General – Page 36

Invest like you'll live forever…

October 11, 2013 by Jon

Dice and Money

Imagine I offered you a bet.

Let’s say I’m an eccentric millionaire (not such a stretch). I’m going to toss a coin. If it comes up heads, I pay you $7000. If it comes up tails, you pay me $4000.

Would you take it?

Would the prospect of winning 7 grand of my money be worth the prospect of losing 4 grand of your own money, when both have an equal chance of happening?

Would you do it?

Now, if you’re like most people, this bet simply just isn’t worth it.

I’m not saying ‘like most people’ because I’ve actually been out there roaming the streets trying to play odd gambles with strangers, like some cross between Willy Wonka and Donald Trump. Psychologists and economists have studied gambles like these (mostly in the abstract), and found that typically, people just don’t go for bets like these.

But why exactly don’t we like this bet? The ‘expected value of the bet is:

(50% x $7000)
+
(50% x -$4000)
= $1500

That is, it’s positive. The expected return of this gamble is positive. In economic theory, you’re taught that people like gambles like these. From a purely economic perspective, it’s a good bet.

But again, economics has given us something that is true in theory, but wrong in practice. So it’s over to the psychologists to come up with an explanation.

There’s a few related constructs that help explain this future of the mind, but central among them is a concept called ‘loss aversion’.

Studies show that losses loom much larger in our mental view of the world than similar sized gains.

Know the saying ‘a bird in the hand is worth two in the bush’? We value things we have much more (2x more according to that proverb) than things we don’t have, but could have.

And we’re hard-wired to hate losing things.

This can create some interesting quirks. What if I put on my Willy Wonka hat again and offered you a gamble that offered a 10% chance of winning $95, and a 90% chance to lose $5.

Would you take it?

What if I offered you a lottery ticket that had a 10% chance of winning $100, and a 90% chance of winning nothing. The ticket cost $5.

Would you buy it?

If you’re like most people (in the experiments) you’re much more likely to go for the second bet than the first.

But check the maths again. Those two gambles are exactly the same. They’re just framed in different ways.

In one, there’s the prospect of losing $5. In the other, there no prospect of losing anything, but there is a small expense.

There’s no practical difference, but when the mind is distracted from the prospect of a loss, it takes a more objective view of the bet.

As humans, we just don’t like losing. And we’ll go out of our way (even avoiding favourable gambles) to avoid it. It’s a principal called ‘loss-aversion’ in economics, and if you look for it, you’ll see it everywhere… (insurance, anyone?)

But losses are also a relative concept. If we were talking 7 cents rather than 7 grand, you’d probably feel differently about the bet (though perhaps not about the weird Willy Wonka dude hassling you on the street.)

Or what if I was offering the bet to poor little orphan Annie? What would you recommend? What about if I was offering the bet to David Koch? What then? The perceived weight of the losses changes, and with it, so does the attractiveness of the bet.

Now I’m not saying that there’s anything wrong with being loss adverse. In fact it seems entirely rational, and if you weren’t loss adverse there might be something wrong with your brain.

But as investors, we need to know that our brains are hardwired this way. And we need to be on our guard in case overly focussing on the losses blinds us to some attractive bets.

Now, let’s come back to our bet for 7 and 4 grand. What if I said I was going to run the bet 100 times? Flip the coin 100 times. Then what would you say?

Suddenly this border-line dodgy bet seems like a great deal. Your mind has probably already intuited out the kind of gain you could expect.

100 coin tosses is going to come down somewhere pretty close to 50 heads, 50 tails. The expected value is now $150,000. You’ll definitely lose individual tosses from time to time, but there is a very small chance that you’ll actually lose money over all.

It’s a no brainier. Of course you’ll take the bet. Thanks Willy Wonka dude.

But the odds of any individual bet haven’t changed. Only the number of times the bet is taken.

In my experience, successful investors can do this. They’re able to put their bets in the context of a long series of bets, and this makes them more likely to take the opportunities that arise.

Think about it this way. What kind of returns would you need from an individual property investment? What about if you imagine a lifetime of property investing, maybe over 100 properties? What kind of odds would you need then?

See how it changes?

Of course it’s easier once you actually have 100 properties under your belt. But there’s nothing to stop you thinking like a pro, straight from the get go.

That’s what I do. I approach every investment, not just on it’s individual merits, but as if it were just one of a life times worth of investments (which I know it is).

I know I’m not going to back a golden winner with every investment. But I know if I get a good system in place, over the long run, I’m practically guaranteed to come out way, way ahead.

And certainly more than if my loss-adverse brain kept me on the sidelines.

Yep, that’s my motto: Party like you’ll die tomorrow. Invest like you’ll live forever.

You can quote me on it.

WTF? Now the "Big Boys" are joining the real estate party…

October 4, 2013 by Jon

In the last post I sent out, one of the charts just wasn’t viewable for some reason. It’s tempting to blame a conspiracy of the big banks and university economists, but it’s more likely that it was one of those technology bugs.

But it’s an interesting chart, and for my money one of the best snap-shots of where the property market’s at right now. So I thought I’d repost it here.

Screen Shot 2013-10-04 at 11.35.16 AM

ANZ pulled this one together. As I said last time, it compares auction clearance rates and the year on year change in house prices. It’s a pretty tight fit, hey? They’ve been moving in lock step since the GFC.

They also let clearance rates ‘lead’ house prices by 6 months. That makes sense. It says it takes about 6 months before everybody cottons on to what’s happening. Clearance rates are increasing, but prices are a bit slower to follow.

