With the level of worry on this board about 'bad news' flows i thought i would try to provide a brief framework which i am using to evaluate the global economy and hence the structure of my own investments.
All boom bust processes contain an element of misunderstanding or misconception. The primary reason for this is the belief by market participants that the market is in a state of equilibrium (efficient market hypothesis) rather than my belief that at most points in time the market actually is in a state of unequilibrium (or artificial equlibrium due to interference) due to the fact that humans try to analyse a situation but then also try to influence or take advantage of the situation. Positive self-reinforcement leads to additional resource allocation and eventually a self-defeating boom/bust scenario.
We are currently witnessing the unwinding of the current periods excessiveness: essentially currency surpluses used to deflate a countrys currency through international carry trades, financial engineered products that were priced on recent historical data (that was also a period of relative stability, leading to insufficient pricing for risk), a period of easy credit terms, a rising housing market that allowed consumers to refinance for current consumption (housing equity as a means of 'income' to support expenditure) and a build up of consumer based export industries (exporting nations) and a build up of consumer infrastructure (such as retail shops businesses, retail based warehouses etc, for the importing nations).
These factors are all interlinked due to the rise interlinked intermediation of the global economy.
As this process unwinds we are going to see most of the financial pain centred around the catalysts that were built to unsustainable levels during the previous periods excessiveness (of course there will also be indirect pain through related industries, but the storm of readjustment wont be focussed on these areas as they never benefited from the postive reinforcement of the boomtime conditions).
As you watch the GFC unfold through the media, you will see a number of D&G articles. These articles will create the appearance that world capitalism is comming to an end. I beg to differ, if you look through the underlying nature of the article you will see in nearly all cases it relates to the unwinding an unsustainble resource build up.
Therefore in my opinion avoid allocating investments (whether its shares or buying underlying property) to
1) Retail shops/shopping centres and discretionary retailers;
2) Office buildings within major financial centres;
3) Export companies that target discretionary consumer spending;
4) Domestic importers that target discretionary consumer spending;
5) Fiance companies that use financial engineering as a means of making profit.
6) Companies that rely on high debt
7) Companies that rely on acquisitions to manufacture earnings.
Whilst the market values of such investments are falling, they could very much present value traps. Future losses will be curtailed as such sectors downsize, but even after the losses are curtailed, what will be the catalyst to restore future earnings to previous levels (hence the value trap).
In regards to residential property, i think performance will be mixed.
I split Australian residential property into 3 sectors: lifestyle, upmarket, generic traditional housing.
Lifestyle property could well be in for a time of future underperformance, as its underlying intrinsic economic usefulness is low (hence lifestyle). This sector will be significantly effected by both reduction in retierees income and net wealth and erosion of wealth amongst the wealthy (2nd properties as beach homes etc).
Upmarket properties could also be in for a time of future underperformance (but i think less so than lifestyle properties, because their instinsic economic usefulness is higher) because its performance is correlated more to the health of the business sector than to traditional property valuation measures (average incomes, interest rates etc). The level to which Australia goes into a recession will be the most important factor for this asset class, not interest rates. If australia avoids a deep recession then i think upmarket properties will stabilise very quickly (but maybe not show much in the way of near term future outperformance, because business conditions wont return to their former boom time conditions for a number of years).
Finally we have generic medium priced and lower housing in capital cities. I just cant see why this type of property has a risk of material depreciation. At the end of the day step back and look at the big picture, there is still a structural undersupply (which is building due to the current downturn in new starts). And i cant over emphasise this differentiating factor to between Australia and the US (i dont have the figures in front of me, but a signficant amount of residential property in the US towards the end of the boom was never build even for the purpose of an investment rental property, they were acquired solely for the basis of flipping which was evidenced by the vacant nature of the property, ie properties were developed and then left vacant in order to be resold) This underlying demand will create a floor in how low prices can go. If Australia enters a recession some people will loose their jobs and of these a portion are at risk of having bank possessions (But not all, just because someone becomes unemployed doesnt mean they will automatically loose their house, the correlation wont be 100%). But underlying this fact will be new buyers who are trying to enter the market (because of the demand surplus). Some of these new buyers will be put off by the GFC, but others who are in safe employment or have adequate savings or other factors will still be happy to buy. So you have to look at the MARGINS effecting supply and demand.
