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Worried about a property crash? These nine facts answer it better than most…

By | Investing Times News, Lifestyle, Recommended by the Investing Times | No Comments

IMG_2386What causes a property market to crash? Is it a falling economy? An unemployment outburst? A building oversupply? Should we concentrate on consumer confidence data? Or is it as simple as common-sense about supply and demand?

There has been a long-standing fear that Australian property could tumble, with some of the world’s most renowned investors (Jeremy Grantham and Robert Shiller included) claiming the valuation metrics for Australian property appear distressed or weak. However, these investors have been proven wrong again and again.

It raises an interesting point about the real drivers of residential property. The Investing Times tracks nine key supply and demand data indicators to answer this question, and while we acknowledge is not a crystal ball, it does seem a useful proxy in a world of excessive fear-mongering and ignorance.

Here are nine metrics you might want to add to your watch-list if you are interested in the wellbeing of the property-market. For strong future returns, you want to see:

  1. Rental yields strong relative to interest rates (differential less than 1.5%). Positive (Current stance) 
  2. Overall employment growth above long-term average. Negative
  3. New building growth sustainable relative to the population (between 1-2x population/building ratio). Negative
  4. Total housing market sustainable relative to size of the economy (housing stock to GDP ratio less than 300%). Negative
  5. 5-year price growth at sustainable levels (equal to or less than nominal GDP). Negative
  6. Recession risk low (yield curve positive). Positive
  7. Overseas arrivals increasing (six-monthly trend change). Neutral
  8. Lending growth expanding (home loans and other credit) above long-term average. Positive
  9. Rental income growth exceeding inflation (YoY change). Negative

Property marketSaid another way, for a crash to occur, we should be able to identify it because the catalyst is likely to be rising unemployment, falling migration rates, a recession, an interest rate spike, or a realisation that prices are simply too expensive relative to the size of the economy. And as can be seen in the chart, the strength of the data has a strong correlation to the future 5-year outcome.

Of course, this could be narrowed on a state-by-state level, or suburb-by-suburb level, and would make the research even more relevant (eg. Sydney and Perth have very different dynamics currently). However, using the weighted average of the 8 capital cities is still useful for the overall health of the property market.

Is a property crash likely in the next 5 years? With the current scenario showing only 3 of the 9 indicators positive, the data tells us there is an increasing reason to fear for the wellbeing of the property market in the short-to-medium term; although any calls for a crash would appear premature – at least for now.

One reason for continued demand is record low interest rates – especially relative to rental yields – and this is unlikely to change in the near term. Another reason is offshore demand, although the official numbers have shown overseas arrivals have stagnated since the currency fell below $1.00 in mid-2013, this currency drop has made Australian property 25% cheaper for an offshore buyer.

Therefore, while the general supply and demand outlook of property fundamentals has deteriorated over the past year, there are still healthy demand drivers. Overall, the data seems to illustrate there is a basis for growing caution, with the overall score  significantly lower than we have seen on average over the past 20 years, which may point to lower average returns and/or marginally increasing risk (although this should be no surprise).

What do you think of the supply and demand backdrop? What other factors would you consider? It is a healthy debate worth having.

Please note, this will be a regular feature in the Investing Times reports, so if you are interested in seeing more data like this (we run a similar model on the share-market with similarly strong correlations) then please request a free trial report below. We also have a range of other thought-provoking articles available at www.investingtimes.com.au or encourage you to subscribe at www.investingtimes.com.au/subscribe

Trial today

RECOMMENDED BY THE INVESTING TIMES

Worried about a property crash? These nine facts answer it better than most…

| Investing Times News, Lifestyle, Recommended by the Investing Times | No Comments
What causes a property market to crash? Is it a falling economy? An unemployment outburst? A building oversupply? Should we concentrate on consumer confidence data? Or is it as simple...

Long-term investment themes: 10 year + view of the trends, opportunities and challenges

| Economy, Investing Times News, Recommended by the Investing Times | No Comments
Drawing attention to the outlook and big themes present in the economy is always a healthy perspective. Below are a number of key themes to think about as you monitor your...

Facts about the Chinese economy: How likely is a financial crisis in China?

| Economy, Investing Times News, Recommended by the Investing Times | No Comments
China is undoubtedly important to the global economy and with embedded signs of rising bad debts, there are enormous concerns surrounding China’s ongoing stability. Since 2005, China has accounted for...

It’s not (totally) the baby boomers fault: Why the working population matters most

| Most Viewed, Politics, Recommended by the Investing Times | No Comments

We have an unprecedented rise in the over 65 age group and our working population is growing at a more modest rate. This article will detail the real problems we face and how you can profit from it.

MOST VIEWED

17 stock metrics: value, growth, dividend strength, stability, momentum and sector analysis

| Investing Times News, Most Viewed, Share-Market | No Comments
If we agree the primary objective of stock-picking is to pick the winners and/or avoid the losers, then we must start with a framework that helps determine which companies to...

