Monday, April 18, 2005

Stocks Up! Real Estate Soars!

After the action of last week, it is a pleasure to be able to title an article--Stocks Up! The good news is that our portfolios have increased during the down-turn!

Our families stocks have held up well and our real estate holdings have increased in value. We received three offers on beach real estate in the past three days! Myrtle Beach is one of many "baby boom" towns across America where the supply of second homes in good locations can't seem to catch up with the demand.

Understanding the population profile in America can help one understand the real estate boom. Jeremy J. Siegel, the Russell E. Palmer Professor of Finance at the Wharton School of the University of Pennsylvania, devotes a couple of chapters to the population phenomenon and he titles one chapter "The Future that Cannot be Changed".

Siegel reports that after the baby boom from 1946 to 1964 the fertility rate in the United States, Japan and Europe dropped below 2. The rate in Japan and Europe has continued to fall. However, demand to move to the US is very strong and immigration has boosted the US population in two ways. The new immigrants tend to have higher fertility rates.

Siegel writes many of his words in regard to the aging boomers and the up coming effect on public pension funds. The good news for the US is that the increase in population from immigration and from the fertility of the immigrants will decrease the strain on our pension funds. According to Siegel, the largest age groups in Japan in 2050 will be 75 to 79, 70-74 and 65-69 years old. In the US, there will be just as many people in their 20's as there will be in their 50's and each group will be larger than those in their 60's which in turn will be larger than those in their 70's.

In other words, our country, even with a deficit in our social security accounts, does not have the same problem that Europe and Japan have.

The other good news is that the boomers in the US are currently 41 to 59 years of age. They are in their peak earnings years and the trend to early retirement has shifted. These folks will work an average of at least 13 more years. Americans are currently the wealthiest they have ever been. Wealth should continue to grow sharply as this large group of people are enjoying peak earnings and "empty nests".

It seems that it is going to become the norm that 50 year old Americans own two homes or more. Many of us old folks can remember when it was a big deal to have a two car family. The current housing boom is broad based. Millions of immigrants and "echo boomers" are buying first homes or moving up to larger first homes. The older boomers are buying second homes at a record pace.

The recent "slow down" in our economy is good news for real estate. There was a risk that Greenspan was going to have to "kill" the market with every higher interest rates. The bond market has rebelled. The ten year bond is back down to a 4.24% yield. This leaves home mortgages near historically low rates.

The big decline in the market the past few days has been the shift out of materials and energy. The price of steel, for example, has broken the prior trend as has the price of oil. It is not clear that the final peak in oil has been made but steel is not likely to peak again in this cycle. Many folks do not appreciate that the price of steel and other metals do not go up much if any over time. Folks generally do not appreciate the power of the laws of substitution and compound interest.

Siegel presents a chart that shows what $1 invested in 1801 would have become by 2003. Invested in stocks $597,485, in bonds $1,072 and in gold $1.39. The same dollar left in a mattress would now buy seven cents of what it would have bought in 1801.

Peter W. Huber and Mark P. Willis have a book out call "The Bottomless Well". Readers who do not appreciate the power of the law of substitution should read this book. The amount of oil used today in the US is a small fraction of total energy consumption. Day after day, minute by minute and even second by second, we are learning how to use electricity to replace higher costs fuels. I'll write more about "The Bottomless Well" later but suffice it to say that it is true that we are not going to "run-out" of energy; we use energy more efficiently every day; the cost of illumination has dropped by ten thousand-fold over the past two hundred years! (see page 93, The Bottomless Well).

A very important and related point that many of you need to hear is that whereas the risks of holding a portfolio of bonds increases with the length of time that you hold, the the risks of holding a stock portfolio decreases with the length of time you hold it. I am amazed at the amount of bonds, bond funds, hybrid bond funds, balanced funds, annuity products, fixed rate contracts and other low yielding instruments I find in retirement accounts--young and old! Many of the older folks have accounts that will not be spent for years as the beneficiaries are young. Even 50 year old folks have thousands of dollars invested in bonds that they do not expect to withdraw for an average of 25 years. This is fool hardy. They are guaranteeing a poor return.

The bottom line is that the market has given us all a chance to buy. Valuations are reasonable and the commodity inflation bubble has popped. Company after company is buying one company after another. Investors who buy good values will hit take over plays every now and then but whether they do or don't portfolio values are likely to increase at 11% or more compounded over the next 20 years. A huge difference than the 4.4% offered by bonds.