The Dangers of Value Manias - dummies

The Dangers of Value Manias

Value stocks aren’t immune to manias. The value sector contains a large percentage of bank and financial services stocks. The inflation of the 1970s generated a lot of real estate lending by banks and savings and loans. However, when Congress shortened the real estate depreciation schedules in 1986, many real estate projects became untenable. Stock prices of major banks declined as much as 75 percent from 1989 to 1990.

Because value-oriented stocks sat out the growth stock mania of the late 1990s, they didn’t have major gains to surrender in the bear market of 2000 to 2002. However, they made up for it by funding the mania in housing prices from 2004 to 2007. After the marginal buyers were sucked in with teaser adjustable-rate mortgages, no one was left to buy. Supply overwhelmed demand, which in turn started the decline in home prices. Financial panic ensued when bonds backed by shaky mortgages turned bad as housing prices declined. Again, stock prices declined dramatically.

However, one segment of the value-oriented universe did extremely well through the housing debacle of 2007 to 2008. Energy and commodity prices soared beyond anyone’s wildest expectations. Ten years ago, the price of oil was scraping $10 per barrel. The low prices of the late 1990s caused oil companies to de-emphasize finding new energy sources because of the low return on investment. But as demand from emerging nations such as China and India increased, supply couldn’t keep up with demand, and energy and commodity prices skyrocketed along with their associated stock. But high energy prices sow the seeds of their own decline. At some point, the economic dislocations caused by higher energy prices will overwhelm the growth in demand for energy, and prices will decline. The only question is when.