As a youngster, playing with soap bubbles in the backyard, I would try to blow the biggest bubble, just short of making it burst. I would eye-up the bubble and ease off when it looked like it was ready to pop.
It worked, most of the time.
Back to the present. Most folks that I know are either home or condominium owners. Phrased more accurately, they are debt owners in servitude, living inside the pricing bubbles of the real estate market. Others have money invested in the stock market, also lounging inside the bubble of stock investments.
How does one comport oneself when sitting inside a bubble?
What strategy should one use to navigate bubble economics, irrational exuberance, consumerism, and emotional accounting?
The “buy and hold” approach works very well in the aggregate sense, until a correction erases part of your savings that you were counting on. Or, a bankruptcy dissolves your retirement equity held in companies like Nortel and BlackBerry, or a future Uber?
The timing of these corrective events remains elusive.
Diversification might help – but what exactly is diversification? Understanding how exactly industries are linked or not linked together, and which events are held in check by diversification can be complex.
The condominium market is a case in point.
Going by recent stats, the Toronto condo market has tightened considerably in the last year. A 22% increase in average price; a 10% drop in listings; and an overall drop in sales have contributed to scarcity in apartment rental units and a shortage in supply of accommodations. To me, all this constitute bubble dynamics: demand outstripping supply resulting in tightening market and steep price increases.
Back to the original question: how does one make decisions when operating inside a bubble?
We know that price increases are a result of “too much money chasing too few things.” The speed and amount of circulation is obviously related to those stubbornly low interest rates that incite most prospective purchasers to borrow and buy that “thing” now than in the future, and pay the interest for having that preference.
The too few things side of the equation: in the real estate market, it’s typically the onerous government regulations that stifle production, creating a scarcity or demand backlog.
That is the fear we all struggle with when operating inside a bubble.
We know fully well that the “thing” we just purchased is not 20% better this year over last year. It certainly is not bigger or brighter or fancier than it was last year, it is simply scarcer, and it is only scarcer today. It may not be scarce tomorrow.
Your condominium has not increased in size by 20%. Money is no different than condominium units when it comes to the laws of supply and demand, scarcity and abundance. The currency circulating has decreased in purchasing power by 20% because there is too much of it out there – just not in your hands.
Similar to my childhood antics, The Bank of Canada is keeping its eyes on the bubble. By raising rates to 0.75%, it’s tapping the brakes to try and curb inflationary pressures – to make sure that the bubble doesn’t blow up in people’s faces.
However, the raising of rates does not have immediate wide spread material impact, except for the impact it has on perceptions we hold about the future.
To emphasize this point, the Bank of Canada governor Stephen Poloz claimed (paraphrasing):
“it may take up to two years before this increase takes full effect on inflation. If economic growth continues, then we will continue to gently tap on the economic brakes with another cautious increase”
The strategy for operating inside a bubble seems to fall on our perceptions about the future that drive our present actions.
Whether you are exposed to the housing bubble or not, if you own a condo in the Central Toronto area classified as C12, you are sitting pretty with the average condominium price topping the $1.3 million mark.
Sleep well my C12 neighbors!