Peninsula outlook 2018: Stocks and real estate
Until about a year and a half ago this was one of the most hated stock bull markets in history – few wanted to believe. We had fears of deflation, recession, Brexit and plenty of political uncertainty. The fear of losing money, still fresh in the minds of many investors pummeled during the 2008-2009 crash, kept enthusiasm relatively low. But, over the past year or so we have witnessed a change in investor behavior that is reminiscent of late-stage bubble action – we saw a melt-up in prices. More recently, however, markets have come under pressure as investors come to grips with a fairly substantial uptick in interest rates and the prospect of an accelerating economy.
The sharp rise in the market since late 2016 has pushed stocks to the second highest valuation in history. With the CAPE Ratio (cyclically-adjusted price-to-earnings) now sitting at 32, even when factoring in the February declines, the only more expensive market in history was the 2000 Dot-Com Bubble, when valuations hit about 30 percent higher than where they currently stand. So, there shouldn’t be much debate about whether or not stocks are back in bubble territory. But, when will the party end? Well, if we get through this current volatility and stocks find a floor, and if the bubble once again starts to exhibit euphoric investor behavior, then we may well see another 20 percent to 30 percent increase over the next couple of years. It sounds ridiculous and quite optimistic I know, but this would be fairly typical price action of a bubble. If this plays out as history would suggest, it would take the Dow Jones up over 30,000 in what could be one last flurry of price acceleration as speculators embrace greed and throw money blindly at the market. Jeremy Grantham (the well-respected institutional money manager at GMO) recently wrote about investor behavior when markets are in bubble territory and others, including Robert Shiller (Yale economist) and Bill Miller (well-known fund manager) have echoed similar thoughts about the current market exhibiting signs of speculative behavior. It is important to note that the euphoria that had been missing during this long bull market finally started to show in 2017. And, it’s worth noting that any temporary weakness we may get, may indeed be fleeting. We are in a midterm election year , when we often see the worst pullback in the market of the four-year presidential cycle. History has shown that short-term declines in midterm election years have averaged nearly 17 percent since 1950, so any significant pullback may be a nice buying opportunity. And, for those who can hang on for the ride, the subsequent 12-month gains (2019) from the lows could be impressive with average historical returns of 32 percent.
Assuming we get through the recent correction in stock prices and the bull market resumes its upward trend, I certainly hope the scenario laid out by Grantham comes true (He sees potential for another 30 percent rise in the broad market over the next couple of years). But, as I have written about on many occasions, it’s impossible to predict the catalyst for the bursting of a bubble and it’s also impossible to predict the duration of any bull market (bubble or not), so there is no denying that risks are elevated at this point. If the upward trend persists and prices push further into nosebleed territory, my intention will be to reduce stock exposure significantly at that time. We have no way of knowing if we’ll experience a crash following such a steep final leg higher (if we get it) or simply a garden-variety bear market (decline of 20 percent or so), but I think the probability of a pretty severe decline will be high.
I checked in with local Registered Investment Advisor and Chartered Financial Analyst Joe Gagnon, to get his take on the current market and the economy. Why Joe? Well, I can count on one hand the advisors and money managers I know of who predicted both the Dot-Com Bubble and subsequent crash in 2000-2002 and the Housing Bubble and collapse of 2008-2009, and Joe is one of them. I heard Gagnon warn of the risks of both of these bubbles before they popped. Gagnon has more than 30 years of experience navigating the markets and is a longtime Palos Verdes Estates resident.
Revenue growth no longer enough
Chaussee: What’s your outlook for the markets?
Gagnon: Given elevated valuations and high profit margins, total returns for stocks will be well below average, likely in the 0 to 5 percent range annualized over the coming 5 to 10 years.
Chaussee: Do you anticipate a recession and/or bear market in the next year or two?
Gagnon: I don’t see a recession on the horizon because the corporate tax cut will likely have a positive impact on the economy. But, if we get through the current drawdown and the melt-up in stocks continues, we could very well follow that at some point with a bear-market correction of greater than 20 percent.
Chaussee: Are there any places left to find value in the stock market? What would you avoid?
