It's impossible to predict with certainty how much more insane our
financial markets will get before an inevitable correction. But my personal
bet is: A lot!
For my reasons why, take a few minutes to watch the chapter on bubbles
below from The Crash Course. For those who haven't seen it before,
the takeaway is this: bubbles pop only when greed in the market has been
exhausted:
Bubbles make no sense economically. Or rationally. But they happen all the
time as a part of the human condition.
Even while financial bubbles are enabled by dumb monetary and banking
decisions, their actual genesis is rooted in primal human emotions. Greed
on the way up, and fear on the way down.
The hardest part about these bubbles is not being swept up in them.
As the above video shows, history is chock full of asset bubbles. We
humans just never seem to learn. Like Charlie Brown's endless attempts to
kick Lucy's football, we get suckered in by the promise of easy riches, only
to end up flat on our back when the market suddenly yanks that promise away.
Wash, rinse, repeat.
Most of you reading this might be thinking “Hey, I’m a reasonable
intelligent person. I won't fall victim to the next bubble.” Perhaps, but
maybe not. The numbers say that the majority of you will. Unfortunately,
being smart -- even a genius -- is no protection against being ruined by a
bubble.
Remember from the video that even Sir Isaac Newton, easily one of the most
brilliant humans ever to live, got his clock cleaned by the South Sea Bubble:
(Source)
Bubbles are much easier to enter than to exit. As they build, all your
friends and neighbors are diving into the pool and enjoying easy riches. You
deserve some of that good fortune, right? And there will be plenty of eager
parties willing to help you get on the bandwagon.
But when the bubble pops, though, action becomes much harder to take. At
first, everyone assumes that the sudden drop is a temporary aberration and
that the party will shortly resume. As prices fall further -- and they
typically fall at a faster rate than when they were rising -- folks become
paralyzed by fear on the way down, slowly realizing that their paper profits
may indeed be gone for good. At first they're unwilling to give up the dream
of the "sure thing" they so recently had, and then, once the losses
start mounting, they find themselves resistant to locking in those losses by
selling. Instead, they hold on to the increasingly threadbare hope that
prices will at least recover to where they can ‘get their money back.’
Of course, that never happens. For all those who bought in during the
mania, their money was hopelessly betrayed the moment they placed their bet.
And that’s what bubbles are – merely bets. And that bet is: I bet I
can get out before everyone else.
That’s mathematically impossible for the majority. It’s really only
possible for a very tiny few who have the vision and the discipline (and more
often than not, the luck) to pull it off. Very rare are the people who get
out at the top.
Don't Be A Victim
So, to avoid becoming victim in the future, the first thing you need is
the clarity to know when you have a bubble on your hands.
Well, it really doesn’t get any clearer than this:
Why Toronto (and Other Cities) Inflate Housing Bubbles to the
Bitter End
Feb 20, 2017
“Let’s drop the pretense. The Toronto housing market and the many
cities surrounding it are in a housing bubble,” Bank of Montreal
(BMO) Chief Economist Doug Porter told clients in a note last week.
Many have called it “housing bubble” for a while, but now it’s
official, according to BMO.
In January, the benchmark price and the average price were both up
22% year-over-year, with the average price of detached homes up 26%, of
semi-detached homes 28%, of townhouses 27%, and of condos 15%.
Double-digit price increases have become the rule in recent years.
But this jump was “the fastest increase since the late 1980s – a
period pretty much everyone can agree was a true bubble – and a cool 21
percentage points faster than inflation and/or wage growth,” Porter
explained in his note, cited by BNN.
(Source)
Holy smokes! Or rather, what are people smoking up there? Bubble weed, or
something. A 22% yr/yr gain? On top of a string of recent years of
double-digit gains?
Here are two more features about bubbles we need to keep in mind:
- Bubble exist when prices rise beyond what incomes can
sustain
- Bubbles always have a blow-off top
First, house prices rising a ‘cool’ 21 percentage points above wage growth
over a single year is the very definition of bubble behavior. Simple math
tells us that anyone who borrows to buy property eventually has to pay that
loan back.
The money to pay back that property loan comes from wages. Ergo, property
prices and wages cannot depart from each other forever, or even for very
long, without a lot of repayment defaults resulting.
As for ending in a "blow-off top", that's just how history tells
us bubbles finally exhaust themselves. They draw in every last sucker and
lazy-thinking ‘investor’ until there's no "greater fool" left
willing to pay a higher price. This doesn't require 100% participation from
the local population; only 100% participation from everyone who can
be drawn in. When that finally happens, that’s when the bubble bursts all of
its own accord.
There's another way for a bubble to end, but it practically never happens.
