There’s a lot of stuff out there that is useful when you’re first starting out, but is actually BS.
If you’ve been reading my blogs for a while, I hope one thing is starting to jump out at you.
In many ways, ‘the cycle’ is the least interesting dynamic in property.
And that makes sense. Look at the ‘cycle’ in the broader economy – what does that give you? Maybe swings from negative 1 or 2 percent growth, up to 4 or 5 percent growth.
Not all that much to get excited about there. I wouldn’t get out of bed for a property deal that gave me 4%.
If we look at it closely, when we’re talking about ‘the cycle’, what we’re really talking about is the ‘over-correction’ dynamic.
So in the business cycle context, people get excited and things go well. But then the economy runs a little too hot. We overcorrect on the upswing. But then prices and wages go up. That starts to pull things back a bit. We’re in the middle of the road for a while. But then we pull back too far, people start getting a little nervous, they cut back spending, and we overcorrect to the downside… and round and round we go.
The ‘cycle’ describes a car driving down a straight road that maintains its course by swinging to the left, until it’s time to swing to the right. Then swinging to the right, until it’s time to swing to the left…. And so on.
It describes an observed phenomena in many natural systems that there is no static state. Rather, there is a continual process of correction around a desired average.
So don’t talk about the cycle. Talk about the over-correction dynamic.
And I know every property analysts and their dog in this country talks about the property cycle – but very few of them understand what they’re talking about.
And just as the ‘cycle’ gives you relatively small movements in the broader economy, the cycle, or over-correction dynamic, gives you very small movements in property prices. And by that I mean, ‘the cycle’ is almost impossible to identify in the middle of everything else that’s going on.
I mean, show me any significant trend in property prices over the past twenty years, and I’ll show you a structural force that was driving it.
The boom in Sydney from 2000 to 2003 – I would point to the flow through of the Olympic infrastructure spend, and the negative gearing changes introduced in 1999.
Or the slow down from 2003 to 2006? Two rate hikes and a whole lot of jaw-boning from the RBA.
2009 to 2012? Mining boom.
2013 – 2017? Foreign capital inflows and strong immigration.
You get the point. I’m simplifying to be sure, and there’s no way of knowing what the exact cause was… truth is, there’s always a number of factors pulling in different directions at any given moment.
But my point is that what we call ‘the cycle’ – the tendency for the market to move in swings and roundabouts because natural systems have a tendency to overshoot – is a very small part of the story.
Now, why does this matter?
It matters because a lot of investors ‘play the cycle’. And a lot of analysts out there encourage investors to play the cycle by banging on about the cycle all the time.
And they’re all missing the point.
One, the cycle, or overcorrection dynamic, is too small to create serious returns. It’s not worth dicking around with.
Two, it creates this false sense of certainty about future directions. It creates ridiculous ideas like: this markets done well in recent years. It must be due for a breather. Or, this market has done nothing. It’s due.
If you’re basing your investment decisions on ideas like this, you’re going to get slaughtered.
Let’s take Perth as an example.
Take the boom that took place between 2010 and 2015. Was the cycle telling you to get into that one?
Not at all. There was nothing in the Perth’s market history that would have given you any idea that that boom was coming.
Because that boom had nothing to do with the cycle. It was all about the mining boom and the surge of population that went with it.
Or take the correction that kicked in in 2016. That looks like the cycle right? Bad times follow good times.
But again, that had nothing to do with any inherent cycle – it was about the mining investment boom coming to an end, and population flows reversing.
And what does the future hold. Well, the cycle will bottom and Perth’s fortunes will pick up.
That probably is what will happen, but it won’t be due to any overcorrection dynamic. I’ll be watching what’s happening with the Western Australian economy, and how their managing their transition through the mining boom fall out.
When Perth’s market picks up again, it will be because the economy or population flows have created the right conditions for a recovery.
It absolutely won’t be because of the ‘cycle’.
So be careful with this. The idea of a cycle is fallacy.
It is a useful fallacy when you’re starting out. It’s good to remember that markets can go up and down, and it’s not just a one way street.
But as you become a more sophisticated investor, you need to let this go. Put it in a box alongside Santa Claus and the Easter Bunny.
If you believe there is a cycle, or it is the cycle that is driving things, you’re going to miss what’s really happening.
And what’s really happening – that’s where the money is.
Heard any BS about the ‘cycle’?
Hugh says
In 2007 the median prices of houses in Perth and Sydney were virtually the same. Since then the median price in Perth has basically not moved due to the mining downturn with thousands of people leaving, while Sydney’s has doubled due in part to overseas investors.