Relative Returns and Real Estate

Following on my recent posts on setups, I'd like to take some time in explaining why a setup in housing developing. Permabulls on housing are finally turning into bears, and this crudely suggests a short-term bottom is near.

You should invest in assets on a relative basis, which means you need a complete picture in order to make intelligent decisions. Since everything in investing is relative, saying that lowering interest rates will stimulate demand is boneheaded. If assets are rising 100% a year, then 50% interest rates are a steal. On the other hand, if everything is dropping 10% a year, no interest rates are compelling, no matter how low. It's all relative.

Bernanke has already said that he will keep interest rates at 0% for another two years. Now let's think this through. As Boomers retire, they will find it's getting harder and harder to survive. Social Security isn't properly indexed to inflation and Bernanke is punishing savers, aka Boomers. Bond are already richly priced, which means part of the benefit of owning bonds (declining interest rates) is gone. The benefit of bonds now is derived entirely from interest income, which we all know is non-existent. In other words, Boomers need to look elsewhere for income opportunities.

Stocks

Stocks are one asset class that will benefit from persistently low interest rates. People tend to make blanket statements about stocks and dividend yields (5% yields are “good”, etc.), but they forget that dividend yields can only be judged relative to bond yields. Because bond yields are so low, by definition stocks can justify a lower dividend yield. This implies that higher P/E ratios can be justified as well. All these people who say that P/E ratios “must” go to below 10 before the next bull market begins are not seeing the entire picture. Excuse me, but weren't interest rates above 10% the last time stocks bottomed in 1982? Are we not in two entirely different environments?

Real Estate

Real estate is another market that will benefit from interest rate policy. In the years ahead, we will likely see a bifurcated market: Higher end homes are going to come down a lot more on a relative basis than lower end homes. Take some time to look at 10 cities where it is better to rent than buy.These are overvalued areas that probably have some more downside.

Being in the market in Las Vegas, I can see with my own two eyes that foreign investors are stepping in. They are supporting this market. Boomers will step in as well because even modest 5% ROI deals look mighty attractive next to 0.2% CD rates. These are the kind of deals you can find easily in distressed markets. Remember, it's all relative.

People are getting really bearish on America, but I must remind you that most other places in the world are worse. We still have the deepest markets. We still have the biggest economy by far. Although America is turning away from free-market principles, it is still a lot more free-market than many nations. If we could just figure out a way to stimulate investments by lowering tax rates, we would be in line for a boom for the ages. All this rich vs poor rhetoric is noise.

Buffett may try to pontificate about how the rich supposedly pay less in taxes than the poor, but he seems to forget that Berkshire Hathaway has to pay corporate taxes before he pays any taxes on dividends or capital gains. Comparing his tax rate to that of his secretary isn't really valid. Raise tax rates on the rich and I guarantee you capital will flood to Asia, stimulating a megaboom there. Raise taxes on the rich, and you are bringing the exact same policies that Greece enacted over to America.

Relative Returns and Real Estate is a post from: Expected Returns