Real-time thoughts & analysis of the markets, economy & more...
Co-founder & CEO of AllenWargent property advisory & buyer's agents.
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Pete Wargent blogspot
Co-founder & CEO of AllenWargent property advisory & buyer's agents, offices in Brisbane (Riverside) & Sydney (Martin Place) - clients include hedge funds, resi funds, & private investors.
4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.
"Unfortunately so much commentary is self-serving or sensationalist. Pete Wargent shines through with his clear, sober & dispassionate analysis of the housing market, which is so valuable. Pete drills into the facts & unlocks the details that others gloss over in their rush to get a headline. On housing Pete is a must read, must follow - he is one of the better property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.
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Stocks snapped their 10 day winning run shedding 0.4%. It was good while it lasted.
As RP Data now reports property data in "real-time" it released its January property data results today (not sure whether APM deliberately releases its property data for December just a little earlier in order to confuse matters).
Anyway, not many surprises - RP Data reports Sydney prices up 1.8% in January and 1.7% growth in Perth.
Sydney still pretty "resilient" from where I'm standing, whether or not January growth figures prove to be anything more than a mirage.
No interest rate cut in Feb based on the performance of growth assets, commodity prices or easing AUD.
A Pommie migrant, I first set foot on Aussie shores in Sydney in 1999, and the hot topics of the day were the invasion of East Timor and…housing affordability. A lot has changed in that time, for me especially as I’m currently living in East Timor. But Sydney’s housing affordability debate drags on in its predictable manner.
One unwelcome change for residents during that time is that property located close to the city, as well as being expensive to buy, is now also expensive to rent. The debate has worn so depressingly thin that it was a welcome change to see some levity breathed into it by SQM’s Louis Christopher this week.
Of course, there is a serious underlying point here, and Christopher impressed by delivering some decisive but well-chosen words, quoted in this Property Update article here.
Sydney market sectors
Economists are forever guilty of taking a necessarily top-down approach to their studies and continually overlook the primacy of the individual. I’m been guilty of the same thing myself as I’ve spent much of my time overseas over the past year or two.
The Sydney premium property sector will continue to march to its own drum, little affected by wages growth, rather by swings in confidence in the economy and the extent or otherwise of the share market recovery – buyers in this sector tend to have material levels of equity and investment assets.
The median-priced sector of the market continues to suffer from a shortage of quality, well-located dwellings. Every time I’ve let any of my properties around the eastern suburbs, the city or the inner-west in recent years they've been re-let instantly and sometimes even before being advertised. In such a tight market, it’s small wonder that rents have jumped upwards over the last half decade.
The sector of the market which is inevitably struggling is that of first homebuyers. I wouldn’t want to generalise too much but statistics of late seem to imply that first homebuyers are increasingly opting out of buying, or simply can’t afford to opt in.
Housing affordability issues in popular capital cities are nothing new. I remember when I went to train as a Chartered Accountant in London’s West End on the princely trainee salary of £18,000pa. I rented a flat for £400pcm located precisely 96.4km from the office, condemning me to 3 hours+ a day of travel.
Worse, even after the government swiped its share of my salary, I had to hand over £3,600 of my net pay to Great Eastern Rail and the London Underground just to get me to work! If you’re familiar with the Tube I don’t need to tell you about the 'pleasures' of the Central Line from the City to Bond Street in rush hour…
On the day I qualified as a CA, my salary doubled to £35,000 and of course I’d dearly have loved to buy myself a 1 bedroom flat in Marylebone W1 so I could walk to the office
I might just as well have wished to go for tea with the Queen at Buckingham Palace (actually that’s a terrible example, as I did end up doing that – rather, I might just as well have wished to fly myself to the Milky Way or Planet Zog). Clearly it was never going to happen so when I could afford to do so, I invested my money elsewhere.
The role of immigration
Yesterday, Britain’s Daily Telegraph ran an article which stated that London has become a city only for immigrants and the very wealthy.
Through a case study, the article noted that whites are being forced out of the city due to the 1 million Muslims and many other races having “taken over” the traditional working class suburbs. Although the ‘locals’ have tried to mix with immigrants, the immigrants’ refusal to change their culture (particularly when wearing the niqāb or burqa) has led to racial tensions, the article reports.
Is Sydney heading down a similar route (assuming the article is accurate and in some way reflective of wider trends, that is)? One hopes not, although some of the internet forum comments have been worrying of late.
What I do think is likely is that the Census-reported home ownership rates in Sydney of 67% will fall closer to the significantly lower ownership rates seen in other developed cities such as London and New York.
