The two bubbles that have inflated and burst over the past fifteen years are making it painfully apparent that the stock market is entering an era of volatility that will be defined by terminally repeating boom and bust cycles. The fundamental driver of these cycles is the insistence by politicians that government ‘do something’ about every economic adjustment. Unfortunately, this process of ‘doing something’ is frequently financed by borrowing from the future or printing money to spend in the present. Over the long-term, this distorts incentives and creates booms and busts of increasing magnitude.
The way that these distortions work through the economy is by generating the appearance of increased demand to businesses. (Consider than an individual business cannot distinguish between higher prices that are driven by more demand and higher prices that are driven by inflation) As businesses attempt to adjust to this perceived demand increase, they hire more people and order more supplies. This generates ripples throughout the economy that create the appearance of an economic recovery, which last until it becomes apparent that the perceived increase in demand was not real. At this point, businesses will bleed inventories, release workers from employment, and cut costs. This will also ripple out throughout the economy, drive the boom, and bust spiral downward.
The Boom and Bust Cycle
The key to riding this boom and bust cycle is the ability to recognize when a boom is being stoked so that optimal value can be captured from your investments. Similarly, it is important to understand when a bust cycle is playing out since the best buying opportunities are frequently presented during times of economic destruction. Ultimately, this means that successful investors must become adept at ‘swimming against the tide’ and selling out when the market looks hot, along with buying in when the market is ice cold.
The ideal way to structure deals so that market cycles can be navigated successfully is through leveraged income property investment. The reason for this is that the revenue from the tenant rent will allow the investor to ‘outsource’ the mortgage payment so that a downward adjustment in market prices does not force the investor to sell at a loss. This ‘staying power’ allows the investor to ride the market cycle back up after the bust so that when the asset is sold, it can be done so at a profit that is reinvested in new opportunities. This entire strategy rests on purchasing investments that are sensible from day one.
As investors, we do not have the ability to influence this up and down cycle caused by irresponsible government policies. However, we do have the ability to structure our investments in such a way that we can benefit from the cycle of irresponsibility that creates repeated economic booms and busts. It is not possible to precisely time the turns of market sentiment, but it is quite possible to create a portfolio that derives maximum benefit from the inevitable changes in sentiment by studying the course of past market cycles and recognizing the growth of bubbles before they burst.
Action Item: Train yourself to ‘swim against the tide’ of popular sentiment so that you are not caught up in the booms and bust of manipulated markets. Understanding the fundamentals of what creates market cycles is what will allow you to recognize when they are being stoked and when they are primed for collapse. (Top image: Flickr | mudpig)
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The Jason Hartman Team
“The Complete Solution for Income Property Investors”
