My Monday Rant

It’s been a little while since I’ve had the opportunity to write to you, as so much has been happening. We held our first investment forum for 2017, discussing the great property bubble with some of the best in the business, which was a great success. We had a full house of clients, developers and investors. I’ll be sharing key take outs of the forum in the coming weeks.

Over the past few weeks, a whole bunch of stuff has been happening, so I thought I’d give you a run down of what I’ve been seeing and thinking:

+ Don’t be fooled. Everyone talks about how great the performance of the US stock market has been over the last decade. A closer look will tell you that even the German stock market has performed better than the S&P 500. Don’t believe everything you read in the paper.

Source: Yahoo Finance

+ The US stock market has been falling over the last few days leading up to the healthcare vote in the US. Financial media had been reporting the impact this has had on markets. This is the drop they’re talking about…

Source: Thomson Reuters

I’ve also been reading about what this means, and what impact it will have on financial markets. No one still know’s what caused the Black Monday crash in 1929…88 years on, and we expect people to have the answer to something that hasn’t even happened. Let’s get serious for a second folks. The same doomsayers that were telling us a Trump Presidency would be catastrophic for financial markets continue to publish their pessimism and expect the general public to hang off their every word.

In the end, the bill was shot down and stocks rebounded.

+ This is why you shouldn’t take forecasts seriously, even from Central Banks. Wage data was released last week. I thought it would be amusing to revisit this chart, which shows the RBA’s regular forecast of wages with actual.

The RBA has been forecasting higher wages since 2011. They’ll be right eventually.

+ Prime Mister Turnbull has been considering allowing First Home Buyers (FHB) to access their super to purchase a home. This has to be the height of stupidity. I will not waste your time and expand.

+ Apparently foreigners are “hoovering” up all of our property. No one could really quantify this, until now. We have the data (dun dun duuuuun):

  • NSW – 25% of new supply
  • VIC – 16% of new supply

So, 1 in every 4 in NSW and 1 in every 6 in VIC. Not very “hoovering” is it?

When we hear the the term “foreigner”, most people think of the Chinese. And rightly so. Here’s how much the Chinese make up of foreign buyers:

It’s quite staggering actually.

Nevertheless, do you ever wonder why this is the case? This is one of many reasons. Although a compelling one, the storage of wealth probably ranks higher than price, certainly from the discussions I’ve had with Chinese investors. Anyway, here’s price and yield from the point of view of our Chinese neighbors.

+ The Melbourne/Sydney apartment property boom/bust theory continues. We’re told construction, prices etc. have all the traits of a bubble not seen anywhere else in the world. If we take a look at other mature apartment markets in the world, such as New York, we’ll quickly learn that this has happened before and has not ended the way the doomsayers claim. Here’s New York apartment prices (per square foot) since 1910. They’ve been climbing since the 1950s.

In the end, no one really knows what the future holds. No one really knows what impact certain events will have on financial markets. Trying to front-run the global markets’ investors is nothing but pure speculation. It’s easy to do it when it’s not your money. Next time someone tells you what they think, or what you should do with your money, ask them what they’re doing with they’re money.

 

Here’s where millionaires are flocking to

Money may not buy happiness, but it does buy the ultimate flexibility for making financial and lifestyle decisions.

For many of the world’s millionaires, money provides a highly effective means to escape their home country when times get tough. They can pack their bags, and move their family and capital to a location that will provide superior opportunities for prosperity.

According to a new report by New World Wealth, this couldn’t have been truer for 2016, as the amount of millionaire migrants increased by 28% from the previous year.

Human and capital flight

In 2016, there were a total of 82,000 millionaire migrants that left for greener pastures. Here are the countries they’re feeling and flocking to.

Here are the top 5 net outflow countries.

France tops the list for a second straight year, as rich people dodge conditions that they consider to be adverse. France has rising religious tensions and populism, but it also has a tax system that is not particularly friendly to the ultra rich. The International Business Times calls the ongoing problem a “Millionaire Exodus”.

China and India both continue to have net outflows of millionaires, but two of the more interesting countries on this list are Brazil and Turkey.

