Eavesdropping On Economic Lessons From a Tradesman

construction

This morning I was relaxing in my hammock while enjoying the mild spring weather.  With coffee in the mug next to me and two year old Mr. Root of Good Jr. playing on the deck not far from me, I was planning on a morning of peace and quiet.  I set the lofty goal of finishing the last hundred pages of Nanjing Requiem, a work of historical fiction set in the 1930’s in Japanese-occupied Nanjing, China.  I managed to finish the book this morning, but not entirely in peace.

My neighbor has a contractor installing hardwood flooring for her.  The occasional sound of hammering and sawing broke the solitude I’m accustomed to in my mid-morning layabout sessions in my hammock.  Lucky for me, I was able to eavesdrop on a conversation between an older gentleman (presumably the general contractor overseeing the larger remodeling project) and a younger guy in his late twenties.  I took the younger guy to be the foreman or supervisor of the hardwood flooring crew dropping by to check on their progress and work out the next few days’ schedule with the general contractor.

I’ll paraphrase the first part of the conversation between the two tradesmen, probably embellishing it at points where I can’t remember the details.  The general contractor did most of the speaking, and did his best to recount the inflation of the housing bubble and the eventual popping of the bubble from his perspective here in North Carolina (a relatively non-bubbly area compared to California, Florida, Nevada, and Arizona).

Back before the housing market crashed, things were a lot different in the building industry.  Everything was booming, and we worked long hours six or seven days a week to meet the demand of new home buyers and those wanting to remodel with their new found wealth from home equity loans.  Back then, you knew some of these customers couldn’t really afford to buy all the house they were buying or all the remodeling they “paid” for.

But times were good and we didn’t worry too much as long as we were making good money.  The banks were so eager to hand out money to anyone who asked for it.  Homeowners could cash out every penny of equity (and then some) to pay any price we asked for remodels.  Developers and home builders had no problem getting seemingly unlimited credit lines and loans from the banks to build homes and whole neighborhoods “on spec” [on speculation; without buyers].

 

Times were very good.  I know one developer that had over $120 million of single family houses under construction at one point before the crash.  Man, was he rolling in the money!  I never had more than a couple of houses under construction at once plus a few crews doing remodels.  We felt invincible when the money kept rolling in but had the feeling that this can’t go on forever.

When all the foreclosures and trouble started in California, that was the first sign that something wasn’t right.  Not long after that, things started to slow down here.  I made sure to pay all my suppliers and subs because I didn’t want to owe anybody money and I wanted to keep operating as long as I could.  I still lost it all during the crash!  That guy with the $120 million of projects did way worse though!  He still owes me money, but I don’t hold that against him.

The banks got really tight with their lending, you see.  The builders and developers had their credit lines shut off and simply didn’t have the cash to keep building new houses on their empty lots, and couldn’t even finish up the houses that were close to completion!  Nobody could borrow money from anywhere to do anything.  And home buyers couldn’t get financing as easy as the old days.

 

The housing market turned into a strong buyer’s market overnight.  If you had cash or financing in hand, that is.  Prices went down so low but it was hard to get financing.  So many good, reputable builders went bust because they couldn’t clear our their inventory fast enough (even at lower prices) to repay the financing.  Lots that used to sell for $100,000 to $200,000 were almost worthless if you tried to offload them wholesale.

I don’t mean to scare you, but it was ugly back then.  Nobody knew what was coming next as we went into 2008 and 2009.  Today, everything is going great again and people are remodeling and new construction is making a good comeback.  The slower pace today is a lot better than the craziness of 2006, 2007 and earlier.  You can hire a new crew one at a time as you need them, and buy a new truck and equipment slowly as you get more jobs.  You don’t want to stretch yourself too far because you never know when you will hit a soft spell when work dries up.  The last thing you want is to owe too many people too much and then lose it all.

This guy didn’t have a PhD from the London School of Economics or U. of Chicago, but somehow I felt like his five minutes worth of advice to the twenty-something guy was worth as much as an MBA.  The older guy gave a concise economic history of the housing bubble and the crash, highlighting the key elements of risk and ways to mitigate the risk today.

