Monday, 19 February 2018

Investment Bubbles – Past and Present

There have been many famous speculative bubbles in the past. There appears to be a few forming current. While it can be profitable to ride the investment while a bubble is forming, it is important to recognize when an investment is in a bubble, and to get out before the bubble bursts. Doing that is, of course, easier said than done.

One of the earliest bubbles was the famous tulip bulb mania in Holland that ended in 1637. It seems very silly looking back that seemingly rational people would pay more than ten times an average annual salary for a single tulip bulb. That bubble burst, as it obviously had to, and prices came back down to earth. Many people were financially devastated in the process.

Another famous bubble was the South Sea bubble that burst in 1720. Shares of stock in the South Sea Company went from a little over 100 pounds to near 1000 pounds, and then right back to where it all started. This bubble, from nearly 300 years ago, sounds not like the gold bubble of less than 30 years ago. In the middle to late 1970's the price of gold was trading much of the time around the $ 100 level. Then a huge rally gained steam at the end of that decade. The final blow-off occurred with gold reaching approximately $ 850 per ounce. Silver made an even greater advance. When the bubble finally burst in the first couple of months of 1980, there was a quick drop in both metals, with silver falling all the way back to the starting price. The gold market fared somewhat better, with prices holding about two and a half time the starting prices at the culmination of a 22-year bear market. Gold prices only now, after 27 years, are approaching the old record price, and that is not adjusted for inflation. Silver is still trading less than a third of the price it reached in 1980. Not a good long term hold.

Another great bubble was the tech and dot com mania of the late 1990's. The price of any stock with a "dot com" in its name went on a parabolic price move upward. Many of these stocks had no earning, no prospect of earnings, no business plan, and only a vague idea for a product. Investors would bid up these shares to market caps far greater than many well-established companies with real products and earnings. Most of these stocks are now trading on the pink sheets for pennies. This bubble, in amount of the price rise and amount of the inevitable fall, far eclipses some of the more famous, older bubbles.

So what about today?

Perhaps the most obvious and visible bubble today is in the Chinese stocks. Some will argue that these are real companies with real incomes, with growth rates that justify the high prices. However, there is a mania in China as its citizen's line up to open brokerage accounts by the tens of thousands every day, buying everything in sight. This is a group of people with little experience investing. They just buy because prices are going up, much like many beginning and even experienced investors did during the dot com mania. They will most likely get burned when the inevitable pin finds the bubble. Those analysts that should know better keep telling investors that "this time it's different." It is never different. The same story repeats again and again.

Another bubble in the process of bursting is the real estate market. Recently there have been headlines daily about investors making thousands of dollars overnight by house flipping. Condos were being pre-sold to flippers. People were borrowing on their increasing equity lines of credit to leverage more real estate holding, or just to live beyond their means. Ordinary housing was being priced far higher than any person working for a salary could afford. If you did not have a house to trade up from, a trust fund to tap, or an inheritance, you could not possibly come up with a down payment. People in high paying professional jobs could not qualify for the most base starter home in many markets. Schemes were worked out to get around the down payment requirement, and to get around the income reporting and verification requirements. This kept the bubble going. All the real estate agents in the world saying "this time it's different" could not stop that bubble from bursting.

One interesting exception is currently in the Manhattan real estate market. Prices of condos and co-ops in Manhattan are still rising fast as the rest of the county is seeing prices drop. What is happening? There are a few logical reasons. The city is more desirable now that it has been cleaned up and made safer. Congestion and travel times are a factor for people wanting to live close in rather than spending three or four hours a day commuting. But prices for decent apartments are well beyond the reach of anyone working for a salary and having to deal with financing. This is a problem in much of the nation, as pointed out earlier, but in New York it is magnified beyond reason. If a doctor or other highly trained and highly paid professional moved to Manhattan and wanted to purchase a home suitable for a family, he / she would not make anywhere near enough money to qualify for a home, let alone be able to save enough for 20 % down. If a doctor can not purchase a home near where his practice is, then I would suggest that area is in a bubble.

If the real estate boom continues in Manhattan, the only people left who will be able to afford an apartment will be hedge fund managers, star baseball players, rock stars, actors, or those receiving huge inheritances. The city will lose its soul and character. I hear so many stories of people who paid $ 200 thousand for an apartment 20 years ago, and are now able to sell it for six million. One new building on Central Park West with over 200 units, sold out with an average sales price of $ 10 million per unit. Apartments with a park view were getting over $ 6000 per square foot. As desirable and great as Manhattan is, the price of apartments is in a bubble. It will burst. Those who pay these prices will get burned when the bubble bursts. So what can pop this bubble? The falling dollar, another bubble in reverse, has encouraged foreign purchases of desirable real estate. The consensus on the dollar is that it will keep falling for the rest of eternity. It may well have hit bottom, or be close to it. Any reversal of the dollar could end the demand from foreign buyers. Also, since the hedge fund bonuses are a primary driver of the high-end real estate market, an end to those high fees would also cause a reduction of demand. Hedge fund manager fees are also in a bubble, in my opinion, as is CEO pay. How can a hedge fund manager justify taking such large fees with such generally poor performance? How can a CEO justify taking a $ 200 million fee for leaving a company when the price of its stock is in the tank?

