Who is the new Eastern European ‘Tiger’

Today’s Daily Reckoning begins with the observation that if you want to buy innovative companies that can grow their earnings consistently over time, sadly Australia isn’t the best place to be looking.

We get economic growth when resources are saved and invested.

But the Australian Financial Review reports this morning that there are some individual global companies that spend more on research and development than we do as an entire country. Not only that, the amount of venture capital available for start-up businesses is ‘dire’.

So much for Australia’s ‘knowledge economy’. This is compounded by the fact that the dividend imputation system biases existing companies to pay out their profits as dividends.

But as a shareholder — unless you need the income — you want companies to reinvest capital in the business when the returns are expected to be high. You’ll see bigger returns in your portfolio over time — and the economy should get higher growth too.

But hey, there’s always plenty of money for companies around the property market! Non-bank lender Pepper Group is due to raise $146 million in its upcoming Initial Public Offering at $3.32 a share. In Australia, Pepper mostly hunts in the nooks and crannies of the property market where the big banks don’t want to go.

Pepper will be one for you to keep an eye on. For us over at Cycles, Trends and Forecasts it’s moving consistently with our position that there is further credit expansion coming.

It doesn’t appear to be slowing down anyway if today’s Financial Review is anything to go by. According to the latest data available, ‘The value of home loans held by property investors continued to expand at a quicker pace than the banking regulator’s 10 per cent-a-year cap in May.’

The paper notes that there is a lag between loan commitments and official data. So the suggestion is that the banks might be reining in their lending enough to get under the 10% cap in investor loans. It just isn’t showing up yet.

Here’s the deal: companies like Pepper make a mockery of this process because APRA doesn’t regulate them. The cap doesn’t apply.

But what happens in Australia is pretty small fry anyway compared to the other major economies. It’s important to keep tabs on what’s happening elsewhere.

After all, if we go looking, there are plenty of reasons why credit will expand and take land prices higher. Britain is one of those. The Financial Times reported the other day that a company called Amicus Finance is in talks to get a UK bank license. What’s it want to focus on? Property lending, of course!

This is interesting in the context of a recent Wall Street Journal report that some of the biggest hitters in London property are bracing for the market to cool after its heady run up over the last couple of years.

Take the news about investment funds run for the Church of England, the Duke of Westminster and the Queen — hard to get much bigger than these three — that own huge chunks of London.

They have reportedly ‘reacted to the boom by cutting exposure to the city, strategizing for the next downturn and diversifying elsewhere…

For example, ‘Grosvenor plans development projects that will start during the next downturn…

Here is the memory of 2008 ingrained in existing players. Phil Anderson would tell you this why the real estate cycle has to run at least 18 years, and also why the cycle never repeats in depth in the same location twice.

That tells us when the next major downturn hits it won’t be a huge collapse in the UK. We will have to look elsewhere for the signs of the downturn — most likely where the banks have lent the most and have the youngest management.

We’re talking people in key positions with little to no experience of what the UK went through in 2008 — and the reasons why. (Those reasons are not what you’re probably thinking. See here for what matters most).

Here’s where today’s Markets and Money launches into a bit of a thought experiment. Here’s a guess for one country that might be setting up for a major boom and subsequent bust: Poland.

The Wall Street Journal reported yesterday that foreign money is flocking into the Polish commercial property sector. Apparently, they’re attracted to its expanding economy and low real estate prices. Poland has more people than Canada.

It also enjoys the US version of ‘most favoured nation’ status because it’s a bulwark in Eastern Europe against Russia. There’s a lot of US money, military hardware and technology up for grabs for Poland to toe the US line.

Germany won’t mind chipping in either to keep Poland secure. That’s especially true if German money keeps going into Polish real estate like it has over the last five years.

One German investment manager went as far as to dub Poland an Eastern European ‘tiger’ because of its fast economic growth. A tiger? That’s what they used to call the East Asian economies before their collapse in 1998, and Ireland before 2007.

But importantly for us, Poland was behind the Iron Curtain for a heck of a long time. Its economy was totally stifled and the lives of a generation or two totally stunted. One consequence is that millions of Poles don’t have any experience at all of a land price led downturn.

When you unleash a real estate boom on a country that hasn’t seen how prodigious — and how dangerous — it can be, it’s like taking the lid off a pressure cooker. They’ll think they’re economic geniuses when all they’ve done is unleash the genie of land speculation. Look out nearby!

Poland was once a dominant country in Europe. It’s perfectly possible that as the locals accrue more and more unearned gains and riches in the land market, the people could fill with hubris at the return of Poland to its former heights. It could be a massive set up.

To be clear, this is speculation on something due a decade from now. I may be off the mark with all this. Only time will tell.

The coming boom is going to unleash a few economic tigers. Such is the nature of the jungle. It’s hard to tell whose stripes are real and whose are painted on.

Poland is not big enough to cause a major bust globally on its own. It will react to its bigger neighbours. But you could have said that about Spain or Ireland last time. A rising tide lifts all boats…

Suffice to say, talk of better times ahead doesn’t sit with some people. There are a lot of people waiting for the next crash right now. But as a bit of Polish history can tells us, generals always fight the last war.


Callum Newman+,
For Markets and Money, Australia

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Originally graduating with a degree in Communications, Callum decided financial markets were far more fascinating than anything Marshall McLuhan (the ‘medium is the message’) ever came up with. Today Callum spends his day reading and researching why currencies, commodities and stocks move like they do. So far he’s discovered it’s often in a way you least expect.

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