Tuesday, September 9, 2008

Is The Bubble Bursting

According to The Bloodhorse, Sheik Mohammed's Bloodstock Manager, John Ferguson said, "If somebody is thinking of buying a racehorse, this is a good time to do it because I think there will be value to be had throughout the course of the year." It's unclear whether that was before or after yesterday's relatively weak Keeneland September Sales results.

He may be right. You can certainly buy horses for less money now than the same horse would have cost a year ago. However, I think the current environment for unraced horses has some of the signs of the early stages of a post-bubble bear market in financial markets.

First, some of the typical characteristics of a financial bubble:
1. Prices go higher than anyone thought was possible.
2. There is no fundamental basis for the level that prices reach.
3. Many people are buying purely as a speculation, because believe they can resell to someone for even more.
4. Some people believe that prices will never go down because 'this time things are different'.

How does the situation in the very recent past meet these criteria:
1. Prices are at all time highs (although in fairness, not so much different than in the 1980s at the top end of the market).
2. The 'fundamentals' (earnings from actually racing the horses) make it impossible for something like 90% of the horses sold at auction to ever earn a profit for whoever owns them during their racing careers.
3. The entire concept of 'commercial pedigrees' as opposed to 'breed to race' pedigrees is an open admission that many breeders subscribe to a version of the greater fool theory...they believe that there are buyers who don't care about winning, and will buy their horses at prices unjustified by the horse's potential to earn money on the racetrack.
4. I've heard plenty of people say "prices won't go down much as long as the Sheiks and Coolmore are around". This kind of misses the point of what happens if they choose to stay home one year.

If the current drop in prices is indeed the early stage of a bursting bubble, then the following may happen:
1. Prices will go down further than many thought possible.
2. Eventually fundamentals will drive the market...there will be no interest in 'commercial pedigrees', and much more of the market will be driven by the idea that the horse being purchased has a reasonable chance of eventually earning the money back.

I don't want to overstate the latter point though...people do buy racehorses for reasons other than making a profit (obviously), so the link to fundamentals won't be as strong as in other markets.

My overall point is that now may not be a good time to buy at all, despite the apparent bargains. It might be a good time to sit on the sidelines and wait for the bottom in prices. Just remember...when the true post-bubble bottom is reached, most people are usually screaming that its the end of the world and the market will never come back.

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