An important principle of market economics is that a bull market in one sector is a bear market in another, corresponding sector. For instance, if prices in the commodity market are soaring, it means that the value of the dollars used to buy those commodities is on the decline in comparative proportion. At the same time, the "price" or market value of the dollar may be rising against junk bonds (which is the same thing as saying the price of junk bonds in dollars is going down). In comparison then, commodities would be experiencing an explosive bull market when "priced" in junk bonds.

In a capitalist system, investment capital will gravitate toward markets that can provide the best returns with the least risk. Although investors do analysis and due diligence to determine where they should invest their capital, there is a large element of mass psychology in these aggregate capital flows. Once the trend of capital movement gets started (say, toward stocks from bonds), it picks up momentum quickly as the flocking mentality sets in: each new investor uses the shear weight of other capital flows to justify the decision to follow along.

The aggregate movement of capital can be sudden and dramatic when market conditions change for the negative. A falling market can generate a "flight to quality" in which large quanitities of capital leave the falling market in search of a safe haven. Money gets driven from one market to another by fear and uncertainty.

Following the collapse of the Tech Stock Bubble beginning in early 2001, a substantial amount of investment capital fled from the equities markets and into U.S. real estate. Some of this was institutional investment funds, but by far the most important portion of it was money committed by individual investors. As the stock market fell and individual Americans felt the bite on their 401(k) plans and mutual fund statements, they began withdrawing their money and investing it first in their homes, then later in real estate generally. The perception that "home values never go down" and "you always need a roof over your head" combined with uncertainty in the equity markets to generate a flight of capital toward real estate.

Once the capital flows shifted toward real estate, momentum quickly drove prices up. This takes us back to basic supply and demand as a fundamental factor in real estate price increases: more and more dollars have been chasing a finite number of properties in disproportionate amount. In effect, the "price" of dollars denominated in real estate has been dropping as dollars flood that market.

Looking at a comparative chart of U.S. real estate versus the S&P 500, we can see that home prices started strongly trending upwards at the same time the Tech Stock Bubble began to deflate. Since 2001, Americans have been investing heavily in their homes and other real estate assets in lieu of putting their money in equities or other markets.

The flight of capital swooped out of the equities markets and landed on your block.

Next Up: Inflation Returns with a Vengeance

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