Embracing the outer suburbs
I’m no town planner and I don’t pretend to have all of the answers to these things, but it's obvious that the city needs more affordable supply and equally obvious that middle-income Sydneysiders are not keen to embrace the western suburbs, which exacerbates the affordability issue.
This is exactly what was alluded to in the tweet to Louis Christopher where he was asked if he would live in Fairfield thereby risking “getting shot”. If we continue to think of the western suburbs in that way, well, yes, the affordability level of Sydney’s inner-suburb housing market is doomed.
The dangers and hardship of living ‘out west’ in Sydney are wildly overstated. Currently I’m living smack in the middle of the Comoro community, one of East Timor’s notorious distrito, and I walk to Timor Plaza through the shacks every day. Sure I could live on a hotel-style resort next to the US Embassy, but I moved to Timor to experience East Timorese culture not to mix with the US paramilitary, decent blokes though they are.
In the past year, we’ve had civil unrest and uprisings, some brutal knife attacks by the beach and slashings, terrifying off-shore earthquakes and, occasionally, people do indeed get shot. Even Nobel Peace Prize winner Prime Minister Ramos Horta was shot in the stomach. But I’m not going to add much by simply avoiding living in the local community, so I live in the heart of the community and take care late at night.
I’m not unsympathetic to the plight of first homebuyers. In fact, I still rent myself and I’m in my mid 30s. I’ll probably buy a residence in the next year or two, but I'm unlikely to be buying in Sydney.
People ask me about shortcuts to home ownership. There aren’t any - unless you are gifted a deposit. There are so many two-income household these days that prices have been forced northwards by other self-interested homebuyers. Capitalism is characterised by individualism and self-interest; we've known that for centuries now.
If you earn the median Sydney household income of $75,000 then to save a deposit you need to find a way to save $13,000 of it per annum to have a chance of save a 10% deposit over 3 years (by no means an easy feat the way rents have been going). That means no holidays to Hawaii. No plasma screen TVs. No Foxtel. No i-Tunes or i-Phone apps. It’s not easy, but since when has life ever been easy?
Even if the much-vaunted house price crash eventuates and Sydney’s prices drop by 20%, 30% or 40%, first homebuyer problems and the housing affordability debate will never – and I do mean never - go away. If a correction does happen, banks won’t be dishing out 100% mortgages: that’s one certainty you can bank on.
Australia versus the world
In East Timor, we’ve experienced a nasty bout of inflation which has pushed prices up sharply, although around half of the population of 1.2 million continues to earn US $1 per day.
I’m certainly no Michael Palin but was lucky enough to travel to 25 countries last year, including Egypt (revolution, violence, massive civil unrest), India (countless millions slum-dwelling), Portugal and Greece (25% unemployment), China (incredible poverty, no freedom of speech under Communist regime), Sri Lanka (human rights abuses, Tamils, too many guns), Vietnam (wide-scale post-Communist impoverishment), Malaysia (seemed quite nice), Thailand (although still mainly agricultural, recovering reasonably well from the Asian crisis and the collapse of its currency - despite illegal immigration issues) and Hong Kong ($1 million+ for an apartment in the sky), among others.
Australia has an amazing quality of life with capital cities that are expensive. I’ve seen a lot of the alternatives, and without exception, they've all been worse. I’ll leave the final word today to none other than Mr. David Koch and wife Libby:
“We’re sick of the whingers. This is the best country in which to live, work and play. Financially and economically, we are the envy of the world.
Think about it; no economic recession for 21 years, avoided Asian Financial Crisis in the '90s, avoided Global Financial Crisis in 2008-12, low unemployment, low inflation, solid economic growth and strong financial system.”
"Sydney house and unit prices rebounded in the final quarter of 2012 to finish the year at record highs, according to full year figures from Australian Property Monitors (APM).
Sydney house prices rose by 2% over the quarter to be up 3.4% for the year with the median price rising to a record $656,415, the first time the median price has been above $650,000.
Sydney unit prices gained 2.3% over the quarter to be up 5.6% for the year and also posted a record median price of $475,314.
The rises for the quarter were based on upwardly revised September quarter figures.
APM revised the Sydney’s median house price for the September quarter from $641,890 to $643,578, while the median unit price was revised from $458,562 to $464,572.
Australian Property Monitors senior economist Dr Andrew Wilson says Sydney again “illustrated the resilience of its housing market”.
Wilson says the Sydney market revival is being driven from the middle upwards rather than from the top down.
“We are seeing a lot of activity in the middle price section of the Sydney market between $500,000 and $900,000, and that’s what is pushing up those median house prices to record levels," he said in an interview on AFR TV.
Wilson says the prestige market in Sydney, which has to date been the ‘weak link” in the market, may also start to grow in 2013.
