Lets Discuss 'Priced In' From A Traders Perspective
A: Forget Manhattan real estate for a moment. Lets talk about the equity markets and I want to talk about some of the 'feelings' I'm getting and anyone out there into this stuff can tell me what you're feeling. In February, I did a different type of post ("Sometimes We Get Lost In The Dark") with the same idea to describe the 'feelings' I had in my gut, the Dow was 12,381 at the time and the S&P's at 1,353; ahhh the good old days. Since that post, the Dow is down 33% and the S&P's are down 37%; so have equities re-adjusted enough?
Unfortunately, probably not but the pricing in process is in full force and is likely much closer to the end than the beginning. A glimmer of hope I guess, but I fully expect the markets to make new lows; especially if GM/F are allowed to fail and another credit event / confidence shock occurs. I do believe these guys should go into bankruptcy protection and re-structure to do the things necessary to solve the problems that led to their demise; but will gov't allow this near term disruption that brings with it so many more job losses? The whole thing is a mess and recall what I stated in the "Sometimes We Get Lost In The Dark" piece nine months ago:
No matter what you hear about this current situation, we can't argue that we are in a period of de-leveraging. Risk is being repriced and the credit markets are in shut-down mode as the industry around it attempts to corrects itself. Games that worked before, do not work now. And since housing is illiquid and nobody knows how Americans will be impacted by any economic slowdown, which few deny is here, it is impossible to predict the short term bottom for prices.Okay. That was my gut around nine months ago. I call the stock market the stars because that is the investment mechanism with the most reach around the country that generates positive & negative wealth effects; most have some exposure to the stock market as opposed to say buying corporate debt. Now when I look to the stars (equity markets), I see a different constellation. A smaller one. A less distinct one. Its hard to make it out, but its there with some imagination. Uncertainty reigns supreme and stocks are pricing in the challenges ahead with the information at hand.We don't know what other obstruction may pop up. We don't know the level of certainty or uncertainty that this information will bring with it. So we look to the stars for some sense of direction. The stock market is the stars, and is the tool that most use to figure out where they are when confused, or lost. But in this unchartered world where we don't know what lies ahead, this widely used, widely publicized vehicle is not a very good navigator for one real reason. Stocks trade on information available and investor sentiment for the near term, lets say the next six months. If the world around us slows and earnings come down, then the entire valuation model of equities (p/e) will have to re-adjust to the weaker times that we know are about to come.
In terms of how this affects us, confidence will remain low as long as stocks remain low and jobs are being shed! These two forces...
a) one's portfolio; which likely took a huge hit as equity markets plunged
b) one's primary source of income; which is likely significantly more uncertain today than 12 months ago.
...are vital to the confidence of any one individual. They say its a recession when your friend loses their job, and a depression when you lose your job. The psychology is accurate. Fact is, stocks will price in the worst possible outcomes well before the officially declared unemployment rate hits its peak and GDP rebounds and stays in growth mode. So for sake of this discussion, lets look at what the stock market has done and the phenomenon of 'priced in'.
First lets clear up what the stock market is. The stock market is a discounting mechanism that is not rational and attempts to value the security price of a corporation's health & future prospects with the information at hand at that time. Which brings us to the trading term 'priced in'.
'Priced In': simply refers to the point at which a stock's price has reached a level which takes into account the positive or negative information at hand and the uncertainty or certainty that may ahead. The more uncertainty there is, the longer the pricing in process lasts; and vice versa. The stock market is not perfect, and the stock market is often wrong as it was in late 2007 in pricing in the severity of this credit crisis and I expected an adjustment. Now, you can define 'priced in' a variety of different ways, the end point is all the same. A good example of 'priced in' would be when a company announces horrible news, yet the beaten down stock rises after the news is released. The flaw remains with the fact that the stock market is an irrational discounting mechanism that is imperfect in its calculations.
Todays example: HEWLETT PACKARD - Like most stocks, HPQ was sold off in the past 3 months as uncertainty and negative news gripped the markets. Stocks priced in this uncertainty and lower profit potential as the slowdown spreads globally. Margin calls and forced selling enhanced this process making it very painful for everyday investors. HPQ's stock fell from 49 to just under 30, as traders priced in the potential hit to this tech powerhouse. This morning, HPQ delivered solid earnings and provided guidance into 2009's expected EPS that came in above analysts dampened expectations. The result is HPQ's stock price is trading up about 12% as traders remove the previously priced in uncertainty, and now attempt to price in the clarity provided by the corporate guidance. Now, will it hold at these levels?
