How Marilyn and I Turned $10 Into $1,000,000!

The DJ US Mortgage Finance Index is down 61.9% during the past year! The last time a broad stock market mortgage index reached a 60% decline rate, my wife and I purchased two deluxe ocean front condos at Myrtle Beach for $5 down each and the assumption of the outstanding mortgages. Over the next 15 years, our equity in each of these properties soared to over $500,000. Opportunity knocks again! Such opportunities do not come around very often. Again, the last time a broad index of mortgage companies was down this far was in January of 1991.

In the 1960's, Juanita Van Caspel, a Financial Planner wrote a book called Money Dynamics. It was well received and updated several times, the last being in 1982 as I recall. In this text she included a real estate cycle chart called the "Long Cycle". It was this text, and a missed opportunity in 1973, that gave Marilyn and I the courage to buy numerous beach condos in the months preceding and following the collapse and bankruptcy of the Bank of New England, during the real estate recession of 1990-91. In addition to the two purchased with only $5 down payments, we purchased several others with down payments of from $100 to $10,000. At the time we bought, Ken Fisher was one of my favorite authors, however, it was several years later when I discovered a book of his called "The Wall Street Waltz". In this 1987 book, Fisher included an excellent two page chart showing the smoothed real estate cycle going back a couple of hundred years. Both Fisher and Caspel referenced the work done by Clarence Long around 1940, thus the name "The Long Cycle". Long got much of his data from charts produced by a Civil War Union Military Planner who obviously had plenty of free time.


The real estate cycle averages 18.3 years but with rare exception it last between 17 and 22 years. The reason for the 5 year variance is that the economy does not follow a smooth sine wave pattern but is bumped around by other shorter and longer term cycles, by the unique characteristics of each cycle and by investor swings in sentiment. Mark Twain was the economic genius who noted that "History does not repeat itself but it does rhyme".

When the business cycle is mentioned to most investors, they think in terms of the 4-year inventory cycle which is also known as the Kitchin cycle, after Joseph Kitchin. Ken Fisher and other investors have noted that a series of two, 7 to 11 year Juglar Investment Cycles, named after Clement Juglar, combine to make one Long RE Cycle. Please note that from the stock market bottom in Jan 1991 to the October 2002 bottom was 11+ years while the bottom in 2002 to the bottom earlier this year was less than 6 years. But please also note that the first of these two actually ended in the down turn of 2000-2001 but was extended by the events of 9/11/2001.

There are many other complicating factors. The world is moving through a long innovation cycle that started as far back as 1971! It is clear that this wave of innovation is not finished. This wave is very broad based with a continuous flood of innovations in bio-technology and in computer-information technology. Also, the "4-year inventory cycle" varies from 3 to 5 years and it is often influenced by and confused with the 4 year presidential election cycle. Over the past 10 years, Japanese technology has dramatically reduced the power of the inventory cycle. Inventories are now maintained at very low levels by just-in-time manufacturing techniques, instant sales data and the substitution of automation for labor has allowed for profitable small production runs. The irony is that the reduction in the power of the cycles gives the FOMC and the Department of the Treasury more power over the economy.

As noted above, the Juglar investment cycle averages slightly more than 9 years and two Julgar cycles combine to make one Long Real Estate Cycle that averages 18.3 years and no matter how you count the last two,from 9 plus 8 to 11 plus 6 years, the sum works out to almost 18 years. A marker was laid down last week by California based IndyMac Bank. On July 1, the company was forced to deny rumors of insolvency only to be "outed by New York Senator Schumer". Even though 96% of deposits were insured by the FDIC, persistent rumors and the public statements of Schumer caused a run on the bank. As noted in other postings, bank failures tend to occur very close to market bottoms. The time between the failure of the Bank of New England and the IndyMac bank is 17 years and 6 months.

Again, the Long RE Cycle normally takes 17 to 22 years to go from bottom to bottom. The Long RE Cycle is typically composed of 12 to 14 up years, followed by 5 to to 8 years of "roll over" and ultimate collapse. The distortions of 9/11 made this cycle appear to be one of the very long varieties with little room for a down turn to mature before the Presidential elections. The strength of investment in capital goods allowed Canada, Australia and the UK to avoid the 2001-2002 recession. It seemed like the volatility of the cycles had been dampened by the sophistication of the central banks.The US economy continued to grow even after the housing market fell hard. Unlike the previous cycle, the overbuilding of resort hotels never reached even close to the prior level. Commercial real estate markets continued to show strength. It seemed safe to assume that since the first Juglar Cycle had lasted from January 1991 to October of 2002, over 11 years, then the second Juglar cycle would take us over the hump of the Presidential Election Cycle. It appeared that the next trough would not occur until 2011 or later. It is an understatement to say that it did not work out this way. The over building was in second homes this time around. Instead of owning an investment in a hotel partnership, investors owned a second home or more. When the down turn came, it came hard. Housing statistics are now at levels not seen except at or near major bottoms.

