I know I will get flamed for this We have prescribed to the theory that it’s always a good time to buy for the last 23 years and have been steadily accumulating and adding to our portfolio. However looking at global trends in long term interest rates and inflation; the risk reward ratio feels skewed. US 10 year Treasury yields are up from 0.5% to 1.5%. Inflation in the US at least is showing signs of increasing. The biggest risk is that the attitude of senior Treasury officials and Investment bankers seems to be to let inflation increase outside targeted bands and it will still be ok. We have not decided yet whether to make another purchase H2 this year or to pay down more debt.
What are you actually concerned about here though? If they 'let' inflation increase outside targeted bands, that means they will not raise raise rates. If inflation results in higher rates, that seems to be bad for property, but it also depends on what happens to wages. The crash from higher rates leading to forced selling scenario is many steps removed from the current situation.
If wages continue to stagnate (looks like they will) then we may have a plateau, which means buying is not the best option due to opportunity cost of better investments. I don't have a crystal ball, just adding a scenario. Not too many levers to pull other than immigration, which is on pause for at least 2 years.
Inflation is actually good for real assets like property. The key question is the reaction by central bank officials. Do you think they will be hawkish and lift interest by more than enough to contain inflation, in which case property and share prices fall? Or do you think that central bankers will be too scared to lift interest rates (due to high levels of government and personal debt, politics etc) adequately and they let the inflation genie out of the bottle? (while providing every pseudo intellectual cover as to why they don't need to lift interest rates just yet due to transitory inflation). In the latter scenario both CPI inflation and asset price inflation pick up. Personally I think global central bankers lack credibility. They have taken credit for low inflation in recent decades which was primarily due to the rise of China and thus lower costs for manufactured items rather than their actions. They have taken the path of least resistance at every turn for decades. Now we have globalisation in reverse, rising manufacturing costs, geopolitical concerns, reduced global productivity, various supply shocks triggering sharp increases in prices dislodging previously anchored inflation expectations. We also have 'modern monetary theory' which is an intellectual rationalisation of spending more and keeping interest rates low, which just happens to justify what politicians would like to do. If you think that central bankers lack credibility the correct strategy is to lock in a low fixed rate mortgage with rates fixed for as many years as possible, close your eyes and buy. As for migration, I can envision Australia becoming a highly desirable place to migrate to post covid due to the trauma experienced in source countries (e.g. India) and we will need immigration to keep the economy chugging along. The Federal government will have a major incentive (tax revenue) to expand quarantine centres to facilitate permanent migration. So maybe less tourism more migration depending on how covid progresses over the years ahead.
If inflation is the main fear of coming price drops, I simply can't see asset values going down - it's inflation after all. If you're predicting another black swan event that destroys real value, e.g. another covid-like event or debt crisis or (imagination blank) then yes asset values can fall.
Which investments make good inflation hedges? Certain specific investments do well when inflation is climbing. Choosing among these assets should reflect your own goals, and also how severe the inflationary climate is. From business insider 1. Stocks In general, returns on stocks beat inflation. Rising prices can mean more profit for companies, which in turn boosts share prices. No guarantees, of course, but over the long term, the stock market has historically provided returns that beat inflation. Passive index investing is the easiest way into stocks, and doesn’t rely on an aptitude for stock-picking. Technologyand other growth stocks, which outperform the overall market, make the most solid hedges against inflation. Consumer goods companies and others in the defensive sector, which produce basics people need, also do well. 2. Commodities “Commodities tend to have outsized returns during times of high inflation,” says Adem Selita, CEO of the Debt Relief Company. Commodities are a type of real asset, things like crops, raw materials, or natural resources. Their prices go up those of other goods or services that use those goods. In particular, precious metals like goldand silver have long been considered an inflation hedge. As physical assets, both gold and silver have intrinsic worth, unlike the dollar or other currencies. Other inflation hedges include energy commodities, like oil and gas. 3. Real estate Real estate is both a real asset and an appreciation-oriented one. Like commodities, land and property values tend to rise alongside inflation. If you’re not ready to buy actual property, you can still invest in real estate through a real estate investment trust (REIT). These are publicly traded portfolios of properties; although technically securities, they are influenced by real estate trends. 