October 8th, 2008 by Potato

Fear is the name of the game lately in the markets. I’m off in vacationland on dial-up, so I’m a little disconnected from everything, but I couldn’t help but check in on the markets the last two days, and it’s been pretty damned scary. Because of that, I couldn’t help but make a post.

Huge, dizzying drops in the stock market. I was in physiological shock (hyperventilating, cold sweats) at how bad the market was on Monday — I was really glad I slept in and only checked at the end, so at least it wasn’t as bad as it was briefly. Tuesday was another terrible day, bringing us back down about to where things stood briefly on Monday.

I’m sort of at a loss as to what to do. I can’t justify selling out — as much stress as it’s causing me, I figure this just means we’re closer to a bottom today than we were on Friday, and panic selling is rarely a winning strategy. There is a lot of fear out there; it’s looking like we’re in for a major recession rather than a brief correction. Credit is seriously tightening: TD is upping their mortgage/HELOC rates even though the prime rate hasn’t changed [before I got to publish this, the central banks lowered the bank rate by 0.5%, but TD only lowered prime by 0.25%]. But the market is the great pricing machine, and maybe that is now priced in to stocks.

There are a couple of huge losses on my screen right now: Priszm, the income trust that manages a number of Canadian KFC outlets, is down 71% for me (not counting distributions). Even after the distribution cut, it’s yielding 34.6%. I have to wonder if that just represents panic selling, or unloading of something under $3-5 to free up margin, or if they’re toast? Does someone out there know some bad news I don’t? Should I bail and at least get something from it? That’s a question I had to face last week when the clinical trial of a biotech start-up I invested in went poorly. The stock instantly went from $2 to $0.10 [and today to $0.04]. I thought very hard on selling out, looked at the balance sheet a few times (the liquidation value should be about $0.05/share), and decided to just sit tight in the very slim chance some good news came around, though that’s a very slim chance, especially since in this environment they can’t really raise money to have a second go at a clinical trial.

Oddly enough, I’m still fairly optimistic about the stock market in general. It’s probably not going to get better this week or this month, but just in case it does I threw another $200 into the TD e-series index funds today to average down into these prices. My dad, who maintained a bright outlook through the gloominess of the past year, finally seems to have lost his optimism this week. He thinks we’re in for a reinforcing downward spiral of margin calls and increased credit costs. He says if the banks won’t lend to each other, they won’t lend to anyone, and the whole economy is going to grind to a halt until this gets sorted out, and everyone is going to get mauled in the process. Even the Canadian Savings Bond program had to delay their issue this year because of the chaos in the credit market.

Interestingly, a friend just had their offer on a house accepted last week. The housing market scares me right now. The stock market is fast, and liquid, and dizzying. We just had a major crash, and could be in for more, but then it was hard to see coming, and should stabilize shortly. The housing market on the other hand is slow and pondersome, and you can just see the downturn coming from miles (years) away, and can’t do anything about it — you can’t even short a house or a condo as a hedge. As for my friend: well, she’s going into this with eyes open. She knows it’s a rough housing market, she knows my views on the matter, and she got 3% off asking, so that’s something. Plus she’s got to live her life, and doesn’t want to wait any longer. In what I consider a bizarre twist, my dad, who also thinks that “condos are going to be going for pennies on the dollar in 2010”, and who won’t touch a Canadian bank stock — not because of ABCP, but because of the trouble he thinks regular Canadian mortgages are in for — supported her decision.

“We bought our first house in late 1987,” he said, “right near the peak of the last boom. Our house was worth about half what we paid for it by 1990. Last year, just for shits and giggles, I asked a real estate agent friend what he thought we could get for it if we were to sell. He said we’d get about $1.2 million. This week, if I had to sell, I’d be lucky to get $600k. Sure, the listings are still way over that in this neighbourhood, but nobody can buy right now; there’s a good three dozen homes for sale that have been up since the new year, and only 3 that closed. If you need to move it, you’ve got to price it down, and the market is going to come down. But when you buy a house, none of that matters. Just look at us: we bought right at the peak, and just held on through down and up and down again over 20 years, and we’re still living there. The price of the house hasn’t affected us at all.”

Well, Wayfare just lapped that right up. She is, of course, beset with the worst kind of house lust and it also seemed to reassure our recent homeowner friends. Heck, maybe that’s exactly what it was designed to do — there’s no sense in panicking our friends when at this point there’s really not much they can do. I, of course, disagree with my dad. Overpaying for a house is something that follows you for almost the rest of your lives. Even if you never sell, if you pay 20% more for a house, then your mortgage payment will always be 20% more. That’s a big part of your household budget that could have gone to vacations or cars or early retirement. If your house goes down by 20% and you lose what equity you had built up, then you can’t get a HELOC to fund a roof repair or the Smith Maneouvre; if you do have to sell and move, then your equity is wiped out and you’ll have to pay extra for a CMHC high ratio mortgage on your next house. If you lose your job, you can’t necessarily count on selling the house to get back your equity if you don’t have any. It is, by it’s nature, a highly leveraged purchase. Buy into the troubled stock market at the wrong point and all you’ve lost is what you invested, but you could be in for more pain if that was a leveraged purchase.

So in addition to the general bubbliness of the housing market (high housing costs-to-rent costs and housing-to-income ratios), there are a number of other nasty factors like the tightening of lending standards (no more zero-down, 40 year mortgage people to feed the fire), increasing rates, decreasing credit availability, looming recession fears, and of course, the psychological effect of witnessing what’s happening in the States just below us even if we were completely economically isolated, that all come together to make me afraid of the downturn in real estate to come. And unlike the stock market, that doesn’t get priced in quickly; this could be a few years of pain ahead. Sellers can sit in their homes for a long time, refusing to sell (except for the very few who can’t), making prices sticky. The September numbers were just released, and the downturn has finally started picking up momentum, with a 6% decrease for Toronto.

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