Dec 31st, 2008 at 12:35 pm
Bubble Trouble
Paul Krugman has a graph of price-rent ratios normalized so that the 2000 level is defined as 100:
One interesting thing about this is that you could have been looking at this data in May 2002 and decided that Las Vegas real estate was overvalued. And I think someone who thought that will be vindicated over time. But at the same time, you could have looked at this data in May 2002, bought property in Las Vegas, and sold it five years later for a healthy profit. You could even have waited for the Las Vegas market to be clearly on the downswing and still made plenty of money. Which is part of the general problem with bubble psychology — the mere fact that a bubble is under way doesn’t necessarily make it irrational to hop on the bandwagon.
42 Responses to “Bubble Trouble”
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December 31st, 2008 at 12:38 pm
I thought that’s why bubbles were supposed to be dealt with at the macro level and not the individual investor level.
December 31st, 2008 at 12:41 pm
This is extremely perceptive – people make a lot of money during bubbles. Not all of those people lose their shirts when the crash comes. Virtue must be its own reward, as it sure doesn’t provide windfall profits.
December 31st, 2008 at 12:46 pm
C’mon, Matt. Didn’t you ever play musical chairs as a child? Bubble investing is simply making sure you’re already in a chair before the slow kids (a.k.a. “The Greater Fool Theory”).
December 31st, 2008 at 12:53 pm
Al’s got a point. It’s more likely that you’d look at the graph and think that LV is undervalued relative to the 20 city numbers.
December 31st, 2008 at 12:54 pm
Normalizing the vertical scale has a negative impact on the quality of the graph. You could have shown the price/rent ratio outright.
(BTW, said ratio is affected by bubbles and demand spikes, but most strongly by the mortgage rate, which usually piggybacks on monetary policy decisions taken elsewhere.)
==
Paging Mr Tufte, a Nobel Prize economist and a bigfooted blogger need you stat.
December 31st, 2008 at 1:07 pm
Dear God someone tell me where those lines go next.
December 31st, 2008 at 1:11 pm
Dear God someone tell me where those lines go next.
God only knows.
December 31st, 2008 at 1:17 pm
Well, Bobbo, they don’t usually approach the “100″ mark asymtotically. They generally plunge well below it and then gradually go up again. But past performance is no guarantee of future losses.
December 31st, 2008 at 1:35 pm
They usually overcorrect, but on the one hand you’ve got the government doing all it can to keep mortgage rates absurdly low (4.5%!) while on the other you’ve got a nasty recession that most are predicting will last through 2009.
Flip a coin and duck and cover.
December 31st, 2008 at 1:41 pm
It’s still irrational. You can see a bubble and decide to ride it, but how do you know when to get in and when to get out? That’s the trick, and even that tiresome glibertarian on CNBC, Alex the Predictor or whatever his name is, could not have given you an exact timeframe. The “winners” in a bubble are essentially high-stakes gamblers, whether or not they know it.
December 31st, 2008 at 1:41 pm
You are confusing market timing and underlying value.
Dean Baker sold his house and started renting in (IIRC) 2004 because he thought that houses were overvalued.
He was right, but he was also about 2-1/2 years early.
Market timing is a sucker bet.
December 31st, 2008 at 1:44 pm
puzzled one: MattY always posts crappy graphs. It might as well be a law of nature. Try as you might to summon the mighty Tufte, you will never succeed.
December 31st, 2008 at 2:10 pm
“But at the same time, you could have looked at this data in May 2002, bought property in Las Vegas, and sold it five years later for a healthy profit.”
Sure, money making strategies are super easy to spot – after the fact. Someone tell Matt: investors have to make their decisions in real time. And a lot of supposedly smart people get it wrong, like this guy:
“House price increases largely reflect strong economic fundamentals, including robust growth in jobs and incomes, low mortgage rates, steady rates of household formation, and factors that limit the expansion of housing supply in some areas.” — Fed Chairman Ben Bernanke, Oct. 20, 2005
December 31st, 2008 at 2:25 pm
Which is why I don’t short stocks that are overvalued. Because you can’t identify exactly when reality will set in for investors, a stock can be overvalued and still double twice before reality steps in…
December 31st, 2008 at 2:56 pm
Depends on how overvalued. I made good money by investing in SRS and SKF (inverse ETFs for REITs and Financials respectively). Course there’s no worry for margin calls with an ETF, shorting is much more dangerous that way.
January 1st, 2009 at 9:59 am
I agree with the sentiment of the post, but the graph adds nothing but confusion. Why Vegas? Why price-rent ratios? Why normalize?
I wasted time trying to figure out the point of including the graph, before realizing that isn’t a good rational one.
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