Monday, October 30, 2017

The Cost of NOT Investing

Asset price bubbles are a tricky thing. 

Recognizing a bubble may be tough enough.  Predicting its bursting is another story altogether.  Like earthquakes, both the timing and magnitude of a pop is difficult, if not impossible, to measure.  And then there are the after-shocks, similarly difficult to quantify, although we may think we know a thing or two about them.

Now once you think you're seeing a bubble -- after all, a bubble is a bubble -- does that mean you should not invest?

Welcome to the Land Down Under

We're not going to take a position on whether the Australian housing market is in a bubble or not.  But we'll tell you that its an ongoing debate.  And this debate has been, err, ongoing for well over 15 years.

Earlier this month, the Economist put out an interesting article that included this diagram.  Wow, or booya, it sure looks like a housing bubble, doesn't it?


But, on deeper investigation, the blue line was also disconnected from population growth or per-person-GDP way back in 1990.  Wouldn't that mean it was a bubble already in 1990, or certainly 2003.  Well...

In May 2003, the Economist magazine put out a story called House of cards, in which their economics editor explained that:
"Over the past few years, house prices have been booming almost everywhere except Germany and Japan. Since the mid-1990s, house prices in Australia, Britain, Ireland, the Netherlands, Spain and Sweden have all risen by more than 50% in real terms. American
house prices are up a more modest 30%, but that is still the biggest real gain over any such period in recorded history. Commercial-property prices in some big cities have also been looking rather frothy."   
... and ...  
"This survey will conclude that the latest housing boom has inflated bubbles in several countries, notably America, Australia, Britain, Ireland, the Netherlands and Spain. Within the next year or so those bubbles are likely to burst, leading to falls in average real house prices of 15-20% in America and 30% or more elsewhere over the next few years, in line with average price declines during past housing-market busts."

Looking back at this now ... more than 14 years later, it has been one-way traffic in Australia.  Had you invested a dollar in Australian housing in May 2003, it would be worth over $2.1 dollars today.  You would have more than doubled your money.  And the biggest one-year dip in house prices, according to an index that weights the eight largest Australian cities, was approximately at the 1% mark.  Hardly a 30%+ correction.

In June 2005, the Economist would continue with an article called In come the waves explaining that "America's housing market heated up later than those in other countries, such as Britain and Australia, but it is now looking more and more similar."  In this article, the Economist would not quite call Australia a bubble, but worse, would allow that inference based on a diagram and some "compelling evidence" and also would misdiagnose a correction in Australia.

"The most compelling evidence that home prices are over-valued in many countries is the diverging relationship between house prices and rents. The ratio of prices to rents is a sort of price/earnings ratio for the housing market. Just as the price of a share should equal the discounted present value of future dividends, so the price of a house should reflect the future benefits of ownership, either as rental income for an investor or the rent saved by an owner-occupier."

"Calculations by The Economist show that house prices have hit record levels in relation to rents in America, Britain, Australia, New Zealand, France, Spain, the Netherlands, Ireland and Belgium. This suggests that homes are even more over-valued than at previous peaks, from which prices typically fell in real terms. House prices are also at record levels in relation to incomes in these nine countries."

"The rapid house-price inflation of recent years is clearly unsustainable, yet most economists in most countries (even in Britain and Australia, where prices are already falling) still cling to the hope that house prices will flatten rather than collapse."

Looking back at this one now ... had you invested a dollar in Australian housing in June 2005, it would be worth over $2.0 dollars today.  Doubled your money.  And no flattening and certainly no collapse.

Conclusion

Our point is that, sometimes you can decide a bubble is a bubble, but if you don't invest you might protect against a chance of losing 30% (if the economists are right, which they more regularly are not), but you've also lost the chance of making 100% in this example. 

Australia is an unusual case: they have had 26 years of pretty much unabated growth without a recession, although they have come close.  The story Australia helps tell, though, is important. 

It's easy to constantly call a bubble, and maybe one day you'll eventually be right.  But in the meanwhile ... is losing 30% by investing any worse than missing out on making 30% by not investing?