The Terrible, Horrible, No Good, Very Bad Economy
The nightmare is real...and a dream for the contrarian investor! (Part I)
What a time to be alive! The picture above summarizes how most Americans living paycheck to paycheck feel today: THE WORST IS YET TO COME.
But don’t fret. The contrarian investor sees moments like this as an opportunity of unparalleled proportions. The worst may indeed be yet to come, but those who steel themselves against the buffeting of the coming fear storm and buy when others are fleeing all manner of assets can realize RAPID gains in wealth and income. Once we set the table for today’s analysis, I’ll walk you through my take on a range of investment opportunities in two parts.
Because you live and work in the US, you don’t need to go to your favorite social media, television, or internet news site to know things are pretty darn sucky. But just so we’re all on the same page, let’s review a few data points to frame our discussion.
Real Inflation (Measured the Old School Way)
Inflation in the US economy may be the highest it has been in the lifetimes of nearly every living American. The official print for inflation year over year is currently 8.2%. However, if measured using the Consumer Price Index as it existed in the worst of the stagflationary 1970s, we see YOY inflation over 15%. Yikes!
Debt to GDP Ratio
Debt as a percentage of the US Gross Domestic Product (GDP) is higher than it has been at any time since the founding of our nation: 125% of GDP as of October 2022
Caution: War Zone Ahead
The current administration and Congress seem committed to taking us into WWIII. As a point of reference, our debt as a percentage of GDP at the start of WWII was 44%. By the end, it was 119%, and we were the winners! Economically speaking, we are already in a full-tilt conflict with China, our biggest competitor on the global stage. Last week, the Biden administration announced a ban on computer chip manufacturing equipment sent to China by US corporations. It warned of criminal charges for Americans who help the Chinese increase their chip manufacturing capabilities.
Beware of the Bear
And what shall we say about the stock market? Bear is a word that comes to mind. When stock values have declined 20% or more from their highs, it is called a bear market. Conversely, when it increases by 20% or more, it is called a bull market. Right now, the bears have it.
I could go on, but rather than break down everything wrong with our current economy, and based on the news above, you might think this is a gloom and doom report, but you would be wrong.
Ahoy! Opportunities Ahead!
The truth is, I’m excited. Really excited. These are the moments when contrarian investors like me find their best opportunities to invest and win BIG. It’s not that I like to see current investors suffer. It makes me sad and even a little mad to see so many people struggle with their investments, but suffer they will, and, hopefully, take away valuable (albeit costly) lessons from their mistakes. I’ve been there too. I played no role in their misfortune, and neither did you. In these times of vastly distorted valuations and widespread debt serfdom, it is time for you to save and invest your way out of paycheck-to-paycheck uncertainty and gain true Financial Independence!
I’ve given a rundown of the enemies of profitable investing, fear being foremost. I’ll offer my take on several asset classes one by one, and these reflections will get you primed to think about the opportunities you can identify, invest in, and profit from! As many investors are running for the hills or asking themselves if it is time to do so, this is the moment - or very nearly so - for you (and me) to survey the damage, identify the gems lying about the ashes and make our investing moves.
Real Estate
“Ninety percent of all millionaires become so through owning real estate. More Money has been made in real estate than in all industrial investments combined.”
“The greatest astonishment of my life was the discovery that the man who does the work is not the man who gets rich.”
Andrew Carnegie - American Industrialist and Philanthropist
There’s a reason I’m starting with real estate. Owning real estate is how most millionaires become millionaires. Famed industrialist Andrew Carnegie sums it up in his first quote above. In the internet age, the latter part of that quote may not be as accurate anymore. Still, since most of us cannot start a Facebook, Google, or Microsoft, real estate becomes the next best leading candidate for us to achieve financial independence.
The second quote is essential to understanding how to own real estate. The real estate you buy to live in requires you to continue working since it does not pay for itself. The real estate you buy to rent to others, provided you’ve done your homework, will pay not only for itself but provide an income besides.
What Cards are on the Table?
Let’s run down the critical issues for Real Estate:
According to the Case-Shiller Index that tracks home prices, homes nationwide have increased by 40% in just the past two years!
Meanwhile, salaries have failed to keep pace with inflation in general and housing in particular.
Mortgage interest rates saw a massive increase of 246% in the past 24 months, increasing the median national mortgage from $1,609 in 2019 to an astounding $3,200 for loans originating today.
The above metrics, combined with real inflation north of 15%, mean housing is about to hit an economic wall unless something drastic changes. So, what are the things that could change?:
Interest rates could come down. The Federal Reserve, the entity responsible for the massive increase in lending rates, could choose to do an about-face. They have a few reasons that might compel them to do so:
The impact rate increases are having on home sales. They have dropped for seven months straight.
