Imbalances and time series
As I mentioned in last week’s post, there are a lot of reasons for optimism now, despite the ongoing health and economic crises. This week, though, I want to explore what I see as critical issues to society’s overall strength in the years to come.
Specifically:
Market imbalances, including stocks and residential real estate and how imbalances have become major factors in the expansion of wealth disparities and growth opportunities.
Time series in investing.
Market imbalances
In his insightful Wall Street Journal article, “Thank the Fed for the Stock Market’s Run—and the Plodding Pace to Come,” James Mackintosh points out that:
“Stocks have done better than their norm of the past century even if you invested at the high in 2007 and held through both the worst financial crisis and worst pandemic in 100 years. What on Earth is going on?
The answer should give pause to investors who plan to hold for the long run. Stocks have won big, not primarily because earnings went up but because the cost of money went down almost to zero. A repeat in the next decade is almost inconceivable, which means future returns are likely to be pedestrian, at best.”
He continues, saying “In 2020, falling earnings coincided with much higher valuations of future earnings, as lower interest rates and bond yields made stocks look more attractive. Unpack that thought and the implication is that we are paying more for the same future stream of income. That is, stocks offer pretty much the same prospective profits and dividends that they did before, but at a higher price.”
Residential real estate: Slipping away as a way to build generational wealth?
If you already own residential real estate, these days are about as good as it gets—your home or investment properties are likely valued at an all-time high, essentially wherever the properties are located, and there’s high demand should you decide to sell. In fact, a CoreLogic analysis states that homeowners with mortgages (roughly 63% of all properties) have seen their equity increase by a total of $1 trillion since the third quarter of 2019, an increase of 10.8%, year over year. This is an average equity gain of $17,000 per homeowner in Q3 2020 and the highest in over six years.
For everyone else—roughly, about 40% of Americans currently rent—buying a home has become a daunting financial task at best, and often, totally out of reach. This is exacerbating existing opportunity and wealth imbalances.
To make matters worse, the flood of homebuyers hasn’t correlated to enough of a decline in rental-housing prices, so people in lower-to-middle income brackets continue to find themselves on the precipice of housing insecurity and homelessness.
Compound this with widespread unemployment, especially in lower-paying jobs, and America is facing significant social and economic crises that could take several years to rectify. This is extremely detrimental to our collective psyche at a time when we need all the hope, optimism and opportunities that we can get.
Bringing back balance?
In residential real estate, there’s a stark imbalance between sellers and buyers, supply and demand. Typically, the markets will find a way back to balance, back to an inventory homeostasis that moderates price increases and encourages inventory to turn over.
Imbalances create bubbles and if factors don’t organically emerge that soften the frenzy, eventually the bubbles pop.
Take our current situation: we can’t continue indefinitely with interest rates near zero and inventory at record lows while prices soar. It’s simply not sustainable. However, many investors, homeowners, and would-be buyers are committed to moving forward, in part because there are almost no alternatives in which to invest.
Issi Romem recently wrote an excellent analysis for The New York Times of the complicating factors that have pushed many homebuyers to overpay. In the article, “Explaining the Frenzy in the Housing Market,” Romem notes:
“Typically, 55 percent to 70 percent of American home buyers are selling one home and buying another, with the remainder buying for the first time.
Since the spring, the share of first-time buyers in the housing market has risen sharply. Unlike repeat buyers—who contribute equally to demand and supply—first time buyers contribute only to demand. The share of first-timers, which hovered around 31 percent in 2018 and 2019, increased to about 34 percent during the spring and summer of 2020, according to a National Association of Realtors survey report.”
Romem also points to the broader use of online sales tools for real estate transactions—from video tours and virtual open houses through closings—as a further accelerant:
“Thanks to innovation, the housing market is operating faster than it used to, and that has helped make supply and demand imbalances more extreme.
Here’s how it works. Suppose that for every two sellers in the market, there are three buyers. In other words, the market is a hot one, dominated by sellers. Accelerating the pace at which buyers and sellers successfully pair up and exit the market reduces the number of buyers and sellers equally, and can be thought of as leaving two buyers for every one seller.
Because that ratio of two to one is even more unbalanced than three to two, it implies more intense competition over homes for sale. [The opposite would be true in a buyers’ market, in which faster matching of buyers and sellers would make buyers scarcer than before.] By helping speed up the home-buying process, innovations also reduce for-sale inventory and shorten the length of time homes are on the market. [In isolation, it also shortens the time buyers are in the market.]”
