April 2003 - Making Cents Bubbles: Past and Present Bubbles: Enron, Tyco, Internet stocks. Much of the mass corporate fraud of the late 1990s had one common ingredient: the gullible public investor. Without buyer enthusiasm in the final stock dumping ground, no successful bubble can be achieved. Though the media tends to portray the public investor as having the integrity of Gomer Pyle, perhaps the truth is, the corporate executives weren’t any greedier than the public, just the smarter poker players. The big beneficiaries of the inevitable bursting of stock market excesses have been, arguably, residential real estate and the long-term bond market. With interest rates dropping to historical lows and fear the prevailing emotion ruling the stock market, public investors have fled to the perceived safety of real estate and bonds.

In the case of the long-term bond market, particularly treasuries, the downside could easily be 20-30 percent with even moderate interest rate hikes in the coming years. And for what? A four percent yield? The risk-reward ratio is senseless. The flood of dollars into real estate combined with low interest rates has caused a similar imbalance. While desirable areas like Hilton Head may always be more insulated from price bubbles, the overbuilding, over-financing, and over-buying of many upscale residential areas is noteworthy. Christopher Wood, a leading real estate analyst, was quoted recently in New Yorker magazine saying, “In a real estate crash, the top end of the market usually cracks first. Then the bad news cascades down. The American housing market is the last big bubble.” In 1989, Wood advised his New York friends to sell their apartments (pre-peak) and rent for a while. He is issuing the same advice again. Obviously, this goes against the grain. But if you asked 10 people today whether they would rather have their money invested in real estate or stocks, 9 out of 10 would say real estate. Three years ago, the answer would have been the opposite. But you can’t navigate the road ahead by using only your rearview mirror. As for stock market bubbles, it is important to understand the symbiotic relationship between large companies, brokerage firms, their products and the public investor. To quote market historian and analyst Sy Harding, “It’s an ugly truth, but Wall Street professionals and insiders do not compete so much with each other for profits as they strive to take their profits from public investors.” Of course, Wall Street insiders’ most useful partners are some of the largest investment banking firms in the U.S. More importantly, this relationship will continue. Firms will simply attempt to transform themselves into friendlier appearing, though no less devious entities. When one of the largest brokerage firms in the world can receive only a 100-million-dollar slap-on-the-wrist after making billions peddling shares of worthless new Internet stocks to the public, you know they’ll be back. Some are already trying with conservative-sounding doublespeak, pushing warm and fuzzy insurance products, many of which are as out of place in an investment portfolio as Hanibal Lecter at a salad bar. Note that not all equity investors fared poorly over the last two years. Short-sellers obviously made money. Anyone obeying some basic fundamental rules has emerged largely intact. Two important ones: don’t pay a P/E or expect a P/E ratio higher than the growth rate of a stock. And if a large percentage of a company’s book value is comprised of intangibles and goodwill, stay away. Following these rules would have immediately eliminated the Enrons of the world. I’m not necessarily a believer in any of the worst-case scenarios for stocks, bonds, or real estate. However, like panicked passengers on an overloaded ship running to the opposite side, things look out of balance. Each investor should ask himself if he has over-weighted his holding in one area by irrationally acting on fear or greed and running the wrong way at the wrong time.™ Mark Allbaugh is an independent financial consultant and president of Insight Financial Group (843) 785-7320. The opinions expressed herein are his alone and represent neither an offer to buy or sell securities. Mark Allbaugh is an independent financial consultant and president of Insight Financial Group (843) 785-7320. The opinions expressed herein are his alone and represent neither an offer to buy or sell securities.