Home Sales:  Not The Logical World of Supply and Demand

           Generally speaking, the law of supply and demand dictates that when the supply of a certain item goes up, the price will come down.  But not so with houses, it seems.  The National Association of Realtors reports many months of rising inventories of home listings, yet prices in most areas are not yet backing off.  What’s happening?

           Bob Prechter in his book The Wave Principal of Human Social Behavior describes the difference between valuing an item financially and economically.  Human behavior with respect to the price of investments is, in a crucial way, the opposite of that with respect to the prices of goods and services.   When the price of a good or service rises, fewer people buy it, and when it falls more people buy it.  In contrast, when the price of an investment rises, more people buy it and when its price falls, fewer people are interested.  This difference is not accidental; it is fundamental.

           The law of supply and demand always produces predictable behavior in the sale of goods and services—half of the participants want higher prices and half want lower, producing a rational  balance. 

           In finance, almost everyone wants prices to go higher for very basic reasons: to enhance their sustenance and ensure their survival.  In economics, survival instincts work OK.  But our primitive survival instincts are so unsuited to the world of finance that instead of enhanced success, they virtually assure failure if not checked.  Rather than get excited as prices fall like rational consumers of goods and services do, investors become excited to buy as prices rise, causing investors to get the first part of the great American investment creed wrong.  Remember “Buy low and sell high”?.  Please repeat that three times.   And then, when prices fall, investors feel an internal pressure to sell.  Both of these impulses are contrary to the way consumers behave in respect to goods and services, and compel investors to do the exact opposite of buying low and selling high.   It doesn’t make sense, but investors instinctively feel like they are doing the right thing, enhancing their survival chances, by investing backwards.

           So what does this have to do with housing?  A lot.  Seasoned real estate investors know that a key to making money in real estate is to buy it at the right price.  Buy low.  If you are considering buying real estate right now, ask yourself, “am I buying low or buying high?”  If you are not sure you are buying real estate low, re-read this article and see if you are behaving differently than if bread were on sale.

 Chart of the Month

This chart, of Consumer Price Index numbers from the  Bureau of Labor Statistics gives some interesting insights into the potential for inflation in the future.  All of the spikes occurred during or right after wars.  Do we have a war on now?  The gridlines are 10 years apart and show a propensity to spike every 30 years or so.  When will we be 30 years from the last spike?  Does inflation tend to creep up slowly so you can adjust or does it spike up suddenly?  The spikes all go up into double digit inflation.  Since prices of bonds and other dividend paying investments are closely tied to inflation, do you know how higher inflation would affect your investments?  If you are a fee based client for whom we use Adaptive Market Strategies, we plan to take care of this for you.  If you are not a managed account client and you would like to be better prepared for a potential surge in inflation, please call the office for an appointment to address your concerns.  778-4000.

 October 2005