Recession risks: what are 10 of the top indicators to watch and why it works.

| Economy, Headline Article, Most Viewed | No Comments
What does it take to identify an impending recession? Obviously, this is an extremely complex question. However, there are at least 10 factors that have had a strong historical track-record...

Can Warren Buffett and Robert Shiller both be wrong at the same time? Unlikely.

| Headline Article, Investing Times News, Most Viewed, Share-Market | No Comments
Warren Buffett and Robert Shiller should be familiar names to anyone with an active interest in the share-market. They are two of the most respected individuals on the planet when...

It’s not (totally) the baby boomers fault: Why the working population matters most

| Most Viewed, Politics, Recommended by the Investing Times | No Comments

We have an unprecedented rise in the over 65 age group and our working population is growing at a more modest rate. This article will detail the real problems we face and how you can profit from it.

17 stock metrics: value, growth, dividend strength, stability, momentum and sector analysis

By | Investing Times News, Most Viewed, Share-Market | No Comments

IMG_3386 (640x481)If we agree the primary objective of stock-picking is to pick the winners and/or avoid the losers, then we must start with a framework that helps determine which companies to include.

For the vast majority of investors, this begins with a screening process to reduce the direct share universe down to a manageable number. The problem is that most screening processes involve no validation despite the fact there is an abundance of academic literature on the topic.

In the Investing Times attempts to offer logic, academic rigour and validity to this screening process. The idea is to assess the stock universe using the 3 F’s of Investing – Fear, Fundamentals and Forces – which leads us to 17 factors that each have academic support in contributing to out-performance. They generally aim to achieve dividend strength, growth, value, stability, momentum, sector bias and pricing acknowledgement.

17 factors sharemarketThis allows us to illustrate a number of “optimal” portfolios across differing styles – including balanced, stability-focused, dividend-strength, deep-value, growth-bias and sector rotation (we highlight optimal because it is subject to varies weaknesses we are transparent about).

The underpinnings that make the research different to others is that it focuses heavily on relativity to the sector median. This is vital and a key advantage to creating out-performance on a risk-adjusted basis. For example, a utility company (typically with a high depreciation expense) should not be compared to a bank as their earnings and cash-flow are accounted for very differently. Therefore, our logic implies that the Price to Earnings ratio should be isolated and compared by sector rather than by market.

Our data has allowed us to stress-test the outcomes of a stock universe over 6 years, involving more than 850 data validation periods. We acknowledge this isn’t nearly enough to have outright conviction, however we believe a combination of 6 years of stress testing along with a body of academic literature supporting the underlining metrics is a form of validation.

Creating a portfolio using the 17 metrics

As the founder of the Investing Times and Australian Investors Association, Austin Donnelly always said, “There is a difference between a good company and a good investment”. BHP may be a good company but it is not a good investment if you buy it at the peak of a mining boom. Therefore, the idea is to create a portfolio of investments with strong fundamentals and attractive pricing. The logic is that if any of the 17 indicators hinted to a buy signal, these are recorded and scored. If all seventeen indicators are suggesting underlying appeal, there is a reasonable likelihood of strong future performance.

If you wish to see the net result and top 20 holdings using this fundamental rigour, we encourage you to request the latest report as a free one-off trial. We will send this via email as a value-add with no obligations or cost.

Trial today

RECOMMENDED BY THE INVESTING TIMES

Worried about a property crash? These nine facts answer it better than most…

| Investing Times News, Lifestyle, Recommended by the Investing Times | No Comments
What causes a property market to crash? Is it a falling economy? An unemployment outburst? A building oversupply? Should we concentrate on consumer confidence data? Or is it as simple...

Long-term investment themes: 10 year + view of the trends, opportunities and challenges

| Economy, Investing Times News, Recommended by the Investing Times | No Comments
Drawing attention to the outlook and big themes present in the economy is always a healthy perspective. Below are a number of key themes to think about as you monitor your...

Facts about the Chinese economy: How likely is a financial crisis in China?

| Economy, Investing Times News, Recommended by the Investing Times | No Comments
China is undoubtedly important to the global economy and with embedded signs of rising bad debts, there are enormous concerns surrounding China’s ongoing stability. Since 2005, China has accounted for...

It’s not (totally) the baby boomers fault: Why the working population matters most

| Most Viewed, Politics, Recommended by the Investing Times | No Comments

We have an unprecedented rise in the over 65 age group and our working population is growing at a more modest rate. This article will detail the real problems we face and how you can profit from it.

MOST VIEWED

17 stock metrics: value, growth, dividend strength, stability, momentum and sector analysis

| Investing Times News, Most Viewed, Share-Market | No Comments
If we agree the primary objective of stock-picking is to pick the winners and/or avoid the losers, then we must start with a framework that helps determine which companies to...

Recession risks: what are 10 of the top indicators to watch and why it works.

| Economy, Headline Article, Most Viewed | No Comments
What does it take to identify an impending recession? Obviously, this is an extremely complex question. However, there are at least 10 factors that have had a strong historical track-record...

