Showing posts with label housing. Show all posts
Showing posts with label housing. Show all posts

Sunday 23 July 2023

How to identify potentially threatening asset price bubbles?

In a globalized world, with few barriers to capital flows, investors around the world can bid up prices for stocks, bonds and real estate in local markets from New York to Shanghai.  

Central banks have fueled these purchases with record low interest rates and by entering the bond market as major buyers themselves  

Largely as a result, global financial assets (including only stocks and bonds) are worth $280 trillion and amount to about 330% of global GDP, up from $12 trillion and just 110% in 1980.


Traditionally, economists have looked for trouble in the economy to cause trouble in the markets.  

They see no cause for concern when loose financial policy is inflating prices in the markets, as long as consumer prices remain quiet.  

Even conservatives who worry about easy money "blowing bubbles" still look mainly for economic threats to the financial markets, rather than the threat that overgrown markets pose to the economy.   

But financial markets are now so large, that the tail wags the dog.

A market downturn can easily trigger the next big economic downturn.


Summary:

The general rule is that strong growth is most likely to continue if consumer prices are rising slowly, or even if they are falling as the result of good deflation, driven by strengthening supply network.

In today's globalized economy, in which cross-border competition tends to suppress prices for consumer goods but drive them up for financial assets, watching consumer prices is not enough.  

Increasingly, recessions follow instability in the financial market.  

To understand how inflation is likely to impact economic growth,  keep an eye on stock and house prices too.



Housing bubbles and Stock bubbles fueled by borrowings

Be alert when prices are rising at a pace faster than underlying economic growth for an extended period, particularly for housing.  

  • Home prices typically rise by about 5% a year.  
  • This pace speeds up to between 10% and 12% in the two years before a period of financial distress.
  • Once prices for stocks or housing rise sharply above their long-term trend, a subsequent drop in prices of 15% or more signals that the economy is due to face significant pain.  

In general, housing bubbles were much less common than stock bubbles but were much more likely to be followed by a recession.  The downturn is much more severe if borrowing fuels the bubble.  

  • When a recession follows a bubble that is not fueled by debt, 5 years later the economy will be 1% to 1.5% smaller than it would have been if the bubble had never occurred.
  • If the investors borrow heavily to buy stock, the economy 5 years later will be 4% smaller.
  • If they borrow to purchase housing, the economy will be as much as 9% smaller.


Monday 13 August 2018

Housing is a volatile investment indeed, at least for most people.


Statistics show that housing on the whole is a relatively tame investment:

  • Average annual percent change:  3.1%
  • Number of years positive:  15
  • Number of years negative:  5
  • Number of years between 0 and 10% positive:  13.
  • Number of years more than 20 percent positive: 0
  • Number of years more than 20 percent negative: 0
[Housing is thus an example of low volatility investment, with a tame and steady 3.1% annual gain with 15 positive years out of 20 and no 20% annual fluctuations.  Also, you get to live in it.]


Two caveats.  

Caveat number one is:  the price of a house is very large.  So a 5% (or $10,000) move on a $200,000 asset is significant and a 20% (or $40,000) move is gigantic.  Volatility as a percentage should naturally attenuate as the base of an index rises.  Sometimes the opposite happens when bubbles go into correction.

The second caveat is: leverage magnifies volatility.  Suppose you buy a $200,000 house and that you, like most others do, borrowed 80% of the value.  Your equity is $40,000.  A 5% or $10,000 price decrease now translates into a 25% ($10,000/$40,000) change.  [The mathematics:  if your equity is only a fifth of the asset value, you must multiply the volatility figures by 5x.]

Here are the housing volatility figures, this time assuming an 80% mortgage:
  • Average annual percent change:  15.5%
  • Number of years positive:  15 
  • Number of years negative:  5
  • Number of years between 0 and 10% positive:  2
  • Number of years more than 20% positive:  10
  • Number of years more than 20% negative: 2
Note especially the decline in the number of years between 0 and 10 percent positive:  from 13 to 2.  Looked at it in this light, housing is a volatile investment indeed, at least for most people.


[Remember too the impact of leverage on volatility.  This comes into play, too, when looking at companies to invest in.  If they've borrowed a lot of to finance the business, that, too, can lead to higher volatility.]