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 Are we running out of fools? Not if our pals in Washington have anything to do with it.
Even if you've never heard of the "greater fool" theory, you've certainly experienced it. The phrase - coined by John Maynard Keynes - describes the crazy phenomenon that causes investors to pay far more for an asset than its intrinsic value would demand.
It's been the chief driver of every stock market bubble in history.
"I'm foolish for paying this much," the logic goes, "but a greater fool will eventually pay me more."
If you've bought a house... I'm sure those words sound familiar.
They are the investing script that inflated the housing bubble that eventually brought the American economy to its knees.
What's worrisome, now, is that Washington is ready to do it again. It appears convinced that without "greater fools," the housing market will never grow - or at least not grow at the pace our economic puppeteers would like.
In this week's episode of the Slap in the Face Award, Steve McDonald tells us about the latest craziness in the housing market... and why he says "we all deserve what we get."
Click the video...
Click here to watch the video
Steve is right. What's happening is "beyond stupid." Educating yourself about what's going on is the first step. It will ensure you're not a victim. But it won't put any coin in your pocket. For that, we have to look at who's playing the game.
The key is to take advantage of what's happening without getting involved in the foolishness.
Stick with assets that remain tied to their intrinsic value. If you can't measure it or if the measurements are skewed, it's simple. Stay away.
There is no doubt Wall Street's big banks will benefit from a reinflated housing market, but you need a polygraph to sort through their balance sheets. Stay away.
A clearer way to profit from the trend is through homebuilders. That's not an earth-shattering idea by any means. But remember, these companies become riskier as the bubble expands. If you are going to invest in the sector, be sure to have a firm exit strategy... and stick to it. Carefully monitor their fundamentals, and homebuilders like DR Horton (NYSE: DHI) and PulteGroup (NYSE: PHM) are direct ways to play rising property and home prices.
Another simple option, with less risk, is to look at real estate investment trusts (REITs). These companies own large chunks of real estate with a variety of uses - from apartments to malls to hospitals. They often pay strong dividends, which make them popular for income seekers.
A recent headline-grabbing REIT is American Residential Properties (NYSE: ARPI). Going public just last year, the company invests in single-family rental homes that it acquired after the recent housing bust. It represents perhaps the most direct way to play Washington's latest mortgage-market move.
Be warned, though. If we see housing prices soar, American Residential Properties will rely on "greater fools" to keep profits growing.
As Steve says in his video, "In 2008 we could plead ignorance because few of us really understood what the government had done with mortgages." But that's not the case today. We know exactly what's happening. Washington is lowering its standard... struggling to find the next fool.
That's the key with all of this. We know the script.
Yes, you can certainly make big money playing a housing rebound, but invest in assets with measureable intrinsic value.
Your investment strategy should never rely on the ignorance of others. Do it often enough and you'll end up the greatest fool.
Good investing,
Andrew Snyder
Editorial Director, The Oxford Club
To access the Investment U archives, please visit InvestmentU.com.
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