The zero rate trap – The Economist 09-18-15

Salient to Investors:

No Fed tightening was a sensible decision. The Fed is in a trap: low interest rates have raised global equity markets, whose collapse in August helped in preventing the Fed from raising rates.

Most British homeowners have variable rate mortgages so while interest rate cuts staved off a potential disaster in the housing market, the UK housing market did not return to more affordable price levels as it did in the US.

May Rostom at the Bank of England says:

  • The ratio of house prices to first-time buyer incomes in London is 9.4 versus 2.6 in 1996 and 7.2 at the last peak in London.
  • The 1971-1980 and 1981-1990 birth cohorts face sharply rising debts to get on the housing ladder but their incomes have not risen near as fast.
  • Since 1995, the debt of older generations has barely budged, while that of those aged 25-45 has shot up in real terms. A world where younger households reach 65 and still have debt is possible.
  • The widening wealth inequality across income or socioeconomic categories is also across generations as the low-rate regime has boosted asset prices for the older generations that own the assets.

The Bank of England is in a trap: if it raises interest rates and forces down house prices, young people not yet on the housing ladder would benefit, but for those with high debts, it would be a disaster. Building more houses is not enough: even Savill’s forecast of a 55% rise in homebuilding over a 5-year period would produce only 167,000 units in 2018, versus the 240,000 needed.

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Taxed Out of Mansions, London Investors Head Down-Market – BloombergBusiness 08-06-15

Salient to Investors:

Even the wealthiest property investors are fleeing London’s best districts due to higher sales taxes of up to 12% on the amount above £1.5 million.

Camilla Dell at Black Brick Property Solutions said clients are spending an average of £2 million less on each transaction this year and are buying in less expensive neighborhoods because taxes are less when splitting the money between several properties in the sub-1 million-pound market.  Dell said prices below the tax threshold of £937,000 pounds are climbing and owner-occupiers are being penalized.

Lonres said sales of London homes for £2 million or more fell by a third in Q2 from a year earlier and a buyers’ market has returned, with no improvement in market conditions seen before September.

Johnny Morris at Hamptons Intl said £500,000 apartments in London typically yield 4% to 5% versus 2% for a luxury home in London’s best districts.

137 homes in Kensington & Chelsea were sold in April, the lowest monthly total since March 2009.

Knight Frank said 2015 prices through July dropped 2.3% in Chelsea, 2.1% in Knightsbridge and 0.6% in Notting Hill.

Giles Hannah at Christies Intl Real Estate said the decline in prime central London is temporary and prices will eventually continue to rise – the market has historically recovered from shocks before.

Savills said their average sale of a London home fell by £200,000 to £3 million in half1, 2015 vs. half1, 2014, and the number of transactions fell by 15%.

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U.K. Buy-to-Let Real Estate: Headed for Mayhem? – Bloomberg 07-16-14

Salient to Investors:

  • Economists say a rise in interest rates or falling prices could repeat the record high repossessions of private-landlord homes after the 2008 financial crisis. 1 in 3 economists predict an increase this year in the BOE rate.
  • The BOE’s loan-to-income cap does not apply to buy-to-let, the fastest-growing type of mortgage by value. Rob Wood at Berenberg Bank said this was a mistake because buy-to-let is a way to speculate on rising house prices, and the small-landlord market could rise more after April 2015; when pensioners will be released from having to invest their retirement savings in an annuity.
  • Buy-to-let lending rose 19-fold in the decade through the end of 2007, while UK home values tripled.
  • The National Landlords Assn said amateur landlords were a record 72 percent of the buy-to-let industry in Q1 2014, versus 62 percent two years prior.
  • The Council for Mortgage Lenders said private-landlord mortgages in April were up 57 percent from a year earlier, while homes bought as rentals were 14 percent of all new mortgages in Q2.
  • Huw Van Steenis et al at Morgan Stanley said buy-to-let investors in Q2 had more than 10 times the impact on prices versus the UK’s Help-to-Buy lending assistance program. London Central Portfolio estimates almost 50% of the new homes bought in London in 2013 were buy-to-let.
  • David Whittaker at Mortgages for Business expects the BOE to opt for a “light-touch regime” to private rentals because you have to differentiate the amateur who needs protecting from himself and someone who owns 1,000 properties.
  • Howard Archer at IHS Global Insight said there is a desire to have a decent amount of properties available to rent because many people cannot afford to buy houses.

