Financial Markets
The first two months of 2008 have been turbulent for the financial markets, and by turbulent I’m mostly thinking of the sound of wind rushing past the ears of someone in free-fall. So far the S&P 500 index has fallen from 1450 to 1300 for the year, a drop of 12%. Recent financial news
The most recent market decline of similar size was the unwinding of the tech bubble in 2001. There the market dropped from 1200 to almost 800 in a period of 17 months, a loss of 33%. There is no reason these events should be similar, but at least this suggests that there may be plenty of room to fall before a bottom is found.
There are two reasons to think that this reset will be much more pronounced. The first is that the problem is with the financial sector. In the dot-com days, it was a misvaluation of a few hundred tech companies. Today’s crisis has the seeds of an all around banking collapse.
The second has to do with the state of the world economy. Take a look at this picture:
The brown line shows the spiking price of oil, which has been headed up ever since 2002. The two blue lines show the value of the SP500 basket of stocks. The dark line shows the index in dollar terms, and the light blue line shows how much oil the SP500 buys.
The price of oil has gone up by 5x from the stable range it traded in during the 80s and 90s and the oil-equivalent value represented by the SP500 peaked in 1999. These markers dont appear to follow the earlier cyclic changes, but instead are an inelastic deformation of the status quo.
What should an investor do in this climate?
- The overall US stock market will be hit by declining dollar, recession, and credit problems. There may be buying opportunities, but my prediction is a repeat of the 2001 bubble collapse, only bigger with the SP falling to 1000 or so. Get out of US stock funds, since there is negligible gain and negligible taxes anyway.
- Put the balance in cash for now. (A lot of people are doing the same since treasury yields have fallen to 1.5%!)
- I got out of commodities in late 2005, shifting oil and mineral investments to the general stock market thinking that commodities were overheated. This was an attempt to time the market, but subsequently I did not pay attention to matters and missed out. There was a small 10% pullback in oil at that time, but since then it has grown another 50%. The commodities pricing is being driving by generational forces, and is probably a safe bet for the next ten years or so. Get back in about 20%.
- Mortgage loans go for about 6% these days. It might make sense to take a 30-year fixed interest only-loan on the house and invest the proceeds. 30 year treasuries go for 4.5% right now, so with the tax breaks, I can almost break even loaning back to the government. For a 400k loan I would be paying about 24k per year, which I can still write off against my rents when it becomes a rental.
- Silicon Valley real-estate is cooling a little, but demand in good neighborhoods will remain high because the cream of the crop still come here for startup opportunities. The closer to Stanford the better. The fed is expected to lower rates yet again, so mortgage rates may drop into the summer, as will prices.
Hmm…