Brazil continues to be deep in economic crisis, with its worst-ever recession likely continuing into its eighth-straight quarter in Q4 2016. The country also recently impeached Dilma Rousseff in August 2016. On the other hand, the Washington Post describes Turkey as a country that is in a “permanent state of crisis”. This may be a fair criticism, since in 2016 there was the assassination of a Russian ambassador, a currency crisis, an economic crisis, and also an attempted military coup.

Like most people, millionaires don’t like uncertainty – and they have the wherewithal and conviction to get out of places that have ongoing issues.

Here are the top 5 net inflow countries.

In 2016, Australia was the number one destination for millionaire migrants, with the United States and Canada being close behind.

New Zealand also had the amount of net inflows double, while the UAE remained a popular location for the wealthy in the Middle East.

Demographics is super important, especially when it comes to the topical issue of housing affordability. These charts show us the millionaires migrating to Australia. What they don’t show however, are the countries general population growth.

Here’s historical and forecast population growth for Australia:

To put this into perspective, we’re sitting at number 5 in the world!

We need to focus on the bigger issue here. How we, as a country, as businesses, as people, accommodate and take advantage of this trend.

Source: Visual Capitalist, NAB

Here’s where you should invest your money

When I tell people what I do, one of the first questions I’m asked never surprises me, “where should I invest my money?” I always struggle with this question, although it’s what we do in our firm each and everyday, because it’s such a difficult question. There’s so much more to it than the question that’s asked. When I respond with, “what are you investing for?”, people are generally stumped. However, the response is also always the same – and it never surprises me either…”to make money”. No sh*t! Why, what’s the money for? When investing, it’s super important to be very clear on what you’re doing, and why you’re doing it. It provides you with the clarity you need to make good investment decisions.

Nevertheless, in an attempt to answer this question, I decided to provide my point of view on major asset classes:

Cash

Cash is king. They say you should hold 3 months’ of expenses in cash. I don’t think there’s a hard and fast rule. It really depends on your situation and plans.

  • If you’re young, have a stable job, no intention on leaving your job, 3 months may do just fine. Sure, you won’t be getting much in return but it’ll go a long way in an emergency.
  • If however, you don’t want to be held hostage by your job, hold 12-18 months’ of expenses. This gives you the opportunity to work on your new idea – often referred to as ‘f*** you money’.
  • If you’re retiring or retired, hold 2-3 years’ worth of expenses. You never know when the next financial crisis will cut the income from your portfolio by 25%. It also helps avoid having to sell assets at fire sale prices.

Bonds/Fixed Income

This is where you’re going to get your diversification from your stocks and other risky assets such as property (if you need it). Having said this, if you can stomach the ups and downs of risky assets, and you’re not replying on the income, you could probably build a case not to invest. Personally, I don’t hold any bonds or fixed income (not personally or in my super fund). I can ride a 50% draw down on risky assets without feeling sick. Then again, I’ve also got time on my side. Others aren’t so fortunate.

If you’re retiring or retired, bonds will give you regular cash flow, and provide your portfolio with cushion – when you really need it. Okay, I can already hear you thinking it, what about rising rates and the impact on bonds?

To give you some indication of the performance and behaviour of bonds over the last 31 years, I’ve prepared the below table. It shows us the average return for a world bond index, as well as the best and worst returns and when they occurred (click for larger image):

Source: Returns 2.0

If you’re not convinced, let’s go back even further and see what happens in bond bear markets. Consider the post-war period (1941-1982) when yields on the US 10 year went from 2% to 15%. You know what the worst loss during this time was? 5.01% in 1969 – fairly mild. In fact the average loss during this time was 2.1%. During this same time, inflation averaged 4.49%. Inflation was what hurt bond holders, doing twice as much damage than the impact of rising rates.

Here’s the list:

Source: Ben Carlson

As long as your holding bonds for the right reasons, income, diversification, greater price stability etc., I believe there is a genuine need for bonds in a well diversified portfolio.

Property

First thing’s first, pay off your home loan they say. I totally agree with this concept. If however, you’re in a position to do so, why not invest at the same time?

Personally, I believe most investors should hold property in their portfolio. The downside however, is that it’s a lumpy asset. Especially at current prices, it’s not cheap. Rental income doesn’t get me excited, so what is it? Land. Pure and simple.