Low interest rates as a compounding factor
Remarkably low interest rates are a factor on a couple of fronts. First, there’s the obvious one: People can buy homes with higher asking prices when interest rates are very low. Second, low interest rates mean that many typical interest-based investment and savings tools aren’t generating returns. In the past, it was a lot easier to collect interest income on certificates of deposit (CDs) and bonds. Now, with next-to-no interest generated from them, everyday people are looking elsewhere to build wealth.
Mom-and-pop investors
Another inventory factor is the profusion of people using equity in first homes to buy investment properties to rent, while still holding first homes in which to live.
While this has been an investment strategy for mom-and-pop investors forever, for years the focus was to build some retirement income and security. Now this area, too, is amped up. Instead of owning one or two homes, many are leveraging their initial investments into ownership of dozens (and even hundreds) of rental properties. In many secondary markets, this further drives up rental and purchase prices, often in areas that lack concurrent income growth.
Slowed construction
Take a look at this Redfin analysis showing a seven-year drop in new construction inventory and it’s obvious that one way to get us out of the supply hole is for new construction to begin in earnest:
Another opportunity that bears watching (and that I’ve touched on in past posts) is the potential reuse of overabundant commercial properties, particularly retail-driven behemoths like shopping malls. In that alone, there are interesting opportunities to address several challenges, from mixed-use and mixed-income housing, to reuse of abandoned stores and senior housing, too.
Housing as an inflationary hedge
There doesn’t seem to be much chance of significant inflation now or anytime in the future, and typically, people don’t invest when there’s deflation, so we’re defying the logic in the equations of typical inflationary/deflationary times.
And housing and energy are usually extracted from the inflation equation, anyway, which doesn’t make sense when the costs of both have huge impacts on people’s lives and the economy—and never more so than when so many people are pushing the boundaries of what they can truly afford.
Everything’s more expensive now, but somehow, it’s not reflected.
Time series: what they are and how they factor in
Time series are relevant to when you buy or sell investments, and the point is this: are you investing or are you trading? In the Investopedia article, “What is a Time Series,” Will Kelton defines a “time series” as:
“...a sequence of numerical data points in successive order. In investing, a time series tracks the movement of the chosen data points, such as a security’s price, over a specified period of time with data points recorded at regular intervals. There is no minimum or maximum amount of time that must be included, allowing the data to be gathered in a way that provides the information being sought by the investor or analyst examining the activity.”
Time series indicate real returns of a specific period of time and I think they’re important to discuss because they help to demonstrate why it’s difficult to pick a top or bottom—it’s not the right methodology for most people. It’s more suited to day-trading, not investing for the long term.
For housing, there was a clear time series event between 1995 and 2005, when underwriting for loans was nearly non-existent. Then, in 2008, the mortgage industry and the residential housing markets unwound. If you bought in 2006 or 2007, you didn’t really make too much money.
If you bought stocks at the beginning of COVID, then it’s likely that you’ve made a decent chunk of money, particularly if you invested in tech stocks. That’s why people everywhere are bragging about how much they’ve made—and this causes a frenzy, others buy into it, literally, continuing to invest and drive valuations up.
Today, people are looking for quick gains. And it’s taken over everywhere that investments can be made, from the profusion of day-trading behaviors to the fix-and-flip strategy for real estate. Our collective psyche seems to no longer have the patience for the long game, and that’s further reinforced through news media and social media.
We have to understand the differences between algorithm-driven behaviors and human behaviors to rectify some of the imbalances. People make financial decisions. Computers don’t. They simply take in data and try to predict behaviors.
What we’re seeing now is the acceleration of human behaviors, driven by artificial intelligence. We’re always looking for the edge, the alpha. One of the truisms of traders is that traders must trade. Sometimes, though, the best thing to do is just to stay put and not do anything. You can’t time the markets. And COVID isn’t over—its impacts could last well into 2022. So, that’s where people are making judgment errors.
We need to look at the entire playing field and figure out the moves ahead, not simply in this moment. Which is why The Queen’s Gambit is my recommendation this week.
If you haven’t already watched it on Netflix, do. It’s a brilliant look at many facets of human psychology and behaviors but strategically speaking, the series lead, chess prodigy Beth Harmon, is the ultimate tape-reader, predicting her opponents’ moves by studying past behaviors and strategies and using available information and insight to predict future moves. Fascinating—perhaps the beginnings of artificial intelligence? Remember IBM’s Deep Blue? Enjoy the show.