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Jeremy Grantham’s Bullish Two-Year Outlook – Barron’s 11-19-13

Salient to Investors:

Jeremy Grantham at BMO writes:

The Greenspan-Bernanke policy of excessive stimulus, now administered by Yellen, will continue, and that the path of least resistance, for the market is up.

It would take a severe economic shock to outweigh the effect of the Fed’s relentless pumping of the market as seen by its continued advance despite almost universal disappointment in economic growth.

US stocks, especially the non-blue chips, will rise 20% to 30% in the next 2 years, with the rest of the world including emerging market equities outperforming in at least a partial catch-up. Then we will see the third market bust since 1999.

US stocks are badly overpriced with the prospect of negative real returns over 7 years. The sharp and unexpected uptick in parts of the US IPO market indicates we are in the slow build-up to a badly overpriced market and bubble conditions.

Most foreign markets are overpriced but less so.

There are few signs of a traditional bubble in equities – US individuals are not yet consistent buyers of mutual funds. There are no wonderful and influential theories as to why the P/E structure should be much higher today as there were in Japan in 1989 or Greenspan’s theory of the internet driving away the dark clouds of ignorance and ushering in an era of permanently higher P/Es in 2000, though today’s unprecedented margins, usually the most dependably mean reverting of all financial series, are apparently now normal.

Prudent investors almost invariably must forego the fun at the top end of markets so should now be reducing their equity bets and their risk level in general.

Yellen also thought the housing bubble merely reflected a strong economy and has happily gone along with the failed Fed policy of hoping for a different outcome despite repeating exactly the same thing. The consequences threaten to be just as bad again within 2 or 3 years. Greenspan had had no serious job prior to becoming Fed chairman, and a proven record of almost laughable failure as an economic prognosticator to the stock market in the 1970s.

The crash of 2008 is overwhelmingly seen as a financial event, but commodity price rises and the only US-wide housing bubble in history are understated in their contribution. The general bias in our economic thinking exaggerates the significance of the financial, paper world at the expense of the more mundane, but more important, real world.

We had the largest ever price rise in oil and other commodities, despite the absence of inflation in wages and consumer prices, hurting demand. Oil prices rose due to the rapidly rising long-term cost of finding and delivering oil and short-term shortages. The housing bubble was GMO’s warning signal.

We are almost back to normal in home ownership, perhaps within a year of full readjustment of the excesses.

The wealth effect from housing is greater than from the stock market and more dangerous, because home ownership involves over 30% more of the general public and those additionally impacted had typically far less liquidity to deal with a crisis than did stockholders.

Economic growth is slowing down globally, most obviously in Europe, and has a 25% chance of overwhelm even the Fed in the next 2 years. The general lack of global fiscal stimulus and almost precipitous decline in the US Federal deficit do not help.

Economist Kenneth Boulding believed economics had lost its way in a maze of econometric formulas, which placed elegance over accuracy.

The theory of rational expectations does not fit the real world and resulted in 5-7 decades of economic mainstream work being largely thrown away.

Efficient Market Hypothesis is the most laughable of all assumption-based theories, which tells us that investment bubbles have not occurred and could never occur, despite at least 4 of the great investment bubbles in all of investment history in the last 25 years – Japanese stocks in 1989, the Japanese land bubble in 1991, US stocks in 2000, and the first truly global bubble in 2007 in global stocks, fine arts and collectibles, and almost all of the real-estate markets. Brainwashed by the EMH, Bernanke and Yellen could not, or would not, even recognize the risk.

During the 1970s and 1980s, EMH helped reduce the number of quantitatively talented individuals entering the money management business.

The S&P 500 is within ±19% of its trend two-thirds of the time. Volatility is 19 times more than justified by underlying fundamentals, caused primarily by individual investors driven by behavioral factors that result in herding – non-experts simply feel more comfortable in a herd, and being wrong on your own is the cardinal crime for an investment manager so managing career risk results in very destructive herding and a great deal of extrapolation.

Extrapolation dominates the workings of the market. Keynes said extrapolation is a convention we adopt even though we know from personal experience that it is not applicable in the real world. For example, in 1982, 30-year bonds peaked at a 16% yield as inflation touched 13% so to extrapolate a full 13% inflation is as foolish as extrapolating currently very low inflation for 30 years. The same is true for extrapolating profit margins.

Economist Hyman Minsky said periodic financial crises were well-nigh inevitable because a form of extrapolation would occur with stability generating more risk-taking and on into a spiral until something inevitably would go wrong.

