Analysis Series: Five Graphs For Finding The New Investment Opportunities

By Daniel R. Amerman, CFA

Five Graphs That Explain How The Fed Creates Extreme Investment Price Movements

As explored in this analysis, the fundamentals governing investment valuations have changed in the last 20 years. Using real estate as an example, we have seen increases in prices that dwarf historical averages - even in inflation-adjusted terms. Yet, the losses can be much greater as well, as can be seen in the graph below.

The five graphs use the tools of financial analysis to explore in detail an aspect of investment valuation that is counter-intuitive for most people but yet is likely to be essential for investors in the modern era: how what might seem to be bad news can in a logical and rational process create new levels of investor profits that may substantially exceed historical averages. These new relationships have changed not only real estate investment, but have also changed investment performance for stocks, bonds and precious metals.

When we understand why the recent past has been so different from long term averages, then we can also understand why some of the largest profits and losses in history may still be ahead of us - but what will govern those profits and losses are factors that few homeowners and investors are taking into account today.

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Using The Five Graphs To See The 1-2-3 Cycle Of Exaggerated Profits & Losses

In this analysis we will use the five graphs to explore the years represented with the red numerals "1", "2", and "3" above, which cover the entire period between 2001 and 2017. We will first use the graphs to explore how the stage was being set for "2", an eventual record breaking plunge in real estate prices, even while real estate prices were still soaring during the "1" portion of the cycle. We will then go through the five graphs again, and see what created "3", the next rapid asset appreciation portion of the cycle and the second towering golden spike of exceptional home prices (which, as can be seen, bears an almost uncanny resemblance to the first spike).

In sequence, as we move from "1" to "2" to "3", we will gain a much better understanding of: 1) what caused the largest potential real estate profits on a national basis in the modern era; 2) what caused the largest potential real estate losses in modern times; and 3) what caused a second round of some of the largest potential real estate profits in the modern era.

The last twenty or so years have been dominated by this 1-2-3 cycle, with profits, losses and a degree of volatility that do not have a prior historical equivalent in the United States. The next twenty and more years may very well also be dominated by similar factors, and for investors who wish to be prepared for the heightened profit opportunities - as well as the heightened risks - there is simply no substitute for understanding what has caused each stage of the 1-2-3 cycle.

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The Sixth Graph - The Multiplication Of Wealth

In this analysis we add back in a sixth factor, that of inflation, and explore how even low rates of inflation create a multiplicative skew that separates housing from other investment categories.

1) We will break out and intensively analyze various time periods between 2000 and 2017, using the actual historical data to identify ways in which the sixth factor has magnified cyclical housing gains in practice while reducing the associated cyclical housing losses.

2) Based upon that data and using a series of easy to follow graphs, we will introduce a simple numerical formula, and use that formula to see how wealth can be quite literally multiplied for homeowners, as well as housing and REIT investors (even without mortgages or borrowing).

3) Using various historical time periods, we will examine in detail the positive skew, use the simple formula, and find out how marginal profits have been multiplied upwards by factors of 3X and 4X in practice, even while sometimes entirely wiping out what should be the associated homeowner and investor losses.

4) Using the insights developed through studying the multiplicative skew and the 1-2-3 cycles, we will discuss how the same "hidden" opportunities historically experienced in the #1, #2 and #3 cycles, could be of critical importance in the future, particularly if the cycles do indeed continue onwards to #4 and #5.

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A Remarkably Accurate Warning Indicator For Economic & Market Peril

Would you have appreciated a single number that could have given you a clear and unmistakable warning before the tech stock bubble collapsed? How about an unequivocal mathematical warning in 2006 that major financial trouble was on the way, well before the problems of 2007 and 2008?

These warnings did exist and they can be seen in the gold areas of the graph above. They are called "yield curve inversions", and are quite uncommon, having occurred only three times in the last 35 years. The red areas show the three recessions of the last 35 years - and as can be readily seen, each yield curve inversion has been relatively quickly followed by a recession.

After languishing in obscurity for many years, "yield curve inversions" are back in the news again, because we just may be nearing another inversion.

In this nine step analysis, we will review what yield curve inversions are, consider the potential for Fed rate increases leading to another inversion, explore the fundamentals of why inversions can be such an accurate early indicator of coming recessions, and look at the powerful information value for investors and investments.

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The ABCs Of Popping A Third Asset Bubble

Movies can have quite predictable plot lines that we know in advance - but we love them anyway. It could be a romance, where the girl is going to end up with the right guy through a series of improbable events, even though that looks impossible to begin with. It could be an action movie, where our tough and underestimated hero overcomes seemingly impossible odds to just barely win in the end, after all.

There are movies that play over and over again in the financial markets and the economy as well, and while the particulars change, the plots can repeat themselves.

In this analysis, we are going to take a look at a market "movie" that has played out twice in the modern era, and follow the A-B-C-D plot line that was followed in each case. We will then take a look at more recent events, see if A-B-C have been occurring, and ask if D could be coming after C for the third time in a row?

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Is Traditional Financial Planning Blind To The New Sources Of Profits?

Some investors are concerned that the future holds new risks which traditional financial planning strategies do not adequately take into account, and that this could lead to substantial underperformance in practice over the long term.

In this detailed financial analysis of the United States real estate market from 1975 to 2017, we will explore a quite different kind of risk with traditional financial planning - which is the inability to identify profits that can greatly exceed historical averages.

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Will The Federal Reserve Create Two Major Investment Arbitrage Cycles?

Martin Feldstein, who was chairman of the Council of Economic Advisors under President Reagan and is currently a Harvard professor, recently wrote an extraordinary editorial in the Wall Street Journal in which he strongly advocated that the Federal Reserve pursue policies that would: 1) continue to raise interest rates; and 2) thereby pop asset bubbles in the stock and commercial real estate markets; 3) which would cause an estimated $9+ trillion in investor losses; 4) possibly lead to another recession and the accompanying major job losses; and 5) would be followed by forcing interest rates down again to near historic lows.

This analysis has three goals:

1) To explore in detail what Feldstein is proposing and explain why he is proposing it with the best of intentions.

2) Using Feldstein's proposal as a tangible framework, understandably link what may seem esoteric to many people with the overwhelming practical implications for their personal lives and financial outcomes. We live in an age in which extraordinary and unconventional Federal Reserve actions still dominate the investment markets to an unprecedented degree - and not understanding what is happening, why it is happening and what may be coming next, provides no protection to investors whatsoever.

3) To lay out how what Feldstein is proposing (or something like it) would create a sequence of major price movements across the markets, including bonds, stocks, real estate and precious metals, that would not be a "random walk" - but can be understood in advance. This could allow for the use of two cycles of investment arbitrage strategies.

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Social Security Purchasing Power &  Quality Of Life In Retirement (Series Overview)

Social Security is not fully inflation indexed, and this is particularly true when we take into account the critical interrelationships between Social Security benefits and Medicare premiums. The in-depth series linked here provides essential information for Social Security decision making as well as financial planning for retirement.

How The National Debt, Interest Rates, & Inflation Can Change Investment Outcomes (Series Overview)

The United States government is heavily in debt, and is going still deeper into debt as the result of high annual deficits. As explored in this series of timely analyses, the large and climbing national debt is likely to powerfully impact future interest rates and inflation.

When we look at future stock prices, or bond prices, or real estate prices - interest rates and inflation will be of crucial importance. The relationships and timing identified in the series linked here have critical implications for the price paths that may be traveled by all the major asset classes in the short, medium and long term.