Did you get a financial grip?

The official release date of my book Get a Financial Grip was 30 May 2012 and it wasn’t an easy gig to release a book on investment at that time.

In fact, I got a lot of earache for making the “gutsy” suggestion that growth assets such as equities and property would represent good long-term choices for investors, as the end of the world seemed to be nigh according to many.

My logic was based squarely upon the fact that when measured on a historical basis, Australia’s stock market was trading at reasonably cheap earnings ratios.

And while Australia’s population continues to boom and our economy remains an inflationary environment, prices of quality well-located properties are also likely to be significantly higher a few decades from now (an appropriate time horizon for property ownership).

Of course, I did not suggest simply placing an enormous bet on Australian assets at prevailing prices and my book presents a full discussion of the benefits of diversification across different asset classes and markets from other countries as well as detailed consideration of a range of appropriate investment strategies.

And naturally, I don’t pretend to be able to predict the near-term movements in markets, although it is truly amazing how many claim to have this foresight. Instead long-term owners of stocks and properties should focus on the growing income streams while also aiming to gain from capital appreciation over the long haul.

“If you don’t take a chance, you don’t stand a chance”.

Stock valuations since 30 May 2012

Stock markets had taken a tremendous pounding through 2011 with spooked investors exiting the markets fearing the dreaded “double dip” recession in the US. The financial press was having a field day about the European debt crisis and then there was the impending doom of the “fiscal cliff”…

 stock valuation1

And yet, incredibly, stocks are almost 25% higher than they were on the date of my book’s release, and that is before you even account for dividend returns. Meanwhile bank accounts and term deposits are paying a miserable rate of interest.

In the short term the outlook is always uncertain, but over the long run owners of a diversified portfolio of quality dividend-paying stocks will fare well.

Property prices since 30 May 2012

Australia’s property prices had reportedly fallen by 7% nationwide by the end of May 2012 (way more than this in areas of low demand, but much less in quality outperforming property types and locations).

The usual commentators argued that house price declines would accelerate and yet – if you are believer in the level of accuracy of such indices(!!) – Australian property markets bottomed out precisely 24 hours before the release of my book on 29 May 2012 and began to increase on 30 May.

Since then prices have rebounded across Australia by around ~3.3% nationwide and are increasing.

As always the last 12 months have seen certain property types such as apartments in Sydney fare very well (+4.7%) but property prices in other cities such as Hobart and Adelaide slide. There is never any one ‘property market’ in Australia or in any other country.

Real Estate Bubble?
What of the infamous “Australian property bubble?” Notoriously, Professor Steven Keen predicted that Australian property prices would “crash by 40%” in 2008. He got that prediction horribly wrong but has since amended his prediction stating that prices will fall in “real terms” over the next 10 or 15 years.

Those of us who owned multiple investment properties in cities like Sydney raised an eyebrow at the original “40% crash in 2008″ claim. I would never say never, because anything can happen within reason. But it was a big call to say that prices would fall by 40% in 2008 when demand appeared to remain high.

Since that time prices have increased significantly in the major property markets such as Sydney and Melbourne as evidenced in the RBA’s chart below. And over those years, average wages have moved higher and each dollar of our currency is worth significantly less.

dwelling prices

More frustratingly for those who took Keen’s advice, weekly rent increases have blasted upwards way ahead of inflation since mid-2008, while – crucially – many of those who have owned property made significant progress towards paying down their mortgages (statistics show that 56% of mortgage holders with major banks are ahead of their repayment schedules).

This simply highlights how difficult it is to predict the vagaries of markets and time them accurately. Although we often believe that we are skilled at the timing of markets, in reality we often do it very badly indeed.

Charting

Keen initially produced a chart dating back to 1992 which showed the correlation between dwelling prices and mortgage acceleration, but then allegedly deleted them from his blog due to the relatively low correlation of 0.63. He since replaced them with trimmed charts only dating back to 2007 which show a clearly higher correlation of 0.853.

Keen’s charts make for great reading but take no account of the emotional connection or otherwise that Australians attach to property ownership or renting. The fact that housing prices generate such a phenomenal level of debate bears testimony to the importance that many Australians still attach to property ownership, as do the recent jumps in the auction clearance rates in our major markets.

Philip Soos, researcher at Deakin University, has written a number of interesting articles which produced charts dating back as far as the 1860s which show why he believes that the property markets will crash. That’s fair enough.

I quite clearly remember when I was a Uni student myself stating that property prices in London were “ridiculously high” and were “totally unsustainable”. My statements haven’t stopped prices from moving more than 250% higher today, though.

Again, that’s not to say that there cannot be a crash in Australia, but charts from 1860 prove little either way. For example, I could show you a chart from 1861 which shows that the population of Sydney was a paltry 56,000 at that time, whereas today it is well over 8,250% higher at 4,627,300 and growing by close to 60,000 people per annum (over the coming few decades the Sydney population is projected to increase to around 7 million).

Alternatively, I could also show you a chart which shows the monster decline of interest rates from 17.50% to 3.00%, or cite how property ownership in Australia increased from 50% to 70%,  or quote that today there are many more two-income households, or…

There wouldn’t be much point, however, because once a commentator has a preconceived agenda and then posts data to support only the predetermined conclusion then the data loses its meaning.

Capped supply

The problem for a city such as Sydney, the geographical spread of which is constrained by National Parks and the Pacific Ocean to the east, is that the population is increasing significantly every year but there is very little more available space.
I can’t pretend to tell you what will happen in the short-term and we certainly could see mean reversion over time. But while millions more people compete for the ownership of the same limited acreage of prime location land (and while our central bank has a stated policy of devaluing the currency with every passing year) it seems likely to me that actual land and property prices in the future will be higher than those of today.

Sentiment improving

It was interesting to hear from my publishers that sales of my book have recently increased significantly, which suggests to me that consumer sentiment has improved and that people are belatedly starting to believe once again that investment markets might again pick up. Of course as markets move higher so does the risk of a forthcoming correction in stocks.

It just goes to show how fickle we are as people. And it also shows why the best investors tend to be the ones who have the fortitude to go against the crowd.

inflation[sam id=29 codes=’false’]

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Pete Wargent

About

Pete Wargent is a Chartered Accountant, Chartered Secretary and has a Financial Planning Diploma. He’s achieved financial freedom at the age of 33 - as detailed in his book ‘Get a Financial Grip – A Simple Plan for Financial Freedom’. Pete now manages his investment portfolio, travels and works as a consultant in the finance industry from time to time. Visit his blog


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