Nationally, house prices rose by 1.9% over the quarter to finish the year in positive territory – up 2.1% to a median of $542,299.
Unit prices increased by 1.6% over the quarter to be up 2.4% for the year with a median price of $417,123.
September quarter figures were also revised.
The median house price was revised downward from $533,480 to $532,274, while unit prices were upwardly revised from $406,415 to $410,508.
All capital cities recording house price gains over the quarter – the first time this has happened since March 2010.
“I think it is no coincidence that we have historically low interest rates and we are just starting to see a consistent rise in confidence in housing markets," says Wilson.
But he tempered this by saying capital cities and sub-markets are still performing at different levels.
“We are still seeing the fractured type of outcome."
Sydney is the only capital city market where house prices are above their previous peaks, but APM expects that based on current trends, Perth, Canberra and Darwin will achieve record house prices in 2013. "
It's no doubt hard work for real estate writers trying to think of something different to say several times per week. On Thursday, Terry Ryder vented his spleen - again - about "lies and propaganda" from "vested interests" writing about property (vested interests being an unusual subject for an article signed off: Terry Ryder, founder of hotspotting.com.au). The other day he was fuming about talk of a property bubble, and the day before that the lies about housing shortages and then it was something else or other, can't remember what.
Today it's me in the firing line after quoting an article about Sydney's middle sector of the market being "the only sector" of the property market to be at all-time highs - see today's further article in Sydney Morning Herald and another one in Property Observer here.
Terry R notes that among other regional areas Karratha, Dubbo, Mudgee and Whyalla have recently shown growth.
Look, fair enough - if you want to get bogged down in semantics - I'll admit I do not consider the town of Mudgee (population 10,000) to be a "sector" of the property market, I suppose you could feasibly term it a sub-sector though. Truth be told, I couldn't even tell you exactly what prices have done in Mudgee though some pretty good growth in 2012 springs to mind (just looked it up - 9% growth).
I'm probably one of the very few people to have actually travelled to all of the listed places in the last couple of years and all I say is, if you're comfortable in these days of elevated household leverage investing in small towns and remote regional markets, then, truly, go for it.
I wouldn't be. Having seen some the regional market bloodbaths in some overseas markets, I'm happy enough sticking with the boring capital cities approach.
APM reports today that apartments in Sydney increased in median price by 5.6% last year, though obviously some sub-sectors of the market performed significantly better than others. Other capital cities such as Melbourne, Adelaide, Brisbane and Canberra were weak in 2012.
Prices of some quality properties in key suburbs of the inner-west of Sydney have grown by around a solid 25-35% over the past 4 years or so. Again, I'm not talking about prices doubling overnight, just strong, steady growth.
As anyone with even half a brain who invests in capital cities knows, it is preferable to aim to invest in the cities which have notexperienced a recent boom which is precisely why I picked out Sydney at that time ahead of other cities which had already shown strong growth.
So yes, since its spurt through to Q1, 2004 price growth in Sydney has been lower than elsewhere, that's a given - but prices therefore haven't fallen from peaks in the same way as in other capital cities (hence "resilient") and I expect RP Data to report that strong growth has continued in Australia's largest capital through to January.
If you want to take the approach of carefully selecting time-frames for capital growth (or for that matter, individual suburbs like Canterbury) then pick any regional market you like from around Australia and note that prices are as cheap as chips as compared to quality city suburbs - that's due to poor long-term growth. Almost as pointless an argument...
Personally, I invest in large and capital cities for the long term - the reasons for which I explained here with not much value in me reproducing - if you want to 'hotspot' (if that isn't unacceptable verbing of my adjectives) in Mount Isa, Wagga Wagga, the Pilbara or near wind farms off the coast of Tasmania, then, sincerely, best of luck to you.
The old regions versus capital cities debate has been well and truly done to death - you just have to take your viewpoint and go with it. I think the old phrase is: "let's agree to disagree".
Remember that property is best treated as a long-term investment, and long-term price growth ultimately has to be sourced from real and sustained wages growth. And also remember the concept of risk versus return. Let's just see wait and see what happens to regional markets in Australia the next time the economy shrinks.
No particular surprise - if you don't build enough appropriate dwellings, people shun the more affordable suburbs and the population grows at 60,000 per annum, that's what going to happen.
APM reported apartment prices as up 5.6% through 2012 and house prices up 3.4% year-on-year.
Sydneysiders need to embrace living in the western suburbs rather than dismissing the idea out of hand, a subject I might blog about a little more when the urge grabs me. At the moment, I'm rather busy eating a digestive biscuit, but I may get around to it in due course.
