Navigating A Perfect Financial Storm

Lesson number: 

When the Dow Jones Industrials finally closed above 14,000 on July 19th, 2007, it appeared to me to be a milestone surrounded by way too much optimism. CNBC, Fox Business News, and too many financial analysts in the business publications I read were too bullish for my liking. On July 19th, the analysts were already predicting that Dow 15,000 was just around the corner. The hard lessons I've learned during the booms and busts of the past all began when everyone was so optimistic. Whenever this occurred, a painful correction seemed sure to follow.

This lesson on the Navigating the Perfect Financial storm was inspired by a one page interview in the August 13th Edition of BusinessWeek Magazine titled "Life In A Time Of Bubbles." The individual being interviewed was Jeremy Grantham, the chairman of Boston money market firm GMO. His firm manages $145 billion in assets and he is considered a reliable authority on money management. In the interview, he states that we are in the first-ever global bubble which will affect everything from stocks to real estate to antiquities. Jeremy argues that when this bubble bursts, the fallout will be painful and severe.

Keep in mind that Jeremy is not the first, nor the last individual who has a prediction of some degree of financial gloom ahead of us. The world economy revolves around bulls and bears in every asset category. However from my own point of view, I keep witnessing too much easy money being made in the marketplace and not enough value being created for the compensation received. Prices today just keep getting bid up for all sorts of goods and services, compared to historic values and they continue to defy good old common sense. As an example it was reported in the August 13th edition of Forbes Magazine, which quoted a New York Times piece reporting that "eight people are vying to buy one of five parking spaces for $225,000 in a 34 unit condo building on West 17th Street in Manhattan. This translates into $1500 per square foot." And you really don't even own the land beneath that $225,000 parking space. While this seems quite excessive, keep in mind that Manhattan is not the most expensive place in the world to live. London has even higher living costs.

And according to a Mercer's Survey which covers 143 cities across six continents and measures the comparative cost of over 200 items in each location, including housing, transport, food, clothing, household goods and entertainment, New York is ranked number 15th worldwide. It is the world's most comprehensive cost-of-living survey and is used to help multinational companies and governments determine compensation allowances for their expatriate employees. The weakened dollar has a lot to do with New York's ranking, since it's value compared to other currencies is hitting historic lows.

According to Jeremy's Grantham's assessment, land is the most overvalued asset. He claims that you can build a house today for the same price adjusted for inflation as you could 20 years ago. However land has tripled or quadrupled in real terms putting it into bubble territory. Speaking from first hand experience, the land values on my homes have followed this pattern. Unfortunately the tax assessors take advantage of those jumps in land values and instead of owning your home today you become a tenant to your municipality and pay them a hefty rent annually for the privilege to live in your own house. Then if you are part of the crowd who collectively owes $6.8 trillion dollars in mortgage debt in the United States, you will also be renting from your mortgage holder. Mortgage debt is up 64% from five years ago and includes home equity lines of credit and "cash out" refinancing, when consumers increase their overall mortgage amount and take out money based on the increased value of their homes.

In the latest real estate boom, extra cash extracted from home equity lines of credit to buy second homes, cars and flat screen TV's; as well as send kids to expensive colleges is about to dry up if home values remain stagnant or drop. And since consumer spending fuels such a large portion of the US Economy, it appears that a perfect financial storm can be coming.

According to Jeremy, the safest assets to be holding today are cash related like T-Bills and money market funds. If he is right, you might want to take a hard look at your investments and stay ahead of the curve with a flight to safety. All booms and busts happen in cycles. The question is where are we today? Are we closer to a boom or a bust in the economic cycle? Now is as good a time as any, to start paying close attention to your financial asset allocations. Don't get caught up in a herd mentality. Like all worthy causes, a well thought out financial plan coupled with definitive timetables for execution can save lots of pain and suffering. Don't leave your future to chance. Be prepared to face tomorrow and the next three to five years by doing some diligent research and making the proper decisions to prosper during both booms and busts.