Investment is about sentiment, not value

November 18th, 2008 | economy, emerging markets, real estate

One of my most profitable investment tools has been an understanding of why sentiment can often produce counter-intuitive results. Consider this statement by the Indian Finance Minister Chidambaram:

“Hotels must cut tariffs; airlines must cut prices; real estate must cut rates of apartments and homes they sell; car makers and two-wheeler makers must cut prices,” he said, while addressing industrialists at the Indian Economic Summit being organised by the World Economic Forum and the CII in New Delhi.

FM asks realty firms, airlines to cut prices

Of course the Finance Minister wants GDP growth at the cost of profitability, especially in an election year. Every economic transaction adds to the GDP, even if it is loss making for the parties involved. You could boost GDP by paying half of the unemployed workforce to dig a ditch, and the other half to fill it up (yes, India actually has a program along those lines.)

But the deeper question is - why don’t these industries (especially real estate) cut prices to get inventory moving ?

The answer lies in sentiment - real estate is not supposed to go down. Realtors have sold the emerging markets this marketing drivel for too long. A normal market would attract buyers as prices go down. But in today’s sentiment-driven world, reducing prices actually might scare away buyers who see something that “isn’t supposed to happen”. Realtors worry (correctly) that a precedent of lower prices will encourage buyers to wait even longer.

So now we wait for the ongoing credit crunch to force the realtors to sell sell sell, and for the sentiment to turn. And you can bet the market will overreact on the downside too.

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Investment is about sentiment, not value

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