Euphoria is not an investment strategy

There is a lot of talk these days about the euphoria surrounding the Vancouver and, especially, the Toronto housing markets. There are those in government who are worried about the direction the markets are taking and then there are those looking to profit from it, such as the banks, realtors, mortgage brokers and promoters.

It certainly is interesting following the action from Calgary, with its real estate market sitting idle thanks to weaker oil prices and little interest among foreign buyers.

From t he outside, all of this reminds me of the similarity between market bubbles and Ponzi schemes as both play into greed with those in early making the most money and those last to the party losing the most.

What is happening in Toronto and Vancouver isn’t altogether different from the tech bubble in the late 1990s, the run- up in the U. S. housing market just prior to the financial meltdown in 2008 and the frequent calls for $ 200 oil in the mid-2000s. We are also worried about the current direction of the U. S. equity market after eight years of an ultra- low interest rate policy from the U.S. Federal Reserve, and the bets anticipating huge fiscal stimulus from the Trump administration.

As an investor these are the times when it is most important to separate fact from fiction, especially when it comes to forward expectations and measuring the upside potential versus downside risks. To help, here are five warning signs of an overheated market that is ripe with risk.

IMPULSIVENESS AND FEAR OF MISSING OUT

One of the greatest psychological flaws that affects investors is the fear of missing out and not doing as well as your neighbour, which can lead to all kinds of irrational, ill- timed crowd- following behaviours.

Some are extremely adept at taking advantage of this flaw in others — think of those fist- pumping conferences featuring promoters and motivational speakers all willing to share with you their secret sauce on becoming a multi-millionaire.

Although the fine print on most investment brochures contain the phrase “past returns provide no indication of future returns,” the front page will often market the high double-digit return made the year prior. Better jump into the Toronto housing market now or miss out on another 33-per-cent yearly rally — don’t worry, we’ll show you how…

Unfortunately, the more overheated the market, the more you have potentially missed out on, thereby the greater the risk you take by jumping in.

‘ THIS TIME IT’S DIFFERENT’

One of most common lines during market bubbles is that it’s always different this time around, a new paradigm, perhaps. There were no shortage of books written and experts touting peak oil in the mid- 2000s, supporting what we know now were unsustainably high oil prices. Foreign companies came piling into Canadian oilsands projects and now they are all leaving, albeit some with a lot less capital than when they arrived.

EVERYONE IS AN EXPERT

When everyone is talking about how easy it is to make money you probably know the game is very close to being over. This doesn’t just mean taxi drivers but it can also include self- help motivational gurus suddenly writing books about how to invest or economists with no commodities background offering their opinion on the future direction of oil prices.

COMMON SENSE IS OUT THE WINDOW

When the numbers don’t add up or make any sense then there is a problem and likely a situation that isn’t sustainable. For example, rental apartments with five per cent to 10 per cent vacancies selling for a paltry 2.5- per- cent to 3.0- per- cent cap rate, foreign students snapping up multimilliondollar mansions, or negative interest rates on both government and corporate bonds.

A MARKET DEPENDENT ON MORE BUYERS

Playing musical chairs can be a lot of fun when there are a lot of chairs, but suddenly start removing chairs (buyers) and the music stops with you standing and your wallet empty. While there are those who can profit handsomely from this game, you have to be early and know when to get out, which is a lot harder than it sounds. The easier and less risky route is to offer advice on how to supposedly do it, for a large fee of course.

In conclusion, although it isn’t as much fun, common sense is not only a better long- term investment than euphoria, it is much safer too.