Can Warren Buffett and Robert Shiller both be wrong at the same time? Unlikely.

| Headline Article, Investing Times News, Most Viewed, Share-Market | No Comments
Warren Buffett and Robert Shiller should be familiar names to anyone with an active interest in the share-market. They are two of the most respected individuals on the planet when...

It’s not (totally) the baby boomers fault: Why the working population matters most

| Most Viewed, Politics, Recommended by the Investing Times | No Comments

We have an unprecedented rise in the over 65 age group and our working population is growing at a more modest rate. This article will detail the real problems we face and how you can profit from it.

Long-term investment themes: 10 year + view of the trends, opportunities and challenges

By | Economy, Investing Times News, Recommended by the Investing Times | No Comments

IMG_0801 (480x640)Drawing attention to the outlook and big themes present in the economy is always a healthy perspective. Below are a number of key themes to think about as you monitor your portfolios as a long-term investor:

  • Baby boomer industries to thrive. The percentage of people aged over 60 years old in the Western World is rising at an unprecedented rate. It therefore makes sense to focus on industries which profit from this sector. Any company which derives sustainable profits from wellness and good health could have appeal. Healthcare, consumer staples, recreation/travel and utilities are all areas of focus, although beware of stretched valuations in some of these popular sectors.
  • Asian outbound tourism to grow. A rapidly growing middle-class in China, India and other emerging economies means greater demand for tourism and luxury goods. Chinese outbound tourism is now bigger than the USA with 83 million people travelling, up eight-fold since 2000. This won’t stop here, so it is worthwhile comprehending how you can profit from this trend.
  • Technology will advance beyond mobile and tablets. Only 20 years ago, Google didn’t exist, Nokia phones weren’t yet popular, CD players were yet to hit their peak and Kodak cameras with film were in their prime. It is dangerous to predict the future of technology, except to expect that it will move fast and unpredictably. Steady profits rarely come from this space, so long-term investors are better to think about companies that won’t be disrupted by technology than those who provide it.
  • A combination of high debt levels and rapid credit growth will be unsustainable. The world of rapid credit growth and excessive debt is not sustainable and appears more likely to deleverage or stagnate. In other words, you will probably want to think about whether your investments can thrive in a world of shrinking or stagnating debt. High earnings growth from traditional banking in western markets may be difficult.
  • The need for infrastructure will grow. The global population will continue to rise, even if at a slightly lower percentage, and infrastructure investment will be required. It is worthwhile thinking about the companies that can reduce the burden of increasing traffic and make steadily growing profits by doing so.
  • Food sustainability will become a global issue. With increasing food demand and less land per capita than ever before, a rising middle-class in emerging markets and greater education on the climate implications of food production, we will likely see a movement towards more sustainable food sources.  
  • Geopolitical tensions will remain. Islam is the fastest growing religion in the world and acts of terrorism are increasing. Unfortunately, 10 years henceforth will probably still have geopolitical issues which will cause ongoing volatility.
  • European political tensions will be ongoing. Having one monetary policy stance for 17 countries is problematic and it will be a miracle if the Greek economy fully recovers whilst remaining in the European Union.
  • Clean energy will gain traction. Climate change is a long-term issue that will attract further investment. However competition will be rampant and political intervention could cause disruptions.
  • Bonds to probably disappoint. Bond yields that are currently negative in real terms appear to have almost no option but to go up eventually, and as they do, prices must fall. If nothing else, don’t expect double-digit growth out of bonds.
  • Shares will likely rise, albeit with volatility. Industries will rise and fall, companies will boom and bust, but tomorrow’s companies will generally be more profitable than yesterday’s. The support of a generally growing population and productivity gains means there is every reason to think that shares will rise over the long-term.
  • The labour force will become more educated but less active. Hours worked per person continues to fall, whilst education standards gradually improve. Technology will be a key driver of the future workforce.
  • Quantitative easing is an area to watch. It is the unconventional monetary policy that every distressed economy seems to be reverting to. Unless we start to see consequences such as inflation, this will continue to be the stimulus of choice.
  • Budget deficits are a long-term challenge. With ageing populations, the social welfare system will come under increased strain both locally and globally. This will create ongoing political tension.
  • Commodities are not dead. Withstanding any major improvements in clean energy or future supply, scarce commodities should move higher as global energy demands grow. The Chinese only have 85 cars per 1,000 people, compared to the USA who have approximately 797 cars per 1,000 people. Steel demand is also expected to grow 65% in the next 15 years. In other words, low-cost producers of commodities could still make substantial profits.

The themes above are intended to be thought-provoking rather than strictly predictive. Hopefully some or all of the points resonate with you in thinking about an advancing world. We also warn that investing based on themes requires meticulous care as the underlying investments can be overpriced and leave you exposed. It is worthwhile using Warren Buffett’s wisdom in this regard, “only buy something that you’d be perfectly happy to hold if the market shut down for 10 years”.

