How To Prepare for Unpredictable Market Events

One year ends, another begins.

Funny that. It always seems to happen that way.

We assume it will happen again, 360 days from now.

However, not everything is as predictable as the calendar.

And even calendars are subject to change. We wonder how many folks at the beginning of 1582 predicted the calendar would change from the Julian to the Gregorian form that year.

The point is, sometimes unpredictable and unexpected things do happen. Not often. But they do happen.

And, like it or not, we expect more unexpected things to happen in 2017. Make sure you’re prepared for them. That’s why we’re here. To help with the preparation…

Not what we expected

As an example of unexpected events, consider iron ore.

By the end of 2015, the iron ore price had fallen from a peak of US$191 per tonne in February 2011, to a low of US$38.50 in December 2015.

It was at that point the future looked dire for iron ore.

The price had crashed, and so had the prices of iron ore producers.

BHP Billiton Ltd [ASX:BHP] had fallen from a pre-crash peak of $43.30 per share, on its way to a low of $14.20.

Rio Tinto Ltd [ASX:RIO] had fallen from $123.12 per share, on its way to just $25.23 per share.

And Fortescue Metals Group Ltd [ASX:FMG] had fallen from $12.78 to a soon-to-be low point of $1.29.

But amid the gloom, hope. The iron ore price has doubled from the low.

Source: Bloomberg
Click to enlarge

The Rio Tinto share price has doubled too. BHP’s share price has almost doubled. And Fortescue has racked up an extraordinary 308% gain.

It goes to show you, when things appear to be at their worst, sometimes that’s the best time to invest.

Perhaps no better example of that is our 2016 Great Repression investment conference.

We came up with the ‘Great Repression’ label either in late 2015 or early 2016. It seemed to fit perfectly with the feeling of investment markets at the time.

As we led up to the conference, the feeling felt justified. The Aussie market was in the red for the year, and talk abounded of the prospects of Australia’s first recession in 26 years.

Things appeared to get worse immediately after the conference, with the increased probability of a Donald Trump election win.

Then he won. Stocks crashed…and then rebounded, in their strongest rally in recent years.

From the low point in November, the S&P/ASX 200 has piled on 10%.

So much for the fears of recession.

So much for the fears of a Trump presidency.

So much for the fears of Australia’s post-resources boom economy.

Stocks are up. The S&P/ASX 200 Financial index, which includes property trusts, is up 17% since the November low.

The Aussie market is bullish on banks and property. What a surprise. When is the market ever not bullish on banks and property?

OK, from time to time investors do turn their noses up at both. 2008 was a good example, as was much of this year as the four major Aussie bank share prices drifted south.

That was until the Trump win.

Now everything seems fine with the markets again. But it always is…until it isn’t. That’s why it pays to prepare for unpredictable and unexpected events — they happen when few expect them to happen.

Happy New Year!

It could be worse than we thought

Getting back to unexpected and unpredictable events, where else should we look but Aussie house prices?

From Bloomberg:

Australian house values increased at the fastest pace in seven years in 2016, as record-low interest rates helped fuel demand for property despite warnings such price increases may be unsustainable.

The average dwelling value in the nation’s eight state and mainland territory capitals rose 10.9 percent last year, compared to 7.8 percent in 2015, date from CoreLogic Inc. released Tuesday showed. That’s the biggest increase since 2009.

The CoreLogic data shows a jump in the pace of growth since the early part of 2016, when average increases were running nearer to 6 percent. The Reserve Bank of Australia cut interest rates to record lows in May and August in an effort to spur inflation, counting on an increase in supply and tighter lending restrictions to help restrain the housing market.

However, the data suggests rate cuts, “had the side effect of boosting an already overheated housing market,” Michael Workman, a senior economist at Commonwealth Bank of Australia, wrote in a note to clients.

We’ll be clear. You don’t need to have a Masters in economics from Harvard to deduce that cutting interest rates will increase house prices.

And we’re not sure it’s fair to say that rising house prices were a ‘side effect’ of the rate cuts.

It’s only a ‘side effect’ in as much as the side effect of chopping off someone’s head is that it will likely cause immediate death.

If that constitutes a ‘side effect’, then so be it.

But we prefer to see it as a direct effect.