I’ve studied finance as a hobby (and for personal gain through my investments!) my whole adult life, but for the uninitiated, it’s hard to wrap your head around the booms and busts of economic cycles.  The younger guy I eavesdropped on this morning might be 28 today which means he was 21 as the housing bubble began it’s implosion.  I would wager he wasn’t paying attention to national trends in housing supply and demand and the intricacies of collateralized debt obligations and mortgage backed securities.  He was probably on his hands and knees learning to install hardwood flooring.  Maybe he was getting into quantity estimation, pricing, and quoting jobs.

I’m sure the younger guy knew something was wrong in the housing market but not really why.  The older gentleman’s anecdotal explanation is pretty awesome to fill in the younger guy on what went wrong and what to watch out for in the future.  Without some perspective of the past, it’s hard to know you’re riding on a wave of excess until after that wave has crested and you are headed for a painful wipe out.

 

Predicting the future

At this point in a blog article, more prescient writers than me might suggest that our stock market, up almost 200% since the lows of March 2009, has crested and is set for a painful crash onto the beaches of a bear market.  I’ll be honest and say I have no idea how long the bull market will last or if today marks the end of it.  I know economic expansions tend to be stronger after really bad recessions.  I also know, like the older gentleman I eavesdropped on this morning, that eventually booming markets decline.  Sometimes painfully.

I don’t mean to scare you, but it was ugly back then (to quote the older gentleman).  I doubt the next market correction will be nearly as painful as the one in 2007 and 2008, but it will still hurt.

What’s a prudent investor to do?  Now is probably a good time to check on your asset allocation and make sure you are comfortable with the percentage of your portfolio you have in stocks, bonds, and cash.  After you review your asset allocation itself, make sure you rebalance to your target asset allocation.  I like to use Personal Capital (review here), but a simple spreadsheet with your current and target asset allocations will also work.

You might find that your stock allocation has creeped up well beyond your target allocation, and it’s time to rebalance.  The market might keep on going on it’s bull run, and you might sell too soon.  But hey, that’s the price you pay when you stick to your asset allocation.  If we see a downturn, you’ll look like a genius!

When we do (eventually) enter the next bear market, you can rest a little easier knowing that your asset allocation is exactly where you want it.  The worst thing you can do a few years into a bull market is to get overly confident and extend yourself too far (options? margin investing? high-flying penny stocks?).  Make sure you are where you want to be today with your investments.  That way, you won’t be as tempted to sell it all and go to cash if we do see a sharp market correction.  The market will switch direction without warning in spite of what market prognosticators will lead you to believe they can foretell.  They really don’t know when the market will switch directions (just like me!).

When the housing or stock market goes up, up, and up for a long time, it’s hard to remember how ugly things are when it goes down, down, down month after month.  But once you live through a severe market downturn, all you have to do is reflect back on your own experience.  And like the older gentleman I eavesdropped on, you can pass your wisdom on to the younger generation who has yet to learn the painful lessons taught by a sharply declining market.

 

Has it been easy forgetting your investment losses from 2007 and 2008?  For young people that started investing since 2009, can you still appreciate risk in spite of the last five years of solid stock market returns?

 

21 comments

  • The slower rate of recovery has me optimistic. But let’s be honest, I have no idea if that is a true indicator or not. There could be a million and one factors that people just aren’t paying attention to that could cause a different outcome. At the end of the day, I like my conservative strategy that doesn’t really depend on what the market does short-term.

    • I definitely prefer slow and steady tortoise like economic growth now that I’m living off my portfolio. While working, it was pretty cool buying stocks at half off prices back in early 2009, but now, I’d just as soon have very boring stock markets.

  • Great post RoG. These are great lessons, and so many people I know (myself included) learn from “school of hard knocks” vs taking instruction. Another interesting and indirect message in the post was the notion of opportunistic buying in bear markets, which requires carrying a certain amount of cash or a warmth towards capital gains / losses from reallocation. I wish I had more of a taste for real estate during the 2008-2010 housing market.

