Investors must ignore 'animal spirits' that blind market reality
A recent working paper from the Wharton School in the United States tried to quantify 'animal spirits' in the run-up and crash of housing prices in 2008.
In his masterpiece 'The General Theory of Employment, Interest and Money', John Maynard Keynes introduced the concept of 'animal spirits', those 'spontaneous urges to action' that guide human behaviour. It concludes that markets are irrational and human instincts insert unpredictability into the world of business.
If Keynes' beliefs provide an accurate representation of today's market, how would this apply to the real estate market and in particular Dubai?
A recent working paper from the Wharton School in the United States tried to quantify 'animal spirits' in the run-up and crash of housing prices in 2008. It concludes that "sentiment had significant effect on housing prices, particularly in the boom and bust of 2000 to 2011". This conclusion is in line with the Keynesian economics that follows the ethos that 'markets are moved by animal spirits, and not by reason'.
When the Dubai market is analysed under the same lens, it helps us understand the irrational exuberance that was witnessed in the last bull cycle from 2004 to 2008, a superfluity of hopefulness followed by a depressing cycle of hopelessness. During the asset boom, we all saw speculators entering the market, trying to flip properties with minimal deposits and developers sell units with the hope of raising the funding through off-plan sales, but we did not understand the potential outcomes.
When the herd mentality takes control, it is difficult for an individual to step back and see the market from a bird's eye view, whether it be at the time of up cycles or down cycles.
Expo 2020 effect
In Dubai's current price cycle, the most obvious example of 'animal spirits' taking control was the price escalation during the run-up to the win of Expo 2020. The World Expo has the potential of boosting the economy of the host city as witnessed during past World Expo events. However, what investors failed to recognise was that the actual benefits of the event would accrue over a longer gestation period and closer to the event itself.
Over the 21-month period in the race to win the position as the host city, prices escalated by 40 per cent and another 18 per cent within five months after the win. A closer examination of the price hikes reveals that the largest increases transpired during times closer to the announcements and immediately after the win. However, months after the win, price gains began to decline as the euphoria of the event died down and speculative activity surrounding the event began to recede. This is an example of how animal spirits were ignited by an exogenous event, which could potentially have great economic benefits in the future.
It is easy for an investor to get caught up in the forces of animal spirits and media blinding them from the ground reality. In order to avoid falling in this trap, a rigorous analysis of the asset's real value must be conducted compared to getting swept away by investor enthusiasm.
Using the media as an indicator of forecasting inflection points is an ineffective tool, as there usually is a lag period between the published articles and ground realities. During the mid-2014 correction, prices had already plateaued but the majority of themes in articles were buoyant, with a general notion that prices would increase further.
It is this lag effect between "animal spirits" as reflected in the media and the "smart money" around inflection points that is the greatest indicator of the ineffectiveness of the media's impact on the predictive role of asset prices.
As 2015 came to an end and price drops began to bottom out, analysts and media flooded the eco-system once again with a general consensus that prices will continue to drop for the remainder for 2016. However, the recent uptick in transactional activity coupled with the strong macro-economic fundamentals at play could indicate another inflection point.
While is too early to state whether an inflection point has been reached, it is worthwhile to closely examine the data in the coming months to see if a base effect is established.
The writer is the head of research at GCP Properties. Views expressed are his own and do not reflect the newspaper's policies.