Despite high UK housing prices, the UK government is encouraging more leveraged mortgages, guaranteeing new mortgages over 5% that will further push prices up so that new buyers can only afford houses at low mortgage rates.

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U.K. RICS House-Price Index Hits 11-Year High on Help to Buy – Bloomberg 11-12-13

Salient to Investors:

A RICS index increased to the highest since June 2002. Mortgage lending climbed to the highest level in almost 6 years in Q3. The gap between demand and supply widened to the most since May 2009. RICS said house prices are expected to continue rising in all regions except northern England and sales expectations climbed to the highest on record – a rise of 3 percent nationally in the next 12 months.

Simon Rubinsohn at RICS said we are still well behind in terms of the amount of properties needed.

The Council of Mortgage Lenders said today loans for house purchases advanced in Q3 the most since Q4 2007.

The IMF says the UK government’s Help to Buy initiative potentially can stoke a housing bubble.

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Priciest London Homes Lose Shine as Sellers Aim Too High – Bloomberg 11-06-13

Salient to Investors:

Price gains for London’s most expensive homes have stalled this year on tax rise concerns and high asking prices.

Savills said London houses and apartments valued at more than 15 million pounds showed almost no gain in the year through September, versus a rise of 5 percent for properties from 1.8 million pounds to 5 million pounds and a rise of 10 percent for luxury residences outside central London. Values in London’s best areas increased at least 128 percent since mid-2005 versus a fall of 19.3 percent for all UK homes. Savills predicts luxury homes in central London will rise 23.1 percent through 2018, versus a 25 percent increase for British houses overall.

Lucian Cook at Savills predicts properties valued over 15 million pounds will rise at a slightly slower pace than the rest of London’s prime market and the UK as a whole, supported by a lack of supply.

Rightmove said average asking prices for homes in London rose 10.2 percent to 544,232 pounds in September and said the rate was unsustainable.

Rosalind Rowe at PricewaterhouseCoopers said a capital-gains tax on the second homes of foreign owners of UK property would generate very little income because foreign investors tend to buy at the top end of the market and hold the asset for a long time.

Liam Bailey at Knight Frank said top-tier buyers are not desperate to buy anything at any price.

Will Bax at Grosvenor Group is cautious about homes worth 5 million pounds or more because the extraordinary market for London luxury homes two years ago attracted irrational demand that has tapered slightly.

Foxtons expects no significant increase in London property sales for the rest of 2013.

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Bubble Trouble Seen Brewing in Australia Home Prices – Bloomberg 11-06-13

Salient to Investors:

Housing in Australia accounts for 60 percent of average household wealth versus a global average of 45 percent.

Average household debt has been near 150 percent of annual income since 2006 versus 135 percent in the US. House prices have not fallen more than 10 percent in any one year for more than 40 years.

RP Data said houses in Sydney took 26 days on average to sell last week versus 36 days six months ago: In Melbourne, 34 days versus 46 days.

Saul Eslake at Bank of America Merrill Lynch said it is easy to see how a bubble could emerge, but for now price increases are not being accompanied by a rapid rise in borrowing or building. Eslake said rising sales to investors puts the housing market in a more precarious position if economic conditions unexpectedly sour because they are not as committed as owner-occupiers, and Australia’s tax structure encourages investors to buy when they otherwise would not.

Investment in residential property by self-managed superannuation funds has risen 65 percent since mid-2008 and 10 percent in the 12 months to June, borrowing on average 70 percent of the value of a home versus 90 percent for regular borrowers.

National Australia Bank said foreigners accounted for 12.5 percent of purchases of new homes in Q3 versus 5 percent through most of 2011.

Michael Blythe at Commonwealth Bank of Australia said Australia’s population concentration puts upward pressure on capital city dwelling prices.

Craig James and Savanth Sebastian at Commonwealth Bank of Australia said talk of a housing bubble appeared in Australian media articles more times in September than at any time since 2003.

First-home buyers accounted for 13.7 percent of loans in August, the lowest level since April 2004, and versus a high of 31 percent in May 2009.

Matthew Hassan at Westpac Banking said buyers are not looking to buy in anticipation of significant capital gains.

Population growth in Australia averaged 1.6 percent a year over the past decade, meaning it needs 170,000 new homes a year versus actual supply of 154,000. ANZ Bank said Australia has a shortfall of 270,000 homes, equivalent to 20 months of housing construction, and will climb to 370,000 by 2015.