I’d be looking for property with development potential (I’m talking residential property – I personally don’t have much experience in commercial property). Land is where the value is derived from, not the dwelling (IMO). Close to transport, freeways, shops, schools, and look for areas where government has a clear long-term plan.

If you’ve got a really long time horizon, 25+ years, look out, further out. I’m talking growth zones. There’s plenty of them – acres and acres of land. The problem is, it’s a 25+ year plan. Unfortunately most investors can’t see beyond the next 12 months, they lack patience.

With prices of dwellings rising so rapidly, it makes it difficult to see exceptional value right now. Then again, it all depends on why you’re buying.

Here’s where Australia’s house prices (real) are (orange line) relative to their long term-trend (blue line). According to AMP, currently they’re sitting around 14% above it’s long-term trend. If you’re buying your family home, which your going to live in for the next 20+ years, and your telling me you think you may be paying $200,000 over the odds. If it’s the property you really want, I say who cares. It always goes back to why your investing.

Source: AMP Capital

Shares

If you want your investments to grow over time, you should be looking at a portfolio of shares. The allocation of and the factors you tilt toward will be dictated by your personal needs and tolerance for risk. Whether it’s large, ‘blue chip’ stocks, or small company stocks, which are more volatile, however have provided a greater return of the long run.

Currently, the broad Australian share market is generating income of around 4.5% pa plus franking credits. You’re certainly not going to get this from cash, fixed income, or rental yield (residential).

To give you some indication of the performance and behaviour of Australian shares over the last 31 years, I’ve prepared the below table. It shows us the average return for the All Ordinaries Index, as well as the best and worst returns and when they occurred (click for larger image):

Source: Returns 2.0

As you can see, the shorter your time frame, 1, 3 and even 5 years, the return range is very wide (look at the best and worst returns). Once you move your time horizon to 10+ years, your return range is much narrower. In fact, your worst 10 year return was 4.51% pa! Interestingly, the average return over all the periods except 1 year, are within 34 basis points of each other.

Done properly, a share portfolio could help achieve many objectives, whether it’s to fund your child’s education, help them buy their first home (refer to my comments on property), provide you with a regular income stream whilst growing your wealth, or be the engine room for your retirement.

If you’ve got the time and the patience, you will be handsomely rewarded over the long run. The next 12 months? I have absolutely no idea. And to tell you the truth, no body does.

Bringing it all together

Over long periods of time, your investments will compensate you for the risk you’ve taken. Risk and return is not dead and diversification still works.

Source: AMP Capital

There are many cases that can be built to invest is so many different asset classes. Whatever the investment, it needs to be right for you and your why. Be clear on what you want and reverse engineer it, the investment decision will be much easier.

Here’s where the Aussie property market is at

My parent’s are looking at selling their family home with the intention to downsize. It’s the typical story, they’re reducing work hours, house is too big, and there’s a bit of equity tied up in the family home. We’ve spoken to a couple of the primary agents in mum and dad’s area, who do a good job in keeping us informed of what’s going on in the property market (and of course it’s always going well, right?).

Anyway, Melbourne hosted 1,179 auctions over the weekend, higher than last week’s 1,114, but down from 1,398 a year ago, down about 15%. Clearance rates continue to remain quite strong at 79%.

You can see from the chart below, the number of auctions have been rising, although weaker from this time last year. So too has the clearance rate, creeping back up to the 80% mark.


Source: CoreLogic

Here’s the latest national data. Perth and Brisbane putting some pressure on the solid numbers in Sydney and Melbourne.


Source: CoreLogic

This information is encouraging for mum and dad. There is plenty of supply on the market and people are buying. Let’s take a look at what people are paying these days. Here’s Melbourne’s median house and unit/apartment prices since 2006.

Zooming out to take a national view point, here’s the annual price change across all capital cities. As you can see, Sydney is an obvious standout. Strip Sydney out of the equation, and the rest of the country is hardly as strong as the commentary claims. Then again, anyone can slice and dice the data to support their case.


Source: CoreLogic, AMP

You don’t need to search very far to find the latest commentary on why Australian property prices are overvalued. There is ample research to support this theory. Here’s a simple yet effective valuation method of Australia’s house prices, relative to their long-term trend. Please note this is in real terms, that is, taking into account inflation.