Another bubble about to burst, in my opinion, is the art market. As with housing, part of the driver for the art market is the weak dollar, both from the aspect of art in the US being reliably cheaper for foreign investors, and as a place to get out of a fiat currency into something perceived to be more tangible. There was a story in the Wall Street Journal today about an actor who bought a horrible Warhol painting about five years ago for 3.5 million dollars, and it just sold at auction for 23.5 million dollars. That's a pretty good return over five years for a piece of art that has questionable long-term appeal. Even more horrifying is the Rothko piece that sold for $ 73 million. If you are not familiar with Rothko, I'll fill you in. He painted large canvases – about $ 100 dollars worth including the stretcher bars, and put about another $ 20 worth of paint, usually in three blobs that resemble a hamburger in a bun. And somehow that becomes worth $ 73 million to someone. I think when he first painted those abstract buns he could have put them out on the street with the trash and nobody would have picked them up. If you own a Warhol or Rothko, sell before reality sets in.

The classic car market has a bubble going on as well, at least in my opinion. There was a huge bubble in the late 1980's in exotic 1960's sports cars, especially Ferraris. There was a buying mania that bought up the prices paid at auctions well into the seven figures for cars that could have been purchased for a small fraction of that just a few years before. Many of the more desirable Ferraris increased by more than a hundred-fold in a very short time, eclipsing many of the famous bubbles through history. What was the reason for this bubble? Many would argue that it was driven by an insatiable appetite by many of the newly rich Japanese. Many of these Ferraris were bid up at auction on behalf of Japanese investors, and the cars were transported to vaults in Japan, much like people might store gold coins in their safe deposit boxes, with some difference in the size of the box of course. Many experts suspect the collector car auction houses rigged many of these auctions to inflate the prices. The Japanese investors did not seem to care what they paid as long as they got a car to put in the vault. And what caused this new wealth for the Japanese investors? You might recall that the Japanese stock market was at the height of its bubble at about the same time. They were buying up US landmark buildings. The bubble in their stock market collapses, even though experts said it could not, and it bought down the market for sports cars with it. The Japanese stock market has yet to get anywhere near its all time high as this is being written. The price of a few selected Ferraris is now only approaching the price, in dollar terms not adjusted for inflation, of the peak about 18 years ago.

So what does this have to do with a bubble in the classic car market now? The emphasis has shifted from exotic European sports cars to much more mundane and ordinary American muscle cars from the mid-60's to early 1970's. Very ordinary Plymouths and Chevys with a muscle car engine, and sometimes some factory paint option like a racing stripe or some other gimmick that would make the car slightly more rare than one off the showroom floor, are fetching prices at auction well into the six figures . I was astounded watching one auction where an orange 'cuda (a Plymouth Barracuda) of early 1970's vintage went for over $ 300,000. This was a car that probably cost under $ 4000 new. I would suspect five years ago if someone put the keys in the ignition and a sign saying "please take me" that there would be no takers. So why is this bubble happening? The classic car experts say it is because the baby boomer men that grew up in the 1960's that were not for one reason or another able to buy these cars, are now in a position to recapture their youthful dreams. There may be something to this. I go to many car shows every year and see pot bellied men in their early 60's standing next to their exhibited Chevelle, Corvette, or 'Cuda. Also, unlike Ferraris, these cars were so undesirable for so long that most have probably been junked or poorly cared for, so clean specimens probably are somewhat rare. Similar cars from the 30's, 40's, or 50's are not fetching anywhere near the prices of the American muscle cars.

It is very difficult to see the bubble from within. It is always obvious that a bubble exists once it has popped. Investors in stocks and futures have some advantage, as it is easier to put in a stop loss to protect against a drop when a parabolic price advance occurs. Other investments move at a much slower pace, which makes the rise and topping action much more difficult to spot. But when everyone says "this time it's different" and then goes on to explain why the price advance will never stop, it is usually a good time to exit. If you are in a theater and smell smoke, it is probably wise to get up out of the seat and get near an exit. It might be a false alarm. Someone might have lit a match to set the time on their watch and the smell drifted past you. You can always return to your seat. But if you wait for proof, and smoke begins to fill the room, someone yells "fire," and everyone rushes for the too few exits, you will wind up getting trampled trying to get out. It is better to sell when the demand is in a mania than after the top when everyone wants out.

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