The Kiss of Death?

05/13/2005 12:00 am EST

Focus:

James Stack

President, Stack Financial Management

Jim Stack utilizes his unequaled knowledge of market history in his analysis of future trends. Here he questions whether the real estate boom may become a bubble, and most importantly, explains why stock market investors should be concerned with this answer.

"Our indicators have deteriorated from earlier this year, but are not at bear market levels. Breadth is slipping, but more in line with what we’d expect to see in a correction than the start of a bear market. We are also nervous about the deteriorating leadership, but it’s not time to head for cover yet. The trend of interest rates (both short and long-term) is bearish, but the absolute levels are not. As such, there’s good reason to give this bull market more time and benefit of doubt.

"The most dangerous word on Wall Street is ‘boom.’ To the media and the novice investor, that may sound strange. After all, what can be bad about something that is seemingly good? ‘Boom’ headlines appeared in late 1968, and again in early 1973, right at the start of two of the biggest bear markets of the past 50 years. The bubble of the late 1990s was no exception, with the single word ‘Boom’ gracing the cover of Business Week in the exact month that the pinhole entered the bubble.

"So it was with trepidation that I picked up the latest Business Week to find the word ‘Boom’ once again – only this time, referring to the US real estate market. Will this turn out to be the ‘kiss of death’ for the real estate boom? No one will know until looking back in 20/20 hindsight a couple of years from now. However, the books written on real estate in the past year easily rival the froth of the final year of Wall Street’s bubble:

"In 1999-2000, the top stock market books had titles such as Alchemy: Turning Common Stocks into Gold, The Roaring 2000s, Desire In The Greatest Boom in History, Dow 36,000, and You Can Be a Stock Market Genius. In 2004-2005, we see book titles such as 40 Days to Success in Real Estate Investing, Unlimited Riches: Making Your Fortune in Real Estate Investing, Investing in Real Estate With Other People’s Money, The Weekend Millionaire’s Secrets to Investing in Real Estate, and The Amazingly Simple Way to Make Millions in Real Estate.

"It is not my intention to disparage real estate investing. But now when it’s most difficult is the time to keep one’s feet objectively on the ground. This is not the time to pile on real estate debt, or seek big profits by flipping houses (buying with the sole intention of selling at a quick profit). It’s late in a ball game that has run extra innings. When the party ends, prices will not crash like the stock market. But sales will quickly dry up, and speculators will find themselves holding a very illiquid investment.

"What does this have to do with the stock market? Everything! The inevitable softening or downturn in real estate –when it comes– will be blamed for the next recession. But it will actually be a result of the recession rather than the cause. And meanwhile, we grow increasingly fearful about the real estate stocks: home builders, mortgage finance companies, REITs, etc. For many of these stocks, the next bear market will rival the generational losses of the 2000-2002 bear market in technology stocks. So be careful. Please be careful!"

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