Reflexivity and the Decline in Home Sales

Recent headlines confidently announced that the 33% reduction in U.S. new home sales for May 2010 was due to the expiration of the new-home buyer’s tax credit at the end of April.

In other words, we are supposed to believe that home sales were robust due to an $8000 tax credit, and now that this credit is over the housing market is bust. Nonsense.

In fact, the reversal in new home sales was primarily caused by an equally large decline in psychological wealth that occurred at the beginning of May - which had nothing to do with tax credits.

Rapid declines in consumer spending are caused by rapid declines in asset values, such as stocks or real estate. While there is much talk about how a drop in stock prices can “predict” an economic downturn, there is little notice that a drop in stock prices, rather than predicting a downturn, may actually be the cause of one.

When people see their net worth decline, they compensate by saving. That is, they decrease their spending and increase their margin of safety, further exacerbating the symptoms of the decline.



The “flash crash” of May 6th 2010 punched the confidence out of retail investors, psychologically forcing them to transfer billions of dollars out of equity investments. So, while April saw inflows to equity mutual funds of $13.89 billion, May saw outflows of $29.94 billion (www.ici.org). Negative headlines caused retail investors to run for the hills - and they haven’t stopped running. These days, the market fluctuates wildly from the trades of hedge funds and volume traders, while those working with retail clients (such as Financial Planners and Brokers) sit at their desks, bored.

Stocks are reasonably priced, with little room for a disastrous collapse like the one from the peak. Home prices are low. Interest rates are low. Despite problems in Europe and Asia, the U.S. economy has all the logical conditions which make it ready to rise from the ashes. However, retail investors and consumers are anything but logical.

Until the chat-room anger and gloom subsides, both stock and housing markets will linger - and the buying opportunities for rational long-term investors will be sublime.
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“…the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be moderate for a time.”
The Federal Reserve, Press Release, June 23 2010

“Housing cannot lift the United States from its new state of Marxist depression, you bunch of morons. The American Dream is just that. Rest in Peace, USA.”
Anonymous comment on a financial news website, June 24 2010
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See also: Reverse Attribution

A Barrel of Reality

BP, formerly British Petroleum, has been making headlines for weeks with its outrageous 35,000+ barrel per day ocean-based spill. With President Obama calling for revenge (at least publicly), and congressmen berating BP executives while vainly attempting to maneuver them into admitting guilt, some say that the offshore oil market is finished. Others add that the rise of alternative energy vehicles is now assured. Still others say that BP is a great buy. This article is a dose of reality all around.

I am a big fan of alternative energy. Wind and solar power have come of age, and can successfully compete with traditional sources like coal and hydroelectric power for electricity generation. Alternative energy vehicles, however, are simply not at the same level.

Despite all the hype about alternative energy vehicles, how many recharging stations do you actually see on your way home from work? How many people do you know who run electric vehicles for personal use (not just for corporate image)? Major alternatives to electric, such as fuel-cell cars, have been “in the works” and “soon affordable” since I visited Ballard Power’s (BLDP) office 11 years ago.

Although fuel cell and electric vehicles hold great promise, they simply aren't ready. No one wants to wait 20 minutes to "refuel" their car. No one wants a low-cost commuter vehicle that goes 35 miles per hour. Nor does anyone want to pay a year’s salary for a car that goes the same speed as their existing car.

Like personal computers, alternative energy vehicles will truly take off once cost and functionality reach reasonable levels, and once the infrastructure to maintain them is in place. Until then, oil and its producers maintain a bright future.

As for BP, should you buy or sell? Although BP looks tempting at these levels, I should remind everyone that the inglorious well is still leaking thousands of barrels per day. Until it’s actually capped, my money is going into more reliable opportunities; like, for example, this disaster's beneficiaries, Chevron (CVX) and ConocoPhillips (COP).
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“Already those who have seen this new model are acclaiming it the finest car of any type yet produced for city and suburban use. You, too, will be delighted with it.”
Advertisement for the Detroit Electric Car Company, 1920.

