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Put It There & the Gift of Real Estate



December 06, 2010 – Comments (1) | RELATED TICKERS: C , EXAS , GMO

In October we talked about how the end of the baby boomer spending wave has led the United States into a prolonged downturn in the economy.  Today, we will talk about a strategy we use extensively and the generational opportunities to accumulate valuable assets during this prolonged economic downturn.

New Drivers in the Economy

My son turns sixteen this week and he is in driver's ed, so beware Muskego in about two or three months.  Although he is not the son of a boomer (I am an "X"er), he falls into the young end of the  "millenials" or echo boomers.  That group, kids in their teens and young adults in their twenties, make up the next large group to come into the economy.  Today, that group has virtually no money, so their ability to push the economy anytime soon is minimal, except for some retail and consumer technology.  When the echo boom is ready to spend however, that spending will look similar to what the baby boomers did in the 1970s through 1990s.

There is a second major driver to helping the economy recover.  However, it is a group of people who is not in the United States.  Througout the world there are litarally billions of people who want the standard of living we enjoy.  They are in places like China, India, Russia, Brazil, southeast Asia, eastern Europe, northern Africa, the middle east, central and south America.  Their demand for higher end products should be a huge driver to the United States economy.  Foreign demand will likely mitigate the baby boomer spending collapse which is dragging the American economy.  Somewhere near the end of the decade, it appears that foreign demand for goods produced in the United States should offset the drop in demand from within the United States.  

From the two groups above, we can find almost all of our long term investment opportunities.

The Boom Ahead

While the financial industry is virtually always bullish (optimistic) about the economy and markets, clearly I have not been since about 1999.  That is beginning to change.  I am very bullish on the markets of the 2020s.  Shorter term, I do not believe we will see real gains (inflation adjusted) in the stock or real estate markets.  We may see nominal gains (rising numbers like 2003-2006) the rest of the decade, but that would likely be a result of a response to a developing creeping inflation.  I would anticipate volatility and a sideways trend for some time yet.

That volatility and sideways trending is a huge opportunity for investors.  It is rare that we see such a floor under markets.  The current floor is a result of massive government intervention.  While politicians can argue over the size of that intervention, it is happening and will continue to happen.  Need proof it will continue?  Right now Democrats and Republicans are arguing over whether taxes should be $3.2 trillion lower or $4 trillion lower over the next decade.  Either decision, or a compromise, raises the national deficit by trillions, but also adds money to the private economy. Fed Chairman Ben Bernanke said on "60 Minutes " this weekend that the Fed may buy more bonds than the $600 billion it already has committed to (which lowers interest rates), again, adding money to the economy.  While this added money might not stimulate growth, and I really do not expect it to for the demographic reasons we have discussed, it does bridge the gap to tomorrow.  Without that bridge, as we have discussed, the gap could otherwise be fairly deep with another drop in American standard of living, which nobody wants. 

The trick for investors is to be very patient and careful in case we fall through the floor one or two more times while real growth takes hold later in the decade.  Chasing short term gains is a recipe for disaster.  Cautious optimism and managed expectations short term are imperative to avoiding portfolio damage.

The Gift of Real Estate

As we have discussed in our annual investor meetings real estate is not done declining in value.  However, given the support given to the economy and real estate in particular by the government, it has likely fallen near to its bottom at this point.  Real estate could drop another 10, 20 or 30% from these levels, but that pales in comparison to the 50% or more drops some markets have seen from higher levels.


Home Price Chart


When the economy rebounds driving commercial property prices later this decade and the echo boom starts buying houses in earnest the next decade we will see real estate prices climb again, probably for an extended period.  Over the next several years those who have the ability to buy property ought to look into buying.  I have gone so far as to tell younger people to only invest in their 401k plans up to the match point, not max out their contributions, so that they can accumulate cash for real estate down payments quicker.

In families where one generation is retiring and another is in their earlier working years, it might be advisable to consider joint family ventures for buying real estate. Make sure to use appropriate legal documents to secure rights for all involved in the future.  

For people who are retiring, they might want to buy income producing property if they have experience in that area.  More likely, we will add Real Estate Investment Trusts (REITs) to existing investment portfolios.  This is a strategy that younger investors can also utilize if they do not want to manage property directly.

Putting a Positive Spin on Things

If you are a baby boomer coming up on retirement or already retired there are a handful of growth and income generating strategies to follow for the assertive side of your portfolio.  One strategy we use extensively is selling put options.  This strategy allows us to take less risk than buying stocks outright and generate income to boot.  While this strategy is new for many people, it rarely takes longer than a few quarters for people to see results.

The basic premise here is that instead of owning a stock, we agree to buy somebody else's stock if the stock price drops to a pre-agreed upon price during a certain time frame (generally one to six months is our normal contract).  In essence we are insuring somebody from losing beyond a certain price on a particular stock.  For that insurance, they pay us a premium.  In about 3 out of 4 cases, in sideways or up markets, the options expire without us having to buy the stock.  We simply keep the premium they paid us and move on to the next investment.  In some cases, we do have to buy the stock because it has dropped in price.  The trick here is to only do these transactions with companies that you would like to own if the price dropped.

Of note, there are some REITs that I will likely be selling puts on in the not too distant future.

Taking Off

Tomorrow I leave for the Gavekal Investment conference in Dallas where I will listen to a number of renouned investors.  Enjoy the holidays and come back in January for the Annual letter.

Until next time, your getting ready for future booms investment advisor.



1 Comments – Post Your Own

#1) On December 12, 2010 at 7:27 PM, RonChapmanJr (30.22) wrote:

"When the echo boom is ready to spend however, that spending will look similar to what the baby boomers did in the 1970s through 1990s."

I doubt this group will ever have the incomes to spend like the boomers did. Stagnant wages, loss of manufactuing base, outsourcing and crappy educations (compared to the rest of the world) do not point to them having the same power.

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