Maybe It's Time to Buy

By Deals | Allan Sloan
Sunday, December 7, 2008

Has there been a time that feels worse than now to talk about houses and stocks? Not in my 40 years of writing about business.

The sickening collapses in house and stock prices from their peaks have trimmed about $13 trillion -- almost a year's output for the entire U.S. economy -- from Americans' net worth. Not since the Great Depression almost 80 years ago have we seen anything like these simultaneous housing and stock implosions, and back then houses and stocks were owned by only a relative handful of Americans, whereas in today's world, two-thirds of us own houses and half of us own stocks.

It's really scary out there. The S&P/Case-Shiller index, which measures housing prices in 20 big markets, continues to fall. Foreclosures mount; dire predictions fill the air. The stock market lurches up and down like a roller coaster on steroids, and seems to fall -- or occasionally rise -- by 5 percent or more every other trading day. Each weekend, you expect to hear that yet another big financial institution has to be closed down or bailed out by federal regulators. Lots of us who have invested for years (including me) have had a big part of our net worth wiped out almost overnight. It makes you feel like crawling into a cellar, closing the door and not coming out until the all-clear signal sounds.

But even though housing and stocks may be the last things you feel like talking about, they are things that you should talk about. That's because for the first time in years (or maybe decades) prices of homes and U.S. stocks have fallen low enough to be considered reasonable long-term investments again.

No, I'm not suggesting that you run out and binge-buy houses and stocks. Even though they have fallen about 25 percent and 45 percent, respectively, from their peaks, houses and stocks could well fall further, possibly much further. That's what happens when bubbles deflate -- things can fall into a reasonable-value zone, then keep falling until they're unreasonably low. It's the other side of an inflating bubble, during which prices can keep rising even after they're unreasonably high.

But if you're prudent -- I'll define that a bit later -- and if you're willing and able to commit your money for at least six years, I think you'll wake up in 2015 or 2016 and see that you've done okay. You won't make the nearly 20 percent a year that U.S. stocks generated during the 1982-2000 bull market, or the even bigger gains homeowners and flippers made on their investments early in this century, when the housing bubble inflated. But you're more than likely to make some reasonable money, much more than you'll make hiding out in Treasury securities or money market mutual funds.

But before you rush to write checks, please remember that you shouldn't put money into stocks or houses or other investments unless you can do it while adhering to the three eternal verities of financial survival. They are: Live within your means or below them; shun credit card debt like the plague it is and don't borrow except for an education, a home or a car; and use your house as a place to live, not as a cash machine or a get-rich-quick scheme.

In addition, don't start investing until you've accumulated an adequate reserve fund. To me, that means enough to cover your bills for at least three months if you (and any other employed people in your household) lose your job (or jobs).

The only exception would be to invest modestly in a 401(k) or similar retirement program to take advantage of your employer's matching contributions.

Now to our discussion. Let's start with stocks, which are easier to analyze and invest in than houses are. Stocks are selling at about the same prices they were 10 years ago, which means the U.S. market as a whole has been dead money for a decade. But that may be changing. In fact, some of the smartest long-term investors in the country, who had largely shunned stocks for years, now say that stocks have moved into a reasonable zone.

Bob Rodriguez of FPA Capital told a Fortune magazine roundtable that the number of stocks that pass his value screen has risen to 447 (out of 10,000), up from only 33 in June 2007. Jeremy Grantham of GMO, another roundtable participant, considers stocks to be reasonably priced for the first time in years. Stocks have reached reasonable levels even by the tough standards of Yale professor Robert Shiller, famous for calling both the stock and housing bubbles.

However, that doesn't mean that the U.S. stock market is risk free. Far from it. No matter how cheap stocks may look, they can get significantly cheaper. The classic example: Warren E. Buffett, the best investor of our time, who issued a buy recommendation on the U.S. market in an Oct. 16 New York Times op-ed article. Standard & Poor's 500 closed at 908 the day before Buffett's article appeared and subsequently fell as low as 741. It's 871 as I write this. (Disclosure: Rodriguez's mutual funds and Buffett's Berkshire Hathaway are two of my family's biggest investments.) Buffett is a director of the Washington Post Co.

The unstated assumption behind what Buffett and these other folks are saying is that you must have the stomach and financial resources to survive declines, possibly very steep ones.

Let me elaborate. You need to have staying power. Don't borrow to buy stocks. Don't use your eating money or next year's college tuition money to buy stocks. Don't bet on having a much better year financially than you're having now unless there are special circumstances, such as being a medical resident about to become a practicing physician. Invest only money that you can afford to tie up for years, if not decades, and that you can afford to lose.

And now to houses, which are much trickier than stocks. That's because while you can buy a piece of the whole U.S. stock market through an index fund and thus diversify your risk, you cannot buy a piece of the total U.S. housing market. You can buy only a house -- and you have to take on a lot of debt to do it, which in itself increases your risk.

Nationally, house prices on average have begun to look reasonable for the first time since 1999, when the housing bubble began. The steep drop in home prices has made them relatively cheap in terms of rent and family income. Those relationships matter because when prices are rising much more rapidly than income (the case until last year), more and more people get priced out of the market. So in order to play the game, buyers and their lenders have to take on idiotic risks -- option ARMs, anyone? -- that ultimately make buyers and lenders look like idiots.

The National Association of Realtors affordability index (the median income divided by the median mortgage payment) has risen to 1.42 from 1.08 in 2006, the height of the real estate bubble. That means that the median household income is 142 percent of the median mortgage payment, up from 108 percent. This index assumes a 20 percent down payment and doesn't cover real estate taxes, insurance or other home owning expenses. Thus "affordability" is in the eye of the beholder (or mortgage lender). But the trend is what matters, not the specifics that the index measures.

Then there's an index kept by David Wyss of S&P. It shows that the ratio of average house prices to average income has dropped to about 2.45 from 3.41 in 2006. That means houses are becoming cheaper relative to incomes. Finally, there's the rent-own index by Louis Taylor of Deutsche Bank, which compares the cost of renting a home with the cost of buying it. Those numbers are starting to reach the point where house prices may be supported by people who buy them to rent them out.

But just because those indicators are improving doesn't mean that buying any house in any market is a good deal. A lot of people tried doing that during the great housing bubble and got burned. House markets are intensely local, even though mortgage financing is national.

When I talk about buying a house, I'm talking about making a serious down payment -- call it 10 percent or 20 percent -- and borrowing the rest at a fixed rate for 30 years. You accumulate that down payment by living below your means and saving. You can probably buy with less money down, but the less you put down, the more you have to borrow, and the bigger chance you're taking.

So there you have it. If you've gotten this far, I hope that you're more hopeful thinking about houses and stocks. They may well be cheaper when the 2010 Fortune Investor's Guide rolls around than they are now. But if you buy conservatively and have staying power, I think you'll feel a lot more optimistic when you read the 2016 issue.

Allan Sloan is Fortune magazine's senior editor at large. His e-mail address is

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