Is pessimism about housing warranted?
Without rational pessimism, people are susceptible to foolish optimism that fuels financial manias.
Optimists are happier than pessimists. If you spend your life seeing the good in people, situations, and outcomes, you live in an inner world of bliss, contentment, and exciting possibilities. If you spend your life looking for brown, you find brown, and you will think people, situations and outcomes are shitty. It’s a simple truth that skeptics and pessimists ignore as they console themselves with seeing what they believe is a more accurate picture of reality. It’s not.
Pessimists are better investors than optimists. Optimists ignore warning signs in favor of Pollyanna outlooks. They scour financial media reports looking for confirmation of their pre-existing biases, and they are the most susceptible to participating in financial manias. Pessimists are more likely to sniff out a scam or see a financial mania for what it is and not play along.
Pessimistic investors have their problems too. Some pessimists get caught in the permabear trap. They spend their time searching the financial media for stories of doom and gloom. They read every post on ZeroHedge as if it were Gospel, and they fail to act on anything for fear of imminent collapse — except perhaps for buying gold, the one commodity all permabears seem to agree on — and lose money on.
Rational skepticism is the gray area between foolish optimism and permabear pessimism. I consider myself a rational skeptic. I was very pessimistic about real estate during the housing bubble because, well… it was an obvious financial mania. I remained skeptical about the nonsense happy-talk from 2008-2012 because most of it was optimism detached from reality.
In 2010 I surprised many who thought I was a permabear by openly advocating buying Las Vegas real estate. I recognized value where market sentiment was dominated by permabear thinking. A rational skeptic looks at the facts of both sides and makes a judgment that often goes against the mainstream. Permabears and permabulls know only one course of action, and it often leads them astray.
Housing Market Pessimism
Right now the housing market is fairly valued, the economy is improving, and the rate of appreciation and rate of rent growth is within normal and sustainable parameters. The current conditions don’t warrant much pessimism.
Is there room for rational skepticism? Of course. Interest rates are near record lows, and when mortgage rates rise, housing will be less affordable unless we get a great deal of wage growth. House prices are 30% too high relative to rent and income, so as mortgage rates rise above 4%, the housing market will face severe constraints on affordability. House prices could fall again. To ignore this risks is to play the fool.
Especially when things are so good.
Morgan Housel, Jan 21, 2016
“For reasons I have never understood, people like to hear that the world is going to hell,” historian Deirdre N. McCloskey told the New York Times this week.
It’s hard to argue. Despite the record of things getting better for most people most of the time, pessimism isn’t just more common than optimism, it also sounds smarter. It’s intellectually captivating, and paid more attention to than the optimist who is often viewed as an oblivious sucker.
That’s because optimists are oblivious suckers. What was the main characteristic everyone who fell for the delusions of the housing bubble had in common? They were all overly optimistic suckers.
The central delusion of the housing bubble was that real estate always goes up. This was supported by a number of supporting optimistic fallacies including:
- Buy Now or Be Priced Out Forever
- They Aren’t Making Any More Land
- Everyone Wants To Live Here
- Prices Are Supported By Fundamentals
- It Is Different This Time
During the housing bubble people believed these things passionately. They were completely certain in their beliefs — sure of the truth of their unbounded optimism.
Unfortunately, they were also very, very wrong. Perhaps the pessimists weren’t so stupid after all.
It’s always been this way. John Stuart Mill wrote 150 years ago: “I have observed that not the man who hopes when others despair, but the man who despairs when others hope, is admired by a large class of persons as a sage.” Matt Ridley wrote in his book The Rational Optimist:
If you say the world has been getting better you may get away with being called naïve and insensitive. If you say the world is going to go on getting better, you are considered embarrassingly mad. If, on the other hand, you say catastrophe is imminent, you may expect a McArthur genius award or even the Nobel Peace Prize.
In investing, a bull sounds like a reckless cheerleader, while a bear sounds like a sharp mind who has dug past the headlines. …
Bulls are often reckless cheerleaders, particularly if bullishness is all they know.
Here are a few other reasons I’ve observed for why pessimism gets so much attention.1. Optimism appears oblivious to risks, so by default pessimism looks more intelligent.
Which often proves to be true.
2. Pessimism shows that not everything is moving in the right direction, which helps you rationalize the personal shortcomings we all have. Misery loves company, as they say. Realizing that things outside your control could be the cause of your own problems is a comforting feeling, so we’re attracted to it.
People who endured chronic unemployment during the recession often weren’t in those circumstances due to their personal shortcomings. Often, these were good people who were forced to live in hopeless despair due to the situation.
3. Pessimism requires action, whereas optimism means staying the course. Pessimism is “SELL, GET OUT, RUN,” which grabs your attention because it’s an action you need to take right now. You don’t want to read the article later or skim over the details, because you might get hurt. Optimism is mostly, “Don’t worry, stay the course, we’ll be alright,” which is easy to ignore since it doesn’t require doing anything.
This is exactly why few successful traders are optimists. Being optimistic about a losing position and doing nothing is how huge losses occur.
4. Optimism sounds like a sales pitch, while pessimism sounds like someone trying to help you. And that’s often the truth. …
5. Pessimists extrapolate present trends without accounting for how reliably markets adapt. That’s important, because pessimistic views often start with a foundation of rational analysis, so the warning appears as reasonable as it is scary.
Most people extrapolate short-term trends to infinity. Most real estate buyers during the housing bubble believed they would be millionaires by now.
Failing to account for markets’ ability to adapt is the cause of death of most pessimist forecasts.
This is usually the problem with permabears, but permabulls are equally likely to buy a overly rosy forecast. In fact, I would argue they are more likely due to their underlying optimistic bias.
Should you ever listen to pessimists? Of course. They’re the best indication of what’s unsustainable, and thus probably about to change, and thus the soil of what’s to be optimistic about.
This is why rational skepticism is the best way to approach all investing. Know and acknowledge what might go wrong, evaluate the risks, and protect yourself if necessary.
It’s entirely possible California real estate prices will appreciate 10% per year for the foreseeable future, but what if that doesn’t happen? People who bought during the housing bubble had no contingency plan, so when the best-case scenario didn’t come to pass, it was very painful for them. Don’t make the same mistake.