Sunday, 18 August 2013

When The Last Bears Become Bulls

It is one of the basic dictums of investing that the sign of a market turn is when the last bears become bulls, and vice versa.  For the last few years, Moneyweek have been saying that the UK housing market is grossly overvalued.  Now, even Moneyweek believes that the juggernaut of Liberal-Tory bribery to banks and borrowers is unstoppable.  They don't like it.  They think the Government policy is bonkers and will end in tears with lots of people losing their houses and their money, as they've set out in their End Of Britain Video, but for now they think house prices will rise.  The crash being all that bigger when it arrives.  They are not the only ones who have capitulated.

The financial consulting group, Fathom, have also for the last few years pointed out that Britain has remained in a huge property bubble that is damaging to the economy.  A couple of years ago, I quoted Stephanie Flanders BBC blog, where she referred to a note out from Fathom where they said that the problem of the banks, and of credit into the economy, would not be resolved until house prices crashed.  One of their top economists again recently described Osborne's "Help To Buy" scam as bonkers.  He's not alone, nearly every economist believes the policy, which is an almost exact replica of US policy in relation to Fannie May and Freddie Mac, which led to the sub-prime crisis, is one of the worst pieces of economic policy for years.  Yet, Fathom too believe that as a result of this policy, UK house prices could be bubbled up by as much as another 15% in the next three years.

Another, respected economist who specialises in the property market is Henry Pryor.  He too has argued that UK house prices have been in a bubble for the last few years.  He doesn't think much of the Government proposals either, but he too believes they will inflate the bubble even further.

What all the economists and economic pundits realise is that the Government policy has nothing to do with sound economic policy, and everything to do with trying to get the Government elected in 2015.  The UK has an insane infatuation with property bubbles.  Rising house prices like rising prices of anything else impoverish people.  If you go to the supermarket and find that your shopping bill has doubled, most people can understand this has made them worse off.  Yet, people have the insane belief that when house prices rise they are somehow made better off!!!

Some of the discussions on the Moneyweek website illustrate just how insane people can be in deluding themselves with that belief.  So, for example, people argue that if house prices rise that allows them to borrow more money against that higher value.  They seem to forget that when you borrow more money you again become worse off not better off.  The person lending you the money not only wants it back, but wants it back with interest!  Yet, the Tories know that for their core voters, especially the Daily Mail and Express reading pensioners, who bought their houses for a couple of grand back in the 1960's, or 70's, rising house prices are a winner.  They look at the fictional value of their house, and think they have become closer to a millionaire, even though if they bought another, better house they would find themselves brought back to reality with a bang, when they found that what was once in reach is no longer so.

Osborne and the Liberal-Tories know that this will all end badly, but they hope it will end badly after the next election.  For Osborne its a win-win situation.  If it works, the Tories win the next election.  The Liberals get annihilated, and then he will have five years to push through their agenda.  If its not enough to get the Tories elected, the property crash will happen when Labour takes over, and he hopes they will get the blame.

But, Osborne and Moneyweek and the other pundits are all likely to be wrong.  His belief, and there's that the current policy of bribery will push up house prices is based on the notion that government bureaucrats are all-powerful.  They believe that the low-interest rates of the last 20 years, and particularly the last 5, have been down to the actions of central bankers in printing money, and setting official interest rates at unsustainably low levels by diktat.  They haven't.

As I set out in my posts The Rates Of Profit, Interest and Inflation, interest rates have been low because for the last 30 years, globally the rate of profit has been high and rising.  It made available more money-capital than could be productively invested.  In the last five years, that has been accompanied by a slow down in capital spending by global firms as a result of the after effects of the 2008 financial crisis.  But, as I set out in those posts, the rate of profit is now falling.  Postponed capital spending is now having to be made up, and firms seeing productivity growth drop need to invest more capital to make up for it.  The number of new products has slowed down, as Apple's figures have shown.

Whilst central bankers have continued to stress that they will keep printing money, the markets have pushed ahead and raised interest rates anyway.  The US 10 Year Treasury Yield is now bordering on 3%, having more or less doubled over recent months; the UK 10 Year Gilt is not far behind at nearly 2.7%; even the German 10 year Bund is approaching 2%.  The reason is simple as set out in those posts.  It is the market that determines interest rates not politicians and central bankers.  The demand for money-capital is rising, and with it the rate of interest.  More money printing is pushing up inflation, and with it interest rates, because if you are facing inflation of 3,4.5% or more, why on earth would you lend money at just 2%.  On the contrary, normally you would expect to earn about 2% on top of inflation.

As market interest rates normalise to around 5-6% in coming months, that will have an inevitable impact on mortgage rates, which in turn average about 2% above the ten year yield.  Huge numbers of people are struggling to pay their mortgages at 3%.  How many will be able to do so in a climate of falling real wages, when they are faced with a mortgage rate of 8%?  Yet that could be the situation people face in the next year, despite all the Government scams to keep them down.  When that happens, it will be no different than in 1990, when interest rates rose, and property prices fell by 40%.  In fact, there is a lot of nonsense talked now about things being different this time - they always are until the crash occurs and everyone says, why didn't anyone see this coming?  Well, in 2008/9 things weren't different.  The credit crunch sent interest rates up sharply, and UK house prices fell 20%.  It was only swift action by Gordon Brown and others to resolve the credit crunch and save the banks that reversed that.

