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?
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