Pete Wargent blogspot

Co-founder & CEO of AllenWargent property buyer's agents, offices in Brisbane (Riverside) & Sydney (Martin Place), and CEO of WargentAdvisory (providing subscription analysis, reports & services to institutional clients).

5 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 finest property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.

"Pete is one of Australia's brightest financial minds - a must-follow for articulate, accurate & in-depth analysis." - David Scutt, Business Insider, leading Australian market analyst.

"I've been investing for over 40 years & read nearly every investment book ever written yet I still learned new concepts in his books. Pete Wargent is one of Australia's finest young financial commentators." - Michael Yardney, Australia's leading property expert, Amazon #1 best-selling author.

"The most knowledgeable person on Aussie real estate markets - Pete's work is great, loads of good data and charts, the most comprehensive analyst I follow in Australia. If you follow Australia, follow Pete Wargent" - Jonathan Tepper, Variant Perception, Global Macroeconomic Research, and author of the New York Times bestsellers 'End Game' and 'Code Red'.

"The level of detail in Pete's work is superlative across all of Australia's housing markets" - Grant Williams, co-founder RealVision - where world class experts share their thoughts on economics & finance - & author of Things That Make You Go Hmmm...one of the world's most popular & widely-read financial publications.

"Wargent is a bald-faced realty foghorn" - David Llewellyn-Smith, MacroBusiness.

Sunday, 6 July 2014

Currency

Strong pound of the 1990s

When I first came to Australia in the 1990s, I originally lived down in 'the Shire' before Lara Bingle had become famous from her tourism advert, and before the short-lived reality drama series (no doubt deliberately) portrayed the region in a less than positive light.

It was a great decade for Poms visiting Australia - except, that is, for the poor English cricket team - since the pound sterling periodically bought up to three Australian dollars, meaning you could jag an Italian restaurant meal and a Crown Lager down at Renato's in Cronulla for the equivalent of a Pommie 'fiver'.

Australia was still to some extent seen as an economic backwater by many Europeans, yet we all know what happened during the next decade. 

Britain's highly-leveraged housing markets, especially those located outside London, tanked in sympathy with their subprime-infested US counterparts, while Australia cruised its way through the global financial crisis by embarking upon an unprecedented boom in mining construction, the unwinding of which has yet to play out with any real gusto (click chart):


Forecasting currencies - 4 methods

As a participant myself in the earlier stages of the mining construction boom during my finance career, I learned two very important, interchangeable rules about markets:

(1) forecasting commodity prices is a fool's errand; and

(2) attempting to anticipate currency movements is a mug's game.

In the resources sector, monthly Board Reports follow ASX releases which follow Annual Reports, all of which have plentiful in-built assumptions for commodity prices and exchange rate movements.

Most often, however, they have proved to a greater or lesser extent to be wide of the mark, due to unforeseen developments, thus leading to the introduction of requirements for variance analysis disclosures by International Financial Reporting Standards (IFRS).

There are essentially four ways in which you can attempt to forecast exchange rate movements:

(i) Purchasing Power Parity (PPP) - through e.g. comparing the price of equivalent goods in different jurisdictions;

(ii) Relative Economic Strength - stronger economic growth should in theory both drive up interest rates and attract investment from overseas, and thus in turn should strengthen strengthen the currency. (and vice-versa);

(iii) Econometric modelling - building a range of assumptions using variables such as, for example, interest rate differentials, to model future expected FX movements; or

(iv) Time Series analysis - the currency market equivalent of charting and/or technical analysis in the equities sphere.

Over the short term, while I'd consider a time series or technical approach to be useful, if far from infallible, over the longer term I'd definitely lean towards a Relative Economic Strength approach as the most useful measure. That is to say, over time fundamentals are of far more importance than technical signals or indicators.

The fallacy of forecasting

As alluded to above, it's nigh on impossible to forecast short-term exchange rate movements with any level of accuracy. But that said, there can come a point where you may feel it appropriate to take a position based on the expected future performance of an economy.

Last year, for example, I bought property in London - partly because I thought house prices would increase (they have), and partly because I felt the UK economy would rebound (which it has).