Choosing the Right Broker

INVESTOR PSYCHOLOGY

Investment books typically say that you can choose the right broker by checking their background, pedigree, past performance and investing style: the best brokers will have a track record of success.

Such advice seldom works. It assumes that making money is the client’s primary reason for choosing a broker. It also assumes that the investor actually wants to make money, which is not necessarily the case.

Investing is more about psychology than anything else. Therefore, choosing the right broker is mostly about psychology as well.

The descriptions here are written tongue-in-cheek, but describe real investors and real brokers. Recognizing which one of these reflects you most gives you a powerful advantage.


TYPES OF BROKERS

The Punching Bag – The punching bag broker is essentially a displacement target, whose main purpose is to serve as an outlet for frustration. For instance, a Japanese businessman who is surrounded by superiors may get scolded regularly, yet has no one with which to do the same. The broker, in this instance, would serve as the person against whom the powerless individual could vent his frustrations. Those looking for a punching bag broker should pick either a meek broker who is used to it, or a strong broker who won’t care. A punching bag broker can be an important source of stress relief through Freudian displacement (taking out your aggression against a socially acceptable target), and can lead to greater success in other areas of life, such as work and marriage.

The Thrill Provider – The thrill seeking client does not wish to invest in index funds or other practical investment vehicles, but rather wishes to be part of the exciting world of mergers and acquisitions, penny stocks and new issues. It is not so important whether the stocks go up or down, so long as risk and danger is omnipresent. A broker that specializes in thrill providing is usually a frequent trader, and will cost the client more in trading commissions and taxes. Selecting a thrill seeking broker is an excellent alternative to more harmful options like gambling, drugs, or marital infidelity.

The Loser – The hypochondriac investor should seek a broker with a mediocre record. This way, a client can tell his friends how much money he lost, how horrible it is etc. and get as much attention and sympathy (“injustice collecting”) as required. The loser broker is also good for those who are afraid that success will bring undue pressure to their lives, and so who just avoid being successful altogether. Note that those who use a loser broker are not investing to win, but rather are investing to intentionally fail; therefore, it is important to choose a broker who is not particularly successful. A moneymaking broker will not meet the required psychological needs.

The Arm Candy – Arm candy refers to a broker at one of the world’s top investment firms, whose membership requires a high initial investment amount or referral by an existing member. The purpose of the arm candy broker is primarily snob appeal. For example, a client can say, “My broker at Goldman Sachs told me…” and know that dropping the name “Goldman Sachs” implies a certain elite status and cache that a local boutique would not. Investment returns are not as important as having the account itself.

The Team Player – The team player relationship – perhaps the most healthy of all client-broker relationships - is when client and broker work together to create winning strategies. Good calls are held, and bad calls are dropped before they become overly bad. The client calls the broker just often enough to maintain a regular presence, but not often enough to annoy. With a team player broker, one will actually be working with a broker in a partnership, and so investing prowess and a match of styles is important. Team player relationships tend to break down into co-dependency.

The Discount (Online) Broker – Discount brokerages give no investment advice at all, so winning or losing is completely due to individual investment decisions (assuming the investor does not ask friends, lovers etc., in which case that person becomes the substitute broker). Those who use discount brokers love the intellectual challenge of investing, and tend to believe that they are superior to most other investors. During the early and middle stages of market cycles this idea of superiority may have a grain of truth to it, but is definitely not true during bull markets, when uneducated investors open accounts in droves. Discount brokerage users also tend to believe that their strategies are “secret,” even when they are buying small amounts of stock in large corporations that trade millions of shares a day. Since they are working alone, discount brokerage users must be keenly aware of their own psychological shortcomings (hint: if you make a mistake once, it is a mistake. If you make the same mistake several times, it is not a mistake).

The broker descriptions above are, of course, not exhaustive, and several types may be blended together. Nevertheless, knowing your own motivations – and making sure these motivations are healthy – is useful knowledge. By eliminating those motivations that are most unhealthy, investment success can be improved exponentially.
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"He is a masochist who wants to lose."
Sigmund Freud, in regard to compulsive gamblers