The trouble with mental pegging to bubble levels

I had a great trip to Vancouver. Weather was spring-like, even sunny. Scenery there is stunning. And the new rapid transit line takes you from the airport to downtown in 25 minutes for $3.75; fantastic. Many natives are complaining though about the inconvenience and economic cost to local business leading up to the Olympics next month. Apparently, tourism and skiing traffic so far have been way down this year as people avoid Vancouver, thinking it will be too hectic and booked because of the Olympics. That is unfortunate because it really is a lovely and unique part of the world to visit.
I noted quite a sentiment shift over last year among attendees at the 2010 Vancouver Investment Conference. The remarkable rally in stocks and commodity prices the past few months has buoyed animal sprits again it seems. There is quite a bit of hope that the crisis is behind us and that pre-crisis price levels are a reasonable target up from here.
Watching the incredible news coverage out of Haiti the past week, I am of course, dumbfounded. The loss and suffering, the heroic acts it inspires in many: all surreal and all important points of reference for those of us presently in more fortunate circumstances.
As I mentioned in my talks in Vancouver: over the past couple of years, I have periodically likened the enormous shock of the financial crisis to the idea of an earthquake. Although the risks were building for a long period of time, and although Richter-like risk measurements were foreboding, too few people were taking note of the warning signs. Few saw the crisis coming; even less took active steps to avoid the loss and damage. Today, it strikes me that few people are now prepared for a likely long-period of after-shocks that will continue to ripple through financial markets and the economy for the next few years. We have to expect and navigate the after-shocks if we are to survive and thrive this challenging era in the world.
A few people were telling me about how they have been buying real estate in the US the past few months at “50% of its value” etc. And for sure, some may be finding some deals; the danger in that is this: saying we bought something at a discount to its previous market value suggests that the previous market value was valid and that the item is now selling for less than its worth. Coming out of bubble peaks however, this type of math can be quite dangerous. For example, tech stocks that were supremely over-valued in 2000 were not necessarily “good buys” after their prices had fallen 70-80%. Or in early 2008, remember all those Sovereign Wealth Funds swooping in to buy US financials early in the credit crisis, paying discounts of 20% to peak market values, only to face the horror of further 70%-90% declines after that. We should keep in mind that prices out of bubbles usually fall much lower and much longer than one ever dreamed possible.
US commercial real estate prices have been dropping dramatically the past year, with the commercial property index now down more than 40% from the peak. But we should keep in mind that Japanese commercial properties dropped 80% from the peak after their property bubble burst. So really a “good” entry price has to be assessed from the ground up rather than the top down, and based on many more factors than just where price has been in the past.
In 2010 I think there will be several large financial after-shocks. Some of these are likely to come via a realization of the number of countries in the world which are now left weak and over-levered coming out of the credit bubble. Other shocks are likely to be on-going real estate declines in both residential and commercial properties; on-going credit defaults and bank losses; stubborn unemployment; stubbornly weak consumer demand and astonishingly persistent over-capacity and over-supply in most goods and services.
Last but not least of course, I am concerned that stock and commodity prices are at risk of another major decline in this environment. Stock-a-holics that have not yet learned lasting lessons about risk will probably get some more opportunity to do so in the months ahead.
UK’s David Blanchflower, was one of the very few economists to anticipate the severity of the credit crunch. As a member of the Bank of England's monetary policy committee he consistently called for rate cuts in defiance of his peers. In this January 15 interview, Blanchflower warns of the risks now of assuming the crisis is past and of being overly optimistic about a “v’ shaped recovery. He calls such ideas 'The economics of lunacy:'

This entry was posted in Main Page. Bookmark the permalink.

Leave a Reply

Your email address will not be published.