Bubble Behavior

Brian Cochran

Every Monday morning, seven JMA team members meet for our Investment Committee. Much of our decision making is driven by quantitative analysis, but we also take time to share sentiments our advisors see in clients. The team is always on the lookout for behavioral red flags that can serve as a market indicator. We are most concerned when we see what we call “bubble behaviors.” When an asset class is at its peak, you’ll often see certain signs in investor sentiment. Bubble behaviors include fear of missing out (FOMO), over-concentration to one asset class, disregard for risk, high levels of excitement or enthusiasm, taking advice from family and disregard for price of investment, to name a few.

After nine years of upward-moving stock markets, you’d expect bubble behaviors to come from stock investors. While it’s true we’ve observed a few concerning behaviors from stock investors, most of the irrational exuberance we’ve witnessed has revolved around one asset class: real estate. Here are some things I’ve heard from clients:

"I'm quitting my stable, high-paying job to work real estate full time."

"I'd like to take a large withdrawal to buy a property that I'm turning into an Airbnb."

"I'm funding my kids' college expenses by buying real estate and renting for 15 years."

"I cannot focus on my investments right now. My time is going into my house-flipping business."

"I'd like to buy another rental property, but I can't find anything at a price that makes sense."

“The stock market seems overvalued. I’d rather own real estate, where there’s no risk.”

As you can see, there is very little skepticism about real estate. Don’t get me wrong, I'm not against real estate as part of a diversified portfolio. I've owned rental properties before and often consider investing in commercial real estate. However, alarms go off anytime someone thinks an investment involves "easy" or "automatic" profits. I also get concerned when someone expects big returns from residential real estate, where the average long-term growth is only .64% above inflation*. If history is any indicator, we will continue to see this sort of excitement surrounding real estate until the sector rolls over. Which means I’ll also continue to help clients navigate real estate investment in a more realistic way.

*Source: Case Schiller Real Home Price Index 1953-2018

The information provided has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Brian Cochran and not necessarily those of Raymond James. The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material. Investing involves risk and you may incur a profit or loss regardless of strategy selected.

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