Failure to embrace the suburbs to the west of the city can only lead to a housing crisis of epic proportions.
As I've mentioned continually through the past 15 months it has been the inner west which has been the hub of the action, with more auctions and higher clearance rates than any other region.
As also noted probably too often it is that sector of the market close to the median price which was always likely to see the heightened activity.
"The APM senior economist Andrew Wilson said heavy competition in Sydney's middle market put upward pressure on prices.
''It is in that $500,000-$600,000 price bracket where most activity has been in Sydney over 2012,'' he said."
It will be interesting to see whether Aussie shares finally snap their 10 day winning streak in today's trade.
Stocks in the US fell marginally as economic data was somewhat weaker than expected.
I normally find daily share market commentary incredibly tedious, but this is an unusual streak we are in the midst of.
In fact, we haven't, from memory, had a 10-day share market run like this for a decade when stocks were recovering from the tech wreck. That said, the recovery from the sub-prime crash through 2009 over the course of the year was a strong sustained run too.
Anyway, with US stocks looking to make minor losses, it will be a big test for the Aussie market today...
“In 44 years of Wall Street experience and study, I have never seen dependable calculations made about common stock values - or related investment policies - that go beyond simple arithmetic or the most basic algebra.
Whenever calculus is brought in or higher algebra, you could take it is as a signal that the operator was trying to substitute theory for experience, and also to give speculation the deceptive guise of investment.”
Very important quote that.
What Graham is saying that when making forecasts of the future, any prediction which goes beyond a very broad brush approach involves so many unknowns about the future that there is little value in trying to forecast with any level of accuracy.
The most dependable branch of security analysis, therefore, is that of rating bonds, because analysts can use interest cover ratios – a known current figure – in order to rank them.
When it comes to valuing stocks there is a great difficulty in projecting an unknown growth rate on earnings into the future.
The further into the future one tries to project, the more sensitive the calculation becomes to slightest error.
Forecasting in action
The cited example is that if you ascribed a 15% growth rate to a company’s earnings today of $1, in 15 years the earnings would climb to $8.14 – a growth rate and earnings power which might justify a valuation of 35 times earnings at £285.
But if the projected earnings growth rate was only to be 14% then the earnings would only climb to $7.14 over the same period. Investors might only be inclined to value such a growth rate and earnings power at 20 times earnings, and thus the final stock valuation would come in at only $140 – a drop of some 50% from the first example.
This example is fairly involved, but the principal is absolutely correct: as the future contains so many unknowns, forecasts become highly sensitive to small errors.
Nassim Nicholas Taleb would take this a step further and suggest that Black Swan events affect forecasts in such dramatic and unforeseen ways that all forecasts of the future are effectively rendered useless.
The problem with Taleb’s point is that by definition humans can do very little about such unknowns until they become known, and therefore the forecasting models of standard deviations and bell curves have no suitable replacement. We can only make forecasts based upon what we do know, not upon what we do not.
Three decades ago, no-one forecast the internet, after all!
I’ve recently been reading Debunking Economics by Steve Keen. It’s a good read and includes some thought-provoking ideas. Think back to Graham’s quote:
Whenever calculus is brought in or higher algebra, you could take it is as a signal that the operator was trying to substitute theory for experience”.
Keen himself said that he was no expert on house prices and indeed that house prices are only a tiny part of his interest, but after he predicted a major collapse in the debt and housing market he was perhaps a little unexpectedly thrust into the headlines.
Keen invokes some phenomenally complex models to show why he believes debt levels will come down.
I don’t pretend to understand all of them and I think it’s an unnecessarily cheap shot when he is met with smart-@rse comments like “tell me what the wires do”. The fact is that Keen comes up with some thought-provoking stuff.
I think, though, that if we are to see a slow or accelerated period of debt deflation, it is as likely to be driven by human emotion as it is by phenomenally complex economic models or second and third derivatives models of credit growth.
In this regard, the Minsky Model has something to be said for it: it talks of investors becoming spooked and fleeing the market due to the income not covering the debt repayments.
It’s a valid enough theory although in Australia we do have tax laws and sometimes government incentives which distort the market.
The credit markets and the availability of cheap money or otherwise play a key role in debt levels. So does affordability – the natural speed limit on property prices is people’s ability to pay for it.
But also so does rational profiteering and the invisible hand of capitalism. Investors buy property to make money, no other reason. And homebuyers and first homebuyers buy purely out of self-interest too. If they believe prices will fall, they tend not to buy.
Stock prices and house prices and driven much by human emotions. If people believe they will be higher in the future, they tend to buy, and if they believe they will be lower they tend to sell.
