Wages flat, ASX down, house prices…up?

Tuesday, 1 August 2017
Melbourne, Australia
By Bernd Struben

What I think is unique to Australia is that so many Aussies have an iron-clad belief that house prices only ever go up. That’s dangerous. And I fear they’re going to get the shock of their lives when they realise it’s not true.

Kris Sayce

Today’s opening quote comes from publisher Kris Sayce. It’s how we concluded the first of our four-part interview series in yesterday’s Port Phillip Insider. If you missed that, you can read it here to get up to speed.

The reasoning behind the interview series is to uncover the motivations that drove Kris to launch his new premium service, Crash Market Investor. We also hope it will give you a better insight as to what the looming crash is likely to look like. And, importantly, how you can profit before, during, and after the meltdown.

Today we pick up where we left off, with an eye on Australia’s exorbitant house prices in the face of a lacklustre share market. A trend that continued to run strong in July.

Though the rate of price increases slowed, homes in Sydney and Melbourne are still more costly than ever before. From The Australian:

Dwelling values rose strongly in Australia’s capital cities in July, even as the trend of spiralling prices on the east coast showed further signs of losing steam, according to property researcher CoreLogic.

Home values across the capital cities rose 1.5 per cent in the month of July, with most individual capitals rising, figures for the month show.

The gains were led by a 3.1 per cent jump in Melbourne, while values in Sydney added 1.4 per cent.

Now let’s put the 3.1% monthly price rise in Melbourne into perspective. If home values keep going up at the same rate, it would see the city’s already stretched house prices double in the next 23 months.

Does that sound sustainable to you?

Meanwhile, the Aussie share market appears out of gas. The following headline is from today’s Australian Financial Review, ‘ASX records worst July performance for six years as Wall Street soars to record’.

The champagne corks might have been popping on Wall Street during the past month with the Dow Jones, S&P 500 and Nasdaq all closing at fresh record highs, but for local investors it was a case of dry July with nothing much to celebrate.

Indeed, it was the worst July in six years, according to Bell Potter’s Richard Coppleson, and despite the last day of gains the major S&P ASX 200 index has now fallen for three months in a row.

I don’t mean to beat the drums of doom and gloom here. But if you add Australia’s stagnant wage growth to the mix, it’s hard to see how a major crash is not on the cards.

Which brings us back to Crash Market Investor, and how you invest if you know the crash is coming, but you don’t know when.

But first…to the markets.

Markets

Overnight, the Dow Jones Industrial Average gained 60.81 points, or 0.28%.

The S&P 500 fell 1.80 points, or 0.07%.

In Europe, the Euro Stoxx 50 index closed down 18.37 points, or 0.53%. Meanwhile, the FTSE 100 gained 0.05%, and Germany’s DAX index fell 0.37%.

In Asian markets, Japan’s Nikkei 225 index is up 49.36 points, or 0.25%. China’s CSI 300 is up 0.36%.

In Australia, the S&P/ASX 200 is up 48.90 points, or 0.85%.

On the commodities markets, West Texas Intermediate crude oil is US$50.25 per barrel. Brent crude is US$52.79 per barrel.

Gold is trading for US$ 1,270.29 (AU$1,584.10) per troy ounce. Silver is US$16.84 (AU$21.00) per troy ounce.

The Aussie dollar is worth 80.19 US cents.

Whatever they do, it will be bad for most people

We left off yesterday’s interview with a discussion of Australia’s increasingly unaffordable homes and rather flat share market returns. Today we’ll kick off with a look at the much higher returns on US indices, and what this has done for price-to-earnings (PE) ratios.

Bernd Struben: Last week TheTelegraph reported the following: ‘The cyclically adjusted price to earnings ratio of Wall Street equities has reached a vertiginous 30.12. This stock market metric is higher than in mid-2008 and is exactly where it was before the great crash in October 1929. These are disturbing thoughts. Yet it takes a catalyst to trigger such events.

The million-dollar question here — and it really is a million-dollar question — is what do you foresee as the most likely catalysts to trigger the next crash?

Kris Sayce: That’s easy. I defer to Vern Gowdie on this one. Vern says that there’s only one reason why markets crash — it’s because of too much debt.

Whether directly or indirectly, that’s true. Even the dot-com boom and bust had an element of too much debt. People made bad capital and investment decisions. Those decisions were made with both equity (stock investments) and debt. In many cases, that involved borrowing to buy equity investments.

It was debt again in 2008. I don’t think you need me to rehash all that old ground.