Gagnon: There is some value left in the energy and retail sectors. I’d avoid the hot momentum stocks, in particular, Amazon, Netflix, Tesla, etc. where valuations are surreal and expectations are very high.
Chaussee: What should investors do if they are concerned?
Gagnon: As the market trends higher, raising cash and being patient is the best bet.
Chaussee: What’s your take on the bond market?
Gagnon: The bond market is overvalued and has been for years. Interest rates have stayed low much longer than most investors have expected. The economy, due to high debt levels, is very sensitive to interest rate changes. So, if rates were to rise too quickly it likely would cause economic growth to stall and rates would fall back.
Chaussee: How about real estate?
Gagnon: Because of low interest rates, real estate values in some markets have hit all-time highs. There are pockets of overvaluation, but real estate is not as crazy as in the last financial crisis. It remains to be seen how the change in tax law will affect real estate in the high tax states like California. On the margin it is negative. Certainly, if rates were to rise, real estate could come under substantial pressure.
Chaussee: What similarities do you see between the current market and the exuberance of the Dot-Com Bubble in 2000 and the Multi-Asset Bubble that burst in 2008?
Gagnon: The current high valuations of the large momentum stocks certainly are similar to the Dot-Com Bubble and the Nifty-Fifty Bubble of the early 1970s. The Amazon phenomenon has become so great that it seems every day the company disrupts another industry. Indeed, Amazon has disrupted many businesses already, but with a $700 billion market value, the company will, at some point, have to deliver profits sufficient to justify that valuation. Currently the market only cares about revenue growth for these companies. It’s mindful to remember that Microsoft’s revenue per share has grown over five times in the last seventeen years since the Dot-Com Bubble burst, yet it was only in the last year that Microsoft’s stock price surpassed its 2000 high.
Chaussee: Any comment on Bitcoin?
Gagnon: That is one thing that is unique to this market — the Bitcoin Bubble – and it looks like it may have just popped. It is certainly very frothy and it’s hard to believe that world governments are going to give up control of their monetary policies to cryptocurrencies.
Peninsula Real Estate holding steady
Stocks aren’t the only asset class pushing back into bubble territory – the U.S. housing market, while lacking some of the euphoria present in 2006, still shows prices that are higher, relative to household income, than any other time in history. So, perhaps the Housing Bubble of 2006 makes today’s prices seem relatively tame, since we don’t have the same level of enthusiasm in the market, but in my humble opinion, real estate appears to be on the cusp of another bubble.
I touched base with some real estate professionals to weigh in on the local market and trends on the Peninsula. Here’s what they had to say.
Heidi Mackenbach is part of the Fountain-Mackenbach team at Re/Max Estate Properties. She is a Realtor and Senior Sales Associate with 28 years of experience.
Chaussee: Give me your take of the current market on the Peninsula?
Mackenbach: We’ve been on an upward trend over the past seven years. Going forward, I still see real estate on the Peninsula holding strong. You could argue we have plateaued in some areas, but it’s very difficult to generalize about prices in Palos Verdes. Palos Verdes is very neighborhood or area-specific.
Chaussee: Which areas have been the strongest in the past year or so?
Mackenbach: Palos Verdes Estates, for sure, has been the strongest. Leading the way would be Lunada Bay, followed closely by Malaga Cove. And, any property that has a feature that is highly sought after – a big flat lot or an outstanding view, for example. We have seen so many buyers and such demand for these types of properties that some listing prices have been driven from $2.6 million to perhaps $3.4 million.
Chaussee: Has the demand come from move-up buyers or has it been more from out-of-state or out-of-country buyers?
Mackenbach: The demand has mainly come from move-up buyers with families moving in from the Beach Cities or perhaps the West Side.
Chaussee: What do you think the percentage appreciation was in 2017 for 90274 and 90275?
Mackenbach: In Lunada Bay we saw appreciation of perhaps 10 percent last year. In Valmonte, appreciation was around 8 percent and Malaga Cove was up around 10 percent. But other areas, in the same zip code, like Rolling Hills, was flat. Rolling Hills is a different market and in some cases I think there was no appreciation at all last year. In 90275, most areas of Rancho Palos Verdes, I would think appreciation averaged 5 percent.
Chaussee: Would you define the market as still a “seller’s market?” Are homes moving pretty fast?