Responsible bankers and lenders could prevent the bubble's formation by simply
not lending ridiculous amounts. It almost never happens for the same reasons
that people buy overpriced houses: greed and our social programming to follow
the herd. If all your banker buddies are making big bucks writing loans to
anyone who can fog a mirror, then you'll be rewarded for doing the same.
Nobody wants to be the lone, unpopular voice urging restraint when the crowds
are going wild.
The quotes below from the 1850’s show how this dynamic is nothing new to
society:
“Men, it has been well said, think in herds; it will be seen that they go
mad in herds, while they only recover their senses slowly, one by one.”
“In reading The History of Nations, we find that, like
individuals, they have their whims and their peculiarities, their seasons of
excitement and recklessness, when they care not what they do. We find that
whole communities suddenly fix their minds upon one object and go mad in its
pursuit; that millions of people become simultaneously impressed with one
delusion, and run after it, till their attention is caught by some new folly
more captivating than the first.”
―Charles
Mackay,in Extraordinary
Popular Delusions and the Madness of Crowds
Well, the good people of Toronto -- as well as Vancouver, Palo Alto,
Melbourne, and a large number of other real estate markets -- have fixed
their minds on the delusion that the recent skyrocketing price appreciation
means that home prices will continue to always rise from here. So get in
now! You can't lose! Don't risk getting priced out of the market!
What particularly crazy about this is that we just saw 10 short years ago
how this movie ends. But those caught up in the current mania simply aren't
thinking logically right now. They're fully captured by the bubble mania.
And, as before, it’s lonely out here for those of us trying to be the
voice of sanity and reason. Nobody want’s to hear that now.
And later, once the painful correction has wrought its destruction, those
of us who dared to sound an alert may be blamed as responsible for the losses
- as if by pointing out the delusion we caused the burst to happen.
Conclusion
I could go on and on, risking being the boy who cried wolf, and point out
all the other obvious bubbles infecting our financial landscape that all but
assure a very difficult future of financial and economic pain.
But I won’t at this time, having already pointed out the major bubbles in
last week's article, The Mother of All Financial Bubbles.
The delusion much of society wants to believe in is that we can get
something for nothing. That is, to become rich, all we have to do is buy an
asset like a house or Apple stock and simply wait.
The wealth will just magically arrive. No work performed, nothing new
created, nothing done. Just buy, and wait.
Of course, even a cursory examination of all of life in nature (or before
humans invented thin-air money printing) quickly reveals that actual wealth
comes from hard work, usually coupled with taking risks.
But somehow we’ve slipped back into the common and very human delusion of
that our current culture has somehow figured out how to escape the old bonds
of wealth creation. This time is different!
The Romans re-minted coins in smaller and less pure weights and it worked!
For a while. Then its empire collapsed on itself.
Zimbabwe (and now Venezuela) printed and it worked! For a while. Then its
citizens were left impoverished.
Society's dangerous conceit is in thinking that somehow we’ve managed to,
this time, escape the hard rules of wealth creation and have discovered a new
principle by which we can all get wealthy without doing anything at all. All
you have to do is play the game. Put your money to work! Buy stocks and
houses and you can't go wrong!
And it’s working! For now.
But when we back up a bit, it’s pretty easy to see how this cannot be
true. Not for the majority. Why? Because real wealth isn't a paper gain on a
house. Nor is it even money in the bank. Or a large stock portfolio.
Real wealth consists the final things you consume: food, appliances,
transportation, entertainment, clothes, energy, etc.
Those are real things. They have to come from somewhere. Which means they
have to be produced, stored, transported, and sold. By themselves, your cash
and your stock portfolio have no value. Those are merely claims on true
wealth.
So how can it be possible for everyone to be exponentially increasing
their claims on real wealth, without the underlying pie of real wealth
itself, increasing at an equivalent rate?
It’s not.
And that’s the painful lesson that gets learned and re-learned as each new
generation gets duped and then dumped by an asset bubble.
Sadly, bubbles used to happen only once in a generation. Once those burned
by the last bubble have died off, the younger generation has no living memory
to prevent them from getting suckered by the next one. But for some reason,
our current generation has something of an addiction to bubbles. We've lived
through the tech stock bubble, the real estate bubble, and now we're living
inside the 'everything' bubble.
What's wrong with us?
My advice is to sell your house if you live in Toronto, or a
similarly bubblicious real estate market. Similarly, reduce your
exposure to stocks and bonds at these record highs, and develop a wealth
protection strategy with a financial adviser who understands the risks in today's
markets.
Know what the bubble signs are and be smarter than Newton by standing
aside, nodding knowingly, and tolerating your "smart" friends and
neighbors.
It’s one of the very hardest things to do, but it’s also one of the most
important.
Odds are high you'll be proven the smart one once the current bubble
bursts.
And if you haven't read it yet, read The Mother Of All Financial Bubbles to develop a
full understanding of the risks we're now living under.
~ Chris Martenson