RECOMMENDED BY THE INVESTING TIMES

Worried about a property crash? These nine facts answer it better than most…

| Investing Times News, Lifestyle, Recommended by the Investing Times | No Comments
What causes a property market to crash? Is it a falling economy? An unemployment outburst? A building oversupply? Should we concentrate on consumer confidence data? Or is it as simple...

Long-term investment themes: 10 year + view of the trends, opportunities and challenges

| Economy, Investing Times News, Recommended by the Investing Times | No Comments
Drawing attention to the outlook and big themes present in the economy is always a healthy perspective. Below are a number of key themes to think about as you monitor your...

Facts about the Chinese economy: How likely is a financial crisis in China?

| Economy, Investing Times News, Recommended by the Investing Times | No Comments
China is undoubtedly important to the global economy and with embedded signs of rising bad debts, there are enormous concerns surrounding China’s ongoing stability. Since 2005, China has accounted for...

It’s not (totally) the baby boomers fault: Why the working population matters most

| Most Viewed, Politics, Recommended by the Investing Times | No Comments

We have an unprecedented rise in the over 65 age group and our working population is growing at a more modest rate. This article will detail the real problems we face and how you can profit from it.

MOST VIEWED

17 stock metrics: value, growth, dividend strength, stability, momentum and sector analysis

| Investing Times News, Most Viewed, Share-Market | No Comments
If we agree the primary objective of stock-picking is to pick the winners and/or avoid the losers, then we must start with a framework that helps determine which companies to...

Recession risks: what are 10 of the top indicators to watch and why it works.

| Economy, Headline Article, Most Viewed | No Comments
What does it take to identify an impending recession? Obviously, this is an extremely complex question. However, there are at least 10 factors that have had a strong historical track-record...

Can Warren Buffett and Robert Shiller both be wrong at the same time? Unlikely.

| Headline Article, Investing Times News, Most Viewed, Share-Market | No Comments
Warren Buffett and Robert Shiller should be familiar names to anyone with an active interest in the share-market. They are two of the most respected individuals on the planet when...

It’s not (totally) the baby boomers fault: Why the working population matters most

| Most Viewed, Politics, Recommended by the Investing Times | No Comments

We have an unprecedented rise in the over 65 age group and our working population is growing at a more modest rate. This article will detail the real problems we face and how you can profit from it.

Evidence of 9 quantitative investment strategies that work. Do you track these metrics?

By | Investing Times News, Share-Market | No Comments

IMG_9048 (479x640)If an investor has the foresight to avoid investment bubbles, they have uncovered one of the most difficult elements to a successful long-term investment strategy. However, all too often, these bubbles are only identified with hindsight.

Emotions and market cycles – particularly those developed on fear and greed – mean that investment bubbles are likely to perpetually occur. In other words, it is euphoria which causes an investment bubble to form and fear that causes it to collapse. The Investing Times maintains thorough research on nine investment metrics that can potentially help identify the peaks and troughs in advance. Each have a tremendous track-record and should be added to every investors watch-list.

Below we identify these at a high level along with a performance extract from our Australian research database:

1. Shiller P/E Ratio – The Shiller P/E is a famous metric created by Robert Shiller who is a Professor at Yale University and Nobel Prize winner. His logic is that the traditional Price/Earnings gauge had two major flaws; firstly, that corporate earnings are too volatile, and secondly, that inflation needs to be considered to gauge long-term earnings. Hence he created a long-term gauge that assesses the past 10 years of real earnings (adjusted for inflation) and used this as a proxy for price. This creates a much more stable expectation of earnings upon which investors can make more reliable valuation estimates on price. As can be seen in the performance table, the Shiller metric has worked exceptionally well in Australia, which is backed by supportive global analysis.

Metric 1

2. Long-term Dividend Yield – The dividend yield can be considered one of the most under-rated components of an investment return. The dividend yield is calculated as the average dividend per share divided by the price. Therefore, a rising dividend yield implies that either a) companies are increasing dividends or b) that the price has fallen. The same applies in reverse. Given the negative correlation between dividend yields and the future price of the market, an opportunity exists to use dividends as a proxy for the long-term price of the market. While methods differ, our methodology takes the ‘regression average’ of the dividend yield over the past 15 years and compares this to the current dividend yield. Including a margin of safety, a buy indicator is apparent if the current dividend yield is 5% or more above the long-term average.

Metric 2

3. Market Capitalisation to GDP Ratio – Warren Buffett may be the world’s most famous investor and in recent decades he has unveiled his favourite metric to gauge the overall share-market. Buffett’s logic is that the size of all the listed companies in a given country should roughly track the overall size of the economy itself. The rationale is that business revenues are a subset of the economy and hence should match over the long-term. Therefore, the metric takes the market capitalisation of all companies and compares this to the GDP. Over the long-term, it has proven high-risk to invest when the market cap to GDP ratio exceeds 100% and low-risk to invest when it is low. We apply a margin of safety, so our methodology looks for times when the market cap is less than 90% of GDP for a buying signal.

