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

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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

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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?

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

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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.

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

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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...

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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...

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| 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.

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

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

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.

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.