Vern Gowdie – The Daily Reckoning (Australia) –
Everyone has an opinion on the Australian property market — locals and international observers.
Locals tend to be more defensive — ‘Our market is different.’ Whereas those from distant shores look across the Pacific and see a massive bubble in search of a pin.
Comments include ‘It’s overvalued’, ‘Young people will never be able to afford a home’, ‘There’s more growth left in the market’ and ‘The market may flatten out but it won’t bust’.
Before delving into the potential outlook for the great Australian dream, overnight the US share market posted a 118-point gain and stayed above the 20,000-point level.
Gold was down for the count in mid-December 2016. Pundits were predicting further downside…extrapolating the trend into the future. As usual, when all the pundits are on one side of the trade, the opposite tends to happen.
On 3 December, 2016, I wrote in The Daily Reckoning:
‘The latest “expert” commentary [on the gold price] tells us that “the worst is yet to come”…“The top two gold forecasters who say bullion will suffer further losses in 2017.”
‘… What’s been highlighted here is a classic case of extrapolation…by both the investing public and so-called expert analysts.
‘What has happened will continue to happen.
‘Investors panic AFTER the asset has fallen in value.
‘… The herd rushes in, the industry forecasts prices to go higher, the herd rushes out, and the industry forecasts prices to go lower. We press the “rinse and repeat button” again, and again, and again.
‘Here’s my guess: Based on nothing more than being an observer of investor psychology, the gold price will rebound in the coming months.
‘While I think gold should enjoy a rally from an oversold position, my longer-term view is that gold, in due course, will suffer a far bigger selloff than the one we’ve seen recently.
‘Investors really do not know the value of an asset; all they know is the price.
‘There’s a huge difference.
‘At present, asset prices in markets are being inflated by the twin propulsion of low interest rates and easy access to credit. When, not if, both of these factors are put in reverse, we’ll see true value emerge.’
A fortnight later, on 20 December 2016, gold hit a low of US$1,125. Last night, it closed at US$1,227…up US$102.
So far, the analysts have been proven wrong…again.
Most analysis is propaganda
That’s the problem with ‘analysis’. Most of it is propaganda…peddled for self-interest.
We all know markets go up, down and sideways. Yet most ‘analysis’ is based on only one direction — either up or down.
My views on the share market are well known. In my opinion, it is overvalued. However, when (not ‘if’) there’s a correction of sufficient magnitude, those who think I’m a permabear will be surprised by my bullish demeanour.
Whereas the investment industry only ever sees the share market going up. There’s never a bad time to buy shares… September 1987 or November 2007? No worries — shares always go up.
The same with Sydney and Melbourne real estate. Talk to an agent or property developer and there’s ‘blue sky’ a. Why?
Pick a reason — property never goes down in value, we’ve experienced 7% per annum growth for the past decade, the government has restricted supply, there’s only so much land available.
Every market goes through cycles of over and under value.
The problem is that when a market has sustained a prolonged period of positive or negative performance, the past is extrapolated into the future.
And the silver medal goes to…Sydney
We heard recently that Sydney is now ranked the second most expensive city in the world.
The following excerpt is from The New Daily on 24 January, 2017 (emphasis is mine):
‘Sydney’s housing has been rated less affordable than global metropolises New York and London in a new survey that paints a dire picture for the city’s middle-income earners.
‘The Harbour City’s eye-watering house prices were trumped by only Hong Kong in the Annual Demographia International Housing Affordability Survey, which examined more than 400 cities in nine countries including the United States, United Kingdom, Australia and Canada.
‘Sydney house prices are about 12.2 times annual household incomes which is grossly excessive.’
In the good old days, the multiple of household income to home prices was around three to four times. Perhaps that multiple was a little low, but 12.2 times is a tad on the high side.
To prove property markets are not a one-way street, on 26 January, 2016, Mansions Global reported (emphasis is mine):
‘Sellers of Hamptons mansions are having to slash prices to secure sales as the glitzy summer hot spot’s luxury housing market continues to cool.
