006?
Contrarian investing requires two things:
- A simple yet solid financial analysis you can believe in.
- Faith in your analysis that carries you through when everyone tells you you’re crazy.
If either aspect is missing, the results can be disastrous. For example, gold bugs have complete faith in their investment, but they lack a simple yet solid financial analysis that warrants that faith. Further, I wasn’t the only one who noticed house prices were low and cashflow investment penciled out, but many of those who made the proper analysis lacked the faith in their analysis that provides the courage to act. Those investors missed their opportunity.
Taken together, I don’t think these two articles signal an imminent apocalypse, but they are a sign of a mature market rally and an early warning that the best of times are behind us, not in front of us.