And so it allows us to look 6 months into the future. And what does that future look like? Well, as it shows on the chart, it’s saying that in 6 months, expect to see year on year house prices increases of around 13 percent, and moving higher.

Which, as I said last time, is what I’ve been saying for a while.

But the other point I made in my last post is that it’s interesting that ANZ is now out there making bullish calls on property. That’s a turn of events.

But they’re not running loan wolf, sorry… lone wolf on that one. A lot of the big houses have changed their tune. Take CBA, for example.

They put out a chart on the demand / supply balance in the housing markets last week, and it was one the most interesting I’ve seen in months.

You’ll remember that last week I was looking at supply and demand in the market, and arguing that demand had been outpacing supply for a while now. Mostly because the rate at which we build new houses has been falling for decades, even though our population keeps increasing at a faster and faster rate, and we have smaller average household sizes.

This is what this chart picks up. It’s CBA’s estimate of where the demand and supply balance is at:

Screen Shot 2013-10-04 at 11.35.25 AM

If you follow the track of the green (demand) and red (supply) lines, it shows you that demand is currently running ahead of supply, as it has done for most of the past 15 or so years.

And if you look at their estimate of the demand supply balance (the blue bars), it shows that we’re currently experiencing the biggest imbalance since at least 1990, with demand massively outweighing supply.

And this means, that from the most basic and fundamental level of the housing market, we’ve got huge upward pressure being applied to prices. And that’s their central conclusion. Expect to see more price increases.

I’d even suggest that this estimate is a little conservative, if anything. I don’t remember there being a huge excess of supply in the years before the GFC – growing prices certainly didn’t suggest that there was.

But as I said in my last post, the big guys have some good reasons to be conservative. If you make a big call, put yourself out there, the reputation costs of getting it wrong far outweigh the small bragging rights associated with being proven right.

And this, as much as anything, tells you what’s going on in the market right now. That the big banks like ANZ and CBA are now out there talking up property, publishing charts like these that clearly show the amount of pressure on prices right now… that tells you just how far the market has turned.

These guys wouldn’t be taking positions like this if it was still a 50/50 call. They need a lot more certainty than that before they man-up and put themselves out there.

And so when the big investment houses turn, as they have done in past few months, then it’s as close to an iron-clad guarantee as you get in this game. You can bet the house on it.

House price increases, somewhere north of 13 percent, are now the baseline scenario. That’s the conservative position. It could very easily be a whole lot more than that.

It’s exactly what I’ve been saying all year. These are exciting times.

More reasons for property prices to rise…

September 30, 2013 by Jon

In my last article I noted how housing supply seems to be falling further and further behind demand.

Each year we build fewer and fewer houses. And over the last ten years, growth in the housing stock failed to keep pace with population growth. This is the first time this has happened since WW2!

This has a few really important implications.

The first is that all this talk of a bubble is completely over-blown. (hey? How’s that for a pun? Put that in a Christmas bon-bon.)

Because unless there’s a glut, then there can’t be a bubble, and unless there’s a bubble, then there can’t be a bust. This is one of the most important differences between the Australian story and what happened in America.

We also know that if supply is falling further and further behind demand, then there must be upward pressure on prices. This is as true of housing as it is of any market.

And so this supply shortfall goes a long way to explaining the trend increase in house prices we’ve seen over the past 50 years or so. Not the full story, but a fair bit of it.

And supply doesn’t look like it’s going to come bouncing back anytime soon. This means we can expect to see continued upward pressure on prices.

And all that is true for a given level of demand. But the truth is that there are major structural and demographic changes happening on the demand side that mean the supply and demand gap is getting even bigger.

Which of course means we’ll see bigger and bigger price increases.

So what’s happening on the demand side?

Well, in a nut shell, we’ve seen a bunch of changes that means we need more houses for the same number of people. That means that actual demand for housing is actually growing even faster than population growth, which itself is already growing faster than supply.

Over the past 50 years there have been significant changes in the way we live. Take average family sizes for example. As fertility rates dropped, average family size has been on a steady downward decline for decades now. That means we need more houses to accommodate the same number of people.

At the same time, family breakdowns have split many families in two, effectively doubling that family’s need for housing.

And what’s more, a steadily ageing population has resulted in more people living alone, again meaning we need more dwellings to house the same number of people.

And according to the 2011 census data, of the homeowners aged 70 and over who live alone, 62 percent have a house with three or more bedrooms. That adds up to 238,078 houses with at least three bedrooms occupied by just one person.

Among houses owned by older couples (with at least one partner aged over 70), 82 percent – or 332,752 houses – have at least three bedrooms.

And the Australian population is only getting older, so we’re going to need more and more housing. Some older people might downsize into something more practical, but people are generally reluctant to leave their communities and the family home.

Together, these structural and demographic factors – smaller families, more split families, more older single-person families – mean that the average number of people per dwelling has been on a long-run downward trend for over a hundred years!

That’s what this chart here shows:

What’s interesting here though is notice the small pick up between the 2006 and 2011 census. That’s the first rise in at least 100 years!

How do we explain that? Well, I don’t think there’s been any change in Australian preferences. What I think it reflects is tighter economic conditions through the GFC.

As money became tighter, people started share-housing, kids moved back in with their parents, or delayed starting out on their own.

If that’s true, what it points to is even more pent up demand. As economic conditions continue to solidify around the country, people will look to head back out on their own, and the average household size should return to trend.

