Today the Case Shiller index is again released. Woe is us say the pundits. But are we again making the mistake of comparing to the wrong base? Did any of the appreciation of the last 10 years make any sense? Is there any reasonable expectation that homes will be going back to their values of 2007?
Looking at CPI inflation since home prices took off, we see that inflation has averaged about 2.5%. And with 2.5% inflation in home prices since 2000, the index should be at 135. Which is just about where it is.
So maybe home prices are just right now. Maybe they make sense for the first time in 10 years. Maybe we just need to recalibrate our expectations.
The same sort of analysis can be done with equities. Much press was made off the fact that at some point in the last two years, equity markets stood at the exact same level as 10 years ago, or even slightly lower. However, ten years earlier, equities were near the peak of the tech stock bubble. So making any long term conclusions about the viability of equity investing based upon the prices at the top of a bubble is just wrong headed.
Both houses and stocks are bad buys at the peak of a bubble. Neither should be expected to beat inflation by 10% per year. Long term returns should never be based upon bubble peaks but it may be the case that bubble troughs are simply bringing prices back to sensible levels.
And since this is a blog about risk – it is necessary to point out that expectations for returns that were formed during bubble periods are very risky when the party is over.
Wrong decisions come from unrealistic expectations.