Metric 3

4. The Zone System – Originally created by the founder of the Investing Times and the Australian Investors Association, Austin Donnelly, and then slightly modified thereafter, the Zone System is a long-term gauge of fair prices. The logic behind this system is that the market should average a very similar performance number over the very long-term, but this tends to fluctuate due to the economic cycle and sentiment surrounding fear and greed. Therefore, the Zone System allows an objective view by factoring in approximately two business cycles of historical analysis. Our application of the Zone System is to be willing long-term investors if the market is equal to or below its long-term average (i.e. Zones 3, 4 or 5). In reality, the further below the long-term moving average (i.e. Zone 5), the better the prospects for forward returns.

Metric 4

5. The Dividend Yield vs Bond Yield – The Yield Gap applies logic that investors are always making a decision between stocks and bonds (or growth assets and defensive assets). Therefore, it is common-sense to analyse the pricing of these together. There are various versions on the most appropriate application of this logic, but our methodology uses the market dividend yield compared to the Treasury bond yield over the long-term. By comparing the grossed up dividend yield of the overall market to the 10-year bond yield, we can clearly see which way investors might move their funds. For example, if bond yields are very high relative to stocks, a rational investor will move his/her money from stocks to bonds and vice versa. Our methodology uses the long-term moving average of these numbers and the grossed up dividend yield of at least 20% higher is desirable.

Metric 5

6. The 45-64 year old Demographic – The mature age working population is defined as the civilian population between the ages of 45 to 64. This is deemed to be the most important segment of the population for share-holders as these individuals are the most likely to be net buyers of shares. The logic behind this is that 45-64yo individuals are generally gearing up towards retirement and a combination of greater incomes with lower family commitments in general. The importance of tracking demographic trends is imperative as various reputable studies have shown a declining working population creates high risks of deflation and a 40% reduction in future GDP.

Metric 6

7. The Shape of the Yield Curve – A “recession factor” draws on a body of evidence, demonstrating the power of the yield curve in predetermining recessionary conditions. More specifically, an inverse yield curve is said to be one of the most reliable predictor of recessions among all financial data. Our application of tracking the yield curve is a simple calculation taking the 10-year government bond yield minus the 5-year government bond yield. The idea is to simply avoid the share-market during times when it is negative. It should be noted that a positive yield curve is considered normal as it factors in inflationary expectations and liquidity risks.

Metric 7

8. The Coppock Indicator – The Coppock Indicator is famous among technical traders but is arguably under-utilised by long-term value investors. E.S.C Coppock was a well-known economist in the 1960’s that utilised knowledge of behavioural patterns, especially around bereavement. Specifically, he found that the average human mourns for a period of approximately 11 to 14 months on average before finding stability. Coppock’s logic was that investors experience a similar sense of bereavement when markets fall which requires a period of mourning. He therefore rationalised that an investor would not re-enter the market until this period of mourning has finished. From this behavioural pattern, Coppock created a technical system that identifies recovery patterns in share-markets. While the story is unique, the evidence is compelling and the reason why it is contained on this list.

Metric 8

9. The Average Allocation to Equities – The optimism/pessimism allocation metric is a gauge of household behaviour towards the share-market. It specifically tracks the percentage of household wealth being directed towards personal equities, which has had a history of rising and falling depending on sentiment around fear and greed. If the average household is investing less than average in the share-market, this is considered a sign of excessive pessimism and can be expected increase over time. The same applies in reverse, as a high percentage shows over optimism and can be expected to fall. The inflows/outflows this creates over the long-term has had a significant impact on performance.

Metric 9

Final Thoughts

We can see above that each of these metrics have the ability to idenitify mis-pricing opportunities. There are multiple limitations to each metric, and these need to be understood if you wish to use them as part of your investment philosophy. However, there is a real power of tracking metrics such as the above, especially as a combination, which can be best explained below. We urge readers to add these nine metrics to their watch-lists.

Science of Investing Performance 5 Years

Note: If you wish to see the net result and current standings of these metrics using fundamental rigour, we encourage you to request the latest report as a free one-off trial or by subscribing to our ongoing report.

Trial today

RECOMMENDED BY THE INVESTING TIMES

Worried about a property crash? These nine facts answer it better than most…

| Investing Times News, Lifestyle, Recommended by the Investing Times | No Comments
What causes a property market to crash? Is it a falling economy? An unemployment outburst? A building oversupply? Should we concentrate on consumer confidence data? Or is it as simple...

Long-term investment themes: 10 year + view of the trends, opportunities and challenges

| Economy, Investing Times News, Recommended by the Investing Times | No Comments
Drawing attention to the outlook and big themes present in the economy is always a healthy perspective. Below are a number of key themes to think about as you monitor your...

Facts about the Chinese economy: How likely is a financial crisis in China?

| Economy, Investing Times News, Recommended by the Investing Times | No Comments
China is undoubtedly important to the global economy and with embedded signs of rising bad debts, there are enormous concerns surrounding China’s ongoing stability. Since 2005, China has accounted for...

It’s not (totally) the baby boomers fault: Why the working population matters most

| Most Viewed, Politics, Recommended by the Investing Times | No Comments

We have an unprecedented rise in the over 65 age group and our working population is growing at a more modest rate. This article will detail the real problems we face and how you can profit from it.

