According to many North American economic analyses, we're not headed toward a bubble -- we're in one. But how is this bubble different from past bubbles and what will happen when it ultimately bursts?
Former chairman of the Federal Reserve, Alan Greenspan, said last year, "When bubbles emerge, they take on a life on their own. It is very difficult to stop them, short of a debilitating crunch in the marketplace." That quote alone was enough to send a fear to any investor in the marketplace. But, it did not. The bulls have been marching strong through the market up until this very day.
During Mr. Greenspan's recent interviewat the Global Private Equity Conference in Washington, he warned that markets will get another "taper tantrum" when the Fed raises interest rates for the first time in about nine years. He foresees a "very rocky process" once the Feds decide to start increasing interest rates. He is not alone in forecasting troubles ahead. Judging by the ever increasing concern of some very reputable economists, we are presently living in an economic bubble that has a real potential of bursting.
In short, it is logical to infer that the imminent bursting of the bubble will affect investors and ordinary folk on the street alike. When it may happen is anybody's guess but the consequences of it may be severe. We have been living in an equity bubble for a quite some time and, as of late, a highly advanced one.
The MarketWatch article "We're in the third biggest stock bubble in U.S. history," published last year, suggested that U.S. stocks are about 80 per cent overvalued on certain key long-term measures, according to research by financial consultant, Andrew Smithers, the Chairman of Smithers & Co., and one of the few to warn of the bubble of the late 1990s at the time. The history shows that bubbles form from time to time, and affect some -- or in some instances -- all segments of the economy. A major high-tech bubble occurred in 1990s, but back then, many investors reinvested their money in the real estate sector, which started to improve by 1997, following its 1989/1990 disastrous collapse, both in the U.S. and Canada.
This time may be different though. If the stock bubble bursts, the exit strategy is most probably not going to be reinvesting in already overvalued real estate. By monitoring the housing trends in the U.S., and (up to 60 per cent overvalued) Canadian real estate, a sad realization surfaces. The real estate market isn't doing well in the U.S. The first quarter real estate reports for Canada are also disappointing. Many of those part of the millennial generation, burdened by their heavy student debts, cannot even afford renting apartments on their own, let alone invest in the extremely overheated real estate market. Most retirees face the same problem because of their limited income.
In my estimate, real estate is overvalued by at least 40 per cent and maybe up to 65 per cent in many congested urban areas of U.S. and Canada. If real estate was to crash simultaneously with the stock market, the future doesn't bode well for North American economies. Such possibility may prove to be especially painful to seniors whose livelihood depends on dividends invested in their stocks or the asset value in their homes. When it comes to real estate, which I'm more familiar with, I always warn people that eventually, it all comes down to housing affordability.
If one is able to purchase or rent any kind of real estate by being able to pay for its carrying costs with one-third of their annual income, they could whether the storm, notwithstanding the oscillations in the economy. In other words, if you buy the real estate with a favorable mortgage interest rate for 30 years (or 10 years in Canada), with carrying cost of such mortgage not exceeding one-third of your annual income, you will be able to preserve the quality of your life. On the other hand, if you have to spend half or more of your annual earnings to carry the mortgage payments and realty taxes, as is the case right now with many American and Canadian homeowners, then your quality of life may become bound for disaster with no cash reserves, and losing the equity in your home by the time another market crash occurs.
We are living in times where the stars seem to have aligned for the bubble to burst within almost all sectors of the economy, both in U.S. and Canada. This may spell a serious hardship for an average American and Canadian in times to come. Whether it's going to happen later on this year, or in the next three years, isn't a question anymore. The question is, how severe will it be and are average Americans and Canadians going to have enough resources to sustain it and recover from it?
In times of uncertainty, "cash is king." It may now be time to sell your stock and real estate and hold on to your cash. Later on, you can buy the stocks and real estate cheaper once the bubble bursts and devaluation takes place.
It may be particularly wise to sell your overpriced condominiums and stay away from them altogether as they're extremely volatile to any economic slowdowns.
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