Its The End Of The World As We Know It

Bored with the usual headline of the looming war with China, North Korea, Russia and the Packenham Upper Under 12B’s the Murdoch press has now turned its hyperbolic panic based radar onto the housing market. Apparently that house you bought last year for $3M is now worth one ugly camel, a distributor from a Datsun 120Y and a used yogurt tub…if you are lucky. It does seem that September and October are silly seasons for this sort of thing but usually it is stock market pundits who begin to need the incontinence pads at this time of the year. I am somewhat of an expert on crashes having been through the following in the past four decades –

Black Monday
Savings and loan crisis
Early 1990s Recession
1991 India economic crisis
Finnish banking crisis
Swedish banking crisis
Asian financial crisis
Russian financial crisis
Dot-com bubble
GFC
Icelandic financial crisis
Irish banking crisis
European sovereign debt crisis
Greek government-debt crisis
Russian financial crisis
Brazilian economic crisis
Chinese stock market crash
Cryptos going belly up – not so much a crisis but fun to watch nonetheless

This is probably 17 more financial hiccups that any journalist at the Murdoch stable – whats more I am a keen observer of these sorts of events, In part because of my active participation but also because they are fascinating to watch. My disdain for these sorts of media reports has it genesis in a few keystone points.

1. It seems as if the financial media are caught in their own echo chamber – they are merely repeating and copying each others reports. Original thinking is not taught in media study courses at university. You have to remember that nowadays critical journalism is merely copying someone else’s twitter feed
2. It is an easy target – property prices have been moving strongly for years. As such it is quite natural for naysayers to begin to predict the end of the world. For those who want a rundown on how well gurus’ fare in their predictions see here. Granted this applies to the stock market but there is no functional difference between the two markets. Markets are fundamentally unpredictable – that is their nature, if they were predictable they would offer no reward.
3. I accept that all booms end in a bust – this is simply a natural feature of markets. However a bust or deflation is different to a crash. When people think of a crash they perceive something like 1987 or the GFC where asset prices collapsed precipitously
4. All crashes need some form of catalyst – disinterest is not a catalyst it is a feature of market cycles. In part this is a function of my limited understanding of the way property works. To use an analogy buying property seems to me to be like buying shares using yearly charts. This holds true because your house is only valued once a year when you receive your rates notice. Yearly stock charts are only true once a year – at the end of the year. There is no emotional impetus to stampede out of property because there is no constant marking to market of the price of your house. You dont have a ticker outside of your house telling you from second to second what it might be worth because on most days it would be worth zero because no one wants to buy it at that particular time so the market for your house has no bids.

However, it is always worth looking at a variant perception that is to look at those things that might cause house prices to fall at a faster rate than natural drift due to lack of demand might suggest. Note lack of demand is not the same as panicked or forced selling where sellers are actively competing with one another for a limited pool of buyers. One of the things that does surprise me about property investors is that they dont understand that they are margin traders. You put up a deposit to buy and asset and the bank gives you the rest. This is the same principle as margin lending in stocks . You put up a small amount of coin and use someone else money to control a larger amount of product. This is the fundamental weakness in the property market and we come back to the notion of a catalytic event – interest rates. We have enjoyed a period of sustained low interest rates and this has allowed an orgy of ending to take place. What is surprising among property investors is the lack of understanding of how interest rates affect the nature of their investment. When I ask them what would they do if interest rates doubled their response is that for their rental properties they would just double the rent. I am no expert but I dont think thats how it works…..

To get a sense f the current trend in cash rates the chart below tracks the RBA cash rate for the past ten years. I have also plotted the ten year average rate which sits at 2.88%.

It is obvious that over the long term the trend has been down and that at presents rates are tracking sideways. It is worth noting that simply as a natural function all systems display mean reversion – that is the distribution tracks back to the long term average. There are two ways to interpret this phenomena. The positive case is that you could say that interest rates could stay at this point until the long term average matches the current cash rate. An absurdly positive (and naive) view would be that we go the way of Japan where the cash rate stayed at 0.10% for five years before dipping into the negative. A more realistic view is that interest rates will exhibit mean reversion and track upwards – this may provide the catalyst that the panic pundits are seeking.

The lack of data in housing market is both a blessing and a curse as you never quite know where you stand until you ask the question or the bank asks the question of you. In trading you are constantly aware of the worth of something you are trading – there is no waiting around. This does make decision making easier as there is constant price discovery as opposed to no price discovery in property.  This does make it easier to manage crisis events because you have a friction less flow of information. As an example the chart below is of the S&P/ASX 200 on which I have potted a 90 period weighted moving average.

As you can see this simple tool keeps you in during the bull market of the early 2000’s and throws you out as the GFC is unfolding. Nothing complicated, nothing magical, just a moving average that you can get for free from any number of sites.

So where does this leave poor property investors?

My feeling is that  it leaves them in the doldrums with a systematic enforced slow down in their sector as the banks tighten their own policies to protect themselves from a repeat of 1990 where they almost went broke because of poor lending practices. However, corrective action at present doesn’t protect them from previous transgressions and this combined with uncertainty in interest rate markets does make for an interesting future. As I said all booms end in busts – the bust can be loud and spectacular like 1987 was for share traders or it could be a slow whimpering death much like the decades long asset deflation that has occurred in Japan. My guess is that sadly property investors like everyone suffer from recency bias – this is certainly true of property gurus who have appeared in the last decade. The view is that today was like yesterday therefore tomorrow will be like today. The shock will come when they realise that tomorrow is not like today at all and they dont have a plan for that.