Forecasters, including Shane Oliver of AMP and a number of other highly respected economists, forecast reasonably strong stock price growth and moderate property price growth for 2013 but then as was famously once said:
“The only function of economic forecasting is to make astrology look respectable”.
Aussie stocks completed a tenth consecutive positive trade yesterday as the bull market continues to show its horns.
After a decent break, I’m flying back to East Timor tomorrow.
The Dow is now just one good trade away from the psychological 14,000 barrier moving up 60 points at the time of blogging or 0.4% to around 13,940.
A string of good earnings reports saw the industrials continuing to climb.
The DJIA is now at 5 year highs having already moved up 5.4% in the first month of the year so far. The market is now only 2% from its highest ever level.
Happy days for stock owners indeed.
Consumer confidence remains very low in the US, but when it comes to stock markets, momentum is everything, and the markets certainly have that at the moment.
With term deposits yielding a miserable tick or two above 4% pre-tax in Australia, it is small wonder investors have become bored. Even after stocks have gone on such a strong run high-yielding stocks such as Telstra (TLS) or major banks are returning fully-franked 6-7% dividends.
This often happens when interest rates are dropped so sharply, but investors need to be aware that stocks have already had a few cracks at a recovery since 2009 - you can never be certain that this is the one to be successful.
Could be some turbulent times ahead...
"The S&P 500 (SPX) has more than doubled from a 12-year low in 2009 as corporate earnings have climbed for three years and the Federal Reserve has increased its bond purchases to keep interest rates low to spur growth. The S&P 500 is about 4 percent below its record of 1,565.15 set in October 2007 while the Dow is less than 2 percent from its all-time high.
Twenty-five companies in the S&P 500 are reporting quarterly earnings today. About 75 percent of the 175 companies in the S&P 500 that have released results so far in the quarter exceeded profit projections, while 67 percent surpassed sales estimates, according to data compiled by Bloomberg."
get a lot of emails on a daily basis. I reckon about 80% of them fall into just
three categories. Firstly, there are those which say “congratulations you have
won one million dollars” or similar (I must be the luckiest person in
Australia, though funnily enough I never seem to be paid any of my winnings).
emails that say “properties in Australian capital cities are expensive” (I know - that’s what happens in all capitalist countries: where most people want to live,
self-interested people buy them and the prices tend to go up). And thirdly emails that ask: “How do I/why
should I invest in index funds?”
as humans are a peculiar bunch. One of the stocks I hold has doubled in value over
the past 6 months, so of course I’m currently feeling very clever. If you ever
start to feel clever in investing, it is time to check yourself.
if you’d seen me six months ago I was absolutely livid and cursing everything from insider trading and the irrational market to incompetent company management or the tides of the moon.
was utterly fuming about the stock’s performance and berating myself for trying
to be too clever and beat the market. “Why
didn’t I just buy into a fund?” I was asking myself.I averaged down so hard into the stock that I feared at one point
that I might end up owning the wretched company.
got out of jail on this occasion with the stock market flying over the past six
months, yet if you follow such an approach sooner or later you are likely to
end up with a trading account disaster.
do this sort of thing all the time: assets that move down in value are
dismissed as a result of bad luck and ill fortune; those which appreciate in
value are treated as “intelligent” investment decisions.
A cautionary tale
of investors, including some that I know personally, averaged down into Gunns
Limited (GNS), partly on the basis that it has been one of Australia’s most
as the tide turned against the woodchip industry and the exporting company was
crippled by the strong Aussie dollar, the company eventually became insolvent
and went into receivership.
is a cautionary tale about putting too many of your eggs into one basket and
precisely why I recommend holding a portfolio across different asset classes:
including property, stocks, diversified index funds, fixed interest investments,
art and cash.
also elect to hold commodities such as gold, though personally I favour gold-mining
companies due to them being income-generating (mind you, I do own paintings
that haven’t paid me any dividends of late).
The benefits of an
written many times about why index funds are so effective.
the management costs are very low – you do not have to pay a fund manager to
try to outsmart the market for you, you simply hold a share in every stock in
the index (be it the All Ordinaries, the ASX 200 or, my favoured index, the All
Industrials). Instant diversification.
choose to self-manage my super because research has shown that over time,
managed funds cannot or do not beat the market, so the management fees add no
Why managed funds can’t
win over time
individual years a managed fund may beat the market, but cumulatively the fund
has to beat the market by several percentage points each year in order to stay
ahead – to cover transaction costs, fund management fees, insurance and taxes. It
can happen in some years, but over time, funds will not succeed in beating this
some extent we are a little harsh on the fund industry. Institutions holds such
a large percentage of the market that by definition aggregated fund returns
must to some extent reflect the return of the market: for they essentially are
a fund grows larger, asset elephantiasis
limits the choices of stocks in can hold. Investors swarm towards funds which
have experienced successful years thereby virtually ensuring that future
returns cannot be as great.