Bernd: No, I think most of our readers have a good memory of what happened. Or perhaps ‘good’ memory isn’t the right term here. But they do remember.

Kris: Right. And the core of it was debt. Not just all the subprime stuff either. It was debt piled on debt. Derivatives of debt, and then derivatives of those derivatives.

To say the whole system was one giant mess would be an understatement. The point is, the loose financial system allowed debt to expand to unsafe and unsustainable levels.

There was, therefore, only one way it could go. And that’s what happened.

The question then becomes whether anyone has learned anything from the 2008 financial collapse. Well, as I’ve pointed out before, they have learned something. They’ve learned that if things get really bad again, the government and central bank will bail out the markets again!

As Donald Trump might say, or tweet, ‘Sad’. [Laughs]

The term for that kind of risk-taking is ‘moral hazard’. It’s the idea that people will only take certain risks because they know someone or something is obligated to help them out if things go bad.

Worse than that. Knowing that a bailout is a certainty, the risk-takers will take even bigger risks. After all, if you’re going to go for a big win on something, you may as well make it a really big win, right?

But here’s the really worrying thing. Debt levels in 2008 were way lower than they are today. US and Aussie government debt are both at sky-high levels. Personal debt rocketed.

And businesses are taking on more debts too. That’s not surprising when you look at how low interest rates are worldwide. It’s almost a case of them being stupid if they don’t.

Don’t forget, even the most sensible and conscientious business owner and CEO may feel pressured into borrowing when interest rates are low. Why? Because they may fear that if they don’t borrow to grow their business, others will, and that could see them lose market share, and maybe cause profits to fall.

It’s hard to be an angel when you’re surrounded by sinners…as someone probably once said!

So when the debt binge ends, as I believe it will, it could have a catastrophic impact on the world’s markets. 2008 was bad. I believe the next crash will be much worse.

Bernd: One of the arguments put forward by the permabulls is that a lot of money is still sitting on the sidelines. According to TheSydney Morning Herald, investors have 5% of their holdings in cash. And the sell signal — the signal that could see markets take a hefty tumble — isn’t triggered until that ratio drops below 3.5%. Does that mean we’re in the clear for now?

Kris:[Laughs] Ah yes, the ‘weight of money’ argument. In the financial world, it’s an old-time classic.

The argument is that there are billions, nay, trillions of dollars ‘sitting on the sidelines’, and that, at any given moment, all that cash will wash into the market to buy stocks.

It’s a neat argument. And at first glance, it seems to make sense. Trouble is, it’s complete rubbish.

I’ve seen this argument used before. Leading up to the 2008 meltdown, seriously-minded folks suggested that stocks could never fall again, because of all the money flowing into superannuation each month.

How did that work out?

The reason it’s rubbish is because the amount of money available to invest is only part of the equation when it comes to stock prices, and the catalysts for a crash.

For instance, while it’s true that there is a lot of money on the sidelines, it’s also true that there’s a lot of money already invested in stocks. Although, during the height of a boom, investors tend to forget things like corporate profits; when companies start to disappoint shareholders, investors soon regain their memory.

That’s when the balance of the ‘weight of money’ shifts. When markets turn south, sellers are generally more eager to get out of the market than buyers are eager to get in.

You know the old saying about the market going up the stairs and down in the lift. The falls are quicker than the gains because of that investor psychology. When things are turning bad, investors want out. They don’t want to stick around to decide if it really is all that bad. Sell first, do the research later.

On the other side, the buyers can see all this is happening. They too are fearful. It’s pretty hard for an investor to pluck up the courage to buy a falling stock, or to buy at the bottom.

For that reason, buyers tend to be more cautious. The buyers, by the way, include those with the billions and trillions ‘on the sidelines’. So, I wouldn’t get too hung up on the idea of cash waiting to pour into stocks in today’s markets.

Bernd: Especially not with so much cash pouring into property! You can’t talk about pending crashes without bringing in the Aussie property market. I touched on that in the introduction today.

A few pundits continue to predict strong growth for years ahead. A few others are sounding alarm bells over a coming meltdown. And the mainstream has…predictably…taken the middle road, with property insiders predicting growth to halve over the next year.

What’s your take on this?

Kris: Man, you had to bring up house prices. You do know that I have the single worst track record of predicting Australian house prices, right?

In 2008, when Professor Steve Keen said that house prices would fall 15% or something, I said you could triple or more that fall. I predicted a 50% crash in Aussie house prices.

