Echoes of Past Excess
The four most dangerous words in investing might just be: “this time is different.”
In fact, Harvard economists Carmen Reinhart and Kenneth Rogoff wrote an entire book on the topic in 2009, carefully using data to show that most bubbles, crashes, and recoveries throughout history follow similar patterns despite seeming novel to the participants. The book, This Time Is Different: Eight Centuries of Financial Folly, called attention to the environments that often preceded crashes and allowed bubbles to gain traction.1 These market conditions typically included excess liquidity, loosening financial regulation and lending standards, waves of financial innovation, and a boom in housing prices. The current market checks many of those boxes, and yet, even Ken Rogoff is asserting that the pandemic has caused an environment that is indeed different this time.
Stocks continue to push higher as the pandemic abates in the US, with the S&P 500 and NASDAQ reaching new record highs this week. The question facing investors is whether these prices are a sign of speculative excess or a reasonable conclusion based on pandemic-altered demand and a recovering economy. Investors have clearly favored the latter outlook, but remain concerned about similarities to past bubbles in technology and real estate.
In the late 1990s, the technology sector was booming, the NASDAQ was outpacing the S&P, and newly launched “internet companies” were commanding astronomical valuations. Investors were enamored with the prospect of enormous growth and were willing to overlook the fact that many of the companies like Pets.com or Webvan weren’t remotely profitable at the time of their IPO. Ultimately the technology sector collapsed by more than 75% from the peak in March 2000 to the bottom in October 2002.2 As investors look at the amazing growth of technology sector companies in recent years and the acceleration of that trend during the pandemic, similar questions of durability arise.
The second comparison raising alarm bells for some investors is the sharp rise in housing prices this year. The median existing house price nationally accelerated a record 23.6% from a year ago to an all-time high of $350,300 in May, with sales remaining skewed towards bigger and more expensive homes.3 Local buyers in the Bay Area are inundated with stories of houses selling for stunningly high prices, usually well above the asking price and receiving multiple all cash offers. With the current frenzy evoking memories of the 2006–2007 housing peak, investors are asking whether the current trend is likely to reverse soon.
The key question any time prices are pushing higher is “why?” In the case of housing, the driving factor this time is not excess lending like 2006, but rather a dearth of housing inventory nationally. Available houses are a scarce commodity, and scarcity drives prices higher. Homebuilders are racing to expand that inventory, but after a decade of underbuilding, it is likely to take years to close the gap between supply and demand.
Housing demand accelerated during the pandemic as many Americans reevaluated their need for living space, and were able to move further from city centers due to remote work trends. Demand was further fueled by historically low mortgage rates, a key factor in affordability. The National Association of Realtors affordability index takes three key metrics — home prices, mortgage rates, and wages — and boils them down into a single number. Affordability is well above the 30-year average, hitting 173 last month, which is one of the “most affordable” readings since records began in 1971. This is key because every housing bust in the past 50 years happened when affordability was below 120.4 For now, low rates and a desire for more single-family homes should keep prices high.
The landscape of technology stocks is also fundamentally different than it was 20 years ago. Recently, IPOs have included established market leaders like Airbnb, DoorDash, or Palantir. They have strong cash flow, in contrast to startups still working toward profitability. Incumbent companies like Google, Microsoft, and Amazon have mountains of cash, strong profitability, and established business models that don’t require dotcom-era leaps of faith on the part of investors.
There are nonetheless prominent examples of speculation in the current market. Bitcoin and other cryptocurrencies have been extremely volatile, as have so-called meme stocks like Gamestop or AMC. Importantly, though, the core of the housing market and technology sectors both appear more fundamentally sound and better regulated than they were the last time around.
It is not uncommon for policymakers, corporate leaders, and investors to believe they can rationally understand the myriad of complex economic relationships, and see the next crash before it arrives. At North Berkeley, we have conviction that this type of market timing is impossible for anyone to implement effectively and consistently. Throughout history, markets have reverted to long-term averages and rewarded investors who resisted changing course frequently during periods of turbulence.
It is with this conviction that we regularly rebalance client portfolios to keep them focused on our long-term targets. This means trimming investments that have grown, even while the media is touting these as the hot sectors of the moment. This also means adding to investments that are undervalued, even as short-term headlines proclaim their demise. In the past year, that has meant locking in gains from US large-cap stocks, and adding to depressed real estate funds last summer, which have seen a reversal and become the strongest asset class in our portfolios so far this year.
We don’t know how this time will be different, or when earnings in real estate and technology will have grown enough that valuations reflect long-term averages. Living with that uncertainty is part and parcel of being an investor, and is why we manage client portfolios in a disciplined way that supports financial flexibility and a sense of security in a rapidly changing world.
1 This Time Is Different: Eight Centuries of Financial Folly. By Carmen M. Reinhart and Kenneth S. Rogoff. Princeton Publishing
2 Summary of the “dot-com bubble” Wikipedia
3Record-high U.S. house prices, tight supply weigh on sales Reuters
4 Here’s Why This Historic Housing Boom Can Continue Forbes
This commentary reflects the personal opinions, viewpoints, and analyses of the North Berkeley Wealth Management (“North Berkeley”) employees providing such comments, and should not be regarded as a description of advisory services provided by North Berkeley or performance returns of any North Berkeley client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. North Berkeley manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.