There have been a couple of recent economic studies published that argue that there is no housing bubble. One paper by Himmelberg et al. and another by Hwang Smith and Smith.
Both studies value houses appropriately from the point of view of a potential homebuyer. I don't have any problems with their house pricing formula or data on existing prices, rents, and other variables. My problem is with their conclusion that their results indicate that there is no housing bubble.
The valuation formula takes into account rents for rental housing, interest rates, property tax, maintenance costs, federal and state tax deductions etc. and, crucially, potential capital appreciation. It makes sense to pay more for a house if you think its price will go up. So from the point of view of a potential buyer their formula for valuing a house is correct.
But this builds an expectations component into homeprices. If people think houseprices will rise they will pay more for houses. If houseprices continue to rise this will have turned out to be correct. But if houseprices in fact stop rising then the prices people are paying will turn out to be too high and prices will start to fall. Falling prices mean negative capital appreciation, which means prices should be even lower. There couldn't be a simpler and better bubble generating mechanism.
The two studies I cited assume house prices will continue to rise at historic rates. If you assume that, then people are not currently paying too much for housing in supposed bubble zones and hence the authors claim that there is no bubble - houses are not overvalued. But the instant prices stop rising - for example due to increasing interest rates - suddenly homes are overvalued and there is a bubble!
Similar mechanisms exist in the stock market - as discussed by Soros in The Alchemy of Finance. Stock prices partly depend on expectations of the growth rate of corporate profits. Soros pointed out that sometimes these contain a self-reflexive component where increasing stockmarket valuations feed back into increasing corporate profits. But in the housing market the growth component is even more self-reflexive. If everyone believes houseprices will rise then they will, until people no longer believe this.
In conclusion it is impossible to find whether a bubble exists by looking at whether house prices are currently overvalued based on historic capital appreciation rates. You have to be able to also model the future path of house prices and then ask: "Given this future path, are prices now too high". Yes the two depend on each other - the economics is dynamic and not as simple as the economics in these papers.
4 comments:
The networthiq site seems to suffer the problem of self-reporting.
You can track your net worth on an
OpenOffice Spreadsheet and folks that
have high net worth are generally too
busy to look at what other people are
doing unless they're looking for ideas
to improve their performance.
Your standard trend-trading approach
is generally the best out there statistically. The hard part is to get the emotions out of the way. And also to work in trending markets. Sideways markets are usually unfriendly to trend-trading approaches unless you decrease your time frame.
I didn't see any mention in your site about large players moving the markets against technical indicators or engineered short-squeezes.
You indicated that stock picking is difficult. There are lots of sites out there with automated systems that are then screened by a person. I know folks that look at thousands of charts per day looking for opportunities. The best approach, unless you have unlimited time, is to share research with a group of
talented traders.
Thanks for your comments. You are exactly right on changing the time frame in different markets. I also try to diversify across long-term investment, macro-economic driven investment, short-term trading and daytrading. Recently I haven't been doing daytrading just letting some trades ride for a while. For long term investment my approach is to look for superior stock pickers out there and investment with them. Seems easier than trying to pick stocks oneself. My edge if any is thinking about the macro picture and technical trading not picking stocks - I don't have the time or information needed to do it well. But sometimes there are obvious good deals.
My experience with diversification is
somewhat negative and prefer to stick
with the stuff that I know very well
unless I get a rec from someone that
I trust in a particular field. And
then I need to watch it and I don't
really like to watch long-term investments. But spotting the larger
or secular trends and just riding
those trends works nicely for the
long-term.
I have three accounts with two as
long-term and one as my regular
trading account. It carries short
term to swing-trading (minutes to
days) and a few longer (months) term plays when warrented. When I stick
something in there that should be
long-term, I usually dump it and
then buy it in the other accounts.
For short-term accounts I also keep
an eye on the Open Market Operations
to get an idea as to what the Fed
is doing with liquidity. There are
some proprietary models on this
that correlate short-term repo
operations with the S&P 500.
One other interesting tidbit that
I read this weekend on the guy that
writes stuff under the Dow Theory
Letters is that one big difference
between the very wealthy and the
small investor is that the very
wealthy person can just sit and do
nothing as they don't particularly
need their investments for regular
needs and wants. The small investor
has a compulsion to show a return on
a regular basis. In the extreme
form, you have those at Vegas and
those at the corner drugstore buying
lottery tickets.
I've had discussions with coworkers
about building wealth as a life
skill just like driving or teaching
kids how to read or managing a
checking account. That some accounting and finance background is useful and that learning technical analysis is useful. If for nothing else than capital preservation. And
very few people listen. But some do.
After reading that article, one other thing to add to my usual list
when I get asked for investing and financial advice is to not dip into your savings and investments. The last time that we used any investment money was in 1998 to pay off our mortgage. Since then, it's just been living off of a single income and socking away quite a bit.
Essentially, you have to generate
savings and then get that savings to
work for you at a reasonable return to risk at a time/labor cost that allows you to enjoy life.
Looking at some of the profiles on
the companion site gave me the feeling that folks were just tossing in numbers. The book, Mind of a Millionaire from the 1990s is more
of what I think of as your typical
millionaire. Those that make money,
and then have that money make more
money, don't spend it lavishly but
spend for value and enjoy life and
live the appearance of the middle-
class.
I get John Mauldin's letter too.... I think most of the profiles on NetWorthIQ which have more than one month posted are trying to be accurate. There should be a filter to only include those with multiple months entered. Yeah, most people somehow think they know how to invest, tend to be overconfident etc. and don't need to learn. I know some on Silicon Investor track the Fed actions. Other people seem obsessed with naked shorting and other things....
Post a Comment