For me, the 2013 FX rate of GBP £1 to only AUD $1.50 was far too good an opportunity to pass up, so I used dollars earned in Australia to buy a UK asset. Today, the exchange rate has risen steadily to $1.83 and looks likely to appreciate further.

In effect, mine was both a currency play and a housing market play, which has been a huge win-win outcome for me. 

UK economy on fire

With the obvious caveats referred to above that short-term currency movements will in all probability appear to be haphazard, there does increasingly appear to be a case building for the British economy  to return to its former glories.

Interest rates are still sitting at the lowest rate (0.50%) since the Bank of England was founded in 1694, and have been stuck at that rock bottom level since more than five years ago when the base rate was last cut on 5 March, 2009.

Britain has also engaged in quantitative easing (QE), the effective 'printing' of sterling currency via a bond purchasing program, in order to stimulate economic growth. This unenviable state of affairs, of course, has led the British pound sterling to become relatively much, much weaker than it once was. 

However, the UK economy is now recovering at great speed, and QE looks set to be wound back as interest rates rise again, possibly in 2015. 

After all, the British economy is at long last now growing again at faster than a 3% per annum pace.

Total UK employment is increasing at a rate not seen in decades and has been fired up to a new record high of more than 30.4 million (click chart):


Correspondingly, the UK unemployment rate is therefore tumbling, and may even fall lower than the headline rate of unemployment here in Australia fairly soon given the current blistering rate of progress in Britain's labour market (click chart):


In fact, every economic data release seems to be bring further good news from Blighty right now. 

New car sales are back up at levels not seen in a decade and are growing at around 10pc per annum. 

The UK Manufacturing PMI index (for which a reading of above 50 denotes expansion) rose all the way to an exceptional 57.5 in June. Meanwhile, UK Construction PMI has almost blown off the charts to hit a phenomenal 62.6 in the past month, with that sector now adding more than its fair share of jobs too.

It's interesting to note that when I released my first book only a few years ago at that time I noted how people appeared to have mistakenly written off UK housing market and share markets permanently, typical of a short-sighted viewpoint which totally overlooks the ongoing cyclical nature of these British indices.

Sure enough, the FTSE has been flying, and average UK house prices are now rising again at a double digit annual pace and are set to easily break new highs over the coming years (click chart):


Aussie dollar to weaken?

The flip side to this is that over the next few years the great mining construction boom in Australia, depicted by the engineering construction activity chart earlier in this blog post, will begin to revert downwards to activity levels seen before the boom began more than a decade ago, thus acting as a material drag on the growth of the Aussie economy.

The net result of this is that interest rates are likely to be stuck down at record lows in Australia, while the Bank of England looks to hike in 2015 (click chart):


Should the above outcomes eventuate - which looks likely - the pound sterling is likely to appreciate again and one might expect to see the pound buying more than A$2.00 some time soon, and possibly much more. 

London property

So, those were a few of my reasons for increasing my already significant UK housing market exposure in London last year. 

There is little doubt that in the inner 10km ring of London, entry prices are now high, often sitting at around £600,000+ for two bedroom properties, even in what were often previously considered to be second tier locations.

But the idea that there are no more affordable property choices in London boroughs for international investors is misguided, with entry prices in third tier locations from around £200,000+, with attractive yields and very strong capital growth prospects to boot (email us to find out more; contact details below).

Indeed, in aggregate, the majority of our current enquiries at AllenWargent in our London office are from foreign-based property investors.

This is partly reflective of the fact that - exclusive of financing hurdles and any personal tax planning considerations - there are very few logistical barriers to entry in the London real estate markets for overseas purchasers.

It also reflects a currency play for savvy investors who hold funds in currencies that are equivalently stronger against the pound than their historical norms imply is likely to be the case in the future.

Summary

A weakening currency may not initially attract foreign investment, since it suggests an economy with a poor near-term outlook.

However, a currency which has been weakened substantially by a prolonged recession, but is now strengthening again at pace can see foreign investors clambering aboard demanding instant returns.

And that's exactly what we are seeing play out in London right now.

If you're interested in investing in London property you can contact us at london@allenwargent.com or simply email me directly at pete@allenwargent.com