Pete Wargent blogspot

CEO AllenWargent Property Buyers, & WargentAdvisory (institutional). 6 x finance author.

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Wednesday, 25 November 2015

Boots on the ground

Property correction?

It seems that there is to be weekly property market opinion in the share market newsletters these days, the associated angst a possible indication that dollars which might otherwise have been invested in the stock market have been worming their way into Aussie property in recent years. 

It is true that there have been some stinking recommendations in the property advisory space over time, often in the hapless guise of mining towns and some off-the-plan developments, and of course these are mentioned with regularity.

Yet in contradiction to reports of a property market slowdown in 2016, I've heard scuttlebutt from more than one source that major lenders are being inundated with mortgage applications this month, with processing times and backlogs reportedly piling up to to 3-4 times their normal level.

Refinancing will doubtless account for a good deal of this activity following the recent tightening of mortgage rates, but the real question will prove to be: how much?

Let us not forget that stock tipping newsletters have picked more than their fair share of howlers. I won't list them all (doing so would probably crash the internet, and anyway, I don't have the bandwith), but here are a few standout belters.

Oil and gas company Senex Energy (SXY) may have a sexy stock code, but there's been nowt sexy about the share price, last traded at 15.5 cents having absolutely capitulated over the past year or three.

And here is the chart for department store group Myer (MYR), last traded at $1.065 having floated at an IPO price of $4.10, which even at the time at the back end 2009 looked far too inflated a multiple of earnings. Summarily, a calamity.

Meanwhile regenerative medicine company Mesoblast (MSB) got blasted itself last week following a disastrous listing on the NASDAQ which saw the price crash yet again by another 50 per cent or so from $3.41 to a last traded at price of $1.58. Another catastrophic loss.

This has been merely an hors d'oeuvre, and of course there have been countless others (and I must confess it wouldn't kill me if I never read another bottom-picking article on the subject of whether or not to buy Fortescue Metals).

Speculating a small amount of your money on individual stocks can be fine, of course, and sometimes even quite good fun, but putting too much weight on flighty stock tips is not a plan for becoming wealthy over the long term (particularly stock picks for which no special insights are provided into the companies being promoted).

Strategy is important 

My graphic below charts the simple arithmetic of portfolio losses and shows that a 50 per cent drawdown requires a stock to recover and then increase by 100 per cent in order to get back to break even, while a stock which declines in value by 90 per cent ain't never coming back (technically it could happen, but it would need to increase by 900 per cent in order to do so).

This basic principle of investing is where Warren Buffett's famous "Rule #1: Never lose money!" hailed from. Buffett's Rule #2 is to "See Rule #1", for once you lose a substantial percentage of your money, it becomes proportionately more difficult to make it back.

Supermarket sweep (the institutional imperative)

Some years ago my mate Andy's cousin Dave went to live in Amsterdam, and upon his subsequent return to the UK went through the usual drill of identifying what had changed in his absence (in short, thousands more migrants from eastern Europe, and a glut of Tesco supermarkets). Dave noted in passing that Tesco and other retailers appeared to have flooded the country with superstores, convenience stores and mini-marts, which would end in tears. 

Famously Warren Buffett's Berkshire Hathaway had made a £1.5 billion investment in Tesco, but by his own admission "dawdling and thumb sucking" instead of exiting the investment following a series of profit warnings resulted in a drastic loss of US$444 miilion, one of the biggest losses in Berkshire's history.

Now I am certainly not claiming here that my mate Andy's cousin Dave is smarter than Warren Buffett. That would admittedly be drawing a rather long bow, and in fact most people I know who have gone to reside in Amsterdam have returned with suspiciously slower neural pathways plus an inconvenient nicotine addiction. 

Yet arguably simply by having "boots on the ground" perhaps Dave did have an insight into Tesco's core market that analysts at Berkshire did not? Or is this narrative simply an illusion, another classic case of hindsight bias?

No doubt the key operational metrics and ratios looked outstanding on paper for an investment in Tesco - the financials clearly stacked up very nicely for growth - but it transpired that the institutional imperative had ultimately led to a wave of accounting scandals (the collection noun for accounting scandals always being "wave", of course) that had overstated profits.

It was subsequently revealed that internal control and audit failures had failed to uncover dubiously aggressive accounting entries. Tesco, Sainsbury's and Morrison also saw their share prices getting smoked in 2014.

This does beg the question that if the world's greatest ever investor is capable of making fundamental investment errors (both on entry and exit) of this magnitude, perhaps lesser mortals giving stock tips are too. 

Boots on the ground

Not dissimilarly, in the imperfect real estate market successful property investment requires intimate local knowledge, and not only a review of whether a property stacks up "on paper".

Most property agents are genuine experts in their local area, and the switched on operators with their ears to the ground will generally also have a solid understanding of development approvals in the locality and the supply pipeline. 

It is probably fair to say that only a relatively narrow echelon of the best advisers also have a tight handle on what is happening in the wider economy (let's face it, for many in the property space "macro" might as well be a reference to the local grocery store).

Indeed the fate of mining regions represents perhaps the definitive example of why an understanding of both macro and micro market factors can be so important. If you undertake an internet search for "2012 property hotspots" you will find a long list of recommendations for investment in mining towns and regions, with implied expectations of both double digit yields and pretty much exponential price growth.

Yet commodity prices "never always go up" - sooner or later either supply ramps up in response or demand slows, and if heaven forbid both happen together...well, all bets are off!


The ABS reported today an estimated 32 per cent improvement in Australia's trade deficit in the third quarter. with the seaonally adjusted trade deficit of $7,438 million a moderately favourable revision to the monthly numbers reported (which I looked at in detail here, and specifically exports here). The trade deficit for the second quarter was revised out to a wild $10,946 million).

This implies that GDP growth in the third quarter may benefit from a chunky +1.3ppts contribution from net exports, and could in turn see a solid headline result. I do wonder if GDP growth for the second quarter might be revised down to zilch, though.

Today the ABS will release its latest Construction Work Done figures which we can expect to show a decline in Engineering Construction. 

It will also be interesting to see how the contribution to the economy from the residential construction boom is shaping up, particularly at the state level.

The latest report from the Housing Industry Association (HIA) projected that total housing starts will begin to decline to 200,000 for FY2015/16, to 173,500 in FY2016/17 and then 165,000 in 2017/18. Renovations on the other hand are expected to increase.