And ultimately what the downward trend in household size means is that actual housing demand is growing faster than population growth. So if we know that population growth is growing faster than supply, then we know that actual housing demand is growing even faster than supply.

And this of course means more upward pressure on prices.

Of course, the other important factor here is the expansion of investor demand over the past 30 years or so. I’m planning to write a bit more about that later.

And so looking back at the past 30 years, it’s not hard to see demand for housing to live in, combined with demand for housing to invest in, running far, far ahead of supply.

And so when I look at the prices rises we’ve seen, I just don’t see a bubble. The price rises we’ve seen make perfect sense.

And I see these dynamic continuing to drive the market going forward. Unless there’s a slow down in the rate of population growth (unlikely) or an increase in the average household size (very hard to see where that would come from) OR there is suddenly a lot more supply brought to market (how?), then undersupply and growing prices will be the norm for many years to come.

Add to that the lowest interest rates in 50 years and a cyclical upswing out of a prolonged soft patch, and you’ve got all the ingredients of a boom.

Simple as that.

Pick a bubble, back a shortage…

September 25, 2013 by Jon

So the media has pretty much entirely come around to my point of view. Property has made a come back. The next bull run has begun.

But not happy to leave us with a good news story, the media has gone and run ahead of the game again. Suddenly we’re back into bubble territory.

“Housing Bubble Trouble” – The Age, 22/9/2013

That’s effectively got to make it the shortest bull run in history. Just a matter of months after the doom-merchants had realised their positions had become untenably ridiculous, the boom cycle had run its course, and we had a bubble on our hands.

Turn it up.

What do they take us for?

Even the RBA was out hosing down the media during the week. RBA Assistant Governor Malcolm Eddey said all this talk of a bubble was “unrealistically alarmist.”

That’s polite central bank speech for bulls#*t.

But that’s just the way it is. The media is always fishing for the next disaster story. The next little girl locked in a basement. It’s what sells.

We don’t buy papers to be told everything’s fine. We buy papers to be informed (=scared).

But even though it’s all alarmist rubbish, I still wanted to take a look at this bubble story. I’d bet my last two cents this isn’t the last we’ve heard of it.

Because remember we’ve had people making a song and dance about the bubble since the before the millennium clocked over.

But I want to make the case that there was no bubble. There never was, and there never will be. (ok, I don’t know about never, but not in the next few years anyway.) And the price rises we’ve seen all make sense in the context of the fundamentals – especially those most basic of fundamentals, supply and demand.

And this isn’t just an academic exercise. The stakes are high. Why? Well it’s not just about whether you and I make money out of property over the next ten years. This is about whether Australia remains the lucky country, or falls into an Irish bog hole.

Remember what happened in Ireland? A property market crash there wiped out the banks. The banks held the government to ransom, said if you don’t bail us out we’re taking the economy down with us. The government caved in, and the bail-out package wiped out the government.

I don’t think that will happen here, but it’ not because we’ve got better government or less greedy banks. Oh no.

Because it is true that our banks have a huge exposure to property. Take a look at this graph from the IMF. What it shows is that over 60 percent of the Australian bank loan book is made up of real-estate loans.

Screen Shot 2013-09-25 at 9.31.23 AM

That makes our banks the most property dependent banks in the world. And this list includes countries where there arguably are bubbles emerging, like Canada and Norway.

Now our banks are also some of the best capitalised banks in the world, and our regulators have, so far and relative to some other countries, been on top of their game. So I don’t think there’s any real risk here. But it does highlight what’s at stake.

If there was actually a bubble, and that bubble burst… if a whole lot of mortgages went sour and people started defaulting on their loans… then the banks would be in real trouble.

And if one of them went down, even one of the minor or regional banks, because they’ve all got their hands in each other’s pockets, the whole system would get the wobbles.

And then it would be up to government’s to bail ‘em out of that mess. The government’s got deep pockets and a good credit rating now, but saving a banking sector isn’t cheap. Just ask Ireland.

And this is why we’ve had so many people worried about whether the housing market’s gone bubble or not. The stakes couldn’t be higher.

And of course it’s not hard to see bubbles if you’re looking for them.

This chart here neatly sums up some of the bubble-blowers main arguments. It comes from one of my favourite bubble-blowers, Leith Van Onselen at Macro Business.

Screen Shot 2013-09-25 at 9.31.39 AM

What it shows is house price growth, relative to other ‘housing fundamentals.’ We all know the story. Since the mid 80s house prices have grown quickly, much faster than the economy itself (GDP).

And house prices have grown faster than the cost of the physical house itself (construction costs), faster than the return on investment (rents), and faster than our ability to pay for them (disposable income).

The argument then runs that the fundamentals don’t justify the price. On all these measures, house prices seem over-valued.

Why would house prices grow faster than GDP, if not for a bubble? Why would people invest more in an asset than the returns justify, if not for a bubble? Why would prices run way ahead of the physical cost of the house itself, if not for a bubble?

It’s all very neat.

But it’s all very wrong.

Because there’s an answer to all of those whys: supply and demand.

The dynamics of supply and demand dominate all of these factors. And so if demand is running way ahead of supply, it is possible to have sustained increases in price, even if the “fundamentals” are not keeping pace.

And I’d argue that the last 30 years have been characterised by mismatched supply and demand.

Demand has been increasing strongly, thanks to population growth, demographic dynamics, and financial revolutions that have made property much more attainable to the average citizen.

But at the same time, supply hasn’t kept up. New construction levels fall further and further behind the population growth rate every year, and zoning restrictions tie up and limit the supply of buildable land.