MOST VIEWED

17 stock metrics: value, growth, dividend strength, stability, momentum and sector analysis

| Investing Times News, Most Viewed, Share-Market | No Comments
If we agree the primary objective of stock-picking is to pick the winners and/or avoid the losers, then we must start with a framework that helps determine which companies to...

Recession risks: what are 10 of the top indicators to watch and why it works.

| Economy, Headline Article, Most Viewed | No Comments
What does it take to identify an impending recession? Obviously, this is an extremely complex question. However, there are at least 10 factors that have had a strong historical track-record...

Can Warren Buffett and Robert Shiller both be wrong at the same time? Unlikely.

| Headline Article, Investing Times News, Most Viewed, Share-Market | No Comments
Warren Buffett and Robert Shiller should be familiar names to anyone with an active interest in the share-market. They are two of the most respected individuals on the planet when...

It’s not (totally) the baby boomers fault: Why the working population matters most

| Most Viewed, Politics, Recommended by the Investing Times | No Comments

We have an unprecedented rise in the over 65 age group and our working population is growing at a more modest rate. This article will detail the real problems we face and how you can profit from it.

Stock-picking skills: a key metric from Bruce Berkowitz, one of the world’s best investors

By | Investing Times News, Share-Market | No Comments
In search of perfection: Copy thy best

In search of perfection: Copy thy best

The world’s best investor is a distinguished title – no doubt about it. And a lot of names are regularly thrown around – Warren Buffett, George Soros, Bruce Berkowitz, David Tepper, John Paulson, Peter Lynch, to name a few.

We introduce to you the ‘Investor of the Year of 2013’ according to gurufocus.com and seek to identify what makes his investing technique so special. More importantly, we are looking for lessons and trading ideas.

Introducing Bruce Berkowitz

Without boring you with his life story, Bruce Berkowitz was Morningstar’s ‘Investor of the Decade’ through the tech wreck of 2001 and the GFC in 2007-09. What is most impressive is that the Fairholme Fund, which Berkowitz manages, has returned a cumulative +306.49% since it commenced in 1999 versus a total benchmark return of just +24.39%.

In fact, he has outperformed the index in 94 out of 97 rolling 5 year periods (and investors should know how hard it is to outperform the index at all).

Getting down to what matters…

To be practical for us, we want to know what makes him a great investor. Most people would agree that an impeccable track-record over the long-term is the evidence that separates a good investor from a great one. But the track-record is an outcome, not a formula.

A great investor must have an investing philosophy which enables them to either a) pick the winners or b) avoid the losers.

Sounds pretty simple, but any investor worth their salt understands how hard this can be.

Lessons for Australians

Thankfully, Berkowitz speaks publically about his investing style which creates a fantastic opportunity for us to learn valuable lessons. Below is a summary of the key principles that have allowed Berkowitz to outperform exceptionally:

  • Find the intrinsic value of a business. “People like to predict rather than price”.
  • Take a 5 year view. “We go back five years to measure 5-year performance”.
  • Don’t try to perfectly time your entry into assets. “I have proven time and time again that I can’t time the bottom of the market, but when I see $1.00 selling for $0.50, I buy and my feeling is if I’m early and the price goes down further, I have the chance to buy more. With being early, you look wrong until you’re right”.
  • Only diversify if you don’t know what you’re doing. “Why would I own my tenth best idea when I can own more of my best idea?”
  • Find businesses that are selling at a discount. “I want to buy stocks that other people hate”.
  • Use history as your guide. “History doesn’t exactly repeat itself, but it does rhyme”.
  • Nobody is perfect. “Oh, there are always hundreds of mistakes”.

 

Berkowitz’s key advantage?

It appears that Berkowitz does his best work while analysing the balance sheet of a business. In this sense, he is very similar to Warren Buffett. But while the average investor will find it very difficult to replicate his methodology, Berkowitz loves to refer to the “Price to Book Value ratio”.

In simple terms the price to book value ratio is a comparison of what the market implies a company is worth (ie. the share price) versus what the accountant thinks it is worth. It also has one of the best records in history.

A quick Google search will reveal numerous PhD’s which confirm that a low P/BV results in significant outperformance over the longterm, whereas a high P/BV has the opposite effect. This has become one of Berkowitz’s keys.

Berkowitz loves to find a business that is worth more dead than alive, meaning that if the doors were shut they would get more money than what the current shareholding is worth.

Should we rely on P/BV?

Using common sense, it is unsustainable for the P/BV to perpetually expand or shrink, except in the event of a business failure. Therefore, it is natural to see that this ratio should normalise in the long-run, creating opportunities in companies with an abnormally low P/BV. You will note that the lowest P/BV opportunities are often unloved stocks, at least temporarily, however this is the perfect hunting ground.

Beware that this ratio doesn’t work all the time (if it did, everyone would follow and it wouldn’t work) but don’t be mistaken because it has proven to work in the long-run and across multiple countries.

