Thursday, June 24, 2004

bubbles bubbles bubbles

Okay. I'm convinced. China is a bubble. At least part of it is. China is a complicated place to understand, but it seems that finally capitalism is creating its first bubble generation in China.

How can I say this? Well...there are the traditional measures - massive capital expenditures, a worrying push in inflation and quite importantly - fairly obvious misallocation of capital towards parts of the real estate market.

Then there are the measures that I perfer to rely on - the people. Many in the newly wealthy (young) generations are starting to show signs of excess in their personal lives that tend to mark bubble periods. It marked the 60s in the US in the portions of the country that were affected by that bubble. Then the 80s in Japan and the financial parts of the US (effectively New York). Then the late 90s in the US.

An effective measure of excess in personal lives COULD probably be measured in the consumption of certain drugs - particularily cocaine. Of course such data isnt collected with the accuracy or depth that one would need.

Anyhow - so China is a bubble. What about the US housing markets?

I'm not so sure about it yet. Some parts certainly seem very bubblish. Some signs of Bubbles exist, with house prices far outpacing rent increases, with commercial buildings being much more overcapacitied than housing, with the stock of new housing (inventory) actually climbing to a high - on the other hand, with the notable exception of adjustable rate mortgages there is no evidence of "exotic" methods of financing that tend to signify a bubble.

But I think we ARE in the early stages of a bubble in the housing market - with the recent decline in stock prices many people are starting see their houses not as what they used to think them as - places to live, access to schools, emergency services and the like - but as "investments" that they have made.

This is somewhat dangerous. It does not really signify anything yet - but once the mentality of "we should treat this as an investment" kicks in people will start to try to boost their returns by buying another house, buy a rental housing, refinance to get more equity out of their homes, etc.

We havent gotten to that point yet - but we may get there fairly soon. Money can still be made but caution should be excercised.

I would watch for myself to buy into the trend. That would be the day that I would have to go against the great tide of public opinion and bet that house prices will decline.

Anyhow - another bubble. The debt bubble. This is a bit obvious - we are headed for periods of higher interest rates all over the globe. The queestion is how bad it would be and what we can do about it.

As I've already mentioned I think that the Fed is likely to save Americans first and everyone else second. They are likely to allow inflation to eat away the mountain of debt that the US has created for itself.

Leaving to Europe would seem smart. But not at the moment; I would wait for a bit of instability in the region (although, Britian should be counted as a special case, and I am bullish on UK stocks and even some of it's medium term bonds).

So inflation would be a major concern...on the other hand so is increasing interest rates in the short term.

How about a bond portfolio of 30 year TIPS and very short (max 2 year) US not TIP debt. Mix in some very long inflation protected Euroland debt, long term UK non inflation protected debt and I think you've got a good deal of real return without much risk.

Add in an equity portfolio of highly leveraged US companies, UK stocks and Japanese stocks (buying nations with reflation on the equity end, buying nations with low inflation risk on the bond side).
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