Saturday, April 01, 2006

Has the Art Market Peaked?

New York Magazine has a recent article titled Five Theories On Why the Art Market Can't Crash, and why it will.

I have written two previous posts on related topics Art Money and Fashion and Looking at the Art Market at the Start of the 21st Century which deal with money and the art market.

I am just an artist but I have spent twenty years studying the psychology of the financial markets and have more than an passing understanding of market psychology. I have traded financial instruments through two major crashes, 1987 and 2000, and understand a bit about the psychology of the participants.

I want to begin by redefining some terms. The word "crash" is generally used in a couple of ways. The best definition is a "panic" in the market, emotional or forced selling at any cost, "just get me out". In the US stock markets, the Crash of 1987 was a panic which saw very rapid price depreciation in a very short time. In contrast, the Millennium Crash in the us markets, during the years 2000 to 2003 was an extreme price devaluation, many issues losing 95% of their value during this period, I would liken this to a slow motion crash.

The other, more applicable, financial term which could be applied is called a "Bear Market". In a Bear Market prices decline in a zig zag fashion for the duration of the "Bear" typically 1 to 3 years.

I am not going to use the term Crash for the sake of this discussion, it is a loaded word which does not adequately apply to the current situation. In past periods, the closest thing to a crash probably occurred in the late 70's during the first oil price crisis. I do not have any accurate data for the period, but my recollection was that the art market just shut down. Yes, artworks continued to be bought and sold but there was great financial stress on the US economy and it had a severe affect on the art market.

The art market slowdown in the 1990's, I would characterize as a bear market. Again, my opinion is only based upon observation, but it did not appear to me that this contraction had anywhere near the same impact as the 1975-1982 decline.

Of course if one runs a gallery and sales decline by 50%, you will be apt to correctly call it a crash. What becomes important in this situation is how long the sales decline lasts, a year or maybe two I would call a contraction or bear market. Five years is a prolonged crash.

Can this happen in the art market at the current time? What might be the warning signs leading to a bear market? What other factors could initiate or accelerate the process?

In my opinion the art market is peaking
In the financial world, this is called the topping phase, prices become more resistant to upward pressure as the insiders distribute or sell their artworks to other collectors. The psychological error, made by the new buyers, is that prices will continue to rise at the same rate as before. This increase is exponential and rapidly becomes unsustainable because there is just not enough capital available to support any further rise. I will agree that selected artworks may achieve new record high prices, this is a function of their uniqueness, but overall prices as a whole begin to resist upward pressure.

Another worrisome characteristic of the current art market is it's frothiness. This is a psychological description for the "over excitement" of the players, the fear of "missing out", the "$1000 a pop events", splashy articles on artists in Vogue, you get the idea. Frothiness is a sign that a market is in the process of topping because the participants have become overconfident.

Also, the art markets do seem to track the US stock market and a decline in the stock market will have an adverse affect on the art market. At the moment, my best projection for the US stock market is that it will peak in the first quarter of 2007 and then steadily decline in stairstep fashion for 12 to 18 months.

Finally, inflation is a factor. I expect inflation to increase steadily but not exponentially for the next several years. While this should help the art market I suspect that many artworks have inflation priced into them. This means that the price increases have risen at a rate greater than one would anticipate due to inflation alone and leaves their pricing vulnerable to other factors.

Crucial factors affecting recent art pricing
The first one is obvious, supply and demand. It is my theory that the accelerated prices achieved for the work of "emerging artists" was driven by the lack of supply. There was a lot of new capital flowing into the art market and not enough goods to fill the demand especially in the lower price tiers (under $50k). The demand was filled by promoting "emerging artists" to a degree which was unusual, to say the least. I commented on the mechanics and reasons behind this condition in my two earlier posts linked at the start of this article.

With the increased number of galleries and new artists, I believe that the supply has caught up with the demand. The danger in such rapid price acceleration for emerging artists is that the pricing eventually collides with the prices of artworks by more established artists. At the current time it would be rational to expect a more moderated approach to the pricing of these artworks and more emphasis to be placed on the actual quality of the works offered for sale.

