Anyone watching the real estate market knows that it has been red hot for the past few years. Some would call the real estate market crazy, and some have likened it to the technology bubble of the late 1990’s. Locally, I know a lot of people are involved.

I gained a unique perspective on real estate in 1985, when I lost a million dollars in the real estate market. When someone asks me why I moved to Prescott, I jokingly respond, “impending poverty”.

Most of us have never seen real estate do anything but go up. But anyone who lived in Phoenix or California in 1990, or Texas or Alaska in 1985 can tell you otherwise. My personal experience with the real estate market, as painful as it was, makes me better at what I do now. I recognized the overheated nature of the stock market in 1999 and the fear of missing out that causes folks to stay in it too long. This was when I developed my strategies that Adapt to Changing Markets®, which have worked so well since their inception in 1999.

My experience now tells me that the peak of the real estate market is probably behind us, and a December 23rd AP article confirms it. The first sentence of that article is “Sales of new homes plunged in November by the largest amount in nearly 12 years, providing the most dramatic evidence yet that the red hot housing market over the last five years is starting to cool down.” Inventories of unsold homes are also rising—not a good sign. Another reality check is the heavy insider selling of home building companies’ stocks reported by Sy Harding of Asset Management Research, Inc.

Don’t be lulled to sleep by the slow pace of pricing change in real estate. Once prices turn around, things can get ugly in a hurry.

And, there is a new dynamic in this real estate bull market that was not present in earlier hot real estate markets. The number of investors vs. the number of owner occupants is very different this time. Owners will be patient if prices go down. They need a place to live, and will have to pay rent if they move, so they tend to stay put and try to tough out a market decline. Investors, some of whom never even try to rent their properties but buy solely for appreciation, will not be so patient when appreciation disappears. Even if they lose a down payment, they will likely tell their realtor, “This isn’t working, Get Me Out!”. At that point, a ton of properties can come on the market pushing prices down in a real hurry as only the sellers willing to lower their prices the most will find buyers.

So, if you are holding investment real estate, take a hard look at your plans for that property. If your intent was to hold a few years and make a profit, this may be the best time to sell that you will see for a long while. Times they are a-changing’. Right now you can sell high. I don’t think you will be able to say that in a year or two.

Inflation or Deflation?

Paul Pilzer is an economist and author who has a different way of looking at things. I find his ideas refreshing and thought provoking. Pilzer’s take on inflation was a real eye opener 10 years or so ago when I was first introduced to it.

Economics 101 says that inflation happens when too many dollars chase too few goods, causing the price of goods to be pushed upward. Think of an auction where several bidders want the same thing—the price becomes inflated. We saw a lot of inflation in the 1970’s, and it seemed like it was caused by this simple supply and demand theory.

Pilzer was the first economist I heard say that inflation is really a tax on inefficiency, not just simple supply and demand theory. He points out that in the late 1960’s and 1970’s huge numbers of baby boomers and women entered the work force for the first time. These new workers all had to be trained and equipped to work, which cost huge sums of money. In addition, new workers are generally less efficient than experienced workers. So, despite spending a lot of money on them, these new workers were pretty inefficient and inflation resulted.

A few days ago, I heard a news report about efficiency increases in our economy which have been occurring for many years now. I wondered: If we really are getting so efficient, why are we seeing signs of inflation creeping back into the economy? Then it dawned on me! While the US manufacturing is truly getting more efficient, industry in China and India are making even greater efficiency gains than we are. So, on a relative basis, we are still becoming less efficient than the competition.

Could this be the reason we see gasoline, health care and construction material prices going up and up, but our worker’s wages seem to be stagnating. I think so. It’s the Pilzer effect in action.

I believe that our free market capitalism will adapt to this problem like it has to so many others. It may not be pretty, though. Capitalism can be harsh on those that are not in the right spots or who won’t or can’t adapt to the changes. But on the whole our lives are better for it. It is precisely this dynamic that allows our standard of living to keep increasing despite all of the painful economic changes. Efficiency gives you more bang for your buck. Look at the capabilities you get when you buy a new computer, or the quality and features of new cars now versus ones 25 years ago, the cost of clothes, the affordability of complex toys, the availability of fresh fish and vegetables in any season. These prices have deflated due to efficient industrial processes. Now we need to get this type of efficiency into other areas as well.

Just imagine what an efficient government could mean. Boggles the mind, doesn’t it?

January 2006

Market Highs?

All time highs for the stock or bond markets?

Well, perhaps if you had been invested with me since 1999 or 2000 you would have seen all time highs because of our dodging losses in the rough years of 2000-2002. This is true even after deduction of all fees and expenses.

However, those investors who still cling to the buy-and-hold-is-the-best-way to-invest” slogan pushed by Wall Street are probably still waiting to get back to even.

Three out of four of HCM’s stock market oriented “growth” strategies were at all time highs in December 2005, and both of our bond strategies, Tactical High Yield and Bond Protection also hit all time highs recently.

At the same time, most passive buy-and-hold investors are still well below the stock market highs of 2000 or the bond market highs of 2003—but look at all the fees they saved.

For those of you who decided that you wanted to end up with the most money, period, and became Hepburn Capital’s Adaptive Strategies clients, you have gotten the value you paid for. Congratulations on your good decision. However, investors who went the lowest-possible-cost route have gotten what they have paid for, too, I suppose.