catching a falling knife

my back of the envelope calculations for the next5 years : PER property SYD 35, MELB 28

Normalised (30yr MA of real reported earnings) S&P500 35, ASX200 25. Do you see a pattern ? I went to the UK last month and they are suffering the same prooperty deflation as we are, the americans seem to be reaching the peak. We are participants in a worldwide property bubble, just like all the other ones. Jeez, it’s sad to know were’re not so unique.

Basically anyway you cut it (affordability, yields, historical based PE or accounting methods) we have a property bubble that is deflating. Before this we had a stockmarket bubble that was deflating (but has bounced back a little bit – but may still deflate a lot more). My take : things strongly revert to the mean over decades. Markets are ketokurdic so you can have 3 sigma outperformance or underperformance briefly but things regress to the mean again. You make money most easily by buying low, selling high.

You can still make money in a declining property market by buying/improving property and onselling – as long as your improvement/value add is more than the decline in that period then you make money. I just built and sold a semi for a tidy sum. But there are risks. The market is nowhere near as soft as it has been at other troughs. You are a fool if you think making money in a falling market is easier than in a rising tide. And you’re a complete fool if you think you can make money trading when liquidity tightens up (which it hasn’t in property – there’s still froth, so make hay, just don’t bet the bank on it).

Anyhow, my views only : I think the real (inflation/rental yield-costs) return on residential for the next 5 years in syd will be minus 3%pa, Melb minus 1.5% pa. If you can find deals that add value faster than this erosion and can offload (and assume liquidity doesn’t seize up due to some calamity when you are building) then good for you. My nose tells me now is not the time to play aggressive. Big surprises (3 sigma events) occur with surprising regularlity – my guess every 5 years. So last one was sept 11, before than asian market meltdown/LTCm, and before that interest rates in the early 90’s in double digits.

So you can’t see any of these things happening ? well neither does anyone else and that’s why thinks take a wallop when the 3 sigma event happens (no one expects it and often it is not simillar to the past recent calamity). People use induction incorrectly : they take the near term past and extrapolate to the next 10 years. We have seen huge asset price inflation in the last 10 years, I’m sorry if you missed out. If you didn’t miss out, you’re being like a chistmas turkey if you think it will happen again like before : Bertrand Russels christmas turkey story : turkey was fed every day, it correctly induced it would get fed again every morning. What a genius turkey ! Until christmas day, whereup induction failed and instead ot getting breakfast it got it’s head chopped off.

The first rule of investment is capital preservation. You cannot play the game if you go silly and aggressive and lose most of your capital. That being said no one can predict the future, so it is silly to be completely out of the game at any one time. Ot to be dogmatic. I will be the first to jump headfirst into property again if it shoots up. I wouldn’t put many chips on it though – the chances of a sustainable rally from these valuations is low, low, low.

My view on other things (which are peculiar to me and may in fact be completely false) – which I share with you as some people seem to have a complete lack of imagination when imagining the future and in pricing risk :
Oil : I am staying overweight. I think it will go to $200 barrel before people will change their transport and oil usage patterns in any meaningful way (and use less or more expensive and inconvenient alternatives). 7 years ago people were predicting it would go to $5 a barrel – but then it may have – who was to know the chinese would industrialise as they have done in the last decade instead of having another cultural revolution and deferring industrialisation another 20 years.

In China a city the size of Brisbane is being built everyday. Asset, particularly property price inflation has been phenomenal in chinese cities and along with Vietnam to a lesser degree. The returns have been jawdropping – are they sustainable ? My pick : chinese continue to industrialise, oil being inelastic in the short term, oil prices will rise to ridiculous levels. As long as they retain the undervalued peg of their currency this inflation will be counteracted by consumer good deflation : result- very gradually rising interest rates or no rate increases, until they revalue the YUAN at which point inflation will soar, oil will tank and we will have a worldwide recession.

Prior to that though we may have a recession a la japan : the japanese are quicker and more logical people than us. If you know you can buy a cheaper DVD, computer, car, or maybe soon coming to a place near you custom built chinese produced home shipped to your vacant block, why the hell unless you are an idiot would you choose to buy this today when you know you can get it cheaper tomorrow ??? I guess you can trade the dumb people on the way down (ie add value, sell in a sliding market but make profit)… after a while though do you think even these dumb people would realise that something cheaper/improved today is still not worth buying if they can get bit cheaper and better next year ?????

Hrrmm industrial property (an imperfect substitute) was this the last real sector rotation in proprty in oz, that’s the way I see it. It has maybe reached a bit of a peak (I hold a bit and want it to pump higher – but really, it’s getting silly). Even those wily property developers are going to take a caning, first the residential devellopers, then the commercial ones including that pin-up boy westfield. Don’t be disheartened if you’ve found it hard, if the devellopers are finding it hard, well that means something (like things are starting to suck)-but keep a bit of powder dry, I have a feeling they may well get much suckier.

“time alone completes and rounds all things” (including our waistlines as we age)

Just my rambling thoughts peoples, nice to see the site still going strong, cya in 6 months and you can cane me on my predictions, what a hoot !