And the more the gap wides, the higher prices go. There’s no bubble here. Just simple, text-book supply and demand. And it only shows prices going higher still….

Don’t believe me? Over the next week, I’ll take a closer look at supply, and a closer look at demand, and you can decide for yourself.

House prices defy cross-dressing politicians…

September 5, 2013 by Jon

iStock_000006991355Small

Yesterday I made the point that the governments of the day don’t have that much impact on the property market over the short-run.

The charts show that prices normally do better after Coalition victories, but I argued that this was all about pre-existing momentum, and not about any significant policy differences. A year just isn’t long enough for policies to take effect.

And yet, I also said that a Coalition win this time round will give prices a bigger kick than if Labor wins.

So how does that work? How does it matter and not matter? How is it relevant and irrelevant?

The key here is confidence, and ‘the mind of the herd.’

As I’ve been saying for a while in these blogs, we’ve pretty much had all the property boom ducks in a row for a while now. The missing piece has been confidence.

And more than any other factor – more than interest rates, more than affordability, more than Renovation Rescue – it is ‘the herd’ that determines where the market goes.

Modern markets are like this. It’s what happens in sophisticated and highly-leveraged economies. Once the opportunity for speculation opens up, and once you can use credit to take on positions you could never hold with cash – the instinct of the herd starts to matter.

Now I’m not saying this is a bad thing. It’s just the way it is. But it does mean that as investors, we need to keep a close eye on the herd. We obviously need to understand the fundamentals driving the market, but if we get too caught up in the technicals, and lose sight of where the herd is going, then we can get trampled.

And a lot of really successful investors out there, guys like Warren Buffett, they just seem to have a sixth sense about where the herd is going. And by staying one step ahead, they can turn the power of the herd to their advantage.

Because the fundamentals (let’s call it the market for short) and the herd aren’t always flowing in the same direction. Sometimes they move together – the early stages of booms and busts for example. Sometimes the herd can still be going north while the market’s turned and is heading south – think about the years just before the dot-com bust for example.

And sometimes the herd can be leaning against a market that is trying to push forward. And that’s what I reckon we have right now.

Have you ever seen a bunch of penguins waiting to jump off an iceberg? They all gather at the edge, knowing that there’s food in the water, but also the possibility of dangerous predators. There’s safety in numbers, but no one wants to be the first penguin in the pond.

And so they all hold back. The waiting game goes on and on, until one of them jumps (or is pushed), and then over they all go, in one big rush.

That’s the kind of situation we’ve got right now. The market is pulling hard in one direction, prices are on the rise, but still the herd is holding back.

What will it take to tip the herd into the water?

What about a Coalition victory?

Ok, how would that work?

Basically, herd mentality works on what every individual thinks every other individual is thinking.

So what is the herd opinion about a Coalition victory?

Well, the Coalition owns the economy. In the public’s mind, the Coalition are better economic managers. It may or may not be true, from year to year, from treasurer to treasurer. But it doesn’t matter. It’s the perception that counts.

Studies have shown that in the public’s mind, the Coalition is dad, and Labor is mum. It’s a little mental short cut that a great number of people have taken on, without even realizing they’ve done it. So you go to the Coalition when you think you need a bit of level-headed, no-nonsense discipline. You go to Labor when you want a softer, caring touch.

And so the Coalition owns the economy, defense, law and order. Labor owns health, education, social services.

These little mental short-cuts (because humans have lazy minds at the end of the day) are incredibly hard to shift. We don’t trust cross-dressing politicians. No one believes the Coalition when they say they care about health (though of course they do.) And no one believes Labor when they say they’re all about the economy (though what government could ever not be?)

This is the herd mind.

And so everyone in the herd, will be looking at everyone else in the herd, and thinking, “if the Coalition wins, people will think the economy will get better. There are already signs that the market has turned. They’re going to jump in. The market’s going to go up.”

And they’ll be right. Whether the economy will or won’t do better is immaterial. Everyone thinks it will. Everyone knows that everyone thinks it will.

It becomes a self-fulfilling prophecy.

And so a Coalition victory could be just the trigger the market’s been waiting for. It could be a massive boost for property, though of course we’ll never know the counter-factual if Labor had won….

Now I’ve made a lot of money over the past 6 years under Labor. And I intend to make a lot more money over the next 6 years as well, whoever holds office.

But I haven’t spent too much time worrying about politicians. I’ve done it by staying ahead of the game. I’ve tried to rely on data sources and opinions I can trust. I’ve tried to spend time worry about the things I can control and influence, and ignore the things I can’t.

And I’ve tried to keep my finger on the pulse – to stay one step ahead of the herd.

These are the three keys to successful investing I reckon. Abbott’s not going to make you money. You’re going to make you money.

Get active. Get involved. And develop your own game.

And don’t spend too much time sweating the election. These three keys are everything and all you need to do.

How do you vote if you want a property boom?

September 4, 2013 by Jon

So what’s my prediction for the weekend?

Richmond to beat Carlton by 1 point… Go tiges!

Ok, I know everything is about the election this weekend. And a lot of people have been asking me what I think will happen. Now I’m not paid to have an opinion about that, and I don’t really care, but I can tell you what I reckon it means for property.

So it seems the most likely outcome at this stage is a Coalition win. In a nut shell, if that happens, it should be a solid boost to property.

Now I’d love to tell you that the reason for this is that the Coalition has a raft of superior property market policies, or that their management of the economy is going to be just that much better.