So, have stocks 'priced in' the current wealth of negative news and uncertainties? Probably not, but we are well on our way in the process. The adjustment hurt alot of people, hedge funds, and asset managers. At some point soon we are likely to see a bear market rally, or Elliot wave countertrend rally, or whatever other technical term you want to call it. The end result will be the same; negative news will come out and stocks will rise leaving few wondering why. That's the irrationality of the markets and the phenomenon of 'priced in'. As smart as some people are, this irrationality and mysterious point at which traders think the stock is 'priced in' makes even great trades go wrong at times.
We are reaching the latter stages of government and fed intervention and soon we will be at a point where no more can be done; leaving the stock market to handle negative news on their own. Pity the stock market. Its been about 15 months since the fed started slashing rates, and it takes about 8-12 months for each cut to funnel its way through the economic system. So, for the next 8+ months or so, the system will start to see the benefits of rate cuts occurring up to the very last one in mid-October bringing the FFR to 1%. But this won't stop the deflationary forces from doing their damage and bringing deteriorating economic data for the most of 2009; this is what I believe is not 'priced in' yet. Time will tell.
Translating this to Manhattan real estate, you need to look at the buy side paralysis that came once the stock market sold off big time in October! Why? The credit crisis was in full effect for 12 months already, and the damage was mostly done. What took so long for buyers to realize this? The answer lies in the stock market, the so-called stars! Although the macro economic data was quickly deteriorating, and deflation taking hold, most buyers didnt feel hurt because their portfolio's only declined say 10% or 15%. But once the plunge began, and stocks fell closer to 40%, that is when it really hit home, headlines took the front pages, and buyers took a big step back! The end is near many thought.
Amazing, but not surprising. If stocks have a bear market rally up 15% or 20% from these levels, I guarantee you some buyers here in Manhattan will feel more comfortable with pulling the trigger; leaving out right or wrong, that is just the way it is. If you plan to buy, and you have the means to buy, and you feel wealthier because stocks just rallied, you may feel more confident in bidding. Transaction volume is not going to zero, but it is going to be well below what we got used to over the past 3-4 years as the after-effects of this slowdown hits home here in Manhattan. Adjust accordingly and know that many are continuing to look to the stars to time their re-entry into the real estate market! When they feel better, and stocks rebound, confidence will rise and a decision might be made. While my thought is that this is the wrong way to view a Manhattan real estate purchase, this is how many make decisions. Since stocks are irrational and often wrong, they should not be viewed as the indicator to guide you on a real estate investment! But for most, they do.
Comments (3)
BTW - this post was in response to a conversation I had with a client about a week ago. Consider it just a simple discussion on how the stock market discounts, and how eerily connected some buyers are out there to what the stock market does.
Posted by Noah | November 18, 2008 10:09 AM
I agree that there will be some buyers who will take heart if the stock market bounces back up 15-20%. However, I think the number of buyers that re-enter the real estate market will be small. The vast majority of investors rode the market all the way down, so a 20% recovery won't even get them halfway to breakeven. Also, many buyers are Wall Streeters, many of whom received a lot of their compensation in their employers' stock. Every street firm's stock has tanked, and following Bear and Lehman's demises, no one employed by the remaining brokerages is relying on their restricted stock and/or options as a predictable source of wealth. And this doesn't even factor in that most finance types are getting paid a lot less in the forseeable future, and are seriously concerned about whether they will stay employed.
I also agree with your statement that the stock market is irrational, but only over the short term. It's been very clear for the past year that earnings for virtually all companies would decline eventually. US consumers have binged on credit for years now, initially using their homes as ATMs, and subsequently (for the last year or so) on credit cards. The stock market refused to accept the warning the credit markets were sounding until perennially optimistic equity investors could no longer ignore the facts. My point is that reality eventually intruded on the optimistic stories that equity investors told themselves and none but the congenitally optimistic continue to buy (and get burned in the process). The fundamentals are not there, and that's why the market is unable to sustain the weak rallies of the past few weeks.
The same holds true for real estate. The fundamentals of real estate dictate that the cost to own should not be substantially different than the cost to rent. That relationship drifted apart for years. Eventually, the fundamentals reasserted themselves, which is why we are in the midst of a massive real estate deflation. Manhattan is merely catching up with the rest of the country, and because the run up in prices here was even more excessive than in the rest of the country, the decline will be proportionately greater. This scenario is playing out in London, another city that was supposedly immune to macroeconomic forces (see today's WSJ on this topic).
All told, the re-entry of a few buyers will not stabilize the real estate marktes. Prices will drop until the fundamentals realign, and there's still a long way to go before that happens.
Posted by SRealist | November 18, 2008 4:45 PM
Srealist - "All told, the re-entry of a few buyers will not stabilize the real estate marktes. Prices will drop until the fundamentals realign, and there's still a long way to go before that happens."
yes I agree with that!
Posted by Noah | November 18, 2008 5:39 PM