Saturday, November 04, 2006

Stocks Up and Real Estate Down?

A Tale of Two Headlines

by Peter G. Miller

It's been difficult to pick up a paper during the past few weeks and not notice two major stories: The Dow Jones Industrial Average reached a record 12,000 while real estate values are falling.
A recent visitor from Mars could look at such headlines and instantly conclude that the best place to invest one's money would be the stock market. However, a savvy Earthling might want to look with a little more care.

The old DJIA record was established on January 14, 2000 when the Dow topped out at 11,722.98. At the close last Wednesday the Dow stood at a new high: 12,134.68. That's an increase of 411.7 or just 3.5 percent over almost seven years.
Investors during the same period would have done better with a passbook savings account at 1 percent per year.

The Dow today is not the same as the Dow in 2000 because the same bundle of stocks is not being measured. In April 2004 three firms on the Dow were replaced. American International Group, Pfizer, and Verizon Communications were added while AT&T, Eastman Kodak and International Paper were dropped. In other words, comparing the Dow in 2006 with the Dow in 2000 is not the same as comparing apples with apples, it's comparing apples with yogurt.
Corrected for inflation it would take $13,813 today to buy the same package of goods that $11,723 would have bought in 2000.

The Dow does not reflect the entire marketplace. As examples, the NASDAQ stood at 2,356.59 on Wednesday, down more than 50 percent from the 5,048.62 reached on March 10, 2000. As to the S&P 500, it closed on Wednesday at 1,382.22 -- significantly below the 1,527 level reached on March 24, 2000.

One of the reasons per share prices and dividends have been rising is very simple: Shares are being bought back by issuing companies, which means there are fewer shares available for purchase. At the same time, the number of dollars pouring into retirement accounts increases by hundreds of billions of dollars each year.

For example, companies in the S&P 500 bought back shares worth $116 billion in the second quarter of 2006, a record and 175 percent higher than the second quarter of 2004.
"The record $116 billion in buybacks is the result of over 40 percent of the S&P 500 companies reducing their share count during the second quarter," says Howard Silverblatt, Senior Index Analyst at Standard & Poor's. "The unprecedented expenditure on buybacks and the resulting share count reduction is having a material affect on both earnings-per-share and cash flow. Left unabated, this will eventually impact the supply of open market shares, and therefore the share price itself."

Okay, what about those falling real estate values?

According to the National Association of Realtors existing home prices stood at $220,000 in September, down 2.2 percent from the $225,000 recorded in September 2005.
Even with the new math you have to say that $220,000 is less than $225,000. But how many people buy and sell a house within a year? Isn't real estate a long term investment, something people own for years on end and often for decades?

Let's go back. It turns out that in 2000 -- when the Dow hit the then-record of 11,722.98 -- the typical existing home sold for $139,000. In other words, while stocks have been treading water since 2000, the typical home increased in value by $83,000.

What does it all mean?

First, despite recent news, real estate has done remarkably well in most places and for most people during the past few years when compared with the stock market.
Second, broad indexes -- whether up or down -- are fun to follow but may not be especially useful. No one buys all stock or all real estate, we purchase a particular stock or a given property. For instance, it's surely possible that contrary to the movement of broad indexes in the past few years some stocks rose terrifically while some homes saw significant value reductions.

Third, financial decisions should be made in the context of the particular investment being considered. National trends and broad indexes are nice, but really they're just financial background noise. Most importantly, neither national indexes nor prior experience tells us with certainty what will happen in the future. As stock brokers explain, past performance does not guarantee future results.

For more articles by Peter G. Miller, please press here.
Published: October 31, 2006

For more info on local housing values, go to www.ColoradoDreamHomes.net

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