Mackenbach: Yes, if priced reasonably they are selling within 30 days. If the price is set too high or there is some feature that is disagreeable, then it can take over 90 days to sell and that may involve a price cut. For desirable homes that are priced correctly, we are still seeing multiple offers. We aren’t seeing the same level of high activity we saw last spring (March-May), but for good properties we can see several strong bids. One thing that will keep demand high is that inventory is very low and it appears to be trending down too.
Chaussee: What do you think will be the average price appreciation over the coming 5 to 10 years?
Mackenbach: I think 3 percent or so averaged annually. I don’t see a heated market from here that would push prices up much more. At the same time, I don’t see a potential price drop on the horizon either. We have good job growth,low inventory and plenty of demand. Also, I think the bump up in interest rates hasn’t hurt the market much because it was anticipated.
Chaussee: Are there any areas or neighborhoods that have been overlooked where you see an excellent opportunity for potential buyers?
Mackenbach: The strongest area may be Rolling Hills Estates because of the improvements at the Country Club. The Country Club should really boost home prices near the Club and Rolling Hills Estates.
Chaussee: Do you know the median sale price for 90275 in the past year and the same for 90274?
Mackenbach: I think in Rancho Palos Verdes you’re probably looking at $1.4 million and perhaps $2 million in 90274. There is rarely a home sold in Palos Verdes Estates under $1.5 million and that might be a small home or a fixer. We are definitely at all-time highs in pricing on the Peninsula.
Chaussee: Does it make sense to wait to purchase a home?
Mackenbach: When you are buying a home for your family it is an investment and it is typically a long-term purchase too, it would be better to go ahead and buy. If you’re looking at short-term,it would be better to rent.
Darin DeRenzis is a partner at Vista Sotheby’s International Realty. Darin has 13 years of experience in real estate.
Chaussee: What’s your take on the local real estate market. Is it healthy?
DeRenzis: The market remains a seller’s market and the reason for that is the low inventory. There is about two months of inventory on the market. A neutral market would show inventory of perhaps four to five months. But, what’s interesting about this is that despite the low inventory, which should favor sellers and price appreciation, the median home sale on the entire Peninsula last year only showed an increase of a couple percentage points. But, if you look at specific neighborhoods on the Hill, the median prices are all over the place. Valmonte, Lunada Bay and Malaga Cove have all been very strong, but there are other areas, Rolling Hills, for example, that have been slow and haven’t appreciated much in the past year.
Chaussee: What do you see as forward-looking appreciation potential in the coming years?
DeRenzis: We have not seen such extreme price appreciation that it would lead me to think we are in a bubble. I think the economy in the South Bay is as strong as it has ever been. I would tell a client buying at today’s prices to hope, if not assume, that price appreciation would equal the average annual return that we have seen historically, which would be approximately 4 percent. I would hope we stay in that range. I would not want to see much more than that because I don’t think anyone wants to see the euphoria that led to the recent Housing Bubble – it didn’t end well.
Chaussee: What could throw off your forecast?
DeRenzis: An economic event on the national level could affect us. Perhaps a substantial increase in interest rates. Loans are still around 4 percent, but the Federal Reserve is on a path to higher rates for sure. If we saw a significant jump in rates then it certainly could affect the market. Another consideration is the change in tax policy. We have some of our write-offs going away like limits as to how much mortgage interest we can deduct, but if income tax brackets drop, perhaps that will offset the mortgage interest deduction cap. I don’t think any of the tax policy changes we will see this year will affect the high-end real estate market – the homes that are priced at $3 million and up.
Chaussee: Do you see any areas that have been overlooked or that offer a good opportunity?
DeRenzis: I think Silver Spur may fall into that category. The area has improved with the quality of the remodels. Overall, Palos Verdes is a very mature market and buyers know it well. But, I do think that some of the value on the east side of the Hill is overlooked as opposed to the west side. So, from that perspective I think you could say it has been overlooked somewhat.
Chaussee: The buyers you are seeing now, are they move-up buyers?