    • I just finished a coursera course online about financial markets, and I was thinking how all the 20 and 21 year olds in college today probably can’t truly grasp what it was like back in 2007-2008. Sometimes you have to learn the hard way!

      You’re right about the opportunistic buying in down markets. If you aren’t overextended going into a bear market, you’ll have the cash (and intact cojones!) to make some smart strategic buys when things are being auctioned off at fire sale prices.

      We had our financial house in order and knew we could easily weather an extended period of unemployment of one of us, so we kept plowing every penny we had into all kinds of aggressive investments. It paid off extremely well for us!

  • I’ve only started thinking about finance/investing in the past few years since I finished uni; I try to appreciate the risks, but apparently the risks should be taken at my age because I have all of the time after that to recover if things go south.

    At the moment, my salary has more of an effect than if the market turned. My friend and I are thinking about investing in some real estate and making good use of OPM! If the market goes south and we’ve extended too much, we’ll wither have to sell at a loss to repay loans or (preferably) hold on and take an income from rental.

    I’d like to hear people’s thoughts on using OPM and buy-to-let mortgages to accumulate capital faster, while staying above water in the case of a downturn.

    p.s. I own a (mortgaged) house but that would never be used as collateral because the mrs would kill me!

    • I don’t think there’s anything wrong with taking on leverage to buy real estate and rent it out. Of course it depends on the fundamentals of the deal though. I’m guessing you’re in England, so I have no clue how the fundamentals work there. I know in the US, there are markets where real estate is pretty cheap and rents are still fairly high. Raleigh, North Carolina, where I live is one of those places. It’s easy to “cash flow” a property (take in more in rent than you pay for mortgage, taxes, insurance, and maintenance). A $100,000 USD property I was looking at would have rented for $1000/month. Another deal I’ve considered would be $130-140k USD and rent for $1200-1300/month. I know some areas of England have crazy expensive real estate, but I’m not sure if rents are high enough to provide good coverage of your mortgage and other expenses.

  • I know I “lived through” 2007 and 2008, but I really have no idea what my investments (very small at the time) were doing. I did have a house that we ended up paying someone to take off our hands in 2011, but in late 2008, we bought our current house (and according to most market analysis, it’s still just below what we paid for it). The whole situation just turned me off on investing in real estate.

    I had been working for 6 years, so I wasn’t quite “green”, but I wasn’t very aware of investing, etc as I am now. Our company was actually doing really well at the time, so I kept working and kept putting aside my 401(k) contributions to the match, and continued living rather obliviously.

  • It was scary back in 2007/2008 and I don’t think we had quite the housing market correction over here in the UK that happened in the states.

    The housing boom is happening again in the UK and it does get me slightly worried as I don’t know how people are affording these huge mortgages.

    What worries me is when interest rates start creeping back up again and suddenly those huge mortgages that looked affordable become the complete opposite!

    • I’ve heard crazy stories of million dollar tiny apartments in London. Hard to imagine who’s buying them. And hard to imagine how they will keep paying for them if prices decline moderately. Or if rates readjust on the mortgages as prices increase!

  • The darkest days! I slept very little..didn’t open my statements. It was a perfect storm. My renters didn’t pay..my equity line shut off overnight, margin calls…It was horrible. I still hate to talk about it. Sometimes, l wish l had been like my partner who would take 2-3 home equity loans at the same time (send them in to banks at the same time so it just looked like he was shopping for a loan. I would watch him change his 401k statements with wite-out , scan it and send it in. It looked so bad and amateurish, but Countrywide especially did not care. 3 months later, an equity loan would be taken on his primary residence and then alternated again with the duplex he owned. I was too chicken! I’m still heavily in stocks with my 401k, can’t decide if l’m just gonna let it ride like the last time. I probably will since l won’t draw dividends for at least 5-10 years. Btw..guess who finished her Photoshop class? It felt weird going to school again, but luckily it was a mix of ages in the class. Now, l can’t decide if l want to take the Adobe test and get certified..