How you can copy Berkowitz?

Screening your portfolio for P/BV is the recommended starting point. The odds are it will show one or more of your investments have unattractive fundamentals. The other key lessons are to be relentless in finding bargain prices, don’t follow the crowd, have conviction and be willing to accept that prices may move the wrong way in the short-term.

Note: The Investing Times uses the Price to Book Value ratio as one of its 17 stock-market valuation tools in the “Direct Share Research Weighting Models”. If you wish to see the other 16 metrics and its performance history, request a one-off free trial edition or subscribe here.

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Can Warren Buffett and Robert Shiller both be wrong at the same time? Unlikely.

By | Headline Article, Investing Times News, Most Viewed, Share-Market | No Comments

IMG_9055 (480x640)Warren Buffett and Robert Shiller should be familiar names to anyone with an active interest in the share-market. They are two of the most respected individuals on the planet when it comes to money matters, and each have varied yet complimentary views on what drives the overall share-market.

Therefore, the title of this article has an underlying power behind it. “Can Warren Buffett and Robert Shiller both be wrong at the same time” is really the same way of saying “These two people are legends of their field and worth watching closely”.

The reason these two men are exceptional

Robert Shiller’s CV includes being the Professor of Economics at Yale University and a Nobel Prize winner in Economics. More importantly, he is the man behind the Shiller P/E ratio – a complex and compelling share-market indicator.

The Shiller P/E ratio is known as the more stable and reliable cousin of the Price to Earnings ratio, and is a market valuation tool that has accurately predicted the bubbles of recent decades (including famously for the 1987 Crash and the GFC in 2007/08).

Shiller PE Ratio in Australia

Shiller PE

Warren Buffett is the world’s 3rd richest man and better known for his ability to source businesses that have an understandable business model and long-term abilities to grow. He is quick to tell people he cannot predict the short-term direction of the market, however, underlying his strategy is an optimistic outlook for the overall economy and a strong consideration on its relationship with the share-market. In fact, it is the relationship between the share-market and the economy that has made him a fortune along with his “buy low, sell never” company philosophy. More specifically, Buffett has been documented on multiple occasions for his consideration of the Market Capitalisation of the overall share-market and its position relative to the nominal value of the overall economy. This is called the Market Cap to GNP ratio or the Market Cap to GDP ratio.

Market Cap to GDP Ratio in Australia

Buffett Market Cap to GDP

Utilising the favourite metrics of the smartest minds in a field would be seen by many to be a no-brainer. Going against it could be like ignoring the opinion of the world’s best heart surgeon when needing a heart transplant.

Yet fund flows continue to diminish and the average allocation to equities continues to remain well below historical norms in Australia. This is despite the Shiller PE being below historical norms and the Market Cap to GDP around historical norms.

Summary

It will take time before we know who will make the correct long-term judgement – the Shiller/Buffett duo or the average Australian – but it would seem unlikely to be the latter.

Note: This articles comes from the most popular and commented data from the Investing Times Asset Allocation Research document. This comprises nine of the most influential factors that determine share-market value (including the Shiller PE and Buffett Market Cap to GDP ratio), with a compelling track-record over a 25-year period in Australia.

If you wish to see the 9 metrics, please request a free trial below and we will forward it by email. This is a value-add with no obligation.

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Facts about the Chinese economy: How likely is a financial crisis in China?

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IMG_0174 (640x480)China is undoubtedly important to the global economy and with embedded signs of rising bad debts, there are enormous concerns surrounding China’s ongoing stability.

Since 2005, China has accounted for approximately 40% of total global growth with the economy growing five-fold in just 15 years. However, jitters are now apparent and the past six months has seen the biggest test for emerging markets since the Asian crisis of 1997. A combination of three key factors are being cited; enormous growth in shadow-banking, bubbling asset markets and indebted local governments.

But just how likely is a financial crisis in China? What is their debt position in comparison to other countries and/or history? And what should an investor need to know in order to make educated decisions in related markets?

The Debt Expansion is Fearsome

A scary and newsworthy chart often put forward by media outlets shows the rapid growth in total debt across China. There are many versions of these articles, however even highly respected news outlets such as the Wall Street Journal (WSJ) and Bloomberg have caused stir with headlines such as “China’s Debt Bomb” and “A Debt Balloon With Nowhere to Go But Down”.

Of course, they are intended to inform their audience, but they also use such headlines to sell newspapers. Therefore, it is important to obtain a balanced view of the data.

The reality shows two important but contradictory points. Firstly, China’s debt has ballooned relative to history on both a nominal basis and in comparison to the size of their economy. In this sense, both the WSJ and Bloomberg are correct. However secondly, this debt expansion was from a very low base which means China is still in line with global peers on both a relative and absolute basis.

A Global Comparison

China’s total debt – accumulated by households, corporates and central/local governments – reportedly rose from 121% of GDP in 2000 to 158% in 2007 and 282% in 2014. This 161% expansion in debt looks unhealthy, but looks considerably worse in absolute terms.