DeRenzis: Yes, they are coming in from the Beach Cities. They see they can get a lot more house for their money on the Peninsula now. From a median home price perspective per square foot, Hermosa and Manhattan Beach are more expensive than Palos Verdes. But, Palos Verdes is huge, so I am grouping the entire Hill and somewhat generalizing. If you take certain neighborhoods like Lunada Bay or Malaga Cove versus Hermosa or Manhattan Beach, you might not see such a difference in price per square foot.
Chaussee: What would you guess would be the median price on the Peninsula right now?
DeRenzis: If you factor in every home on the Peninsula, condos and townhouses included, I would think approximately $1.35 million. But again, this includes everything on the Hill. I think the bottom of the market was around 2011 and we hit $850,000 as a median price and we’ve come up substantially from there.
Les Fishman is part of the Butler-Fishman Team at Coldwell Banker. He is a Realtor and Associate Broker with 40 years of experience.
Chaussee: Les, what’s your outlook on the local market here in Palos Verdes?
Fishman: I think we can characterize it by low inventory and high buyer demand. It’s been that way for the past couple of years. What is happening, unlike in the past, is that properties are now coming on the market and they aren’t sitting there for very long, so we don’t have an accumulation of properties for sale. Properties are selling quickly. In 2017 we saw a pretty good uptick in appreciation too.
Chaussee: What percentage appreciation did Palos Verdes get last year?
Fishman: It depends on the area, but I’m guessing it probably averaged 4 percent or five percent. We are definitely in a seller’s market. That’s evident given the inventory and we’re also seeing multiple bids. We list, possibly with a price in the low-end range of what we believe the value is, and most of the time they will sell over the list price. It’s all about pricing a property correctly at the outset.
Chaussee: What does the inventory look like?
Fishman: For single-family homes, it’s probably under three months. There are 102 single-family homes on the market right now. As recently as November there were 122. In prior years, when it was tougher to sell a property we used to see the inventory at six or seven months, but now it’s pretty low. The median home price in Rolling Hills Estates as of November 2017 was $1,493,000. The median in Rancho Palos Verdes was $1,512,000 and Palos Verdes Estates had a median price of $1,903,000.
Chaussee: What’s your forecast for price appreciation over the coming years?
Fishman: My gut tells me maybe 2 percent to 3 percent average annual price appreciation. I’d want to be fairly conservative with my projection.
Chaussee: If buyers are going to see at least some price appreciation over the coming years, albeit nothing too spectacular, would you still recommend buying versus renting right now?
Fishman: Yes, real estate has been a very good investment over a long period of time. The people who have been hurt in real estate have been those who were forced to sell during a downturn. There are a lot of reasons to purchase too that aren’t necessarily financial – pride of ownership and the ability to make improvements to a property that might not be possible as a tenant. If one is looking to rent right now on the Peninsula it is very tough to find a single-family home under $3,000 per month. And, that is probably a three-bedroom, two-bath, 1600 square foot home. For a more desirable property you would have to pay at least $4,000 monthly.
Chaussee: Given the appreciation we have seen in the past 7 years, are there areas on the Peninsula that have been overlooked? Any bargains left?
Fishman: Maybe in East View – that side of Rancho Palos Verdes. It’s tough to find hidden value. There are buyers who want fixers to invest in and perhaps flip, but those homes are rarely on the market for long and tough to find. The buyers from the Beach Cities have been moving to the Peninsula in recent years because you get so much more for your money. And, the schools are some of the best in California too.
Chaussee: Do you see any evidence that we are back in a Housing Bubble or that we will have one again?
Fishman: I don’t think there is a bubble at all despite prices having risen quite a bit. There is healthy demand and people want to live on the Peninsula for various reasons. If we had a glut of inventory because of a really steep increase in price, then maybe we’d have a problem. But, the desirability of living here and the lack of inventory has kept the market healthy, without overheating.
Chaussee: What could change your mind, what would be a warning sign that the real estate market could be in trouble?
Fishman: A serious rise in interest rates would have a numbing effect on the market. It appears they will be rising and that should keep a lid on prices. The other unknown out there is how the recent tax changes will play out. If our mortgage deductions are limited that could put a damper on the market, but it doesn’t change the fact that this is a really desirable place to live.
Disclaimer: The opinions expressed by the professionals interviewed are their own and do not necessarily reflect those of the organizations or companies they work for.