You Can’t Alter the Property Cycle

Trading was mixed in global markets Wednesday night. European stocks remained under pressure, with the Euro Stoxx 50 index falling 1.8%. Financial stocks on the continent were the worst performers.

This weakness initially dragged US stocks down but, after European markets closed, the Fed released minutes from their last interest rate meeting telling everyone what they already knew; that is, that interest rates would remain on hold. As a result, US stocks recovered.

The Dow Jones index finished the session up 0.44%, while the S&P 500 jumped 0.54%.

The Fed minutes related to the 14–15 June interest rates meeting, which was held a week prior to the Brexit referendum. Apparently, Fed officials were getting cold feet about further interest rate rises before they even knew Britain would leave the EU.

The excuses given? The Fed was concerned about the US economy and a faltering labour market. This just confirms the trap US policymakers have gotten into. They don’t raise rates when employment growth is strong, and won’t raise them on any sign of weakness.

The Fed missed the window they had for raising rates, and the market knows it. They are now on hold for some time. That’s partly the reason why gold (and silver) continue to rise relentlessly higher.

The other reason is the weakness of the pound. The UK’s decision to leave the EU has taken the pound out of contention as one of the world’s major currencies. Gold is in some way filling the void, helped by a prone Federal Reserve, who has gone from a tightening bias, to neutral at best, in a matter of weeks.

The weakness of the pound is emblematic of a number of problems beginning to develop in UK capital markets. That is, capital wants out of the country.  Specifically, it wants out of commercial property.

As Bloomberg reports:

Four more U.K. property funds froze withdrawals as investors sought to dump real estate holdings in the aftermath of Britain’s vote to leave the European Union.

Investors are pulling money from U.K. property funds as analysts warn that London office values could fall by as much as 20 percent within three years of the country leaving the EU. During the financial crisis of 2007 and 2008, real-estate funds were similarly hit by redemptions and forced to halt withdrawals, contributing to a slump in property prices that saw values drop more than 40 percent from their peak in Britain.

But according to our resident property cycles guru, Phil Anderson, you shouldn’t worry about this too much. It’s not going to have an effect on the long term cycle.

Phil reckons the cycle has another 10 years to run. That doesn’t mean you won’t see a slowdown or pullback during this time — and Brexit could be a good excuse for a pullback — but it isn’t the end of the cycle.

As Phil wrote in a recent update for Cycles, Trends and Forecasts subscribers:

I am continually staggered by the lack of people prepared to accept the fact that economic cycles exist, let alone make an effort to understand the cause—the enclosure of the economic rent.

This is a tricky concept for many people to understand. Economic rent refers to the fact that land values capture all the benefits of economic growth. Society must pay this ‘rent’ to use the land. The better the land, the higher the rent.

And because land is privately owned (and can be bought and sold like any other commodity), this rent is ‘enclosed’ in a competitive marketplace.

As a result, there will always be competition for prime property because landlords want to collect this rent. The rent then capitalises into land values, and prices go up.

A broad based land tax would remove the incentive to bid crazy prices for land. It would return the economic rent to society (where it belongs) and enable the lowering of taxes on production and labour. But that’s another issue…

The way the system is, cheap availability of credit simply increases the competitive bidding for a chance to get the economic rent. And by the end of the cycle the bidding becomes so crazy that prices collapse.

According to Phil, we’re not at the end of the cycle yet. And Brexit will not bring it about any earlier.

The UK leaving the EU will have little effect on this process in the long run. In fact, it will have no effect at all. Can you see why?

Because the economic rent will still generate, regardless of whether the UK is in the EU or not. And the ‘Brexit’ doesn’t change who collects it.

The entire ‘Brexit’ is merely ‘fluff’ within the wider context of the real estate cycle.

Having said that, London house prices have had a huge run over the last five years (as forecast). They are due a slowdown. Remember, history says the largest land price gains happen in the second half of the cycle.

So Brexit will cause a slowdown, but not a crash, in UK property prices.

What’s in store for Australia?

Well, a slowdown might be upon us here as well, if the performance of the banks is any guide. The share prices of all the Big Four banks are very close to major lows. If this support level gives way in the weeks ahead, expect to see further large falls. The chart of the Commonwealth Bank [ASX:CBA] is a good example:

Source: BigCharts
Click to enlarge

Given the fact that Aussie interest rates are at record lows, and the market is expecting another rate cut in the next few months, the lack of response from bank shares is concerning.

It’s perhaps a sign that Aussie households are maxed out, and don’t have much more capacity to take on debt. Banks survive on debt growth; without it, they cannot grow. So the continual weakness in bank shares is a concern given record low interest rates.

Whether this translates into a flat or falling property market remains to be seen.

Where’s the money-making opportunity in all this?

As I wrote to subscribers of Crisis & Opportunity yesterday, it appears as though financials are no longer responding to monetary stimulus. But real assets are.

In the short term, I think the precious metals horse has already bolted. Of the five gold stocks in the Crisis & Opportunity portfolio, three are up triple-digits, while the other two aren’t far off that.

A big chunk of those gains came in the past two months. So I think the party for gold is in full swing. It’s a bit late to be rocking up now.

But the commodity complex is only just starting to stir. If you’re interested in what’s going on there, and where the opportunities might be, click here.


Greg Canavan,
Editor, Crisis & Opportunity

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Greg Canavan is a Feature Editor at Money Morning and Head of Research at Port Phillip Publishing.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand.

When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases.

Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy.

With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock.

To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Money Morning here.

And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here.

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