Maybe Hockey will do a better job at the helm. Maybe he won’t. But unless he really fluffs it up, it’s not likely to matter much.

The fundamental drivers of a property resurgence are already in place (and if you really want to find a hero in all this, look to Glenn Stevens). The market has already asserted a clear trajectory that all the policy in the world will find difficult to shift in the next 6 months or so.

And a decisive win will bring back to the market the only thing that’s been missing so far: confidence.

There’s an interesting question here. Do elections normally have much impact on the market? RP Data published an interesting note last week, looking at what happened to property after the last 5 elections.

“The five most recent federal elections have been: 3 October 1998 (Coalition win), 10 November 2001 (Coalition win), 9 October 2004 (Coalition win), 24 November 2007 (Labor win) and 21 August 2010 (hung parliament but Labor take power).

Looking specifically at the change in home values over the 12 months following a federal election you can see that in 1998, 2001 and 2004 home values rose however, following the most recent two elections home values have fallen.

The strongest annual increase in home values following an election was 2001, with values increasing by 16.4% followed by the 1998 election where values rose by 10.7% over the following year.”

So, based on this evidence alone, it’s a pretty clear win for the Coalition. House prices rise after Coalition victories – at least in the short run. So is it locked in stone? Or is this all just a coincidence?

Well, first of all, 5 elections is a pretty small sample, and it ignores some massive mitigating factors.

Like the GFC.

One of the biggest global shakeouts in history rocked Australian property through the Labor years. It touched every real estate market in the world. Australia did well to avoid a more horrible fate.

So Labor should feel justified that this comparison is a bit unfair. But it won’t help them much. It’s this story that’s taken root in the Australian public’s mind. And once it’s taken root, all the data and argument in the world won’t shift it easily.

Take the debt story. I’ve been surprised that Labor hasn’t gone harder on this. It is true that (some measures of) government debt have risen in recent years. Why? The Coalition has been able to gain real traction with the argument that it was “Labor Waste”.

But spending was more or less the same under the Labor and the preceding Coalition government. It’s just that the Coalition had a boom that was bumping up the tax take and government coffers. Labor had a GFC and a collapse in tax revenue.

So should Labor have cut spending then? Well Joseph Stiglitz, a Nobel prize winner in economics argues that Labor’s response to the GFC was text book perfect (coming from a guy who actually writes text books.)

He argues that a big splurge of spending early in a crisis is just what you need to maintain confidence, and it actually helps protect tax revenues and the budget bottom line over the long run.

(Of course a resurgent mining boom was a big help as well, and that had nothing to do with Labor.)

But Labor has been completely ineffective in selling this message. This is partly due to Abbott’s effectiveness in opposition, and partly due to their own internal disarray.

If I were Labor, I would have gone much harder on this. In hindsight, as we launch into the 23rd year of uninterrupted economic expansion, it was the perfect thing to do. Housing busts in the US, the UK and Ireland should have been scary reminders of a fate that we were lucky to avoid.

Of course the Coalition government would have done exactly the same thing, so it’s not really about skill. But never the less they’ve allowed the Coalition to out-sell them on a simple message that current debt levels are entirely about ‘waste’. Labor could have easily done more to counter it.

But due to their own incompetence and a raft of other policy mistakes, they’ve given the coalition a massive free kick.

And now, on top of the surging markets that followed previous Coalition victories, a year from now the scoreboard will chalk another win up to the Coalition. RP data report that house prices nationally are already up 4.9 percent over the year. Sales volumes are up a bumping 19 percent. The momentum is already there.

And so it gives the Coalition the chance to engrave their central idea deeper and deeper into the public psyche. The Coalition is just better at managing the economy.

And this idea is gaining so much weight, that it’s becoming a self-fulfilling prophecy.

More on that, and some herd psychology, tomorrow…

DIY Property-Forecasting Kit

September 3, 2013 by Jon

You Don’t Have to Be a Rhodes Scholar, MBA or Economic Professor to Figure Out Where the Property Market is Going… Just read my blog.

It’s amazing what you can learn if you really put your mind to it.

Over the last couple of days, I’ve been doing a bit of a “back to the future” job. Predicting property markets aint that hard when you know what you look for.

But, it’s taking me a long time to… know what to look for.

Back in the day, I used to invest on gut feeling, my personal sentiment and where I was financially, physically and psychologically. However, property investing isn’t a game of golf.

…thank god for that.

It’s all about mathematics, which by the way I’m also hopeless at until you put a dollar sign in front of it.

Yes, it’s quite amazing. It’ll take me a couple of seconds to work out what 7-times-7 is, but if you ask me what 13% of $450,000 is, I can figure it out in a flash.

Anyway, what this lesson is all about is how (from a data point of view), I’ve been able to confidently predict the last 12 months in real estate.

Speaking of 12 months… How times have changed.

Suddenly, all the doom and glooms been replaced by talk of a boom.

It’s a classic paradigm shift. People will hang on to a theory or a view of the world, even as more and more evidence mounts to contradict it. Changing your view is expensive and difficult. But eventually, the evidence against the theory becomes too much, the case against becomes too obvious, and all of sudden everyone changes their view.

This is what seems to be going on in the media right now. There’s been a paradigm shift towards what I, and a handful of others, have been saying for a while now.

So has the media finally got it right?

Well let’s not get too carried away. The media loves sensation. So if there’s no mileage in the line that the property market is imploding, why not run the line that the property market is exploding.

That’ll make the papers sell.

