The Real Estate Bubble, The Commodity Bubble, The Stock Market Bubble. Do you have a short-side strategy to counter the new economic force of stagflation?

February 12, 2011 by · Leave a Comment
Filed under: Economics, Investment 

The Real Estate Bubble
Real estate has been in a bull market for 50 years, but hit a serious bump in the road in 2005. This bump is looking more like a major pothole based on all the negative news concerning the state of real estate in 2006, 2007, and 2008. The question to ask is, “What if the pothole is the Grand Canyon — then how significant is the downside yet to come in real estate? ” .
The fact is that this real estate bubble is not a domestic one, it is a global phenomenon. At the top in 2005, The Economist magazine called the housing boom “the biggest bubble in history, ” with “world residential real estate values escalating from $40 trillion to over $70 trillion ” in the last decade’s bull market run. The article pointed out that the $30 trillion increase in world residential real estate values is just about equal to the GDP of the entire advanced world. Housing prices in the United States, Australia, Spain, Ireland, and the United Kingdom exploded in price during the 1995 to 2005 bull market run. If it looks like a bubble, acts like a bubble, and feels like a bubble, then it must be a bubble! The evidence of the air slowly coming out has been seen on a weekly basis since that article came out. You know this is a serious concern of the Federal Reserve by the Fed’s aggressive policy actions. The Fed cut interest rates in 2007 and 2008, which is exactly what they did in 2001 when they tried to slow down the Nasdaq crash. Nasdaq fell over 80 percent before the bottom finally hit. How far can real estate prices fall before they reach their ultimate long-term bottom? Again, read on as I explore a 1929 downside scenario to come from a debt contraction cycle that has begun. The problem with bubbles is that when they burst, they typically overdo it to a downside extreme like they overdid it on the upside explosion.

The Commodity Bubble
The CRB posted a high in 2008 exceeding its best move ever of 146 percent from 2001. Speculative momentum buying sent gold, oil, copper, silver, platinum, and almost every other commodity to dizzying heights. The U.S. dollar hit its lowest level ever and that boosted the price of real assets that are priced in terms of depreciated dollars. The commodity bulls believe that the combination of a continued weak dollar and the apparent insatiable appetite from China and India for energy and metals will propel prices much higher far into the future. The famous commodity investor, Jimmy Rodgers, has come out with another book that encourages investors to buy China and commodities. Jimmy was interviewed on Bloomberg TV, saying he is getting all of his assets out of the United States and out of U.S. dollars. He said we have “a lunatic Fed chairman ” that is going to blow up the U.S. currency with his reckless Fed policies. He sees the commodity run as early in its bull market. With the price of oil and oil stocks running wild both up and down so violently, one has to wonder if we aren’t once again seeing another price bubble like Nasdaq 2000.
Regardless of what the commodity bulls think, the easy money has most likely been made in commodities. If the U.S. dollar does have a currency crisis, then commodities will have another blow-off-like run before putting in a final top. As the China bubble blows, the perceived insatiable demand for commodities is withering and the commodity bubble appears to be popping. Investors and traders will also need a short-side strategy in commodities. Long-only investing in commodities will no longer work because, as they say on Wall Street, “trees don’t grow to the sky.”

The Stock Market Bubble
The secular boom in stocks has been a very long one indeed. Stock prices have enjoyed the best of all worlds in the “Goldilocks ” economy, not too hot and not too cold. As real estate has its “perfect storm, ” investors continue to pour money into stocks even as prices fall.
Stocks are competing with weak real estate and unattractive bonds. In 2007, stocks experienced a merger and acquisition boom that lowered the supply of stocks outstanding. This propelled the DJIA and the Standard & Poor’s (S & P) 500 to all-time record highs in 2007 right before they severely corrected into bear market territory in 2008. Money goes where it feels the safest and is treated the best, and over the long haul that has been in stocks. The concern of many investors, including myself, is how bad will the economy and stocks get if real estate weakens considerably or interest rates finally start to rise?
From a wide-angle viewpoint, stocks, bonds, commodities and real estate still look very high and overvalued. This does not mean that certain stocks in hot sectors or the market cannot rise substantially. It also doesn’t mean the real estate market can’t have a mild recovery and quite possibly, yet unlikely, boom ahead. With bond yields so low, many see stocks as undervalued relative to bonds, and mortgage rates favorably disposed to future gains in home prices. If I am correct about the coming substantial rise in interest rates, then stocks and real estate will not look as cheap or desirable as the economy falls and jobs are lost. The other concern is that the first two years of a new presidency can be very difficult and volatile for the stock market.
How does everything seem to you? Do you think stock prices are attractive and cheap? Do you think real estate prices are low, undervalued, and affordable? Do interest rates look attractive to you with low, single-digit yields? There is a case to be made that from a long-term secular point of view, there could be nothing but downside pressure in stocks, bonds, and real estate.

This is not intended to be pessimistic, but a realistic explanation why most investors should have a short-side strategy to counter the new economic force of stagflation. More importantly, this is a strategy to deploy no matter which camp you fall into, bull or bear.

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