Juggling Dynamite

Some celebs are feeling the pinch as the housing downturn worsens. Others are actually facing foreclosure and losing their homes to the subprime mortgage crisis. See Celebrities not immune to the real estate crisis.
The credit crisis is not just impacting sub-prime or low income borrowers. I think this is important stuff for regular folks to read and understand. Believe it: the excess and loss of asset bubbles is something that all walks of people can succumb to. These are human behaviour driven cycles. Neither relative wealth, nor large incomes, or education can naturally protect people from getting caught up in financial mania. Only awareness and self-discipline in our individual behaiour can offer hope.
Realizing bubbles are a naturally reoccurring event in human history is a crucial first step to protecting ourselves from getting caught up in them and future losses.

Recently several people with Registered Retirement Savings accounts held with broker/dealers and planners have commented to me that they are frustrated with RSP’s and they are wondering “what is the point?”
The source of this frustration comes from their experience of diligently plopping in annual contributions to registered plans, and seeing little to no growth or outright losses year after year. This is very hard to take. But I would like to get one thing straight. It is not RSP accounts that are the problem here. It is the crap bad investment products people are buying inside RSP accounts that are causing the problem. As I have said before, a flashy car with a defective engine will get us no where fast.
You do not have to buy high risk, high fee assets within your RSP and RESP (registered education savings plan) accounts. Continue making your contributions. Savers in North America receive a valuable deferred taxation benefit and tax sheltered growth on assets we hold inside of registered accounts. It is easier to save into tax sheltered accounts with before tax income than to save outside of sheltered accounts with after tax income. These are worthwhile benefits in their own right.
The trick is that once you have contributed your savings into your retirement plans you must be extremely careful with what you invest your savings in. High fee, long always products like venture capital funds, stocks or equity mutual funds are more likely to erode your capital each business cycle than they are to appreciate meaningfully within your life time. Since most advisors and investors do not have a management discipline that determines when to buy and sell equity investments, most simply buy equity investments as soon as you contribute savings regardless of asset price level or where we are in the business cycle. This is the path to almost certain losses for passive investors.
If you have no management discipline, and your advisor has no management discipline, then stopping paying high management fees for management you are not getting!! You can fare much better with your savings buying guaranteed deposits (GIC’s) or even money market funds at your local bank branch with your RSP contributions. You don’t have to buy equity investments every time you have savings. Unless and until you come up with a management discipline or retain an asset manager who has an actual method for protecting your capital from down markets, do yourself a favour—keep your capital parked, safe and dry.
Recent IFIC numbers for January show that there have been large out-flows from equity funds into money market funds during the market turmoil last month. As I said to The ROB this week in “'Fear factor' sees investors bolting equity funds in January” , I take it is a sign of life that previously complacent investors finally realize that they do not have to always buy and always hold equity funds with their savings.
But: “…it is unfortunate that retail investors only recently realized how delicate the markets were, and pulled money out of equity funds after stocks had plunged.”
The signs of danger to capital were so vividly apparent over the past couple of years. But to see the signs and leave before the losses mount requires one to have and follow an actual management discipline. An objective market timing discipline is precisely the thing that most retail investors and advisors lack.
Given the overhang issues still before us in this ongoing slowdown, and given the still relatively high equity valuations in this contracting earnings period, selling and moving to cash or money market now is still likely to prove 'better late than never' as we find ourselves a few more months from now.

For the past couple of years, market bulls have been roaring great hope and wildly optimistic expectations. Their upbeat forecasts were based on common themes: world economies would decouple from a US slowdown, real estate prices around the world would only have to correct a modest -5% in order to rebound and continue their ascent, and subprime mortgage problems would be small and contained.
In the past few months we have seen that world economies are slowing pretty much in concert, world stock markets are once again highly coupled in their descent, and Real estate prices in the US have already fallen 8% over 12 months ended November 2007. See latest Case/Schiller index. Oh yes, and subprime has been contained alright, at least to planet earth.
But even though a decline of 8% in real estate to November was the worst in many decades, by all indications prices are getting much cheaper by the day. The WSJ cites more evidence of this yesterday in Homes in Bubble regions remain Wildly Optimistic. :
“…even after a year of misery and falling prices, homes in many of these regions still aren't cheap. They remain wildly overvalued compared to average personal incomes. There is a strong long-term correlation between the two figures. And in many regions, house prices would still have to fall a very long way to get back into line.
How far? Try around a third in Florida and Arizona — and closer to 40% in California… Even if house prices stabilized, it would take a decade or more for rising incomes to catch up.”
In many areas, prices could reasonably fall another 20 or 30% over coming months. I just returned from speaking in Phoenix where housing has been particularly overbuilt and is now violently correcting, already down by up to 50% in some areas before buyers can be found.
AND REMEMBER WHY WE CARE about the housing market. The bulk of the economic expansion since 2002 was on the back of Mortgage Equity Withdrawals (MEWS). Without the dramatic ascent of real estate prices and the consequent ability of consumers to refinance and spend, the US and much of the western world would have experienced recessionary growth for the whole of 2001 and 2002 rather than a couple of quarters in 2001. And growth would also have been decidely sub-par even in the '03-'07 period. See the chart GDP Growth: With and without Mortgage Equity Withdrawals. Whether the ongoing real estate contraction happens fast and furious or follows a long slow grind down over the next few years, we will not see record earnings and growth like we have seen for some time to come.
And here is the kicker– this means stock prices are also wildly overvalued at this point, even with their sell-off over the past few months.
For all the optimistic souls who still insist that commodities and raw goods are now shipped to China and India more than the western world. I am sorry to point this out, but the demand at the back door of Chindia has been driven by demand at their front door for finished products and manufactured goods shipped to western consumers.
Western consumers paid for the bulk of their demand through debt and MEWs that they can no longer access. Be wary of optimistic forecasters who site recent corrections as buying opportunities in real estate and equities. A decline of 8%-20% is a start, but it will be little comfort if prices follow their likely path significantly downward from here. As always, the price we pay is our greatest risk.