But just because the media’s done a u-turn over night, doesn’t mean that the property market has suddenly swung from bust to boom.

The ‘boom’ that the media is reporting isn’t some flash in the pan, one-off, never-to-be-repeated-prices kinda thing. As I’ve been saying in these blogs, there are some long-run fundamental dynamics at play here.

First of all there are the non-property factors. Things like low interest rates, here and across the world. Incomes rising (faster than house prices), and improving affordability. A credit squeeze on developers that’s keeping a lid on supply.

These are deep and enduring dynamics that will keep property prices on the up and up over the foreseeable future.

At the same time, there are the property factors. Real estate, like all markets for all sort of things, has it’s own trends and cycles. History has a way or repeating, over and over again.

And when we have a look at these factors, we get a sense of where the market is going from here.

I’ve outlined these long term trend dynamics before. But let’s take a quick look at the highlights.

The first is that mortgage rates relative to yields remain very low. When this ratio, which tells you the property market price of money relative to the property market return on money, gets to levels like this, it’s usually buying time.

It’s easy enough to understand. Rents have been growing faster than prices, while mortgage rates have been falling. That means the relative return on investment is improving.

This will start pulling more and more investors into the market, until prices are bid up to be in line with the kind of returns on offer. That typically takes about 14 years to achieve.

On this measure alone, these are the best buying conditions in years.

(For the blog where this chart comes from, see here)

Second, if we look at prices on a very long run, we can see that property is undervalued right now. Look at this chart here:

When we put our house price chart onto a log scale (useful for things that grow exponentially) we saw that over a long run, property tends to grow by a remarkably consistent 8 percent (with a bit of movement around that trend line.)

It also shows that right now, prices are well below that trend line. And typically, growth returns to trend.

So if property does nothing more than simply return to trend over the next few years, we could expect to see prices growing around 13 percent a year. It would also take the median price in Sydney and Melbourne to the million dollar mark by 2016.

That of course, is just the internal dynamics. We you take into account the record low interest rates and external dynamics, the bounce back could be much quicker, or much bigger than what this simple analysis suggests.

(If you want to read the full article behind this graph, go here)

And how long will the boom last?

Well, if history is anything to go by, we’re looking at at least 7 years, maybe more.

In another article, I had a look at how long growth spends above and below our 8 percent average growth mark. That’s what this graph here shows.

What it shows, is that the periods above and below the trend line are pretty consistent and regular. What we’ve got is:

1983 – 1990: 7 years above trend
1990 – 1997: 7 years below trend
1997 – 2004: 7 years above trend
2004 – ?: 7 years and a few more…

And we’re just tipping towards the trend mark now. Sydney is already growing a 7+ percent year. It won’t be long before we’re back above the trend line. Possible a matter of months.

And if history is a guide, then we’ll probably stay there. We’ll probably enjoy 8+ percent growth for at least the next 7 years. With every chance, as we’ve said, that growth will get up above 13% a year in the near term.

(If you want to read the full article behind these numbers, go here)

This is what history shows us. These are the internal dynamics that are shaping the market right now. And they’re happening at the same time as the external factors, low interest rates affordability etc, are also incredibly supportive.

This is why the next 7 years or so are going to be incredibly exciting. All the stars are aligning.

And how do we make the most of it?

Well, stick with me. I’ll show you a thing or two.

Predictions: Sorry…. I was right (Part 1)

August 29, 2013 by Jon

How did my predictions turn out in the last 12 months?

Now I know I put across a lot of controversial views in these posts. Partly I do it for fun. I’ve always been a bit of a sh*t-stirer.

But mostly I just see that as my job. To tell it like it is – even if that means that a lot of people won’t agree with me, or I end up tipping some sacred cows.

As my old man said, ‘make money, not friends.’

Actually, don’t listen to Dad. That’s terrible advice.

But my point is I don’t do this for popularity, or for a bit of an ego boost. That’s what karaoke’s for.

I’m just sharing with everyone my view of the world and what’s going on – and how I reckon you can make money in times like these.

But now that this election is being defined as a battle between who you can and can’t trust, I thought I’d step forward, and let my record speak for itself.

Comparing my trust-worthiness against politicians might be setting a low bar, but bear with me. What have I been saying over these past year, and did I get it right?

And if you followed my advice, did you make money?

Well to start with, I’ve been saying for a long while now that arguments that Australia was on the brink of bursting property bubble or economic calamity were totally overblown. In my words:

“Claims that Australia is facing a financial meltdown are rubbish.”

I’ve been saying that for a while. And how’d I do on that one? Well if we had had an economic meltdown, or a property bust, you’d know about it. You wouldn’t be hearing about anything else this election.

Ok, perhaps that was an easy one. It always seemed unlikely (to me at least). But there were a lot of people predicting the end of the world, and just for the record, I wasn’t one of them.

But let’s go for something more specific. House Prices

In November last year I wrote:

“If you take the last three rate cutting cycles (1996, 2001, 2008) as a guide, you’d normally expect house prices to be up between 15 and 20 percent this far into a rate cutting run.

And that means house-prices have some catch up to do. The rough maths suggests that they’re at least 15 percent behind the curve…”

I was highlighting the fact that house prices had a lot of upside potential, especially since interest rates had fallen to such lows.

When I made that call, there had only been one quarter of decent growth posted – certainly no clear trend starting to assert itself.

But since then, we’ve had three quarters of solid growth. According to the ABS, house prices were up 2.4 percent in June and 5.1 percent over the year. Still some way to go to 15 percent, but we’re certainly moving in the right direction.