Paul Bloxham at HSBC said developers and households are unlikely to build new houses unless prices are rising, so a housing price boom is a necessary evil.

Adair Turner said the UK economic recovery is heavily focused on that favorite old British activity – another house price boom.

The IMF said Sweden needs to take measures to prevent consumer debt and housing costs from spiraling out of control.

Chinese home prices rose the most in October for the 17th consecutive month of increases.

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Central Banks Drop Tightening Talk as Easy Money Goes On – Bloomberg 10-23-13

Salient to Investors:

Continued stimulus on cooling global growth led by weakening in developing nations amid stagnant inflation and job growth in much of the industrial world risks inflating asset bubbles central bankers will have to face later.

Talk of unsustainable home-price increases is spreading from Germany to New Zealand, while the MSCI World Index of developed-world stock markets is near its highest level since 2007.

Richard Gilhooly at TD Securities said central bankers are wildly pumping liquidity and promising to keep rates down – which is abnormal.

The IMF cut its forecast for global economic growth to 2.9 percent in 2013 and 3.6 percent in 2014, and says inflation across rich countries is short of the 2 percent rate favored by most central banks.

Michala Marcussen at Societe Generale said central banks are concerned we are seeing another false start in their economies, and we need to see 2 to 3 months of better numbers before they are will to contemplate an exit.

The median economist expects the Fed to wait until March before tapering.

Gary D. Cohn at Goldman Sachs said we are economically in the exact same place as a year ago, so if QE made sense a year ago, it probably makes sense today.

Derek Holt at Bank of Nova Scotia said tightening before the Fed is ready to tighten would drive up currencies against the dollar, to the detriment of exports. Holt said the easy-money bias across global central banks will persist until March or April 2014 as the Fed complicated the exit strategies for many central banks.

Joachim Fels at Morgan Stanley said we are at the cusp of another round of global monetary easing, and if the Fed’s delay extends the decline in the dollar, then the BoJ and ECB are also more likely to add fresh stimulus.

Citigroup said the ECB is likely to offer banks another round of cheap, long-term loans in Q1, and the BoJ may ease more to offset a 2014 consumption tax increase.

Thierry Wizman at Macquarie Group said the much weaker dollar will cause central banks to ease because they can be less worried about capital flight if the Fed is not tightening and the strength in their currencies is imparting some disinflation into their economies, giving them a window to cut rates.

David Hensley at JPMorgan Chase forecasts the average interest rate in developed economies to hold close to the current 0.40 percent for another year as it hard to see much changing on the rate front.

The Bundesbank said that apartments in Germany’s largest cities may be overvalued by as much as 20 percent. The BoE is rebutting suggestions of a housing bubble. Rightmove said London asking prices jumped 10.2 percent in October from the prior month.

Michael Ingram at BGC Partners said bubble conditions will remain.

Karen Ward at HSBC sees no rapid withdrawal of global liquidity any time soon as whatever their official mandates, central bankers are supposed to safeguard a nation’s real income.

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U.K. Hometrack House Prices Rise in Strongest Market Since 2007 – Bloomberg 09-01-13

Salient to Investors:

Hometrack said average house prices in England and Wales were up 1.8 percent from a year earlier, the most since July 2010, adding to evidence of a mini-boom in the housing market, as mortgage approvals reached their highest since 2008. The average time taken to sell a property fell to 8.1 weeks, and sellers got 94.6 percent of their asking price.

Richard Donnell at Hometrack said a lack of housing for sale will remain a feature of the market and will keep upward pressure on prices in the near term as demand continues to expand over the remainder of the year so long as the outlook for the economy and mortgage rates remains unchanged.

The Engineering Employers’ Federation raised its forecasts for UK economic growth to 1.2 percent in 2013 and 2 percent in 2014, and manufacturing output growth in 2014 to 2.1 percent. Lee Hopley at the EEF said industry’s prospects have brightened considerably.

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This fund tracks 36 bubbles—and 33 have completely popped – Quartz 08-06-13

Salient to Investors:

Jeremy Grantham’s GMO claims that of the 36 major bubbles it says it tracks, 33 have completely popped, or returned to their prior trends.

GMO’s more recent predictions, the Australian and UK housing market bubbles, have yet to pop. James Montier at GMO says investors are being force-fed higher risk assets at low prices, a product of central banks’ loose monetary policies.

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This fund tracks 36 bubbles—and 33 have completely popped