Greater Fools, Stocks, Real Estate and Gold
Kevin DeMeritt
President, Lear Financial
We feel rich. We can't help it. Our real estate assures us we are.
It certainly assured actor Nicholas Gage he was. Setting aside the fact that the guy gets millions for every picture he does, just one real estate transaction made him rich. In 1997, he bought a relatively tiny 2,800 square foot home in Malibu for $3.6 million. Last year, he sold it for $10 million.
That $6.4 million real estate profit in eight short years boiled down to an $800,000 a year appreciation for Mr. Gage.
We can't help but feel rich when we see monster appreciation like that.
And that's just the problem.
Tough Lessons of the Tech Stock Bubble
It's not as if our dads suffered through the last big bubble. Or our granddads.
We-you and me-lived through the most recent one: the historic tech stock mania of 2000. From the heady 600-to-5,000 NASDAQ run between 1996 and 2000 to Internet stocks valued at a jaw-dropping 50 times earnings, we lived through the mania every eye-opening step of the way.
It was remarkable. There were families taking flying leaps into the fray. Normally rational Americans with virtually no stock ownership experience were calling newly befriended stockbrokers ready to buy anything they hinted at. Stock ownership, in fact, reached a record 50% of households. Everybody and their dog wanted a piece of the action.
Stocks were going to the moon. You couldn't lose.
Until everybody did in 2000. That's when the tech bubble popped. Actually, that popping more resembled a nuclear blast. In five years, from 1995 to 2000, the NASDAQ rose 400%. After March 2000, it began free-falling, eventually losing $8 trillion in value over the next three years. The fallout meant most investors waved goodbye to about half of their retirement assets and portfolio values, a colossal loss aging Baby Boomers may never totally recoup.
And the thing was, few saw it coming. Not that the telltale signs were missing. They weren't. Newspapers were choked with success stories of overnight wealth, of twenty-something, Ferrari driving CEOs, of online companies like Pets.com, with no earnings, going public and raising billions, of BMW sign-on bonuses and secretaries with option portfolios valued in the millions, of ridiculous, "this time it's different" claims by young entrepreneurs who bragged that the old rules of economics were now obsolete-all signs of a mania at the blow-off stage.
But the general public is usually the last to understand such things. Latecomers to a bull market always rely on the mainstream financial news (which is notoriously too late to be of any good) or their brokers (who usually can't see past their own self-interest). Historically, the public is the last into-and out of-a hot market, the masses who transfer their hard-earned, working class money into the pockets of shrewd investors (who, unlike themselves, thoroughly understand the importance of timing). It's the "greater fool" theory: According to the National American Securities Administrators Association, more than 70% of traders-the general public, usually-will lose virtually all their money.
And so it was with this crash. The NASDAQ sunk to 800 by 2002, nearly back to its 1995 starting point. Along the way were too many casualties to count. One of them, Microstrategy, slid from $3,500 per share to just $4!
The bull market in tech stocks was officially over.
But the Fuse Was Lit
Even so, even after trillions lost, the appetites of American investors only grew. Remember, those 50% of American households owning stocks? Despite the NASDAQ train wreck, many of these households were now ready for the next big thing.
That turned out to be real estate. Those with stock profits now shifted their money into homes and condos. In no time, they were joined by Baby Boomers trying desperately to recoup their catastrophic stock losses.
Today, with Wall Street noticeably quiet since the crash, real estate has remained the public's top investment choice. True, gold began an impressive run back in 2001 (starting humbly at $255/oz that April). Sadly though-and as strange as it may seem-gold will probably never be as mainstream as stocks or real estate. Even today, even after doubling in about four and a half years, and with no end in sight, the precious metal is still flying well below the average investor's radar.
Real estate, on the other hand, is as American as apple pie, beloved by both men and women. To no one's surprise, it has quickly taken off.
A bit too fast, in fact. All the lessons that should have been learned from the historic tech stock crash were either forgotten or never understood in the first place. The "this time it's different" chant now applies to real estate and to the galloping gains everyone has made and is making (like Nicholas Gage). What began as a bull market has quickly mutated into a mania that, if anything, has dwarfed the tech stock bubble of just a few years ago.