And if you take the June quarter pace of growth, even if there’s further acceleration from here, you’re still looking at 10 percent year on year. A steady pace puts 15 percent within reach in less than 18 months.

But there’s every chance that prices will keep accelerating, and we could get there a lot quicker.

So on my books, that core promise is still well on track.

What about interest rates?

In February this year, Paul Bloxham, Chief Economist at HSBC was saying that the rate cutting cycle was over and the next move was up. I thought he was nuts:

“Interest rates are going nowhere.

Why?

…what’s inflation doing?

Nothing. It’s going nowhere. It’s right at the bottom of the RBA’s target band and going nowhere fast.

So if the RBA was worried about this “asset price inflation”, they’d have to make the argument that 1. there was a bubble, 2. that the bubble was about to burst, and 3. when it bursts it’s going to take the economy down with it and drive inflation through the floor.

That’s a pretty big call to make.

And could you imagine just how much of it would hit the fan if Glenn came out and said, “Hey, we’re jacking up rates and adding 300 bucks to your mortgage. Why? Because we think your homes are worth too much.”

Forget it. He’d be torn to pieces. And once the dust settled, he’d be lucky to still have a job guiding tours around the currency museum.

Rates aren’t going anywhere, buddy.”

And then in another piece around the same time, commenting on RBA forecasts:

“…the thing that really jumps out at you is just how many uncertainties there are in the outlook – or more specifically, the lengths the RBA went to point them out.

They’re giving themselves plenty of room to cut rates further if they want to. I’d say they’d be expecting their hand will be forced at least once or twice more this year (in the best case scenario!!)”

And what have we had since then? Two rate cuts. And there’s ample scope for at least another one before the year is out.

Perhaps I could be chief economist at HSBC

The point is that over the past year or so, my predictions have pretty much been on the money.

Not bad for a fly-by-the-seat-of-his-pants ruffian, hey?

But the real question is, if you followed my advice, did you make money?

Who can you trust?

August 27, 2013 by Jon

I will tell it to you, straight… No sugar-coating.

In an election campaign battle that has all the drama and power of tough kiddy tae kwon do (have a look, very funny video), Rudd and Abbott have finally found something to agree upon.

And they’re both wrong.

Amazingly, both Rudd and Abbot are singing from the same hymn sheet when it comes to the mining boom. And they’re both way off key.

For Rudd, the mining boom is about to end, plunging Australia into economic calamity, because China is powering down. Our best customer is taking a breather.

For Abbott, the mining boom is about to end, plunging Australia into economic calamity, because Labor’s carbon tax killed the mining boom.

Both arguments are simplistic, stupid…

… and wrong.

What’s the deal, why are both the PM and the PM-in-waiting talking down the Aussie economy and the mining boom?

For Rudd’s part, he’s trying to draw out Abbott’s small target strategy. Abbott’s main line of offence so far seems to be leveraging of the public conception that any pack of monkeys could do better than Labor, and hey, we’re those monkeys.

So Rudd’s trying to scare people. China is powering down, the mining boom is over, and you need a government with actual plans.

For Abbott’s part, he trying to focus attention of Labor’s most unpopular policy, and make it guilty of a sin it could never be capable of. The carbon tax and the MRRT were pretty ineffective. Everyone agrees on that. But they can’t be both ineffective and devastating at the same time. You can’t have it both ways.

And so Abbott is simply trying to scare people – Look at the mess they’ve made already. Imagine what other havoc they might wreak if we gave them another term. Nobody’s safe.

It’s all the politics of fear.

The psychology of fear is interesting. We’re hardwired to pay more attention to threats than to opportunities. A monkey who loses sight of the tigers for the berries, isn’t a monkey for long.

So the parties pay lip service to actual policies and the things they will do for you, but they know the messages that will sell are the messages of fear.

Labor’s campaign slogan is classic. “If he wins, you lose.” Be afraid. Very afraid.

And so the election boils down to both parties trying to present themselves as the least scary option.

Pretty uninspiring.

As investors, it’s important to be aware of this human “threat attention” bias, and the structures that are built upon it. The entire media and newstertainment industry is an example. Good news never made a paper sell.

And so the media will sell us the bad news stories we want to buy. Drive-by shootings in suburbs you’ve never heard of. Disease pandemics in small countries you can’t pronounce. A rout in shares you don’t own. On and on it goes.

The economy is collapsing. The property bubble is bursting. Aliens have infiltrated the White House. The mining boom is over.

As investors, we need to see through this bias in the media and get a read of what is actually going on.

Trouble is though, there are feedback loops. If a story gets repeated enough times in the media, people start to accept it as fact. It becomes a self-fulfilling prophesy.

And that’s what worries me about all this fear-mongering from both sides of politics right now. Repeat a lie enough times it becomes the truth.

Call me foolish, but I’m worried that people might actually start listening to our politicians. And what will they hear?

“The mining boom is over, China is slowing.”

“The mining boom is over, it was Labor’s fault.”

Suddenly there’s a consensus that the mining boom is over. The public accepts it as fact. But it’s just plain wrong.

Oh woe is us! Isn’t there someone we can rely on to tell it to us straight? Who will save us in this darkest of hours?

Enter Glenn ‘Gunslinger’ Stevens, a junior economist on each arm.

Glenn’s been going out of his way to keep us on the straight and narrow, and protect the name and honour of fair Miss Truth.

According to Glenn, the mining boom’s not over, it’s just “changing gear.” It’s just going through a “phase shift”.

