Screaming into the Wind on Australian Property Prices

Continuing our theme of family wealth this week, here’s an interesting story from last week’s World War D conference.

It was the end of day two, and we were on a discussion panel with Phil Anderson, Vern Gowdie and John Robb. It was a Q&A session, and members of the audience were free to direct their questions to whoever they wanted.

The last question of the session was directed towards your editor. It was a tough one…but fair. It went something like this:

Given your negative views on property, which are in direct contrast to Phil Anderson’s, do you feel stupid that you’ve got it so wrong?

As we said — tough, but fair. The question wasn’t asked in a malicious way, nor was it designed to make us look stupid then and there. (It was merely to ask if we felt stupid.) If you want to see the action, you can order a DVD of the conference here.

Now, trying to answer a question like that when the country is in the grip of a property boom is a tough ask. Because no matter what you say, you are wrong. The evidence is there for all to see. That is, house prices are going up, and it’s unlikely they’ll come back down in any meaningful way. Arguing against this reality is like screaming into the wind.

But we gave it a shot. We said that the Australian property market has benefitted from a number of tailwinds over the past few decades. A secular decline in interest rates which has seen the real rate of interest decline to zero in recent months — a historical low beaten only by the emergency low rates seen during the GFC. The chart below clearly shows this secular decline in rates.

The other tailwind was two massive terms of trade booms. One in the early 2000s from a rising China and the other from 2009–11 from a credit booming China. During both of these periods, nominal and real rates increased in an attempt to negate the inflationary impact of a terms of trade boom. It was a job pretty well done by the Reserve Bank of Australia.

a

As an aside, the effect of these booms has quickly worn off, meaning the real rate has continued its secular decline. We see this as evidence of Australia’s structural deficiencies and reliance on the property/banking/consumption complex to drive economic growth.

So we were explaining how these tailwinds were behind the huge boom in property prices, but with China slowing and real rates already at zero, we felt it was difficult to be bullish on property, despite all the evidence pointing to the fact we were, and are, wrong.

We didn’t have any charts at our disposal during the discussion, but here’s a chart of long term Aussie house prices courtesy of Phillip Soos. It clearly shows the boom over the past few decades. It doesn’t show the most recent price spike, which we think will prove to be the blow off top.

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click to enlarge

We also mentioned that we’re renting quite comfortably in a place that if we were to buy, we would really struggle to afford.

But the main point we wanted to make was that we have two young girls to consider. We want them to grow up with an understanding and respect for money and finance. Do we plunge the family into debt in order to secure a property that at these prices will probably deliver a long term return of around 2–3%, considerably less the cost of debt? Or do we wait until the decision makes financial sense, which will free up purchasing power for things like their education?

The other consideration, which my wife correctly keeps reminding me of, is that if we buy at least it will be ours (and the banks, we retort) and we won’t be at risk of having to move by a house flipping landlord. Fair enough.

We finished by saying that yes, we do feel stupid sometimes, but we know we’re not stupid. The fact is that most people buying property now are doing so for emotional reasons, not rational ones. This forces them to pay as much as they can to ‘get in’, and many people get swept up in an emotional tide.

It’s not easy going against the crowd, and it’s not easy being ‘wrong’ for years on end. But keep in mind Alan Greenspan called ‘irrational exuberance’ in the markets in 1996, years before the bubble finally burst. And fund manager Jeremy Grantham lost billions in assets under management for not buying into the dot com boom. Incidentally, Grantham thinks Aussie property is a classic bubble.

As Grantham says, in time, all asset prices return to the mean. Aussie property will too. It’s out of concern for family wealth that we remain so hesitant about investing our hard won savings in what history will prove to be a very low returning asset.

We’re not saying that property is a historically low returning asset. We’re saying it will be in the future. That’s because this market is so highly leveraged. According to economist Kieran Davies at Barclays, our household debt to GDP ratio is now at record highs of 177%.

The IMF reckons Australia will grow below trend for the next few years (meaning employment won’t improve and wages growth will be low). The only way you can get higher house prices in such an environment is to increase leverage. But it’s already at record highs so we’d question how much more juice is left in this tank.

It’s a bit like the leverage built into the global financial system, which is propping up asset prices everywhere. How much higher can it go? We don’t know. We only know that it’s dangerous and very susceptible to an external shock…a black swan event. Just like Aussie property is.

It should come as no surprise then that our family wealth expert Vern Gowdie recommends a mostly cash asset allocation. His view is that you should first protect the wealth you have accumulated. Only when the market offers an attractive long term price should you look to grow that wealth. It’s hard to argue with that.

Regards,

Greg Canavan+
for Markets and Money

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

 


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