In our opinion the more a financial innovation proves successful, the more successful investors will find ways to make it fatal.
Norman Angell’s book, published at the beginning of the 20th century, argued persuasively that new innovations in politics and markets of the period made war unthinkable. People stopped thinking about it. They stopped worrying. They stopped taking precautions. Never had people been more optimistic and more complacent than they were – right up until WWI began in August of 1914. Then, all the innovations that so delighted Angell – industrialization, technological improvements, nationalization – became the exact same innovations that made it the bloodiest and most expensive war in history.
Coincidentally, that was also when U.S. property prices reached their last epic high. In real terms, they went down in WWI and kept going down for 70 years or more. Only in the last 10 years have they gone back up – returning to their 1914 high only in 2005.
And now, a whole new round of innovations are supposed to make market crashes and depressions obsolete. Perhaps it is true. But we wouldn’t bet on it.
The credit bubble has now been expanding at an extraordinary rate for so long that people have begun to take it for granted. But residential property in the United States is taking a breather, maybe even going down a little. U.S. stocks are taking it easy – flat since the beginning of the year. Oil seems stable around $55. Gold is marking time at $640. Bond yields have been rising for the last two months. Where’s all the money going? Or is this great liquidity bubble finally beginning to lose air?
If not yet…when? We wish we knew. Mr. Trichet warns that investors should prepare for a ‘repricing’ of financial assets. We doubt he knows any more than we do…but we don’t doubt he is right.
“Number of vacant homes for sale surges 34%,” says a headline.
“We gave up,” reports a friend from Florida. “We had our house on the market. We tried to sell it ourselves. Then, we put it with a realtor. But there were nearly a dozen other places for sale on the same block. Almost all of them were empty. We just figured that this was not the time to sell. So we put our house up for rent. It’s not ideal, because now we have to manage rental property, which we don’t want to do. But it’s better than losing money. Of course, right now…it’s still empty. We haven’t found a renter yet.”
Many homeowners have already lost money; they just don’t know or don’t want to admit it. They presume that by taking a property off the market, they are avoiding a loss.
‘Cut your losses,’ is an old-time rule in the stock market. You thought a stock would go up…and it didn’t. This tells you that you’re wrong. You should realize that you don’t know what you’re doing; sell the position, and ‘let your winnings run.’
But the idea of ever-rising house prices is so deeply rooted that people cannot believe they’ve made a mistake. They cannot believe that their theory is wrong. They cannot believe that there is something going on which they just don’t understand. Instead, they merely assume that their timing was off.
“I was a little late,” they say.
And they think that if they hold onto the position, the time will come when it will be a good investment again.
Yet, if it is true that housing follows very long patterns – with a cycle as long as 120 years – they might wait a long, long time before they get their money back.