fund transactions grow in size funds suffer from market impact: large parcels of shares which are bought by the
funds themselves impact the market (and they already are struggling to beat the
the biggest disadvantage of an index fund is that they are boring! You can never outperform the market and brag to people at
parties, you can only match the index which you invest in. Yet perversely, the
boring nature of index funds is also their greatest advantage.
by using an averaging strategy, you can achieve tremendous returns over time by
simply continuing to contribute each month. I have a UK index fund which has
been contributed to for 16 years consecutively now: very boring and very
said that: “Once dumb money recognises
its limitations, paradoxically it ceases to be dumb”.
Buffett correctly implies is that in acknowledging that most average investors
fail to beat the market, by reducing management costs and adhering to a
sensible strategy of continuing to contribute each month, investors spread
their risk and achieve a fine result.
Time is the friend of
quality; and the enemy of mediocrity
some extent the same is true no matter whether you are investing in silver, modern art, diversified
funds, property or blue chip shares. The cleverer average investors try to be, the more likely they are to come unstuck.
investors should always look to find value in their investments and buy high quality
assets in a downturn, some level of diversification is important and acquiring
assets over time has the effect of averaging the entry cost.
the case of property we are continually being reminded that property markets
can fall in value (stock investors don't need so much reminding as the most recent material downturn is still fresh in the memory). Investors should well know this. If you don’t know that
stock, commodity, bond or property markets can go down as well as up, do
yourself a huge favour and adhere strictly to an index fund averaging strategy.
all asset classes the longer your time horizon – both for spreading your entry
cost and for length of ownership – the lower the risk.
the duration of a typical mortgage term – 25 years – well-located property and a well-diversified fund of profit-making, dividend-paying industrial shares are a fair bet to
generate worthwhile income and appreciate in capital value too.
shorter your time horizon and the more you place big bets on uncertain shorter-term
outcomes - my Rolf Harris painting immediately springs to mind! - the greater the risk of capital loss.
I blogged the other day on how I felt the odds of a rate cut seemed to be priced far too high by the interbank lending rates.
I said I would take a straight punt on rates being on hold in February, for there just don't seem to be enough drivers at this juncture for further immediate easing action.
The stockmarket is roaring, iron ore is resilient, the dollar has calmed down a bit, property prices appear to be firm enough. Did I mention stocks are up 20% in 6 months? I think I did.
The futures markets have slowly caught on to this.
The ASX 30 Day Interbank Cash Rate Futures February contract is now trading at 97.055, indicating only a 27% expectation of a rate decrease to 2.75% at the next RBA Board Meeting. In other words, the odds are very low, but a small margin is retained to reflect the potential for shock news over the next week.
The market implies a reasonable each-way chance of a cut in March.
I received predictable earache aplenty the other day for daring to suggest in an article that - over the long run - Australian residential property prices would be likely to be to some extent correlated to the growth in household incomes.
I've never subscribed to the theory that over time property should significantly outperform income on a median price growth basis.
In keeping with the general spirit of the Herengracht index and Dutch canal-side housing, it is my opinion that overall the most rational proxy for median residential property price growth over time is household income growth.
That said, I do think that we need to make some allowance for the structural shift towards lower interest rates in recent times, which has naturally led to an increase in household debt levels. It's been often argued that debt levels are unsustainable, yet they have been sustained for many years now.
In the previous decade as highlighted in this article here by Christopher Joye, household income growth was fairly flying along at 5.8% per annum.
However, much of the previous strong growth in Australia has been due to a sizeable increase in the number of two-income households.
For this reason, it is expected over the next decade that household income growth will be materially lower, perhaps at around 4.5% per annum or so, which is close to the 4.4% per annum growth seen in wages since 1990.
Consequently, expect lower property price growth in the future too, particularly as we will see no repeat of the growth spurt caused by the structural shift to lower interest rates.
Of course, if you are an investor in property, then you will look to outperform any median price growth quoted in the media by investing against the cycle and by only buying when sentiment is low.
Take a read of this Business Spectator article where Christopher Joye introduces some interesting arguments - and a couple of interesting charts:
A couple things to note here. One is the relative under-performance of Sydney. Although in the period through to Q1, 2004 Sydney prices skyrocketed, the market has been relatively soft in the 9 years since that time - and over two decades Sydney's prices have significantly under-performed those of other cities.