All boom bust processes contain an element of misunderstanding or misconception. The primary reason for this is the belief by market participants that the market is in a state of equilibrium (efficient market hypothesis) rather than my belief that at most points in time the market actually is in a state of unequilibrium (or artificial equlibrium due to interference) due to the fact that humans try to analyse a situation but then also try to influence or take advantage of the situation. Positive self-reinforcement leads to additional resource allocation and eventually a self-defeating boom/bust scenario.
We are currently witnessing the unwinding of the current periods excessiveness: essentially currency surpluses used to deflate a countrys currency through international carry trades, financial engineered products that were priced on recent historical data (that was also a period of relative stability, leading to insufficient pricing for risk), a period of easy credit terms, a rising housing market that allowed consumers to refinance for current consumption (housing equity as a means of 'income' to support expenditure) and a build up of consumer based export industries (exporting nations) and a build up of consumer infrastructure (such as retail shops businesses, retail based warehouses etc, for the importing nations).
These factors are all interlinked due to the rise interlinked intermediation of the global economy.
As this process unwinds we are going to see most of the financial pain centred around the catalysts that were built to unsustainable levels during the previous periods excessiveness (of course there will also be indirect pain through related industries, but the storm of readjustment wont be focussed on these areas as they never benefited from the postive reinforcement of the boomtime conditions).
As you watch the GFC unfold through the media, you will see a number of D&G articles. These articles will create the appearance that world capitalism is comming to an end. I beg to differ, if you look through the underlying nature of the article you will see in nearly all cases it relates to the unwinding an unsustainble resource build up.
Therefore in my opinion avoid allocating investments (whether its shares or buying underlying property) to
1) Retail shops/shopping centres and discretionary retailers;
2) Office buildings within major financial centres;
3) Export companies that target discretionary consumer spending;
4) Domestic importers that target discretionary consumer spending;
5) Fiance companies that use financial engineering as a means of making profit.
6) Companies that rely on high debt
7) Companies that rely on acquisitions to manufacture earnings.
Whilst the market values of such investments are falling, they could very much present value traps. Future losses will be curtailed as such sectors downsize, but even after the losses are curtailed, what will be the catalyst to restore future earnings to previous levels (hence the value trap).
In regards to residential property, i think performance will be mixed.
I split Australian residential property into 3 sectors: lifestyle, upmarket, generic traditional housing.
Lifestyle property could well be in for a time of future underperformance, as its underlying intrinsic economic usefulness is low (hence lifestyle). This sector will be significantly effected by both reduction in retierees income and net wealth and erosion of wealth amongst the wealthy (2nd properties as beach homes etc).
Upmarket properties could also be in for a time of future underperformance (but i think less so than lifestyle properties, because their instinsic economic usefulness is higher) because its performance is correlated more to the health of the business sector than to traditional property valuation measures (average incomes, interest rates etc). The level to which Australia goes into a recession will be the most important factor for this asset class, not interest rates. If australia avoids a deep recession then i think upmarket properties will stabilise very quickly (but maybe not show much in the way of near term future outperformance, because business conditions wont return to their former boom time conditions for a number of years).
Finally we have generic medium priced and lower housing in capital cities. I just cant see why this type of property has a risk of material depreciation. At the end of the day step back and look at the big picture, there is still a structural undersupply (which is building due to the current downturn in new starts). And i cant over emphasise this differentiating factor to between Australia and the US (i dont have the figures in front of me, but a signficant amount of residential property in the US towards the end of the boom was never build even for the purpose of an investment rental property, they were acquired solely for the basis of flipping which was evidenced by the vacant nature of the property, ie properties were developed and then left vacant in order to be resold) This underlying demand will create a floor in how low prices can go. If Australia enters a recession some people will loose their jobs and of these a portion are at risk of having bank possessions (But not all, just because someone becomes unemployed doesnt mean they will automatically loose their house, the correlation wont be 100%). But underlying this fact will be new buyers who are trying to enter the market (because of the demand surplus). Some of these new buyers will be put off by the GFC, but others who are in safe employment or have adequate savings or other factors will still be happy to buy. So you have to look at the MARGINS effecting supply and demand.