That didn’t happen outside a few obvious pockets of the country: Queensland trophy homes, and areas within Western Australia and South Australia. No coincidence that all three of those states are tied to the resources industry.

But in Sydney and Melbourne…no crash. Not even a whiff of one.

Since then, I think Aussie house prices have doubled. I look at the selling prices of houses in my street. Not the price the real estate agents market, but the actual sales price. It blows my mind how much prices have moved up in just over 10 years.

In the face of that, it sometimes feels as though I’m flogging a dead horse when it comes to predicting a house price crash. But, even though I’ve gone quiet on the subject in recent years — licking my wounds — I continue to look at the housing market and believe that it’s only a matter of time before the major price-crunch happens.

I know incomes have risen in recent years. I know that there are now more two-income households. But that has been a gradual change over 50 years. It hasn’t suddenly happened since 2008.

So for house prices to double, and for the inner-city Sydney median house price to be above $1 million, well, it’s just crazy. It’s not sustainable. I think the big break in the market will come on the heels of the big sub-divisions you see in the inner suburbs.

Land may be scarce, but developers are building more dwellings on the same amount of land. Just because land values increase, it doesn’t mean the value of dwellings on the land will increase.

That’s where I see the crash catalyst — overbuilding of medium-density housing.

Bernd: There’s plenty of that going on in my neighbourhood as well. It’s all fine and well so long as there’s a greater fool out there to buy these overpriced smaller lots. But as the supply of greater fools begins to dry up, that’s certainly a crash catalyst to keep our eyes on.

But enough about Aussie property. Let’s turn to another favourite topic…central banks.

For almost 10 years now the Fed and central banks across the world have managed to keep liquidity flowing and stock markets, broadly, heading higher. If another crash looks imminent, can’t investors count on government and central banks to keep markets from more than modestly correcting by, say, 15% tops?

Kris: Oh, I don’t think there’s any doubt that the central banks will do something. Or rather, try to do something.

I think what is questionable is whether it will work and, perhaps more importantly, what will be the consequence of whatever they do.

To answer the latter, perhaps glibly, I think the answer is that whatever they do, it will be bad for most people.

That’s not even guesswork. You see evidence of that today. I think you have to be something of an ignoramus to not realise the link between low interest rates, money printing and rising inequality.

If you listen to the mainstream, you’d think that the world’s economies are roaring back to life. The bankers and CEOs believe this. They believe it as they’re paying record prices for artwork, and splashing out on the latest Rolls Royce, or buying trophy properties.

Governments believe the economy is roaring back because their banker and business buddies tell them so…over cocktails at the latest soiree.

Meanwhile, the streets are full of protestors, seemingly on a weekly basis. They rail about inequality. They ask governments to do more to help.

What they don’t realise is that it’s thanks to the government, and the government’s employees at the central banks, that inequality exists.

Low interest rates and money printing devalue savings. It’s harming investment as people look for ever-riskier and higher-yielding investments, rather than potentially lower-risk but more stable and boring investments.

So Amazon.com, Tesla, Google and Facebook get all the investor dollars. And other businesses set themselves up to capitalise on the growth of those businesses.

Meanwhile, lower-growth companies can’t attract investment because they’re not as exciting. That makes it harder for them to reinvest in the business, and makes it harder for them to hire new workers and offer pay rises to existing workers.

I know, it’s more complicated than that. But that’s a snapshot of how things are playing out in the world’s economies. There is no recovery. It’s only bluster.

I believe the market will fall heavily within the next two years. And when it does, 15% will be just the beginning.

And on that bombshell…

That brings today’s interview to an end. An interview that revealed some of the more likely crash catalysts.

On one side you have rising PE ratios in the stock markets. Rising house prices in the nation’s capital cities. Stagnating wages. Soaring private, corporate and government debt. Record low interest rates. And investors chasing riskier assets.

On the other side you have investors with 5% of their holdings still in cash. And a beleaguered cadre of central bankers hoping they’ve got a few last tricks up their sleeves.

Now, if you find this all a bit of a downer…despair not!

Tomorrow we’ll look at how you can play all of this to your advantage. Not just by avoiding the worst of the pain when the market does inevitably crumble, but by locking in potentially huge gains during the stock market ‘melt-up’ before the crash.

This ‘melt up’ phase preceding the meltdown is one of the key focuses of Kris’ new service, Crash Market Investor. I’ll bring you all the details in tomorrow’s Port Phillip Insider.

Or if you’re ready to get in on the best ‘melt-up’ stocks now, go here.

Cheers,
Bernd