Secondly, that 21 surveyed economists' average and median projections for residential property price growth over the forthcoming decade are 4.41% and 5.00% per annum respectively, which due to compounding growth would see prices in the region of 50-60% higher 10 years from now.
Of course the figures won't be accurate for there are simply far, far too many variables for anyone to know.
It is worth noting the difference here, though, between real and nominal prices.
I suspect that Professor Steven Keen's initial erroneous 2008 prediction that "prices would fall by 40% over the next few years" (ditto his prediction of a great depression and 20% unemployment) was an off-the-cuff remark which gained him surprising levels of press attention.
But he subsequently subtly revised his prediction, saying that prices could fall in real terms by a similar figure over the next 10-15 years.
Of course we can't know accurately what this means for property prices in absolute terms. It depends to a large extent upon whether we deflate by inflation or by household incomes (which are likely to be higher than CPI), but it is worth noting that over that timescale even Australia's most ardent doomsayer is predicting no kind of material absolute price falls at all.
Although it is popular to talk of "property investment", the near-total reliance on capital appreciation by most investors in residential property means that for most part we are really talking about price speculation.
If you are in property for anything less than Keen's 15 year time horizon, you are to some extent taking a punt on a whole host of unknown outcomes (which is fair enough, but should nevertheless be acknowledged).
With Dow only a few % from its all time highs, and China's Shanghai composite notching up another 2.4% to hit a 7 month high, it could be a bumper year for Aussie stocks which have languished a little to date.
"The Shanghai Composite Index (SHCOMP) rose 2.4 percent to 2,346.51, the highest close since June 1. The CSI 300 Index (SHSZ300) climbed 3.1 percent to 2,651.86. The Shanghai index has risen 19.7 percent since approaching a near four-year low on Dec. 3 amid signs of an economic recovery. The CSI 300 rallied 26 percent."
This is when it pays to use your own eyes and ears.
Certain internet forums have positioned themselves as "alternatives" to the mainstream media and will continue to highlight any doom any gloom they can find.
Don't be surprised by that: there is a big market for doomsaying and it will be filled. A loss of 100 jobs will attract a major headline, but economist projections of unemployment topping out are barely deemed worthy of a mention.
Plenty would like to see a collapse in the world order in the mistaken belief that their lives will become easier as a result.
It's extraordinary to think that against this backdrop of apparent misery, smart stock investors have continued to do what they always do and have made a killing.
The Dow Jones index at close to 14,000 is at double the level that it was at in 2009.
There’s a genuine risk that global bond prices may fall materially over the coming year or three.
It’s common to dismiss bonds as an investment as boring and inferior, particularly when stock markets are heading north. It’s often only when a bear market prevails that people recognise the protection that the stability and safety of bonds could have given them.
In fact, in today’s inter-connected age, it’s common for punters to have viewpoints on manner of investment strategies: stocks are better than bonds, gold is a more worthy investment than real estate, modern art is inferior as an investment to pork bellies.
The laughable thing is that, if you press people with even the flimsiest excuse for questioning you discover that viewpoints are rarely based on any kind of knowledge at all. They’re often merely half-baked opinions drawn from thin air. And nowhere is this truer than…the bond market!
Bill Clinton’s former adviser James Carville once said that he no longer wanted to be re-incarnated as a 0.400 hitter, and instead wanted to “come back as the bond market” because then he could “intimidate everybody”.
I’ve never understood why exactly, but when it comes to bonds as an investment asset class people seem to have some kind of mental block. They just can’t grasp it.It’s probably related to the varied and arcane terminology used, but most people can’t seem to tell you what makes a bond price move up or down…or pretty much anything else about bonds for that matter.
Bonds as an investment
Originally used by medieval states to fund wars, a bond is a form of debt: a lending instrument which companies, local governments/agencies and governments use to raise funds from investors. They tend to suit investors who are seeking a secure and regular income stream, and also represent a reasonable strategy for diversifying risk in a portfolio.
There are three main types of bond: government, municipal and corporate. It can be a tad confusing as there are different names for government bonds depending on the length of time to maturity: Bills (<1 year), Notes (1-10 years) and Bonds (10 years+).
Company or corporate bonds tend to be viewed as somewhat riskier and thus often attract higher interest payments to compensate for the risk of default. Sometimes companies issue convertible or callable bonds which may allow the bondholder to convert the instrument into company stock depending upon the agreed terms.
Lack of growth
The main point that counts against bonds as a long-term investment is that they do not appreciate in value in the same manner as average stock prices or property prices.
If this was a book I would trump up some statistics to show that $1 invested in stocks in 1900 would be worth enough to acquire you half of the moon, whereas an equivalent $1 invested in bonds might just about get you through the Kris Kringle. But, as this is a blog post, you’ll just have to take my word for it that stocks are a superior growth asset over time.