    • That’s right – I recall you said you were in one of the hard hit bubble areas. I did a lot of consulting work on real estate projects down there and it was like a light switch. Work dried up overnight. People that thought they had hundreds of thousands in equity couldn’t sell their house at all.

      As for investments, I’ll letting mine ride (at roughly 97% equities). The dividend yield from our portfolio is almost enough to cover all our expenses, so I think equities (with a year or so cash buffer) is where my best shot lies to financially survive and prosper for my next 50 (??) years.

      That’s cool you finished up the photoshop class! I spent a day or so last week learning GIMP (a free, open source version of photo editing / sketching software very similar to photoshop I think). I reached the edge of MS Paint capabilities and I wanted something “more” for the blog, so I finally devoted the time to learning photo editing and manipulation. My last article on groceries would have crashed my server if I didn’t edit, crop, and downsize the images! 🙂 I’m still at a very basic level, but it will be interesting to learn more.

  • Here’s how I look at it:

    If you don’t aggressively invest there’s no good way to retire early.

    If the market does well then you’ll hit your goal early.

    If the market does really poorly then you’ll spend a few more years accumulating.

    In any of these scenarios, the best thing you can do is diversely invest every month on autopilot. The less I think about it the less likely I am to try and time the market. I did really well during the last recession by just continuing to invest by my plan… month after month of rising markets and falling markets.

    I had no idea that the markets would improve when they did, and I have no idea when they’ll next go down. Some may, and they’ll probably be richer than I. 🙂

    • That was our path to wealth. We never set a “retire by X date”. We just kept piling money away in a diversified portfolio, and knew we might have enough at age 33 or 35, and definitely should have enough by age 40. It worked for us!

  • The housing market is on fire here on the west coast. We put our 4 plex up on sales and it sold in a few weeks. Our rental house sold for more than asking in 2 days. I wonder how long it will last this time. It seems a bit easier to borrow money now than 2 years ago, but that’s just my impression.
    Stock – I don’t worry about it too much. I just focus on keeping my money invested. It should be fine for the long term (20 years.)

    • Great timing, Joe! Who knows how long the housing market boom will last this time. It’s starting to heat up where I am, but I haven’t heard any tales of above market offers and only taking 2 days to sell. However I just found out last night that the real estate rental I was thinking of buying sold for $105k, $6k more than I was willing to offer (and that was based on recent comp sales). And they sold it really quickly, too. That might be NC’s version of a hot housing market.

      Good take on stocks. What’s the point in worrying. If you aren’t in it for the long term, it’s probably not an appropriate investment for you.

  • Hi,

    I first invested in the stock market in late 2007 by buying 100K of stocks…. Very bad timing as you know! After 6 months I was down 30%! I made some mistakes (like stopping investing for a while) but as of today my rate of return is 7.3% annualized, which is great considering the horrible start.

    Of course bear markets will happen, but I don’t mind too much. I don’t think the 2009-2014 recovery is a bubble, it is merely the stock market going back to its original valuation… If you take the S&P500 return from 2000-2014 (even including reinvesting dividends) you get 3.6% annualized…. not bubble like! I think the next bubble is the lifestyle bubble…. People will have no choice to start living within their means, sooner or later…

    • Good point about the reversion to historical valuations. Some part of the 2009-2014 rally has been a reversion to the long term valuations, without a doubt.

      • Didn’t hurt that the Fed pulled out the full faith and credit bazoka vowing to blow away the economic slump, the spectre of deflation, and pesky rising unemployment. Bernake pretty much said, no Great Depression on my watch! To everyone’s amazement, inflation stayed low and the dollar strong. Probably the best US investing environment I’ve lived through, with no single bubble sucking people in (a la techs and, well, everything during the last 2 bubbles). It’s given me chance to hit my number and add more to foreign currency, munis, TIPS, and cash. I continue to diversify which helps me finally feel like I’ve really made it, as opposed to when my gains have all been riding on equity valuation. Still have way too much in equities, but I’m 40 and won’t touch my 401k until 55 at the earliest. Cheers to the good times!

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