Source: ABS, AMP

So we’re sitting above our long-term trend. I don’t think this should come as a surprise to anyone. Markets can remain overvalued and undervalued for long periods of time for various reasons.

Higher prices have gone hand in hand with higher household debt. In fact, over the last 25 years, Australia has gone from a debt to income ratio from the low end of OECD countries to around the top. Although, interest paid is down to the lowest rate since about 2004.

What has caused higher prices?

Of course, lower rates have encouraged investors to turn to property, so too has the uncertainty in the global economy. Having said this, we cannot forget the fundamental driver of prices, supply.

We hear so often about oversupply danger. The over supply in apartments. In fact, the RBA only last week highlighted pockets of danger for the Australian economy, one of which being oversupply danger in apartments.

Since 2009, apartment approvals have sky rocketed, pushing private residential building approvals to nosebleed territory. Detached housing however, flat lining since 1991 with a few bumps along the way.

Even pulling the data period out further, we can see detached housing has been treading water for the last 33 years. So too have apartments, until 2009.


Source: ABS, AMP

Going out even further really puts the high rise construction boom into perspective. What goes up must come down.


Source: Peter Wargent

Are we building more and more of the stuff that people don’t want, notwithstanding the fact that they are selling. Is this part of the problem that is causing the price of detached housing to sky rocket?

Taking a look at the data, we continue to supply a fundamental supply issue – although well and truly down from its peak in 2014 of 100,000 dwellings. Current data suggests we won’t hit ‘oversupply’ territory until 2017/2018.

Source: ABS, AMP

Is there a crash coming?

Yes folks, there is. When? Who knows. In short however, I reckon there will be a few triggers: 1) Oversupply. We’ll need to see the current rate of construction continue for a few more years. As we discussed earlier, current figures don’t see this occurring for a couple more years. Furthermore, supply is being created in the apartment market and not detached housing. 2) A recession. We then need to ask ourselves, what will cause a recession. 3) Higher interest rates. I don’t think we need to spend too much time on this one.

Is property a sound investment?

To date, property has been a solid investment. More recently however, we’re seeing rental yield’s dropping dramatically, which means the real cash return from these investments are looking less and less attractive.

The price investors need to pay today to get into the property market is clearly much higher than it has been before. Like any asset class, to expect growth rates to continue in the short-term as they have for the last few years will be foolish.

Investors need to ensure their portfolios are diversified. Naturally, Australian’s have a large allocation to property, in fact around 60% of their wealth.

Over the long-term however, Australian residential property has returned around 11% pa, very similar to Australian shares, in fact with lower volatility that shares. This is probably because it’s not valued as frequently as shares.


Source: ABS, REIA, Global Financial Data, AMP

For mum and dad, the current situation is quite opportune, although it won’t last forever. We’ll no doubt see a correction, which may drag down the price of their home 15%, 20%, who knows. Although I don’t believe this will be the case in the immediate short-term. Enough time for them to sneak in a sale I reckon.

According to dad however, property never goes down. Maybe because like all good investors, he doesn’t look at the value every second day.

Australian Property. The Million Dollar Club.

Australian property

The latest data is in. The four year Australian property boom has driven the number of Australian suburbs to command a median house price of $1,000,000.

Since interest rates began their downward trend in 2012, the average capital city home price has climbed 40%.

On many metrics, housing is unaffordable – for example, using debt to income ratios. Through the 1990s until the mid 2000s, house price growth was closely associated with changes in debt to income ratios. Since the mid 2000s however, it seems as though underlying demand (as represented by the orange bars) have played a more prominent role.


The demand gap, or supply, is the most basic and fundamental driver that commentators continue to overlook. Take a look at Graph 9. Again, since the mid 2000s, the demand and supply gap has been clearly evident (above zero).


NSW arguably playing the biggest role.

The last few years have provided home owners and investors with phenomenal returns, realised or otherwise. Again, like any market, on lookers forget to take a longer term view. I mean, look at the last five years of returns. They’ve been anything but phenomenal.


Nevertheless, no matter which way you look at it, the cranes continue to do the work. In fact 85% of cranes in use are for residential construction, including student accommodation and retirement living projects.

Doncaster and Box Hill continue to be apartment hot spots, through Manningham and Whitehorse. We’re also seeing a number of projects make their way up into the sky in Brunswick East through Moonee Valley – Maribyrnong – Moreland.