To understand in detail why bonds can be a useful addition to your portfolio, I highly recommend reading The Intelligent Investor by Ben Graham.
Bond prices and yield
A bond is issued for, let’s say, a face value or par value of $100,000 with a 10% yield for 10 years. It will pay annual interest of $10,000 (known as the coupon – from ye olden days before this new-fangled internet thing came along, when actual coupons were attached, to be torn or clipped off for the claiming of the interest payments) on the face or par value of the bond.
The bond will continue to pay the coupon for the duration of the instrument’s life, although after the bond’s issuance it may be traded on the bond market. Note that most bonds pay the coupon every 6 months, although some might pay annually or quarterly.
After it being issued a bond’s price may move much in the way of any other traded security. You may opt to hold the bond until maturity, in which case in the absence of a default, you will get your principal back, but you may also elect to sell the bond on the open market.
This is the part that people can’t seem to grasp: if the bond price falls to $80,000, then effectively the yield increases to 12.5%. Why? Because the interest payment remains the same at $10,000 but you are receiving it on a price of $80,000 ($10,000/$80,000 = 12.5%). The par value remains unchanged at $100,000.
On the flip side, if the bond price increases to $120,000 then the yield falls to only 8.3%. The reasoning is the same - the interest is still $10,000 ($10,000/$120,000 = 8.3%). It really is that simple!
Why do bond prices move?
Yields on new bonds tend to reflect inflation expectations (as inflation erodes value) and interest rates (obviously), and also they reflect default risk. Greek government bonds or corporate junk bonds at times have paid very high yields to reflect the elevated perceived risk of default.
Government bond yields are thus vitally important for they effectively represent the creditworthiness of that country, and affect the country’s ability to raise funds cheaply. Increasing bond yields and borrowing costs can be extremely painful for a country and its budget.
Often bonds are effectively owned by the citizens of a country for they are bought by their pension funds which are compelled to buy due to the perceived low risk nature of government bonds.
There’s a slightly more advanced calculation which is known as the Yield to Maturity (YTM) which, as the name implies, calculates the total return the investor receives if…they are holding the bond until the maturity date. It is harder to calculate, but a simple enough concept.
So we’ve established that a higher price means a lower yield, and vice-versa.
If you own a bond, you want the price to go up as you’ve already locked in your interest. If you are about to buy a bond you want prices to fall so that you can secure a higher yield.
So what makes bond prices move? Mostly: interest rates.
When interest rates are increased, bond prices on the open market fall, which raises the yield of issued bonds. Newer bonds that are issued will have higher coupon to reflect the movement in interest rates.
When interest rates are lowered, bond prices in the open market increase - which lowers the yield of these issued bonds. New bonds are issued with lower coupons to reflect the movement in interest rates.
If you can grasp this then the other concepts such as redemption values, convertible bonds and the rest are a cakewalk.
Today’s bond prices and the yield curve
There’s talk today of a risk of a major bond market correction as the global outlook improves and expectation of interest rates rising increases.
Property investors may be fairly familiar with the concept of a yield curve which shows a graph of the effective yield on a range of equivalent instruments with different maturity dates. Although property investors become transfixed with the 30 day interbank cash rate, the yield curve on government bonds offers a suitable indicator for the longer term health of the economy.
If the yield curve is inverted and yields are falling as the time horizon increases then this is a fairly reliable indicator that the economy is heading towards recession. Luckily for Australia our bond yields look like this:
2 year bond yield – 2.67%
5 year bond yield – 2.85%
10 year bond yield – 3.32%
15 year bond yield – 3.67%
With US bond yields reaching record lows in 2012 (the Fed Funds rate being locked down at 0.25%) the outlook looked bleak, but there is increasingly hope that the US economy may be starting to improve.
The doomers, gloomers and whingers continue to tell us that the world is most definitely ending and that Australia faces the most appalling economic risks of the gravest nature.
Slowly but surely, however, the surveyed major economists, the bond markets and the futures markets are all beginning to disagree with them, suggesting that Australia will see a mildly weaker yet positive 2013, followed by low unemployment and stronger growth in 2014.
I wonder who’s right? Do you find the answer to that question just a tiny bit exciting? I do.
I very much enjoyed reading the first Property Update fortnightly newsletter of 2013 on Friday to keep me abreast of what is happening in the Australian resources economy and the property markets.
In particular there was a fine article by Michael Matusik where he discussed in a very informative manner the impact of the resources projects and boom in investment on Australia's property market outlook.
You can subscribe for the fortnightly newsletter here - there are more than 60,000 subscribers already for this excellent resource.