The prices boom has passed, and commodity prices are down from their peak in 2011. Our terms of trade are down around 18 percent, but Stevens (and most economists) reckon that even when the slide is over, it will still be higher than it was when the mining boom started – leaving us all better off.

The investment phase also now looks like it has passed its peak, but investment is still expanding. It’s not going backwards. BHP is not pulling down mines. It’s still growing, just at a slower pace than before. And it was a mind-blowing pace before.

But the key here, as Stevens points out, is that the next phase, the production and export phase, has barely started. He reckons volumes of iron ore are rising by about 15 per cent a year. Shipments of natural gas won't start increasing strongly until 2015, and will probably have several years of very strong growth, and then remain high for years and years.

The boom is far from over. No economic calamity. Just an orderly phase shift. No tigers. Just marginally smaller berries.

But that won’t stop the pollies from trying to tell you that the world is ending.

Whatever. Shift happens.

Coming home to the lucky economy…

August 22, 2013 by Jon

Man, it’s good to be home.

I love travelling, but there’s nothing like walking back into the house you love, all the familiar smells and quirks, the plumbing where it’s supposed to be, drooling into your own pillow once more….

It’s good to be home.

Travelling is a gruelling adventure. Totally worth, but it does take it out of you. Even when you’re spending most the day by the pool drinking cocktails, like I was.

Oh to be 18 again. With legs to run me up and down the Eifel Tower all day. It gets harder as you get older. And we’re only getting older. That’s why I’m trying to squeeze in as much travel as I can now. No one’s organising Contiki tours for senior citizens.

(Now there’s a gap in the market.)

Let me lay one of my favourite travel quotes on you:

“To travel is to discover that everyone is wrong about other countries.” – Aldous Huxley

Good ‘ol Mr Huxley. Locking yourself in a room and eating LSD is a difficult road to the truth, but he got there.

And this quote cuts right to it I reckon. It certainly struck me travelling around Greece. The media here had primed me to expect riot cops on every corner, students with stones and Molotov cocktails, desperate grandmothers selling their record collections and the cutlery from a blanket in the town square…

But it wasn’t as bad as all that. Not even close. Sure, things are tough. Really tough. And it’s taken a toll on the national mood. But life goes on. The business of living – doing what you can to earn a buck, catching up with your friends, eating, drinking, fighting, making love… it goes on.

Life has it’s own will and it’s own energy. And we’re a very adaptable species. And if we have others to share our misery with, over a couple of glasses of ouzo, then we will count our blessings, take heart from the things that really matter, and get on with it.

This is a good lesson for investors. Our fears always have a bark that’s worse than its bite. We run through worse case scenarios. What if property prices took a 20% hit? The picture we paint in our minds is horrifying. We’re dressed up like some gypsy refugee, begging for bread, unable to upgrade our i-phone 4’s.

But in places where the worst case scenarios became a reality (like Greece), life isn’t a disaster. There’s some adjustment to be made of course, and adjustments are painful in the short term. But often it gets people focused on the things that really matter – our family, our connections, our selves… all the things that money can never buy.

And our ‘quality’ of life never takes the hit we think it will.

What’s the lesson in this? Don’t let the size of your imagined fears put you off.

How about another travel quote?

“A boat in the harbour is safe, but that’s not what boats are built for… Twenty years from now you will be more disappointed by the things you didn’t do than by the ones you did do. So throw off the bowlines, sail away from the safe harbour. Catch the trade winds in your sails. Explore. Dream. Discover.” – Mark Twain

If you let your imagined fears – the sum of all worse case scenarios – prevent you from taking action, you’ll regret it in the long run. Whether it’s travel or investing, it doesn’t matter. The bold and adventurous get more out of life.

But look at me. I spent two weeks swanning around Mediterranean bars and you think I’d single handedly crossed the Sahara or something.

But it’s an important lesson for right now, I reckon. I was only gone a couple of weeks, but it feels like a couple of months. Am I wrong, but has market mood shifted a huge step since I’ve been gone?

Suddenly the outlook’s a lot brighter than it was.

A lot of it has to do with the surprise result that Europe managed to grow it’s way out of recession in the June quarter, ending 18 months of GDP slide. Growth of 0.3 percent was a solid surprise to the upside, though the burden still falls to ‘old Europe’ with Germany leading the way. 0.5 percent growth in France was encouraging though.

If you look at this graph (of quarterly growth), Europe is now levelling pegging with the US, who has also returned to form. It’s a very encouraging sign.

At the same time, business confidence across the G7 (the seven biggest and most important economies) is bouncing back. Minack Advisors have cobbled this chart together from various national indicies.

It’s rough on a level sense, but it’s the relativities that are instructive. And on that measure, looks like we’re back to the pre-GFC average – or where we were in the middle of the ‘09 boom.

For Australia, this is fantastic news. We’ve been relying on an Asian driven mining boom to keep us striding along while the rest of the world dithered. But now, even though the mood also seems to suggest China is on a good track now anyway, looks like we might now be able to rely on the rest of the world for a bit of export support.

That’ll be a nice change. A very nice change.

And these changes will dominate anything that going on domestically – even the election…

One last travel quote for you:

“The whole object of travel is not to set foot on foreign land; it is at last to set foot on one’s own country as a foreign land.” – G. K. Chesterton

Coming home, I’m reminded of just how special Australia is, and just how lucky we are. As investors, as citizens, as families. I’m lucky to call Australia home.

And it is very, very good to be home.