Another, and more onerous factor which could initiate selling pressure in the art market is the recent rise and number of "speculative buyers". Speculators buy something because they feel the price will rise, quality and value are secondary factors. To the speculator it is a game, where winning is everything and the true speculator will cut his losses and run if he feels he is going to lose. This group of art buyers are dangerous to the health of the art market. They act like daytraders and help drive the swings in fashion but have less of a long term commitment to the art they buy and sell. They become new supply in the marketplace and put downward pressure on prices.

Finally, the there are the "investors in art" This would include the various art hedge funds and other wealthy collectors who now consider art as an "alternative investment" While this group may have a financial motive for collecting art, my sense is that they are making longer term investments or buying art because they love it as well. This group will tend to buy higher priced artworks with established validation, perceived quality and liquidity. In a price decline artworks may be bought or sold depending, more on personal or fiduciary circumstances, than emotion and provide some degree of stability in the market. I must note, that this does not keep prices from declining but it does mean that these artworks will have some liquidity if they need to be sold.

Specific warning signs I would watch for.

Froth in the marketplace, covered above.

Last week I took a look at the recent auction results at Sothebys. The auction was a mixed collection of larger and smaller works covering a fairly broad spectrum in time and quality. I started off paying attention to the "bought ins" especially by better known artists as well as where prices fell in the estimated range. Then I noticed something I found curious, a number of lots went off at odd prices, like $6215. Now I am not sure if this is a result of tacking on the commission or whether the bidders were nickel and dimeing each other. Pricing psychology fixates on round numbers, particularly the numbers divisible by 2, 5 and 10, so I wouldn't be surprised at a $10,000 or $8,000 price but a number like $8,230 would indicate some reluctance on the part of the bidders to bite at "make it $8,500 or $9,000"

In the May, the Blake drawings are being auctioned separately by Sothebys. I commented on this decision harshly in a previous post and I feel that if the total for the whole set does not meet or exceed the high estimate (the greed number) it's a bust and a warning sign. Regardless of the press spin, things are not as good as advertised.

Finally, I would watch the fall auctions. Odds favor some sort of initial stock market decline in the fall before the final peak in the first quarter of 2007. If the auction market shrugs off the fall stock market decline (if it happens of course) that would be favorable.

In the past hard assets usually are in favor during the initial phases of a stock market decline. This would lead me to suspect that the peak of this cycle of the art market won't actually occur for another year.

Will the art market "crash"

This depends on what you want to call a crash. I have stated previously that I believe some of the increase in the size of the art market is structural and caused by the unprecedented generation of wealth during the last part of the twentieth century. This is not to say that the art market could not suffer a contraction, a bear market.

I strongly suspect a bear market in the art market will occur starting in 2007 at the very latest and last at least a year possibly two. I cannot predict the degree of the contraction but I would suggest some of the artworks sold at what many perceive as inflated prices will fail to find new buyers. Unfortunately, for artists, I suspect gallery sales will contract and become more competitive based more upon quality than fashion.

Consider this an open thread.


Franklin said...

Consider me impressed. I always enjoy your financial analysis of the art world - your handle on it is authoritative and you write about it with great lucidity.

Let's say for the sake of argument that I'm pretty clueless when it comes to this sphere and I wanted to bone up. (I just read Naked Economics and I'm ready to go further.) What books do you recommend?

George said...


Gee, that's a good question but I haven't read anything recently on the stock market.

For starters read Jesse Livermore which is still available as a PDF:
Jesse Livermore - Reminiscences of a Stock Operator Save the PDF to your hard drive, this link might not be good for long as the book is in reprint. Jesse Livermore was a legendary trader at the begining of the 20th century. Although the particulars of the markets have changed somewhat, his observation on the psychology of the market players is as good as it gets. It's a good read.

Another is Richard Ney's book "The Wall Street Gang" which was written in the 1960's and is a good description of how prices are managed by the insiders (specialists on the NYSE) Some of the technical information has changed but the way psychology effects market pricing is still relevant. See if you can find a used copy it is also a good read.

Everything else is rather technical and probably best chosen by browsing the local bookstore.

Joseph Barbaccia said...

Thanks for the lesson and prognostication, George.
I say that one can own artwork but cannot own art.

Bill Gusky said...

Excellent, thanks -