Nominal GDP in China is estimated to have grown approximately 474% in the fourteen years to 2014, meaning the nominal total debt position has increased over 12x from around US$2.1 trillion to $28.2 trillion.

In comparison, no other country has ever encountered the same debt expansion on both a relative and nominal level. However, before everyone runs for the hills it is important to also illustrate the debt position of other key economies that many consider “perfectly safe”.

For example, the latest total debt figures – including public, corporate and household debts – show China has 282% estimated total debt to GDP, the USA has 269%, Germany has 258% and Australia has 274%. Relatively, all four countries have less debt than Japan’s governmental debt level alone.

Therefore, even after factoring in the misunderstood shadow banking, the Western World faces very similar levels of total debt as China according to the Bank of International Settlements. On this basis, China appears to be on track. The only problem is whether they can handle the next inevitable bad debt cycle.

IMG_0153 (640x480)Bad Debt cycles explained

It would be imprudent to brush off China’s debt expansion, including the shadow banking, on the basis of a global comparison. There are many valid reasons to be cautious about China’s debt expansion. Firstly, the composition of the debt is considerably different to its Western peers, with a much greater portion of higher risk corporate debt (especially lower grade non-financial corporate debt). In China, corporate debt represents 67% or two thirds of total debt compared to Australia which has less than half in corporate debt (47%) and the USA which has only 38%.

This debt composition is important on many levels, no less because it affects the speed and severity of any financial crisis, should it occur, plus it tends to lack the same levels of regulation and hence attracts riskier lending. This is a major risk for an economy known for volatility.

Bad and Doubtful Debts

Using the analogy of an individual that over-leverages on debt, it can be universally agreed upon that the greater the amount of debt relative to assets or income, the greater the risk of a severe collapse. For example, a couple earning $200,000pa with a $2 million home and a $1.8 million debt faces severe risk if either the asset or income falls. On the contrary, it also provides the greatest opportunity for growth if the asset value grows at a rate greater than the interest expense. On a country level, this is no different, and for China a high debt level creates this leverage.

The lesson from the “PIGS crisis” in Europe (the debt crisis of Portugal, Ireland, Greece and Spain) was that the real risk of a financial crisis comes from two sources; rising interest costs, typically beyond 7%, or a spike in bad and doubtful debts.

At present, the effective borrowing rate for China, assessed via its bond yield, is healthy at approximately 2.88%. Therefore, the real risk would be a spike in bad and doubtful debts, which is a key dataset to watch.

Will we see a spike in bad debts?

Whether we will see a spike in bad debts in China will relate to the ability of corporate China to meet its debt obligations. In the current environment, this is heavily reliant on three issues; 1) the overall exposure to resource-related debt, 2) whether the property market stabilises to constrain defaults, and 3) whether Chinese capital outflows can be constrained. In many ways, this is no different to the Western World, with the possible exception of capital outflows.

The biggest difference between China and its global peers is the historical analysis of bad debt cycles, with Chinese downturns far more severe and worrisome than Western counterparts. For example, a commonly cited downturn was the 1997 Asian debt crisis, which reportedly wiped more than 10% of bank assets in China. To put this in perspective, a similar episode today based on current Chinese debt levels would create a financial crisis up to 3.5x bigger than the 2007 crisis in the USA. This is scary stuff.

What to do?

It would seem contradictory to expect and/or fear a financial crisis in China without expecting something similar elsewhere in the indebted Western World. In reality, the backdrop of high debt and high asset prices are a common theme among many of the world’s most important economies.

Regardless of whether you think a crisis will occur, it is reasonable to worry about the impact a Chinese financial crisis would have on the global economy (including share-markets), particularly because of its size and historical volatility. Emerging market bond spreads are one way to monitor proceedings, as this is the markets way of telling us the risk of corporate debt, which China happens to have a lot of. Asset prices are another area to monitor, as a sharp fall in either property or equities could be an obvious trigger for a rise in defaults and the commencement of a bad debt cycle.

Patrick Hess from the European Central Bank said it well, when he was quoted as saying, “a domestic financial crisis is not unlikely to happen in China, and very likely to spread globally, should it indeed happen. To implement all the reforms necessary to avert a Chinese crisis is almost a “mission impossible,” or at least very difficult in the complex Chinese policymaking context, which involves a high degree of institutional overlap, conflicting goals and interests, and political bargaining. Even such a strong leader like Xi Jinping cannot change this context”.

At present, it could be plausibly stated that China faces its greatest debt-related risk since the 2007 GFC and possibly since the 1997 Asian Crisis, with capital outflows and asset values showing weakness. For now, Xi Jinping seems to be aware of the risks and we have seen the introduction of numerous reforms in recent times to counter or reduce these risks, and property values appear to have commenced a mild recovery.

Recent economic data shows the debt-train continues in China as it continues stimulating to avoid further capital outflows. However, rather ironically, the more China borrows the greater the risks become. In summary, investors should exercise a high degree of vigilance and monitor Chinese developments very closely.

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