The construction that is going on is high density stuff. You’ve seen this chart before, which clearly distinguishes the activity in higher-density housing and detached housing. There’s been limited activity in detached housing since the mid 2000s.


Again, like most investments, they typically revert to their mean. Property is no exception. AMP have a great chart they update regularly (below), which shows us real house prices relative to their long-term trend.


Sure, residential property may seem expensive right now. There are many factors driving this. In my opinion, a fierce combination of low interest rates, continued immigration and foreign investment, and an under supply of dwellings are driving prices higher and higher.

This will no doubt change. Markets have an uncanny way of adjusting prices. I encourage you to make investment decisions that are right for you and your personal goals, aspirations and priorities. I strongly encourage you not to make decisions based on speculation and simply in the pursuit of money.

Money is not the end game (although for some it may be), it is simply a means to an end. Be clear on the ‘end’ and decisions with money will become much clearer to you.

John Maynard Keynes once famously said, “markets can remain irrational for longer than you can remain solvent”.

A different viewpoint on negative gearing.

Property

Australian property investors want house prices to drop, but also want negative gearing to stay. Oh the conundrum.

You may have recently read about a hedge fund manager and an economist (sounds like the beginning of a joke, although not, it certainly could be) posed as a gay couple in Sydney’s Western suburbs viewing houses and meeting mortgage brokers for research to determine if there’s a housing bubble. One could have probably done that in the comfort of their own office. But hey…a tax deductible trip to Western Sydney – why not.

Their conclusion (this is for real and not a joke): Australia (as represented by Western Sydney according to the two gentlemen) is in a property bubble (brilliant observation guys, we didn’t know that Australia’s property prices were inflated). Apparently we will see a 50% decline in house prices (although no time frame was given). Banks will cut their dividends entirely (yet again, no time frame was given). Bank stock prices will fall by 80% (you guessed it, no time frame given either).

The skeptic in me says these guys are crying out for a little more attention. Well, they’ve got it. Now what?

Let’s take a look at reality shall we?

Since the mid 1990’s and early 2000’s, we’ve seen a downward shift in consumer prices (inflation) and nominal interest rates. Since then, home ownership has declined, with the most obvious factor being a rise in house prices.

Notwithstanding the sharp rise in house prices and the higher levels of mortgages taken out to fund these purchases, repayments on housing loans are well below previous peaks (see below). Do we have an affordability issue?

Australia repayment housing loans
Source: RBA

One of the biggest demand drivers that continues to be overlooked by so many, is population growth (see below). Although natural increase in population growth has certainly been anything but stellar, net immigration (as we all know) has been significant.

Australian population growth
Source: RBA

Not only have we seen (and continue to see) our population grow, there is one visa category which has been going gangbusters. You guessed it, students. Australia’s easing of immigration rules have meant that it is now easier for students to become permanent residents following graduation. These people too need to live somewhere.

Australian immigration
Source: RBA

Now that we have established that there is a demand for Australian property, what are we doing about it? The flow of new construction (until late) has been very slow in responding to the needs and demands for housing.

We all know that Australia faces a particular challenge around the distribution of our population. We are highly urbanised and a large portion of our population is usually concentrated in a few large cities (unlike population density in comparable countries – this is why an apples-for-apples comparison with Australia is so difficult – but hey, we do it anyway).

We continue to remain sluggish in responding to demand. Not the latest data, but gee, you get the picture. Mind the gap.

Australia population growth
Source: CoreLogic

Vacancy rates continue to remain low and we continue to have a cumulative under supply of 200,000 dwellings since 2001! What do you think will happen to prices when you have a supply issue? It’s basic economics.

To put things into perspective, here (below) are real house prices since 1926. I am not ignoring the fact that property prices are inflated. Both relative to short and long term trends (see below).

 Australia house prices
Source: AMP Capital

Before we jump to such conclusions, let’s think about the underlying issues and address these. Anything else is a complete waste of time and money.

The market will sort itself out. It always does. In the meantime, think longer-term. Think about unlocking more land. Think about accessibility and infrastructure. Think about creating satellite cities.

Unfortunately, the removal of negative gearing will not solve our real problem. Supply.