Reassurance or Foreboding?

As we begin the first full week of June, many investors should be asking themselves the same questions Michael Santoli asked in Barrons this week, which are "after a biblical seven years of wandering, the Standard and Poor's last week finally surmounted its former all-time closing high, set near the apex of the market bubble in 2000. Is this a moment to celebrate or lament, a sign of reassurance or foreboding?"

These are very good questions, indeed, because one can never be sure of the direction of the market, but higher highs are usually the sign of a bull market having the strength to continue the upward trend. However, in the short term there could be some gyrations on the way to the next record, because in a bull market one must also witness higher lows! Don't get too caught up in the various news reports you'll hear, but rather continue with your investment plan in order to reach YOUR goals.

I've reprinted an article from my newsletter written in the first quarter of 2005 that spoke of concerns about speculation in the housing market and how to cope with it, especialy if you needed to buy a home. I sure hope we don't enter another era of speculation in the stock markets again, but then, who would have thought we could create a bubble in housing, so soon after the 2000 stock market bubble? One point I must make is that even though bubbles were created, much REAL WEALTH was also created in the 2000 stock market bubble and the recent housing bubble, depending on when and what you bought. A true advertisement for the warning, "Buyer Beware".

Speculation and the Housing Market in 2005

When Greenspan finishes his term as Fed chief, I am one person who surely will miss his succinct use of language to make a point. The use of the term “irrational exuberance” to explain the dotcom bubble, in hindsight, was right on the money. In discussing the current housing boom, he has used the word “froth” to discuss the “relatively exotic mortgages which are of particular concern”. While there are no predictions of a dotcom era style bust in real estate, the fact that 20% of new mortgages in 2005 are “interest-only”, up from 5% in 2003 is the froth of which Greenspan speaks. Consider a 10% drop in home prices for a moment. With a 10% down payment and an “interest-only” ARM, all equity in the home evaporates, and monthly payments eventually will rise with no principal reduction, because interest rates are rising. Does this sound just a bit frothy or even speculative?

The point is to always remember the cyclical nature of the economy, the stock market, the housing market and life in general. In the economic cycle, we are in the middle of the expansion phase, and within this phase, there are ups and downs. The market will rise and fall during this part of the cycle, but the trajectory should be positive if you think long-term. Housing has been in a boom, since the dotcom bust and could very well be near the top. If you need a house, because it will be your home, shop wisely. If you are looking at real estate as an investment at this juncture, perhaps you could wind up in a situation like the above mentioned scenario.

Here are some facts to consider if you are concerned about the housing market. According to Business Week, “today’s housing prices are predicated on an impossible combination: the strong growth in income and asset values of a strong economy, plus the ultra low rates of a weak economy. Either the economy’s long-term prospects will get worse, or rates will rise. In either scenario, housing will weaken.” We’re already seeing interest rates rise, so “perhaps housing is entering a more sober period when it won’t be the prime generator of growth.” Overall, the feeling is the housing sector will cool off, and areas with more speculative markets will see more depreciation in home values than those which had a more modest increase over the last three years. This has happened before, and it will happen again. This is no new paradigm, it is just “the cycle”.

John Kaighn is a Registered Investment Advisor with Jersey Benefits Advisors and writes articles on various business and investment information, ideas and opportunities. For more information about this and other topics you can visit http://www.johnkaighn.com and http://www.jerseybenefits.com