History's Lessons in Stocks & Real Estate

I'm sure most of us can remember back to the very late 90s and early 2000 in the stock market. Seemed like every day was an up day. With the benefit of hindsight, we see now that, for a variety of reasons, equity valuations had gotten way out of line. One of the ways to measure that excess is to look at what happened to household equity holdings as a percentage of GDP. At its peak, household equity holdings hit 140% of GDP and then promptly cratered. Here's what that looked like:

Source: Federal Reserve Board, Merrill Lynch

The excesses of the stock market were wrung out with some nasty declines and a recession that began in March 2001 and lasted until November of that year.

With the benefit of that knowledge, and that picture as a reference point, let's now consider what has happened to household real estate holdings as a percent of GDP (starting at the same point in time: 1985):

Source: Federal Reserve Board Series FL155035015, Bureau of Economic Analysis

The simple fact of the matter is that real estate assets as a percentage of GDP have got a long way to come down before they're even remotely in line with historical norms (it recently touched 153% of GDP, signalling an even larger bubble than the stock market had been). The deflationary environment in the housing market, I fear, is going to be around for quite some time. There is simply no painless way to undo what has been done. The Fed can help, but nature must take its course.

ADDING: This is an appropriate place to invoke Bob Farrell's 10 Rules for Investing, specifically #4: Exponentially rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.