‘The median price for luxury homes sold in the Hamptons (the top 10% of sales) dropped almost 30% to $5.85 million in the final three months of 2016 compared with a year earlier, according to a report Thursday by Douglas Elliman Real Estate and appraisal firm Miller Samuel.’
Perhaps the previous year’s prices were too high and some froth needed to be blown off the top. But those who bought at the 2015 prices are finding their home is worth two-thirds what they paid for it.
The Hamptons is not the back blocks of Detroit or Chicago. It’s a pretty classy area with well-heeled residents. If they are feeling the pinch, what about the Aussie ‘battler’?
According to Bloomberg on 8 February, 2017 (emphasis is mine):
‘Homeowners, consumers and property investors around Australia are making more calls to financial helplines as three warning signs back up the spike in demand: mortgage arrears are creeping up, lenders’ bad debt provisions have increased and personal insolvencies are near an all-time high.
‘Australia’s households are among the world’s most indebted after bingeing on more than A$1 trillion ($766 billion) of mortgages amid a housing boom that’s fizzled out in parts of the country, but still roaring in Sydney and Melbourne.’
Households have binged on debt. The price of a property is 12.2 times household income.
Little wonder more households are feeling the pinch and are seeking some form of debt relief.
Look to the past to divine the future
The RBA produced the following chart in its February 2017 report, titled The Australian Economy and Financial Markets:
[Click to open in a new window]
Household debt has soared to over 180% of GDP…making Australia one of the most indebted private sectors in the world.
The RBA played its role in ‘facilitating’ this debt binge by lowering interest rates to historically low levels. Hence the sharp reduction in ‘interest paid as a percent of household disposal income’ — even though debt levels have gone through the roof.
If you want to find out where to from here for Australian property, then look to the past to divine the future.
What’s the outlook for the twin drivers of this bubble (debt and household income)?
According to a research paper from the McKell Institute, published in September 2016, (emphasis is mine):
‘Australian wage growth is slowing and is expected to stall in the coming years. Currently, the average weekly wage for an Australian is AUD$1145.70. However, this is expected to only grow in real terms to AUD$1243 per week by 2020.This growth is incredibly slow by Australian and international standards alike, and highlights the threat to the continuation of Australia’s middle class standard of living. At the same time as Australian income growth is slowing, cost-of-living pressures continue to grow, and disposable income is decreasing.
‘Research by the National Centre for Social and Economic Modelling (NATSEM) compared the growth in disposable incomes over the 2004-2014 period with predicted disposable income growth between 2014-2024, and found Australians of most income brackets would experience a significant decline in the growth of their disposable income.’
That doesn’t sound too promising on the household income front.
What if we experience a recession in the next month, year or even three years? Unemployment and underemployment creep up, only adding more pressure to household budgets.
Will tenants be able to afford the rental prices demanded by indebted property investors to meet their loan repayments?
With what we know of the global supply of cheap labour, and the scaling up of automation, it is difficult to argue against future stagnation of household income.
Absent wage growth — coupled with rising cost-of-living pressures — means the only way households can continue with the debt binge is for debt servicing costs (interest rates) to go lower.
In the spirit of ‘never say never’, while it’s possible for the RBA to drop deposit interest rates from 1.5% to zero, banks will never pass the full 1.5% reduction on to loan rates. So yes, rates could come down. However why would rates come down? Not because the economy is booming, that’s for sure. It’ll be due to an economic malaise hitting our shores.
If people are uncertain of their employment, or facing the prospect of taking a reduced income to keep a job, then no matter how cheap debt is, they won’t take the bait.
That’s the negative argument.
The positive argument is that households will experience wage growth, and interest rates remain low. Even in this scenario, the prospect for future (debt-funded) property growth will be subdued by the extent of the household income growth.
And if wages growth of any significance does occur, then interest rates will go up due to the inflationary pressures.
When you do the maths, property values in our two major capital cities are priced for absolute perfection and an extrapolation of the trend.
My gut tells me there might be some more upside — as the bigger fools rush in — but in five years’ time, our bulletproof, unique and oh-so-special property market will go the way of all other bubbles…it’ll find a pin.
For The Daily Reckoning