And, in fact, as Gillian Tett pointed out in a recent Newsnight discussion, even the recent data about rising house prices is highly misleading.  The data shows that really it is a tale of two countries.  There is the country that is London, and there is the country that is the rest of Britain.  In London, with its virtually separate economy, driven by the City, and by the large amounts of foreign billionaires, house prices rose by 8%, and yet in the rest of Britain, prices rose by just 1%.  In fact, as I've pointed out before, - Incredible Indices - even that 1% is probably not to be believed.  And, the situation I described in that post continues.  There are now three properties in the village up for sale.  The house next door to me has been up for sale now for 18 months.  It was originally put up for £450,000.  After 6 months it was reduced to £400,000 and new agents brought in.  Six months later, another £25,000 was knocked off the price, and yet another agent given the task.  Along the road, a very large four bedroom detached house with about an acre of land, with great views across to the forest was put up for sale at the same time for £500,000.  It has gone through the same process, and is now down to £425,000.  An old farmhouse in the village with 5 acres of land was put up for auction a year ago, for £300,000 and still lies empty.  About half a mile away, a luxury house was put up for sale about a year ago for £1 million, and is now down to £800,000, and as a drive into town, the same plethora of for sale signs exists of semis and detached houses up for sale for between £150,000 -£250,000 that have languished there for more than a year.

Every day my wife continues to get e-mails from Rightmove with another list of houses whose prices have been reduced.  Clearly, in the real world not even the picture of rising house prices, despite all the government bribery, all of the media propaganda and unsustainable measures, rings true.  According to Nationwide recently, mortgage affordability is at its lowest for decades.  Well in that case, today would be a very bad time to be buying, because that suggests affordability can only become less.  That can be seen in the US.

In the US, property prices after 2008 fell by up to 60%.  That really did bring back some kind of affordability into the market.  But, over the last year, low interest rates have encouraged house buying, not by US workers, still suffering from low wages and high levels of unemployment, but once more by speculators.  The same buy-to-let brigade that have used low interest rates and government bribes to speculate in Britain have done the same thing in the US pushing house prices up by double digit percentages over the last year.  But, in the last couple of months as US interest rates have risen, that seems to have come to an abrupt halt.  The largely amateur investors who get involved in buy to let will get their fingers burned as with every other speculative bubble.

If you invest in shares, or other such assets, you can get out quickly.  A couple of minutes online will sell your shares or gold ETF.  A phone call to a bullion dealer will sell your gold sovereigns.  But, you can't sell houses like that.  The amount of money you can lose trying to sell a house when the market turns is enormous, not to mention all the cost of doing so.  Its one thing grinning and bearing it if its the house you are living in, its another if its a dozen houses whose rents no longer cover your mortgage payments!

Moreover, its not as though potential buyers do not have substitute goods to turn to.  Besides the potential to rent until uncertainty lifts, many people have the option of simply buying where prices have already fallen for example in Florida, Ireland or Spain.  Even after recent house price rises you can still by a luxury house in Florida for £100,000.  My wife saw a six bedroom house with four acres of land on Valentia Island in County Kerry recently for €150,000, and you can buy villas in Spain from bank sales for as little as €20,000, or luxury villas for between €200-250,000.

When the last bears become bulls, it normally means its the end of the bull market, just as when the last bulls become bears, its the end of a bear market.  It means a capitulation.  In a bull market, those who think its over priced hold off buying, but the more it keeps going up, the more it undermines their confidence.  As Keynes pointed out, the market can remain irrational for longer than most people can remain solvent.  If you come to the conclusion that everyone is buying, and that factors such as the government scams are underpinning it, you become worried that you may miss out if prices rise.  But, its just at that moment when the most reluctant buyers enter the market, that it means there are no more buyers to push it higher.  In the current climate of falling real wages, its not hard to see why the number of potential buyers at current prices is extremely limited.  The Government needs people to believe in the property bubble, because their economic and political agenda depends on it.  Even if that bubble isn't burst by rising interest rates in coming months, its unlikely to withstand the economic slow down when the next three year cycle kicks in mid way through next year.

Osborne's property gamble is unlikely to pay off, but he will survive that just fine.  The millions of people who stand to lose their homes and their money as a result of him encouraging them to make a similar gamble will not.


Boffy said...

According to Rightmove, despite all of the government bribery and scams, even asking prices for houses fell by 1.8% in August!

George Carty said...

What would happen if the government passed a new law that made it a crime for anyone to buy a house for less than it was worth in 2007?

Boffy said...

It would be unlikely to be passed, and would be struck down by the Courts as ultra vires if it was.

George Carty said...

I wonder if the price falls you mentioned in the United States were especially large because those properties are unattractive to foreigners.

Working-age foreigners may not be able to get a work visa in order to immigrate, while retired foreigners would have to spend so much on health insurance if they moved to the United States that it would eat up what they saved on the house itself...

Boffy said...

On the contrary. A luxury 6 bedroom house in Kissimee in Florida is perfect either as a family home, or as a holiday home, as its near to the Florida resorts. That percentage of price drop was also similar across the US.

The same percentage drop happened in Ireland. In the UK prices dropped by 40% in 1990, but were not as over priced back then as they are now, or as the US, Ireland and Spain have been.

The UK dropped 20% in 2008/9 and would have dropped more had it not been for the huge state intervention to reduce interest rates etc. Given that official interest rates are already at their lowest levels in 300 years, and market interest rates are rising, that trick can't be pulled off again.

There is a huge overhand of property supply in the US, Ireland, the UK, Spain and other parts of Europe. Demand is effective demand, i.e. demand backed by ability to pay, and an increasing number of people can't pay their everyday bills let alone bid for property.

The attempts to keep property prices inflated will fail, and it will be the best thing that has happened for decades.