Real Estate and Stock Market Bubbles, their Cause, and What I’m Doing

I posted earlier this month on how I believe the US stock market is overvalued (I feel the same way about the Canadian stock market). I also posted about the real estate bubble in Canada, particularly Vancouver and Toronto.

Many renowned investors and reputable organizations are saying the same – either explicitly or implicitly – that we are seeing either significant overvaluation or bubbles.


Stock Market

– Warren Buffett’s Berkshire Hathaway is sitting on $80B in cash. The largest cash position the Company has ever had. Why so much cash? Probably because nothing is worth buying right now.

– Renowned Value Investor, Francis Chou, thinks the stock market is overvalued right now. Chou helped famous Canadian investor, Prem Watsa, get his start in value investing (particularly focusing on insurance companies). Chou is holding 20% of his portfolio in cash – waiting to deploy it when companies he likes get cheap (they always do at some point).

– Contrarian investor Jim Rogers is long the US dollar and pessimistic about the US as a whole right now. The reason he’s holding the US dollar is because he believes when asset prices fall, people will flood to the US dollar as a “safe haven”. He’s shorting junk bonds (because interest rates are headed higher) and only bullish on agriculture and Russia. This is where he currently finds value.

– The king of Index investing, John Bogle (founder of Vanguard), expects lower returns from the US stock market over the next 10 years because valuations are high, dividends are low, while earnings growth is problematical. Stock markets have returned around 10% annually over the last century but he expects only 4-6% returns over the next 10 years.

– Personal finance guru, Suze Orman, just raised a few million dollars in cash and has 90% of her portfolio in municipal bonds. This shows that she wants the market to go down, expects it to go down, or both.

– The Shiller S&P 500 P/E ratio is currently at 28.44. The only time this was higher was in 1929 before the Great Depression and in 2000 before the Dot-Com crash. Ominous? Maybe. The stock market to GDP ratio predicts stock market returns of -0.6% over the next year (one of Warren Buffett’s favorite measures). The Q ratio also shows an overvalued stock market.

– The Toronto Stock Exchange has a P/E ratio in the mid 20’s based on normalized earnings which is high relative to historic levels.

All of the points above tell me that the Canadian and US stock markets are overvalued. Most of the individual companies that I follow are overvalued. So I think sometime in the future, stock prices will drop but of course no one knows when. The key is to prepared when they do. I’m not selling any of my holdings. I haven’t sold a stock in years and don’t plan on now. Rather, I’m just accumulating cash and waiting. I like Johnson & Johnson and Nike right now but I’ve already built up substantial positions in these two companies and I’m going to wait until I build up my cash reserves.

Canadian Real Estate

I  have already discussed the real estate bubble in Canada.

However, I want to point out the CMHC came out this week and kept its red flag on the Canadian housing market as a whole. Vancouver, Victoria, Hamilton, and Toronto are the most problematic areas. With Victoria being added to the list. Toronto’s suburbs are also now a major concern. This is pretty obvious to anyone who lives in these areas. I don’t know why it has taken the CMHC so long to issue these red flags – maybe because they have a vested interest in the Canadian real estate market?

Macquarie Capital recently issued a report on the Canadian housing market. They stated that the risks in the market overall have risen and prices need to fall by as much as 30% to return to trend levels. They cite overvaluation under various indicators including prices relative to income and real estate as a % of GDP. I don’t think real estate prices will fall 30% across the board in Canada. Rather, I think they will fall harder in some places (Vancouver and Toronto) and less so in other places (Montreal) – depending on their overvaluation in these areas.

The CMHC and Macquarie Capital’s concerns add to a long list of other worried parties: The OECD, the Bank of Canada, Moody’s, Deutsche Bank, Capital Economics, and Wall Street short sellers – Jared Dillian and Marc Cohodes.

The only people who seem to be ignoring the concerns of these parties are the Canadian people. In a struggling economy, this will not end well for Canadians leveraged to the hilt.

Cause of Current Asset Bubbles

So what’s caused this mess? I think it’s the central banks. I think Jim Rogers said it best: “The central banks are making horrendous mistakes. We’d be better off without them. The next period of economic turmoil is going to be worse than what we’ve seen in our lifetime.”

Rogers also made another good point. He noted that the US has had economic turmoil every 4 to 7 years since its creation. It’s been 8 years since the Great Recession. So we’re probably overdue.

I agree with him.

The Central Banks – in Canada, the US, and Europe – have kept interest rates low for so long. Loose credit policy has resulted in a flood of money into the real estate and stock markets as investors chase higher yields. Savings accounts and bonds no longer provide adequate yields. This has pushed real estate and stock market valuations to all time highs. Punishing savers and retirees while rewarding debtors.

Loose credit policy has also resulted in money flooding all around the globe. One good example is money pumped by the Chinese government into their economy which has been extracted by Chinese citizens and invested in real estate aboard – especially in Canada, the US, Australia, New Zealand, and the UK. This has distorted real estate values in some cities in these countries where prices are significantly detached from local incomes. This not only has economic implications but also social implications as it can create social unrest as locals feel alienated by their governments.

But this party will end. It’s never different this time. Interest rates on mortgages and debt will rise – they already are in Canada and the US. The Chinese are clamping down on capital outflows which is already negatively impacting real estate in Canada, the UK, the US, and Australia. An economic shock in China would be even worse. This will bring over-leveraged debtors to their knees. Lenders will clamp down on loans. People have short memories – during the Great Recession in 2008, banks were very reluctant to lend when SHTF. It won’t be different this time.

What I’m Doing

I’m not a doomer. I was fully invested for all of the period from 2009 to most of 2016. 2009 was a great time to invest. 2017 probably isn’t.

My goal is to be patient. Hold onto my current investments. Owe no one money. Accumulate cash. Wait for bargains – they will eventually come as real estate and stocks will return to normal levels. This is when the most money is made. Markets can stay irrational for long periods of time especially when debt is involved. But when prices become extremely detached from fundamentals, the fall is usually harder.

The advantage individual investors have over institutional investors is that individual investors aren’t pressured by clients to produce results every year. Individual investors can sit on their asses for years on end and wait for great investment opportunities to arise.

The hardest parts are sitting on your ass for long periods of time and having the courage to buy when everyone else is selling in a panic.


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