The months of June and July have been brutal times for anything related to the mortgage markets. Banks have been squeezed. Hank Paulson, former chair of Goldman Sachs, is helping the "big boys" put on the squeeze. The "big boy investment banks" never liked having competition from Freddie Mac or Fannie Mae, because of the unfair backing of the US government. Because I believe strongly in free markets, I would not mind seeing Freddie and Fannie out of business. The problem is that the next democratic administration would find the way to re-inject the government into the housing business. Paulson has proposed legislation which would extend a line of credit from the US government to these companies and that would allow the government to buy shares in these companies if conditions warrant such action. In other words, Paulson would be given the power to save or to break these huge mortgage companies.

After the failure of IndyMac, as is typical, the financial press and the rumor mills are now playing the game of "Who is next?". Doomers always expect that once one bank fails that many more will follow. The failure of Fannie and Freddie would confirm the fears of the market and cause more fear, BUT NO! Just when expectations are about as low as they can go, Bush just rescinded the executive block on drilling off our coast and agreed to send an Under-Secretary of State to meet with Iranian officials! The administration has also dropping hints about troop withdrawals from Iraq, up to three brigades, up to 20%. This just at the start of a major offensive in Iraq that will be lead by Iraqi forces and at the start of an offensive in Afghanistan lead by NATO forces!

The USA has had virtually no direct negotiations with Iran since 1979! Suddenly, a meeting that has been planned since June 27, between Javier Solana, the negotiator for the 5+1 group and Iranian officials will be attended by William Burns, an Under-Secretary to Condoleezza Rice. Over the past couple of weeks, Iranians have stated their willingness to meet the US directly. The US position has been that Condi Rice is prepared to meet anytime, anywhere, as soon as Iran suspends production of Uranium. Iran has refused to suspend but ultimately it was Amadenijhad who asked for direct negotiations; each side took a small step toward compromise. All the great deals in history started by a small step in the right direction. With the dance between Israel and Syria coming close to becoming a Waltz, it is time for Iran to join the dance or to become a lonesome wall flower.

It is very interesting that officials from Turkey have met with officials from Iran to offer their mediation services. Turkey has been instrumental in moving the Syria - Israeli discussions along. In the old days, both Turkey and Syria (and Iraq and Israel) were concurred by the Persian Empire. Both Turkey and Syria are predominantly Sunnis and Iran is predominantly Shiite. Something like 80% of all Muslims are Sunni. Iran is more isolated than it may seem. The great majority of Muslims would like to see peace. The only reason Iran has remained independent for centuries is because it is so isolated by its mountainous terrain. Even Alexander the Great was not able to take control of all of Iran. Only the Mongol's were able to sweep in from the north east for a brief period. The people who live in the mountains tend to be poor people. The people of Iran would be very poor, like the Afghans and the Pakistanis if it were not for their oil wealth. Production has fallen from over 6 million barrels per day to around 4 since the 1979 revolution.

The web site www.monstersandcritics.com reports that scores of families are moving out of Pakistani villages next to the Afghanistan border, that there have been tribal leadership meetings held and that 300 to 500 tank reinforced NATO troops have taken forward positions along the border. Like I said yesterday, it will be interesting to see what Saudi oil will buy. Pakistanis rebels who have been fighting India for control of Kashmir have moved in force to the Afghanistan border. Just a short time ago, the war in Iraq was criticized for causing al Qaeda forces to "surge" into Iraq. The surge into Iraq was good for US security and the surge into Pakistan will be good for Indian security. None of us want war but if we must have it, let it be in the mountains of Pakistan. This is what is happening, there is now an insurgent surge into Pakistan. A major thrust by Iraqi troops may send more of these insurgents out of Iraq and into Pakistan. Can you imagine that before long there will be peace talks and a settlement between Pakistan and India in regard to Kashmir!

The table is set. The opportunities are real. Sentiment is going to change as the news media will not be forced to report on progress in Iraq and Afghanistan. Then when the troops start leaving Iraq, there will be more press coverage. There will be ticker tape parades when divisions return home. My guess is that about three brigades will leave Iraq and come home while another three will be redeployed to Afghanistan.

It took a lot more than $10 to buy those two condos. Marilyn and I worked hard to keep them rented and maintained. We built a lot of our equity though sweat.

The price of oil dropped $6 on just the idea that drilling may be approved. The pressure on congress continues to grow. In Georgia, there are now 9 representatives and 2 senators who support drilling and 3 representatives who do not. The democrats are split, 3 for and 3 against. The only questions are how long until there is a political compromise and how much junk will be attached to the bill. The pressure is on. Major deals are going to pass well before the November election. Call me at 336-655-3689 if you would like to discuss how to take advantage of the current market.