Wednesday, March 14, 2007

Sub Primes and the future

Back in January I wondered if banks were crazy because of the loans they were making. Now with the stock markets roiling over the potential failures of sub prime lenders, I am not surprised at what I see when I talk to people in foreclosure. I saw an article at Bloomberg that discusses the potential impact this might have on housing and lending. As the author indicates, when you get to involved in the data you can create a scary scenario that all is doom and gloom.

In fact, most market corrections tend to be over corrections because people usually behave irrationally. They fall into what I have called "Straight Line Thinking" and feel that the current direction of the market will continue indefinitely. Think about how people kept assuming that the stock market would go up in the Nineties ( I did - I switched all my investments out of bonds and into stocks in late 1999), that housing prices would keep going up in the last 5 years (several of my siblings bought beach front property just at the peak of the market and are sitting on very large cash flow drains, unwilling to drop the price on their homes).

Perspective is what is often needed the most when markets are changing and it is the attribute that is usually in shortest supply. People are ruled by their emotions. The underlying fundamentals of our economy are very strong and the failure of a few sub prime lenders will not destroy the housing market or the economy. Look at the stock market graph below. It shows how the market got out of balance, and how once it corrected itself, resumed on the underlying trend of economic growth. The other thing to note is that on a day to day basis the market fluctuations are quite random. A rational investor simply can look at the underlying data, think "the fundamentals are sound" and recognize that "this too shall pass". There's no need to lose sleep over this. However, the astute investor will look for the opportunity that this presents.

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