4. Alternative investments Williams notes that some other tangible assets, such as fine art, vintage cars, and other collectibles, also tend to work well as a hedge against inflation. Again, these are real assets that have intrinsic value to collectors. Although their prices can be hard to predict, the value of these items is expected to appreciate over time, providing returns greater than the inflation rate. Cryptocurrencies, like Bitcoinand Ethereum, may also protect against inflation because there is a cap on their supply. But since cryptocurrencies are so new, dating back to 2010, it’s not clear how they’ll perform during times of high inflation – they haven’t been around in that sort of environment. 5. US Treasury Inflation-Protected Securities (TIPS) Most bonds are not good choices to hedge against inflation. The reason is that these investments pay a fixed rate of interest throughout their years- or decades-long lifespans. Their prices on the secondary market might change, but the interest rate they pay is typically not adjusted. But some bonds, like US Treasury Inflation-Protected Securities (TIPS), have interest rates that are indexed to inflation. That means that their interest payments go up with the inflation rate – and down with deflation – ensuring the payments’ worth isn’t too badly eroded. Because they’re backed by the US government, TIPs are highly safe, and a good choice for conservative investors. You can also use debt to deal with inflation Debt may seem like the opposite of an investment. But incurring it can also be a good financial move when inflation is rampant. Selita notes that inflation makes it cheaper to service – that is, pay – some types of debt, as long as it has a fixed interest rate. In the same way that inflation eats away at the value of your cash, it also eats away at the value of your loan. This benefits individuals that have acquired loans or mortgages in the past, before the period of inflation set in. For example, $1 in 1990 is equivalent to about $2 today, so a $1,000 mortgage payment 30 years ago would be worth about $2,000 now. But after all that time, you’d still be paying $1,000 per month. So the value of what you need to pay is reduced by about half. Effectively, you’re paying half as much each month to service the debt. If you can refinance, try changing your loan or mortgage to a fixed rate rather than a variable rate. That will leverage inflation to your advantage. The financial takeaway Investing for inflation is essential for protecting your wealth. Inflation can erode your savings. So, while keeping some cash handy is great for financial security, it’s best not to keep too much. If you do, you may find that it just doesn’t buy as much as it used to. Instead, plan for inflation by making your money earn. Choose an investment strategy that’s likely to give you a return that at least keeps up with the inflation rate. Look for assets that appreciate, that have a fundamental value of their own, or that pay interest at a fluctuating rate. By keeping up with inflation, you can maintain the value of your money. And maybe even grow it.
I fear central banks will be initially too slow to raise rates but will eventually need to increase quickly which will hurt asset prices given the high leverage of many investors
If they do raise, it will have to be very gently, slow and measured. I think as a society, household debt levels especially for the young and aspirational segments have become too big (leveraged) to fail
I get this sense too. It seems like global markets are moving regardless of what Australia does (Canada and Norway looking to raise this year), and it will twist the reserve's arm at some point. I think the biggest risk to housing though is the lack of population growth, particularly for Victoria. Rising rates will just be a catalyst for bigger systemic problems. I'd hazard a guess that a typical investor is happy to hold a property empty for extended periods if the capital gains are outweighing the funding costs. But as soon as it costs more to hold than the property it can return, there will be many who start counting chips. So my central argument is that investors will find it harder to lease properties over coming years, and increased funding costs will be the catalyst for them to consider this a real issue. Funding will go up, rents will not. On the back of government stimulus, new construction has increased in the last 12 months. Take Victoria for example, building 70,000+ dwellings a year for what was annual population growth of 120,000-150,000 (around 2 people per dwelling, a good stable rate of build). ABS figures show 2020 population growth was 745 people, even after births and deaths. Because of government stimulus, the rate of new approvals has actually increased since mid-2020 so over the next 6 months we will start to see much of these "pandemic builds" come to completion. If the banks' calls on rates are correct, then from late 2022 there will be a compound effect of pandemic builds largely completing and increasing funding costs. In theory, this means the number of properties will increase in proportion to population which should make a glut of rentals (unless investors are happy to keep them off market). However, this will time with increased funding costs. As a side note to that, if population growth continues to stay low then at some point the rate of building will need to adjust. That will have a massive impact on employment in the construction sector. So either the market will be massively oversupplied (Ireland GFC) or employment will take a hit. Either way, without population growth notably stepping up it is going to be rough, particularly for Victoria which was most reliant on it.