It's déjà vu all over again. Amazingly, few see it coming this time, either. Here are some of the similarities between the stock and real estate manias.
Bigger Bubbles and Greater Fools
Consider this:
- More homes are being bought for "can't lose" speculation. According to the New York Times, up to a quarter of the 7.7 million homes sold in 2004 were bought for investment purposes. The National Association of Realtors published a report that puts the "speculative purchase" number at more like a third.
- Included in the "can't lose" mindset is the devil-may-care "tapping" of home equity. This practice rose to a record $715 billion last year, and is projected to rise more this year, according to SMR Research in Hackettstown, N.J.
- Remember Pets.com, the slick Internet company that raised billions without even a record of earnings? A similar thing is happening in real estate in some parts of the nation. Home prices are skyrocketing inexplicably in places like California, Florida, and the Northeast-far surpassing local incomes. That leaves home prices in those areas wholly unsupported and in danger of collapse. Just like those phantom Internet companies.
- "Interest-only mortgages were the standard mortgage in the 1920s, but they disappeared during the Great Depression, and for good reason… the drop in real-estate values during the Depression pushed a large proportion of interest-only loans into foreclosure." That was from the Wall Street Journal. This is from Alan Greenspan: "The dramatic increase in the prevalence of interest-only loans" is a development "of particular concern." Part of the "can't lose" mindset of any mania is to beg, borrow and steal as much of the hot asset as you can because "it's only going up." But when, in the matter of real estate, it doesn't, interest-only and adjustable rate mortgage holders will get hung out to dry.
- Economist Dean Baker, co-director of the Center for Economic and Policy Research, believes that, when the bubble bursts, home prices could fall 11% to 22% nationally, 30% to 50% in some markets. That would result in home equity losses of between $1.2 and $5 trillion. But this would be worse than the stock collapse because, as he sees it and as Don McAlvany in his Intelligence Advisor reported, there could be a simultaneous "fall in consumer spending and demand equal to as much as 2.9% of the nation's gross domestic product. He notes that Japan is still trying to recover from the near simultaneous crashes of its stock and real estate markets more than a decade ago."
- McAlvany also quoted veteran analyst Richard Russell as saying, "Yes, we're seeing 'credit gone wild' and we're seeing 'real estate gone wild.' You can buy a house at an absurd price today and figure on selling it to a greater fool six months or a year from now. But be aware that we're in a credit bubble of monumental proportions, and you better be sure to sell your spec house or your condo before the bubble bursts."
That's right, we're already at the "greater fool" stage of this particular real estate mania. And we're already seeing real estate heavyweights taking their profits and heading elsewhere. "Tom Barrack, arguably the world's greatest real estate investor," a recent Money article reported, "is methodically selling off his U.S. real estate holdings as prices drive the market to nosebleed levels."
Barrack describes one of the telltale signs of the end of this mania when he says that "amateurs" are blanketing the real estate investment field, making it harder to find real deals. "The amateurs are going to get trampled, he predicts, taking seasoned [pros], who should get off the turf, down with them."
About real estate performing its own "2000 NASDAQ-crash" imitation, business journalist Dana Blankenhorn wrote: "The stock market crash did little lasting damage to the U.S. economy because the real estate boom was waiting to replace it," he continued. "…once the (real estate) bubble bursts, all the other debts and deficits plaguing the U.S.-imports and government borrowing and all the rest-all those problems will hit at once. It's going to be the Perfect Economic Storm."
But to Gold?
So when real estate inevitably crashes…does that necessarily mean investors will make another jump, this time to gold?
There may be little choice. Falling real estate will mean that entire industry sector-home builders, building supply companies and mortgage lenders-will decline as well. That and the consumer retraction in spending will be a bit hit on the economy, which won't bode well for a stock market that's already anemic at best.
Meanwhile Investors will be watching wide-eyed as gold and silver thrives on all the uncertainty.
It won't take much, at that point, to turn Mom and Pop America into rabid gold buyers. Remember, the general public is usually the last into a hot market.
All of which boils down to another good reason to invest in gold right now. Because, sometimes, the greater fool is the guy who sits on the sidelines doing nothing.
Kevin DeMeritt
www.goldcentral.com
January 10, 2006
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