Double Double Bubble Trouble

For the past week I’ve been on a business trip in Florida. 

I was here to film some interview and welcome-style videos with my owner-investor, Mark Ford. 

(It was for another business, so don’t expect to see them anytime soon on DIYwealth.)

Mark Ford is perhaps better known as the author Michael Masterson, who wrote the books Ready, Fire, Aim and Automatic Wealth and many others. (You can see all of them and more on his blog.)

During one of our conversations, Mark talked about the difference between price and value. 

He brought up an artist named Tom Wesselmann. 

(I’d link to some of his paintings, but they’re a bit risque.)

Wesselmann had recently received some bad press. The price of his paintings had plummeted. Then a few months later, he received some good press and the price went back up — even higher than before.

Now, for people who had purchased a Wesselmann before this drama, they might have been anxious as their paintings shed millions of their value. 

But ultimately, did the underlying thing that they had purchased change? 

No. 

The whole time, those Wesselmann paintings remained, unsurprisingly, paintings. 

Only people’s perception changed. 

And this was based largely on irrational, emotional, and fear-based concerns. 

That means, for someone opportunistic who wanted to own Wesselmann paintings, it was an absolutely excellent time to buy these paintings, because it was like the art market had put them on sale.

But all that said you’re probably not a private jet traveling, Patek Philippe wearing, Bugatti driving, smaller-yacht-parked-in-your-bigger-yacht type...

So what does this art collection story have to do with your wealth?

Only EVERYTHING, ya jabroni.

Here’s another, related example of what I’m getting at…

I live in Baltimore, but I’ve been looking at potentially buying a home in South Florida. 

My home in Baltimore is a three storey, six bedroom, 2,500 square foot, classic Victorian-era brownstone next to a park and near Johns Hopkins University. 

I bought it for about $300,000 in 2020. I’m happy with the value I received for the price I paid. 

To get something similar in Florida? I’d have to pay multiple times what I did. 

And something similarly priced to what I paid for my current home? I found a lot of small one-bedroom homes. 

Quaint, sure, but I don’t know if I’m getting the same value for the price I’m paying.

For that reason, I don’t think I’ll be buying in South Florida any time soon. In fact, I expect there will be a number of forces that bring prices down in the next few years.

The value of the homes won’t change. But the prices will become more attractive.

Do you see what I’m getting at?

Because once you understand that, there is little — and sometimes no — connection between the price and value of assets…

It completely changes the way you invest.

And by invest, I’m including everything from the stocks you buy, the car you drive, the things you own, the house you live in — all of it.

You become more patient…

You become more shrewd and objective…

And you certainly become more wary of buying when things appear more expensive than ever…

Which is why I’m generally wary of just about every market right now.

Bubbles Are Everywhere in 2021

Ok, you’ve probably heard the word “bubble” before. 

Soap bubbles inflate, have nothing inside of them, and then typically become unstable and pop.

When it comes to assets and markets, it simply means the price has “inflated” far beyond the underlying value of the asset. To an insane degree.

This can happen for a few different reasons. 

One is a speculative frenzy, where market gamblers bet that prices will go up, so they keep buying at higher and higher prices.

(This would be a good place to make a Bubble Bobble reference, but I’m not going to force it.)

A famous example of an asset bubble was the Dutch Tulip market, in 1637, when a single tulip bulb was selling for 10 times a skilled artisan’s yearly salary.

Another is the Dot-com bubble, which burst in March 2000. People were throwing money at any company with a “dot com” in the name. 

People were making fortunes in the stock market. And then they lost fortunes in the stock market.

But bubbles can also inflate due to… well, we’ll call the reason “perverse incentives.” 

Simply, sometimes people are encouraged to make dumb decisions with their money.

Take the housing market bubble between 2001 and 2007, for example.

Lending banks offered subprime mortgages, encouraging people without enough money to afford homes to go deeply into high-interest debt… all so they could purchase homes with rapidly climbing prices. 

The bubble collapsed in 2007 when homeowners couldn’t afford to pay the debt. 

The foreclosures led to lending banks going bankrupt. Assets deflated, prices plummeted…

And all of this triggered a domino effect that led to a global financial crisis.

Long story short: Bubbles are bad news for investors and the economy at large. 

And right now, every U.S. market I see seems to be in or approaching “bubble territory.”

Inflation has caused the prices of goods and services to explode upwards…

Low interest rate mortgages have spurred a spate of homebuying while the supply of homes remains low. This has caused home prices to explode upwards…

And stock prices have climbed to absurd levels despite the fact that company earnings are still reeling from supply chain and coronavirus disruptions. (I have more to say about this in the Chart of the Week column.)

The cause of many of these issues can be traced directly back to the fact that the U.S. Federal Reserve bank has been pouring trillions of dollars into the market…

“Stimulating the economy” by effectively creating dollars out of thin air…

Then purchasing assets like Treasury bonds, mortgage-backed securities, corporate bonds, and stock and bond ETFs.

You can see all the stuff the Fed has bought on this chart:

That’s $8.3 trillion owned by the Fed…

And as of August 27, the chairman of the Fed announced plans to possibly cut asset purchases “this year.”

The Fed also announced plans to begin selling billions worth of its assets by the end of 2021, including some $5.2 billion worth of bonds and $8.56 billion worth of ETFs.

So let me ask you this…

What do you think is going to happen to the markets when the Fed is no longer propping them up? 

In fact, what do you think is going to happen when the assets on the Fed’s balance sheet suddenly go up for “sale” in the open market?

Do you think people are going to want to pay today’s inflated prices for a flood of assets?

I doubt the value would justify it.

So you’re going to need to be careful in the coming months if you’re investing in stocks or buying a home.

I can tell you with 100% certainty that, at some point, the party is going to end, the market will decline or crash, and unprepared investors will be in a world of pain.

But if you remember Warren Buffett’s quote...

“Price is what you pay. Value is what you get.”

You should come out of this mess unscathed.  

At the very least, you’ll go into the markets a bit more cautiously.