Thanks for this feedback I have an interest in Melb as moving next year to Melb I think rents in Melb are stagnant, I see a glut of townhouses currently on the market. Very surprising, cheaper to rent in Melb than Perth. As an investor returns are shocking. When interest rates rise its going to be very difficult to hold Its weird how many think rents continue to rise, but its all about supple and demand. I think there is a good argument to cash in your chips if you have made some serious $$$ in Melb. No one went broke taking a profit
Inflation is controlled by psychology in the long run - the central banks globally have convinced their citizens that they will ensure they keep inflation controlled. If inflation increases outside the target bands it will take much bigger interest rate increases to bring it back under control.
Property market: Low rate outlook baked into the housing market From AFR this morning: Aus are sitting on record-high level of offsets at $205b at the start of 2021 in their mortgage accounts -up from $171b in Dec 2019. This will serve as a significant buffer against any IR rises and this is rising by billions of dollars each quarter. The IR rise is expected to peak at 1.25% cash rate (up 1.15% Vs now) however the banks' lending is assessed at 2.5% high int rates Vs current. 50% of new loans committed have 3-5 yr fixed term, thereby negating any short term rises (if there are any).
Hi Snoopy, Whether buying again or paying down debt is the best thing for you is your own decision. Regarding now being a good or bad time to buy, just a few thoughts. 1) You are right about the 10 year yield, and we have been in a treasuries bond bull market for 40 years. But I think what is going to matter this decade is not interest rates, but real interest rates: ie IR minus inflation. If inflation continues to rise, even increases in nominal interest rates won't necessarily mean an increase in real interest rates. 2) Central bankers want inflation. It's a stated policy. Real estate will be a good hedge if policymakers get what they want. 3) My main point however is that there is no point trying to time the market anyway. We are somewhere in a cycle, and probably closer to the end than the beginning even if this has a few more years to run. What you can do however, is set yourself up to make money in the next cycle after this one. And if that means waiting a few years until it really pops again, is that a problem? I know my point #3 assumes essentially that "real estate always goes up", but I think this is a very defensible position (which I can explain if you like) validated by much of history. Kind regards, John
Agree. This will depend on wages. If it is inflation for everything but wages then people will struggle to meet higher mortgage repayments stemming from higher interest rates. If wage inflation picks up as well and we have a wage-inflation spiral (where unions/workers demand and receive higher wages to compensate for higher expected inflation), then mortgage stress will be contained despite higher interest rates if, as you say, real interest rates (nominal mortgages rates minus inflation rates) falls. At the moment: - Wages growth is low (1.4% year-on-year for private sector wages in Q1 2021) - The unemployment rate is relatively low by historical standards (5.1% in May) - The job market is tight (employers struggling to find the right workers). Job vacancies are 57% higher than pre-covid according to the ABS. - Inflation expectations as measured by consumer surveys are rising So will this translate into a pick up in wages growth? I am guessing that over the next 1-2 years, inflation will outpace wage gains, and this will lead to conflict in labour markets (strikes/protests etc) and then we will see significant wage gains, creating the wage-inflation spiral. Interestingly in Shenzhen, China, factories are trying to cut wages for workers as China is no longer cost competitive with SE Asia. Shenzhen tamps down wages with eye on China's manufacturing exodus That tells us that China is no longer a source of disinflation in the world economy.
I thought they only raised interest rates when there is wages growth. And doesnt wages growth mean higher rents?
Remember, that there is too much debt. So what is essentially going to have to happen this decade is that governments and central banks have to manage a decline in our standard of living (to repay the debt) without us noticing. They will do this via inflation, and as such, there will be winners and losers, and probably social problems.
