Does Investor Psychology Matter?

Posted by urbandigs

Mon Aug 27th, 2007 10:48 AM

A: I had to remove the Saturday Humor videos because it was eating too much bandwidth; just to explain why its not up anymore. Today I would like to discuss the change in psychology that I am noticing due to the 5-6 weeks worth of headlines around the current credit/liquidity squeeze. Does investor psychology even matter? In my opinion, BIG TIME! Whats your opinion?

investor-psychology-nyc-real-estate.jpg

Here are some of the headlines that buyers and sellers of Manhattan Real Estate have been reading recently; no wonder they are so confused:

Drop Forseen in Median Price of U.S. Homes (NY Times)

Cracks May Appear In Manhattan Apartment Market (Reuters)

The Subprime Crisis: Will It Affect Borrowers (NY Times)

The Manhattan Real Estate Slump That Wasn't (NY Times)

Why The Blowup May Get Worse (Barrons)

Sweet. Great stuff. Thank god for that positive NY Times article that explained WHY NYC real estate differs from most other local markets. But even with that article, buyers and sellers have been inundated with headlines in local papers and online media regarding the re-pricing of risk that has been taking place and still taking place right now.

I have mentioned in a few past articles that what I see right now is a psychology shift in both buyers and sellers of Manhattan real estate. What does this mean and is it important? It means:

Buyers - Are beginning to realize HOW the re-pricing of risk will affect them! Buyers are realizing at a lag that lending rates are rising to price in the increased risk with mortgage loans and how that hits their wallets. Buyers are also realizing that prices have not come down and because of that they are a bit MORE WARY of future price appreciation given macro economic red flags that are waving. Combine these changes in thinking and what you get is a MORE CAUTIOUS BUYER more willing to sit on the sidelines than to jump in and bid close to ask.

Sellers - Sellers are reading these headlines and analyzing traffic to their property and it is exponentially raising concern that the two are connected. Before this credit mess hit, if it took 3 months to sell, fine, that's about long it usually takes especially if they priced high to test the market. Now, if the property has been on the market for 2+ months without a bid, its because of the credit mess and that buyers are not chasing! This change in psychology is making sellers a bit MORE EAGER to unload their property in the very near future. However, I am yet to see ANY panic selling or aggressive price cuts across the board. This change in psychology is yet to have a fundamental effect on pricing or inventory trends. If it did, you will see prices come down and inventory rise; not so yet. But you may see some responses to lower offers that you otherwise may have not seen 6 months ago!

The NY Times had a great article recently titled, "A Psychology Lesson From The Markets", where I read this statement -

Rising prices encourage investors to expect more price increases, and their optimism feeds back into even more increases, again and again in a vicious circle. As the boom continues, there is less fear of borrowing heavily, or of lending heavily. In this situation, lower lending standards seem perfectly appropriate -- and even a fair way to permit everyone to prosper.

Many people feel that they have discovered their true inner genius as investors and have relished the new self-expression and excitement. Investors across the world have been thinking that they are winners -- not recognizing that much of their success is only a result of a boom. Declines in asset prices endanger this very self-esteem.

That is why it is so hard to turn around investor attitudes once a downward psychology sets in. The Fed and other central banks do not have lithium or Prozac in their bag of remedies, and so cannot control it.
Before you go and diss this article, you should know that it was written by Robert Shiller, professor of economics and finance at Yale and co-founder and chief economist of MacroMarkets LLC. Oh, and he also was the co-creator of the Case-Shiller Home Pricing Index which allows investors to trade options contracts on 10 metro markets on the CME.

UrbanDigs Says - Investor psycholgy is worth following and is one of the MAIN factors that I consciously monitor when I am out with buyers and sellers. It is a leading indicator of sorts, in my opinion, from the best source possible as to what may come down the road; the buyers & sellers themselves. However, investor psychology is usually a lagging result from macro changes; so how can it be a leading indicator of whats to come (which is my opinion of investor psycholgy)? Think of it this way and it should help explain why I think so:

MACRO CHANGES TAKE PLACE --> INVESTOR PSYCHOLOGY CHANGES TOWARDS NEGATIVE --> BUYERS GET MORE CONSERVATIVE --> SELLERS GET MORE AGGRESSIVE --> PRICES COME DOWN --> VOLUME FALLS --> DATA COMES OUT AT LAG ON THESE METRICS --> MEDIA PICKS UP DATA REPORTS AND WRITES NEW HEADLINES --> INVESTOR PSYCHOLOGY TURNS INTO FUNDAMENTAL SHIFT --> MORE SELLERS COME TO MARKET --> INVENTORY TRENDS REVERSE --> PRICES GET MORE COMPETITIVE --> BUYERS GAIN CONTROL

Now this is NOT a prediction, nor is it an observation on what is going on. It is simply an explanation WHY I think investor psychology is worth noting and how it could be a leading indicator. I'm sure many will argue and thats fine. But this is how I think. The question is how YOU think? The Manhattan story is still unwritten and right now fundamentals are in tact. Let's see if this change in investor psychology that I am noticing has any ripple effect or passes us by.


CAPTCHA Image