What goes up, must come down

By Goh Eng Yeow
27/5/2012

Recently, a young friend asked me for advice on buying a new Housing Board flat.

I took one look at the price list and was amazed to find that even as a first-time HDB home buyer, he would have to fork out about $460,000 for a new four-room flat in a mature estate. A five-room Housing Board flat would cost even more.

My instinctive reaction was to ask him to settle for a smaller unit - a three-room Housing Board flat, if he could - so as not to overstretch his finances.

Background story

Mind the swings

In good times, investors tend to chase after assets till they hit prices well beyond reason, but when a financial calamity occurs, prices tend to be depressed to unreasonable levels. If a prudent investor is mindful of such oscillations between the extremes, whether he is buying a house or investing in the stock market, he is likely to reap outsized gains.

There was another reason for my caution. Over the past 25 years of watching the stock market, I had seen several big swings in asset prices. Markets move in cycles - whether they involve assets as disparate as equities, real estate or motor vehicles.

This leads me to believe that if my friend settles for a more affordable flat and incurs a smaller monthly mortgage instalment, the money he saves can be used to finance the purchase of a bigger apartment, if there is a subsequent market downturn.

And that is the point of this column. In good times, investors tend to chase after assets till they hit prices well beyond reason, but when a financial calamity occurs, prices tend to be depressed to unreasonable levels.

If a prudent investor is mindful of such oscillations between the extremes, whether he is buying a house or investing in the stock market, he is likely to reap outsized gains.

One good example is the equities market. The beguiling calm in the first quarter lulled many traders to believe that good times were back again, as stock prices rose sharply across the globe.

But the turmoil that has again dogged the market in the past three weeks is a grim reminder of how rapidly things can change in the world of investing.

In an article headlined How Quickly They Forget two years ago, Mr Howard Marks, a very successful fund manager and the chairman of United States- based Oaktree Capital Management, observed that the shortness of investors' memories contributed to the big swings in asset prices.

'Things that investors would not touch in the depths of the financial crisis in late 2008 now strike them as good buys at twice the price. The swing of this pendulum recurs regularly, and creates some of the greatest opportunities to lose or gain,' he wrote.

And he had this advice to offer those hoping to profit from such market anomalies: Past patterns tend to recur. If you ignore that fact, you are likely to fall prey to those patterns, rather than benefit from them. But when markets get cooking, the lessons of the past are readily dismissed.

One reason investors tend to forget unpleasant investment experiences so quickly is the very short duration of recent financial disasters.

Mr Marks said: 'When the stock market declined for three straight years from 2000 to 2002, it had been almost 70 years since that had last happened in the Great Depression. Clearly, very few investors who were old enough to experience the first such episode were around for the second.'

A similar observation can be made of the 2008 global financial crisis that triggered a 50 per cent plunge in stock prices across the globe.

The bearishness lasted barely more than a year, before it gave way to the great V-shaped recovery the following year that enabled markets to recover much of their losses.

Then there is the uphill battle to fight against human greed.

'Memories of crises tell us to apply prudence, patience, moderation and conservatism. But these things seem decidedly outdated when the market is in a bull phase, and practising these virtues appears to yield nothing but opportunity costs,' said Mr Marks.

The ups and downs of the real estate market offer a good example of his observation of the amnesia suffered by investors during past bubbles and busts, and their causes.

During the 1970s, property prices spiked due to the high inflation that was triggered worldwide by soaring oil prices. It then suffered a spectacular collapse in 1981, as then US central bank boss Paul Volcker raised US interest rates sharply to curb inflation.

The real estate market stayed in the doldrums for nearly a decade, when Mr Volcker's successor, Mr Alan Greenspan, unleashed a fresh flood of liquidity to try to nudge the US economy out of a recession.

The resulting deluge of easy money fuelled one of Singapore's biggest stock market bull runs in history and a sharp run-up in property prices. Both assets then suffered a big crash with the onset of the Asian financial crisis in 1998.

Although both the stock and real estate markets staged a recovery the following year, the deflationary pressure unleashed by the dot.com bust in 2000 caused them to plummet again for the next three years.

Like the earlier 1970s real estate rally, the recent run-up in property prices had been partly fuelled by the ultra-loose monetary policies practised by Mr Greenspan's successor, Mr Ben Bernanke, as US$2.3 trillion (S$2.9 trillion) of fresh money was printed to nurse the sick global economy back to health after Lehman Brothers' demise in 2008.

It harkens back to Mr Marks' observation that many of the participants in the current property rally are too young to remember the previous boom-and-bust cycles in the real estate market.

And if the script stays true to form, sure as night follows day, prices may fall, as economic fundamentals reassert themselves. It pays to be patient.

engyeow@sph.com.sg