The strengthening of the dollar against other currencies. Higher rates have led to the dollar appreciating against other currencies, which is bad for exports, tourism to the United States, and domestic jobs.
Higher debt service costs (i.e., interest payments) due to the massive increase in government debt pose a risk to the US meeting its financial obligations without printing more money.
In short, three very big reasons the Fed may choose to change its stance in the coming months. I put the odds of the Fed pivoting at better than 50/50, but by the time they do, enough damage will be done to the housing market to open up regional pockets of opportunity for investors.
Home prices could come down. The process of declining home prices is somewhat inelastic. It takes time for homeowners to decide they are willing to sell their homes for less than the extraordinarily high prices seen in recent months. To see significant changes in home prices, you must first see substantial job losses develop. Homeowners forced to sell have little choice when they can no longer pay the mortgage after losing their job. We haven’t seen meaningful job losses develop yet, so unless or until that materializes, housing price decreases will be slight to moderate. This is the most likely scenario in my book, but it will take time to fully manifest. Expect the bottom to be at least a year out, and if the Fed is late in their pivot, up to two years from now. Patience will be key with respect to the national real estate landscape.
Wages could increase substantially. A big increase in wages would take pressure off the housing market but increase pressure on inflation across all assets. This is the least likely factor to change unless the government tries to force higher wages or (unwisely) provides some form of universal basic income to a large portion of the populace. I don’t see this coming to fruition unless we launch into hyperinflation. If that happens, expect to see faster increases in the cost of food and energy than housing, in part, due to rent control initiatives the government would likely enact. The rapid rise in the cost of staple consumables would put incredible pressure on the average budget, so housing prices would necessarily collapse, as was seen in the Weimar Republic. If we see this materialize and you have funds set aside for speculation, short-term rentals that aren’t subject to rent control would likely be the best play.
You might take away from the above analysis that real estate will not be a good segment to invest in for some time. However, other factors present great real estate opportunities in the more immediate term. Let me touch on those now:
Vacation homes, fractional and timeshare properties - In times of economic distress that haven’t led to large-scale job losses, people lose confidence in the economy and look to trim their costs in areas they consider optional. Properties dedicated to vacationing are low-hanging financial fruit to the average owner who sees the sale of it will cut their expenses in the future. These become prime investment opportunities in the most profitable real estate area, short-term rentals. I’ll dedicate a future post to this topic, but well-placed properties used for short-term rentals (vacation spots being ideal for this purpose) can generate more than four times the revenue of long-term rentals and three times the net profit. Start looking at opportunities in places with a high percentage of second homes or other vacation properties. You will have to know the local laws concerning short-term rental, but provided it is not prohibited or significantly restricted, there may be excellent opportunities in this segment now. I just today put a cash offer on a vacation rental that I project will yield a 10.8% cash-on-cash return in year 1!
Florida real estate - There is an unusual development happening in Florida that has to do with the affordability of homeowner insurance for wind. Hurricane Ian has added further pressure to the insurance market. Hence, as prices begin to soften due to economic reasons, the cost/difficulty of obtaining insurance in wind-exposed areas of Florida (that being most of it) will likely be one of the first places to find screaming deals on real estate and at prices well below those in the Pacific Coast and Northeast regions. If you can come up with $25,000 to $30,000 as a down payment and have some margin in your income against expenses, you may find properties in the next six months that, even with a conservative analysis, can yield cash on cash returns of 20% or more. Just be sure to factor in the appropriate adder for insurance costs.
If you have not yet invested in real estate, NOW IS THE TIME to begin learning the ropes of this opportunity. It will be the surest path to creating an income unrelated to your primary work and, thereby, financial independence for the foreseeable future. I have plans for a post on how to mitigate your risk in keeping with your level of risk tolerance in the coming weeks.
Closing Remarks
In Part Deux of this segment, I will discuss stocks, bonds, commodities, and crypto as investment opportunities in this Terrible, Horrible, No Good, Bad Economy. You and your family (if you have one or plan to have one) need to establish a source of reliable income not tied to your primary work. A long-time acquaintance told me that he’d unexpectedly lost his job this week. I asked him if he had any income besides his job. He said no. He has several children, and now, with no job, a great deal of uncertainty ahead. In times like these, such stories will only multiply.
Now is the time, when you are gainfully employed, to change the future course of your financial security. Nothing is 100%, but that’s a poor excuse not to try. Start today, and please share the Au Contraire posts you have found to be informative and helpful to your friends and family so they can gain insights into how to be financially independent too.
Until next time, may peace and prosperity be with you.
The Natural Economist
Next up: A discussion of the Terrible, Horrible, No Good, Very Bad Economy, Part Deux.