Stats Won’t Save Us
Every day, and every minute somewhere on the Web, another statistic that hints at an economic recovery is reported, copied, translated, manipulated and reevaluated. It seems for every positive up tick in economic numbers, there is also a negative. We have been experiencing shaky times for the past 20 months. Every sector is not going to at once join together on an all-knowing graph somewhere and move together as one gradually-rising black arrow.
Stats are meant to give us market indication. “Experts” on the economy make sense of the stats by attaching other positive attributes to them without any solid proof. In social psychology, it is similar to how the halo effect works: If I see Bob Somebody helping an old lady cross a busy intersection, then I automatically believe Bob to be a good person; without having any solid proof. Helping the elderly in dangerous situations is good, I saw Bob do that, so Bob must be good. Similarly, the media tells us recessions are scary and bad, positive things do not happen in recessions; therefore a positive up tick in one sector must mean we are out of the bad recession and into the good recovery. Experts link good news with other good news without any solid proof.
Earlier this month, Newsweek ran a cover that pictured a big red balloon which read “The Recession is Over!” The cover and its related story caused a small uproar that resulted in criticism from President Obama. Although the cover story was meant primarily to sell magazines, the author did make a solid point: “… when economists proclaim a recession over, they’re celebrating a technicality: they mean economic output has stopped contracting.”[1] When the economy stops contracting, it does not simultaneously return to the rising rates we experienced in the years prior to this recession.
The reporting of numbers, percentages, graphs and ratios should only be taken for face value. We use them as indicators, as ways to gauge where we are and the possibilities of where we could be heading. Be aware that we are approaching a period that is sure to be overflowing with economists eager to be the first to accurately predict the recovery by accident. Statistics will punctuate every news story you ingest. A small increase over a quarter is no reason to speculate and sink loads of savings into any financial market. The recovery will come. As we work towards it, I encourage you to stick with the basics. Own stocks that make sense. Consider incorporating alternative investments such as real estate into your portfolio not only because of their soundness, but also because they work as a wonderful hedge against inflation. Pay off debt. Adapt to the times. And, most importantly, focus on those things in your life that you care about the most.
Tangled in the Reins of Negative Equity
Recent housing numbers indicate that first-time home buyers are being attracted to the market via low home prices and the $8,000 federal tax credit. But, the tax credit is scheduled to be pulled before the end of the year and declining home prices are leaving more and more home owners with the burden of negative equity.
This month, The Wall Street Journal reported that 16 million Americans owed more on their mortgages than their house was worth, up from 10 million this time last year.[2] Furthermore, Deutsche Bank estimated that 48 percent of U.S. homeowners will be “underwater” by the end of the first quarter of 2011, as unemployment rises and house prices remain low. A prediction similar to this appears frightening, but what place does negative equity have among the gory stories of today’s economy? I see three major implications.
For starters, if somewhere between 20 and 50 percent of all homeowners have negative equity over the next 2 years, then default rates will continue to plague the housing industry. True, not every residential mortgage with negative equity will default. But, having negative equity is frustrating for owners and the more underwater they become, the better chance they have of defaulting.
Next, this recession has placed a new taboo on debt, causing those that have lots of it to feel guiltier than during times of rampant overextended credit. Those with heavy debt burdens, such as negative equity in their largest assets, are less likely to spend. Our gross domestic product relies heavily on consumers to purchase. A sustained decline in consumption will further constrain our GDP growth and further ail our economy.
Lastly, a large population of home owners with negative equity translates to a large number of houses waiting to be sold. Because no one wants to take a large loss on their home, the majority of owners looking to sell are holding on to their homes. Do not get me wrong, this is not a bad thing if the owner is looking to hold on to the home as a long-term investment or to serve as a primary residence. However, a portion of the huge supply of homes waiting to be sold will be flushed into the market every time there is a bump in prices. Each time, this will dilute the market, bring down prices and elongate the downturn. Consequently, this ever-appearing inventory will also put a damper on the demand for new construction.
From state to state, local markets will continue to be choked by a high percentage of home owners with negative equity. Not surprisingly, the states with the greatest percentages of home owners with negative equity are primarily the states whose real estate markets were demolished by the housing burst. Nevada leads all states with 40 percent, Arizona follows close behind with 37 percent, California falls in third place with 30 percent and Colorado and Michigan round out the top five with 31 percent and 29 percent, respectively.[3]
Speaking Real Estate Today
As it becomes more popular for investors to include real estate as an active player in their portfolios, the asset class is being talked about differently. Left behind are the days of talking about real estate as an integral part of the next speculative boom. Banks are no longer willing to take the responsibility of the loan off the shoulders of the borrower by offering zero-down mortgages. Lending is tighter, though not unreasonable, and borrowers are more educated about the risks involved with taking on a mortgage.
The housing burst exposed the problems involved with treating real estate as a short-term investment. Unsurprisingly, investors today approach real estate differently. Dave Kansas of The Wall Street Journal recently wrote that investors are more cautious and “focused on real estate as something they can use: a solid place to live or play…”[4] Going along with Kansas’ article, investors cannot enjoy a family barbeque in the front yard of their stock portfolio or be awe struck by the view off the back porch of their bonds.
Many investors are irritated with the roller-coaster ride of the stock market. These investors are on the hunt for alternative assets to occupy a larger percentage of their portfolio; making it long-term and balanced, with little need for sporadic buying and selling. On the other hand, some investors feel the impulse to be over active and are reluctant to leave the stock market.
Including an alternative asset such as real estate into your portfolio allows your entire investment livelihood to not solely rely on the stock market. Alternative investments are typically not correlated with stocks, which means when the stock market is taking a dive, alternative investments are likely to be stable or even rising. Including an alternative investment such a real estate into your portfolio can also significantly lessen the impact of inflation, which is currently a concern of many investors. With the steep drop in home prices and mortgage rates hovering near record lows, a number of signs are suggesting that now is the right time to invest in real estate.