The issue, of course, is that folks (your editor included) have predicted an Aussie house price crash for years — nearly 10 years, in fact.

How’s that prediction looking?

Well, by virtue of the fact that Aussie house prices haven’t yet crashed, we’d say the prediction isn’t looking so good.

But, you know us, we often look for a silver lining — especially when it comes to wriggling our way out of a bad prediction. We would humbly argue that rather than the lack of a crash proving us wrong, it merely proves how right we are about the scale of the collapse when it does happen.

To draw an analogy, the popping sound of an over-inflated balloon doesn’t become quieter the bigger the balloon. It becomes louder.

So, if anything, you could argue that rather than exaggerating the scale of the coming Aussie house price collapse, we’ve underplayed it all these years.

Who’d have thought it?

Could a government really crash house prices?

We’re not in favour of the government interfering in anything. No one could argue that governments haven’t played a major role in Australia’s sky-high housing bubble.

First home buyers grants and restrictions on land developments are just two areas where governments have manipulated the market.

But for those who cheer intervention and who believe that an Aussie government would never allow house prices to crash, don’t be so sure about that.

When the political tides shift, governments have a tendency to shift with them.

Governments have been reluctant to put a stop to rising house prices, because it has benefited the Baby Boomer generation, who have grown their wealth based on higher house prices.

However, could that soon change? Baby Boomers are now retiring and downsizing. That likely means they’ll want to cash in their ‘property chips’ in order to have a stash of cash in the bank.

The trouble is, Baby Boomers will soon realise that downsizing doesn’t necessarily mean a property cash windfall. The Baby Boomer couple who decides to sell their four bedroom property in order to downsize to a two bedroom property, will realise that the two bedroom house isn’t half the price of a four bedroom house.

If the Baby Boomer couple wants to stay in the area they’ve lived for 30 or 40 years, they’ll realise the value is in the land. They may very well be able to sell their four bedroom house for a cool million dollars.

But odds are, they’ll have to stump up $800,000 or more for their new two bedroom place. Deduct agent’s selling fees, stamp duty, and moving costs, and the Baby Boomer couple will be lucky if they’ve added much more than $150,000 to their retirement pot.

For that reason, don’t be surprised if federal and state governments take an even more interventionist role in the Aussie property market.

Our bet is that governments will introduce rent controls, and perhaps even price controls on smaller dwellings. The theory here would be that it would protect the value of bigger houses (mostly owned by Baby Boomers), while pushing down prices of smaller houses — mostly desired by first home-buyers and retiring boomers.

Such a policy would drive investors out of the market at the small end, pushing down prices, and establishing a government set ‘yield’ for new investors, or a low price for new buyers.

The government could then say that landlords can’t charge more than a certain amount in rent. And that the rent has to be a certain percentage of the property’s value.

That would stop prices rising and rental yields falling in a low interest rate environment.

Of course, all such crazy plans have intended and unintended consequences. But don’t be so sure that such intervention or other won’t happen.

Again, from Bloomberg:

Singapore home prices fell 3 percent in 2016, the third straight year of declines as the government held steadfast on property cooling measures.

An index tracking private residential prices fell 0.4 percent in the three months ended Dec. 31 from the previous quarter…

The government has signalled it is reluctant to lift property tightening measures it started implementing seven years ago as it wants to avoid overheating the market again…

The residential curbs have included a cap on debt-repayment costs at 60 percent of a borrower’s monthly income, and higher stamp duties on home purchases, after low interest rates and demand from foreign buyers raised concern prices had risen too far too fast.

Home values have dropped 11 percent from their 2013 peak, and sales have declined to about half that year’s level.

Be clear. If a government truly wants to halt house price rises, and if it believes doing so won’t hurt it electorally, there’s no doubt a future government would happily intervene to manipulate prices lower.

Why not? They manipulated them higher for political reasons. Don’t be so naïve as to think the opposite couldn’t happen.

Prices keep on rising

Meanwhile, just as house prices keep on going up, up, up, stock prices keep on going up, up, up too.

When will it end? It will end. Sooner or later.

Until then, Sam Volkering says there is a handful of stocks every speculative investor should consider owning now. Details here.


Kris Sayce,
Publisher, Money Morning

Editor’s note: The above article was originally published in Port Phillip Insider.

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Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Fat Tail Investment Research, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

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