Latest AXA Guide to Investment Markets

About every six months AXA Australia publish an interpretation of what has been happening in the local markets and economy in the context of the global economy. Of the many commentaries published by Australian product providers the AXA guide is one I feel is most written in plain, accessible language.

The latest AXA Guide to Investment Markets, dated June 2011 is titled “Understanding the ups and downs”.

Among the topics covered in the latest guide are:

  • Global debt
  • Surging commodity prices
  • “Two-speed” economy in Australia
  • Australian dollar
There’s one guarantee in economic interpretations – and that is that all the economists will disagree. No-one has a working crystal ball.
So read the AXA guide (and all others) for your interest but with caution – it’s not fact nor gospel.

Is residential property over, under or fair value?

Graphs, graphs and damn statistics!

There is no shortage of articles quoting one “expert” or another about whether or not Australian residential property is currently in a bubble, ripe to boom again or just fair value. Every article seems to be accompanied by a barrage of graphs and statistical quotations to justify the author’s point of view.

If your eyes glaze over at the detailed graphs don’t worry, you’re not alone, often mine do too. I sometimes wonder (suspect) if the detailed graphs are purposeful anaesthesia to make the reader compliant to the author’s conclusions. (Hmm, I think that sentence may have done the same…)

Overvalued or fair value or…?

Who cares?

Really in the scheme of things if property is over or under-valued matters most if you are taking a short term trader’s view – trying to make money within a short time frame from a volatile asset.

What matters more is that new residential property investors are increasingly reliant on a continuing price boom in order to make a reasonable total return on investment (ROI).

With property prices and rents at current levels residential property investors make significant annual net income losses (even after tax returns). That creates a situation where a high capital growth is required to repay the debt, offset income losses and retain a reasonable return on equity.

Yes, my generation and those with an investing memory of about 15 years may say that residential property does generate really high capital growth. But the fact is that all you can say is that over that period it has done.

Can residential property continue to deliver high annualised capital growth over coming decades?

My helicopter view

Value is in the eye of the beholder. People seem to be willing to pay whatever they can to get something they really want. And Australians really want their own home – and a comfortable one at that.

In the last decade the amount of people bidding for property and their ability to pay has rapidly increased for reasons such as:

  • Ability and willingness to borrow higher percentages of income.
  • Ability to borrow higher percentages of the property value, meaning you needed to have saved less before you could compete in the market.
  • Grants to property purchasers.
  • Commencement of lending to a lot of the population previously shunned (e.g. employed yet unmarried females of baby-making age; and those with limited or mixed financial history.).

Consequently in many of our memories we have seen stellar above-average capital growth.

Can that ability and willingness to pay increase as rapidly over the next 40 years and thereby support continuing stellar capital growth?

It would require 40 years of:

  • Above average wages growth
  • Increased percentage disposable income through reduced lifestyle expenses (less kids and more frugal living – yeah right!)
  • Low interest rates
  • Increased willingness to lend by the banks
  • More crazy Government subsidies

I’m not an economist so I don’t even pretend to have a crystal ball. But my rational mind says that in the long term gravity will kick in and force a return to normal long-term growth rates.

Therefore I expect that at some time there may be a sustained period of sideways or even negative growth (i.e. price declines.)

Predicting when that will occur matters most if you are taking a short term trader’s view.

I welcome your thoughts, reaction and responses to my view which you can in the comments section below.

The truth about inflation

If you have a preference for do-it-yourself investing and timing the markets then you need to have an understanding of economics. I have long been an admirer of Dr Ron Woods of Econoclast for the fact that his economic insights are actually understandable as well as often challenging the conventional wisdom. This is the same approach I take to money management and wealth creation.

Inflation is being talked about a lot in Australia at the moment with various scapegoats offered as causes. To get a real understanding of what causes inflation read this article by Dr Ron about “Dodgy Chicken” (reproduced with permission):

and if pain persists…

In the USA Chicken breast meat prices are falling as the demand for “boneless chicken breast” is falling. US consumers are switching to less expensive kinds of chicken meat “with bone”, “skin on” and falling demand for premium boneless breast has led to price falls for this type of meat. Reports that chicken breast meat prices are falling in the US is another example of the difference between relative price changes and inflation. This shows the US and Australia do not have inflation just some prices have become a lot higher relatively.

Many think high food and fuel prices causes inflation but it doesn’t work like that. Rising fuel and food are relative price changes, not inflation. Widespread reports of ‘strained family budgets’ is another sign we don’t have inflation. We’re paying out more from our purses for food and petrol or cutting back on them or other goods. When food prices rise if you want to keep eating the same quantity you have to pay out more of the contents of your purse which leaves less to spend on other items which puts downward price pressure -not upward price pressure- on all other things in the economy. Inflation could only occur if you are given more money to put in your purse so that you don’t have to cut back on anything and that’s how higher prices stick. We wouldn’t have to cut back on anything but the economy would have inflation. In other words only with an increase in the money supply can you get inflation. Inflation is caused by an oversupply of money such that its value falls. It loses purchasing power because more dollars are required to buy the same quantity of goods.

The main reason you have to get a prescription for many medicines is that if you try a cure for a non existent disease you can get into trouble; it can be hazardous to your health. That is an appropriate metaphor for our economy. The RBA has given the economy high doses of interest rates to cure a disease “inflation” which we don’t have; and that is hazardous to investors’ wealth. Not only lost wealth but it is causing other complications like an unnecessary economic slowdown, a collapse in housing construction, soaring rents and lost jobs. In our March 2008 Update Food glorious food I wrote “the RBA don’t see it this way and they have pushed interest rates too high. I really don’t know what will stop this cycle other than some shockingly bad economic or market news or both. It is this prospect of more bad news before we get a rate cut which continues to make me believe the investment outlook remains extremely problematic.” I had turned negative on Australian equities back in August 2007 when the ASX200 was about 700 points higher than now. We reiterated in May that the bounce in the equities was unlikely to be sustained and that seems to have been the right prescription. Remember if pain persists please see your doctor (at econoclast.com.au).

Here is the link to the US report:

Chicken investors squawk: Feed prices soar and demand for boneless breast meat drops unexpectedly.

DIY investors: I recommend you visit Dr Ron Wood’s website and subscribe to his newsletter. Cut through the noise of the popular media and get some real insights.