Tuesday, February 26, 2008

The next bubble in the making.

Over the past 10 years the US economy has experienced the bursting of two major bubbles – the dot com bubble and the real-estate bubble. The Federal Reserve has been blamed for both failures – the first one happened supposedly because the US central bank hesitated to increase its interest rates too much until tech stocks started jumping like kangaroos in the Australian deserts in late 1999. The second bubble was formed just as the dot com bubble imploded and the FED tried stimulating the economy with lowering interest rates to multi-decade lows. Rates on fixed income instruments had fallen to multi-decade lows, and stocks were in a major bear market. Investors had nowhere to go for income. This situation stimulated speculation in the housing market and helped the US economy regain its power and achieve six years of prosperity.

Currently the US and Foreign stock and property markets are weak, ever since the subprime problems started making huge headlines in July 2007. Interest rates are declining again, which leads very few options for investors to invest and grow their savings right now. Somewhere down the road real-estate would pick up again, but it is still too early for that to happen in my opinion. One of the reasons for today’s real-estate bubble is that properties were sold to people who cannot afford them at all. If you are making $20,000 per year and you purchased a property for $500,000, which you were able to afford only with an ARM, with the intent of flipping it out for a huge profit, even if you refinanced your loan to a 0% interest per year, you would still be unable to keep up with the monthly payments. Most of those investors are holding such properties which they cannot afford, but which would lead to huge losses if they sold them right now. Those investors are trying to rent their properties in order to decrease their losses. This creates a very competitive market for landlords right now. Pundits are claiming that now is the time to buy into real estate. I believe that the next one or two years will also be considered “the time” to buy real estate. When no one believes in the real estate market, that’s when it will bottom out and start going up.

One of the few alternatives for investments is stocks that pay a relatively stable dividend, and which have maintained or increased their dividends over the years. There are several dividend based ETF’s out there some of which launched recently. This shows to me that the investment community is anticipating a demand for stable income producing securities in this unstable time. There are several major stock lists out there which contain dividend achievers, dividend aristocrats and high-yielding aristocrats and achievers. With very few reliable sources of dependable income from stocks, investors have few other choices but to invest in the dividend stocks of our times. I think that the dividend aristocrats would be the next bubble that will be formed from the current low interest rates. Investors, burned from the rest of the market, would flock into one-decision large cap stocks with good liquidity, which could be bought and held forever regardless of price. Something similar happened in the late 1960’s until the 1974 bear market with the so-called “Nifty Fifty” stocks.

I am already seeing big increase in interest in dividend paying stocks especially the above mentioned lists. If a bubble in dividend aristocrats/achievers does occur, that would enable me to reach my goals of $200,000 in net worth earlier than expected. If it doesn’t happen, then I would probably expect normal average rates of return of around 10%-11% annually. Very Boring.

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