Wednesday, December 21, 2005

Marin's "Church of the Soft Landing"

According to this post over at Professor Piggington's Econo-Almanac for the Landed Poor (and you really should read that post before continuing):
Legendary investor Jeremy Grantham recently had his research staff compile info on all the historical stock, currency, and commodity bubbles they could find. A "bubble" was defined here as a two-sigma event: an asset price that got more than two standard deviations away from its historical trend. Grantham and company identified 28 financial bubbles, of which every one—every single one—saw prices revert back to the mean.
Since I already had the base data shown here, I decided to perform the professor's analysis for Marin County (see that previous post for an explanation of how this data was collected and calculated). I normalized all of the Marin data to that of 1969 and calculated a best-fitting trend line (green) to the data minima:

(Click on the image for a larger view.)

I then calculated the percent deviation of each of the blue data points in the above graph from the base trend line. These percent deviations are shown in the following graph (along with the average, and both the first and second standard deviations):

(Click on the image for a larger view.)

What does this mean? If Jeremy Grantham and his team are correct, it probably means no so-called "soft landing" for Marin County.

And in the words of the professor:

Of course, there is more to any story than deviations from the mean, but the point here is that history is telling us something. People can make all the excuses and rationalizations they want, but the fact is that markets revert to the mean. Bubbles burst.

People continue to tell themselves (and anyone else who will listen) that San Diego [and Marin County] real estate will be the history's first asset to rise so far, so fast, and never come back down to earth. They will eventually be relieved of this misconception. For now, though, faith in the Soft Landing holds sway.

Well, we'll see... Based on the data shown here, things aren't as extreme in Marin as they seem to be in San Diego.


Blogger sf jack said...

"Church of the Soft Landing"

It does appear some adherents may be facing economics lessons in the near future.

Good for them.

Great data again, as usual - and the more often that facts and figures like this are available, all the better.

Thank you.

Dec 21, 2005, 10:31:00 PM  
Blogger Curt said...

Isn't Califorina different?

Dec 22, 2005, 11:29:00 AM  
Anonymous Anonymous said...

The only difference I see in California is that real estates prices are more vulnerable for big correction than prices in other inland states. The higher it climbs, the deeper the fall it would encounter. Eventually there will be self-correcting process.

Dec 22, 2005, 3:51:00 PM  
Blogger Econ_101 said...

I posted a similar comment about soft landing elsewhere - but I think this is accurate:

I'd love to see the much bandied about term "soft landing" defined somewhere. It sounds pretty tame. I guess it means something like prices will flatten or rise at the rate of inflation.

At this point, such an outcome is almost (logically) impossible. Here's why:

Let's say price appreciation did fall to around 0% (the best case and what I understand a "soft landing" to be), and many people changed their expectations of future gains from 20% (which many people in bubble markets acutally believe) returns to 0%. What would be the result? A sharp drop in prices. Why?

Because it is the price appreciation itself that is creating much of the demand.

Said another way, it is the virtuous (or not) feedback of higher prices increasing demand leading to higher prices leading to more demand. So if the expectations of higher prices is reset in the minds of many market participants (the "soft landing"), the feedback cycle breaks down and demand decreases.

Which participants are buying based on the expectation of recent high returns. Many, but to name a few:

1. Any short term (flipper). The only way flipping can work is if prices are appreciating quickly. With the high transaction costs in RE, flipping makes no sense in a "soft landing" world. In fact, traditional RE books (those before 2003), generally advised that buying a house if you were going to live there for less than 2-3 years was a money looser as transaction costs would be higher than appreciation).

1a. Any "long term" "investor" with a negative cash flow property (which would be most investment properties purchased in last 3 years). Again, having a money losing business with the expectation of making the difference up in appreciation makes no sense if there is no expected appreciation - instead, it's just a cash drain.

2. people who buy more house than they need or would otherwise do. This is sort of like people putting more of their portfolio in mutual fund sectors that have performed well recently. As long as the expectation of higher returns (vis-a-vis other investment opportunities) exists, this makes sense. If expected returns decrease, it no longer makes sense to overinvest in an asset class.

3. Buyers who fear being frozen out of the market unless they buy now, before prices keep them out of the market. If you can barely get in now and expect prices to climb at 20% for the next 5 years (which Shiller points out many LA residents actually believe), then buying a crappy house at an overinflated price makes some economic sense. However, if the expectation becomes 0 or low appreciation, this motivation ceases (or the reaction might even become "Why buy now when prices are falling and I can get more house if I wait 3 more months").

So, in short, a soft landing is almost a logical impossiblilty at this time. Where we to get a "soft landing", it would almost certainly be followed by a "hard landing" as much of the recent demand disappears.

But a "soft landing" sounds, well, soft and fuzzy. And it is really being marketed hard.

Dec 22, 2005, 3:51:00 PM  
Anonymous Anonymous said...

If the previous two cycles repeat, then it would seem that we have another 5-7 years to wait before prices return to the mean. That qualifies as a soft landing in my book.

Dec 22, 2005, 4:27:00 PM  
Anonymous Anonymous said...

Anonymous said...
If the previous two cycles repeat, then it would seem that we have another 5-7 years to wait before prices return to the mean.

Question is whether prices would fall below the mean by 2 standard deviations?

Dec 22, 2005, 4:42:00 PM  
Blogger Marinite said...

There are differences between this runup in prices and previous runups as well as the expectatins driving them. Whether those differences will matter is anyone's guess as there is not much history to go by. And for me, "bust" or "pop" or whatever does not mean all in one year or all in a few months.

Dec 22, 2005, 5:36:00 PM  
Blogger ocrenter said...

is it me or a couple of months ago most of the realtor-speak focused on this being a "balanced" market, and now we have gone from that "balanced" market to a "soft landing".

Maybe in another few months... "accelerated soft landing"?

Dec 22, 2005, 7:00:00 PM  
Anonymous holland said...

Anyone see a correlation between real estate and presidential political party? I have an unproven theory that "real" assets such as oil, and real estate perform well during Republican president reign, while technology companies do better during Democratic period.

During Regan's time, real estate investment did quite well. Later real estate had a sever correction, especially in Southern California (lots layoffs at defense companies) when Clinton became the president because hot money was transferred and invested into technology stocks.

If this theory is proven correct, watch out for the next presidential election in 2008.

Dec 22, 2005, 9:01:00 PM  
Blogger jixau said...

Excellent work!

Grantham has another report that he published in Oct. Worth a read.

In any case there are no absolutes with markets but probablities. When RE prices in Marin as has been shown are over 2 std deviations the probability that it will decline starts to climb. So as bettor the risk/reward favors selling to buying.

Dec 22, 2005, 9:05:00 PM  
Blogger Marinite said...

So as bettor the risk/reward favors selling to buying.

In order to sell there must be a buyer. Let's just hope they have enough sense to buy low.

Grantham has another report that he published in Oct. Worth a read.

Do you have the reference (preferably a URL)? Thanks.

Dec 22, 2005, 10:54:00 PM  
Anonymous Will said...

Your choice of data minima as the basis upon which to fit a line you call the historical trend is odd. A more reasoned choice for the historical trend would be a linear fit to all the data available. Then the dataset does not exhibit the 2sigma bubble property.

Dec 23, 2005, 11:05:00 AM  
Blogger Marinite said...


That's not actually true because although the variation will be half, so are the standard deviations. Anyway, just to put the issue to rest, here is a URL to the analysis you suggested:

Keep in mind what I published is a replication of the other experts analyses. I wanted to be able to compare results for Marin to those of other areas.

Dec 23, 2005, 1:46:00 PM  

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