Something interesting happened yesterday. The 5 year Treasury yield sailed below its historical all time low. In July of 1954 the 5 year Treasury yield spent a month below 1.9%. This was a temporary one month vacation and the only time since the Federal Reserve has kept records that the government’s 5 year bond yield has been below the 1.9% mark. Until Yesterday.
As of yesterday the 5 year Treasury bond is carrying a yield of 1.46%. That is over 21% below the unprecedented all time low in July of 1954. The amazing part of the equation is that it is still trending lower. It is 21% below the record and still trending lower! It reminds me of the famous line delivered by Kathy Bates playing the unsinkable Molly Brown in the movie Titanic. From a lifeboat as she was watching the ship sink she deadpanned: “Now there's something you don't see every day”.
I believe that Molly Brown’s line is appropriate today. We are incurring many events that our nation has never seen before. But the problem is not the events that we are seeing but our reaction to them.
The artificially low rates should be a specter of warning to investors. We are entering a period filled with financial icebergs. The only way to survive is to slow down and be more careful than anytime in your life.
Unfortunately most people are not heeding the warnings in the economy. We have events happening that are unprecedented and many investors are ignoring them as high end real estate, most commodities and all long term bonds are in bubble.
As individuals and as a nation we are steaming full speed into a sea filled with icebergs on a ship that is horrendously overloaded with debt.
My only thought at the moment is that anyone that is stretching to buy a home in the "high end" real estate market is buying a ticket on the RMS Titanic Housing Bubble II.
Low interest rates are pushing people into buying homes that they can’t afford.
Historically people will buy a home that is 3 times their household income. The low interest rates of today are allowing people to buy homes that are more than 6 times their household income.
I would like to suggest that this is 100% above the historical norm! So if you are buying a home today that is 6 times your household income you are making a highly leveraged bet that house prices will never come back down to historical fair value.
And I would like to add that there is definitely a possibility that home prices can go below historical fair value. It is happening in many, many lower end housing markets! Some markets are bottoming at historic valuation lows.
Because of our unsound economy and the historically low interest rates it is very, very imprudent to pay above historical valuation metrics for a home. Lower risk tolerances of investors in the future will lower prices. Higher interest rates will crush prices. Another recession will sink the boat.
The tried and true valuation metrics that you should follow to determine a prudent price of a home is 3 times your household income. And you should not buy a home that has monthly costs that are significantly higher than the monthly costs to rent the same house. Historically, the rule of thumb is not to pay more than 180 times the price of monthly rent for a house.
These are metrics for a normal economy. Presently we are living through the most unsound economy in our nation's history! Is this really the time to stretch your budget and borrow a million dollars to purchase an historically overpriced home?
There is still a flood of investors paying far above historical valuations for high end real estate. They are ignoring the economic warnings up ahead. They are ignoring the valuation metrics of the past.
To all of the speculators that are contemplating running full throttle into the purchase of high end real estate - Godspeed.