by Rajesh Sharma

If you read my blogs, you will realise that I have been slightly pessimistic about investing in property market for more than a year. I repeatedly get asked why the property prices are still moving north while the macro economic variables are moving against it. It is an interesting conundrum, on the one hand all the economic variables are pointing towards downturn in the property market yet the property prices (especially in Sydney and Melbourne) keep defying the logic and continuously head north.  The only response I have is what Prime Minister Turnbull has been saying ‘ we live in interesting times’ my friends.

I would like to borrow a famous quote from Benjamin Graham, the undisputed father of stock market value investing, to describe the state of our property market today. Ben Graham’s mantra was “In the short term the market is a voting machine, in the long run the market is a weighing machine”. Although Ben Graham’s view was in relation to the stock market, I believe this equally applies to the property market; afterall a market is a collection of individuals acting to maximise self-interest. FOLO, the fear of losing out combined with the great Australian dream of having a house with a backyard and a bar be que are pushing everyone towards irrational exuberance in the property market. Demand is being created not by rational investment thinking but from psychological pressures arising from friends and family owning multiple properties and their blatant display of wealth effect. The short term voting for investments in property market is so high that a lot of mum and dad investors have completely forgotton that the risks looming from the liability side of the equation are increasing at a faster rate than the asset values. The irrational thinking that the property market can only go up appears to have been so strongly carved in the general populations mindset that people do not want to be reminded that in the long run asset prices converse towards their value which may be quite different to the price.

Warren Buffet, the greatest stock market investor or our time famously said ‘ only when the tide goes out do you discover who’s been swimming naked.’ My pessimism on the property market is now stronger than ever and finally I am putting my money where my mouth is. I have recently sold my investment property, as I believe that the time has now come for the tide to turn and the asset prices to converse towards the asset values.  I can confidently declare now that I have a very minimal risk of being caught naked when the tide goes out as my liability side of the equation is well under control and the risks arising from it is negligible. I know a lot of you will say who am I to predict the future and I agree completely that I do not know what the future holds but remember the demand for property is being created by people, a great majority of them know the price of everything but the value of nothing and infact a lot of them do not even know that price and value are two very different things which explains the risk taking behaviour ingrained in the our society today. I have no doubt that there are a lot of highly intelligent people who have created a massive wealth in recent years through leveraged property investments, but let me remind you that servicing the increasing cost of leverage is not as easy as it sounds when the tide turns.

Let me explain how the recent world events of the past three months have created a trifecta of economic headwinds that may act as a catalyst for the long due correction in the property market landscape.

The Trump effect

Economically speaking, American public and the world have no doubt that President elect Donald Trump can do no wrong when it comes to making America great again. Just look at how much the financial markets love Trump and his economic policies thesedays. The stock market has been rising like a rocket while the bond market is taking a beating. The US yields are on a northward trend with inflation and business spending expectations at their best in well over a decade creating a very conducive environment for ‘the great rotation’ i.e. smart money leaving the safety net of bonds and moving towards riskier assets such as equities.  

Lets look at the fundamentals behind this newfound euphoria in the financial markets.  In the changed political landscape in the United States where Republicans now have full control of the House and Senate, Trump’s policy agenda to lower the business tax from 30% to 15%, cut the income tax rate for the middle class and pump almost a trillion dollar into upgrading the aged infrastructure appears to have ticked every box any Republican would ever wish for.  The financial market analysts believe that the reduction of business tax alone will have approximately $12 trillion dollar worth of impact to the economy. The ultra loose monitory policy of prior years which has pumped trillions of dollar into the US and the world economy combined with the fiscal response of over $12 trillion dollars would be highly inflationary prompting the US Federal Reserve to wind back the monetary stimulus as quickly as possible. This will lead to increased interest rates in the US sooner than later. Now you will definitely ask me why should we care as we are not in the US and our Interest rate is set by our Reserve Bank. Yes it is true that Interest rate is set by our Reserve Bank which is independent of the US Fed, but if you remember my earlier blog ‘Interest rate devil – will it bite?’ you will also remember that Australian banks borrow significant portion of their funding from the US market. This means that Australian Banks will be compelled to raise interest rates even when our Reserve Bank is staying put. A glimpse of what is to come from the Trump effect can already been seen in the recent interest rate increases by majority of our banks in the last two weeks. Ohh yes, if your bank has not yet notified you of the increase, you will be in few days.  This recent increase from our banks has come about when the US Fed is still to meet to discuss interest rates (for those enthusiasts, US Fed is meeting next week to discuss monetary policy). If you think the interest rate in Australian is staying lower for longer, think again and I suggest you start following the US Fed rather than our lame duck Rerserve Bank.

Australian Credit rating

On 23 November 2016 Australian Financial Review reported that Treasurer Scott Morrision has been given until May 2017 to address deterioration in the budget deficit – either through spending cuts or tax hikes to return the budget to surplus by 2020-21.  The rating agencies have warned that if the Treasurer cannot deliver this, there is a high probability that the Australin Credit rating will be downgraded from the prized AAA.  To the Treasurer’s detriment, Deloitte Access Economics forecasted in the same week that the blowout in the budget will be about $24 billion over four years, to a total of $108 billion giving the Treasurer no hope of maintaining the credit rating in the new year.

I know you would ask me why does the country’s credit rating matter when I have borrowed from a private sector banking institution? Remember the ratings of banks may be separate to the country’s, but they are heavily influenced by the country’s ratings as financial market takes the state of the Australian economy and its future direction as a barometer of the banking sector’s performance. If the downgrade materialises, bank’s funding costs will increase and history suggests that the banks will pass those increased costs to us through increase in our mortgage interest rates. 

The end of the great Australian economic growth story

Economic update provided by the Treasurer last week diclosed the sad state of the Australian economy. The news spread like wild fire in the economic circle and financial markets - the economy has contracted, shrunk, gone backwards by 0.5 per cent. Some commentators started using the dreaded ‘R’ word on the Australian economic outlook. Another negative quarter means our prized ecomony that has been growing for more than 25 years will lapse into "technical" recession. Normally in economics ‘Recession’ is charaterised by a loss of jobs, a decline in real income, a slowdown in industrial production and manufacturing and a slump in consumer spending - spending that drives a significant portion of our economy. I can’t imazine the stress level of living in this brave new recessionary world where uncertainty of having a job is at its highest with increasing debt servicing costs arising from increased interest rates (imported by banks from the US) and vacant tenancy. Put all these together i.e. loss of job and at the same time loss of tenants and a heavy load of debt to service, no doubt even the smartest of us all will find it daunting to manage.   

Now with the trifecta of worries as I have pointed out above, I will leave you to ponder whether you should be looking at taking on more debt in the hope of better tomorrow or reducing the debt load to manage the difficult times ahead. May the odds be in your favour.

Please provide your comments, feedback on this article through our Facebook page. Please like our page Blue Marble Financials and follow us on Twitter

This post was contributed by Rajesh Sharma, Director Mortgage Advising at Blue Marble Financials and is for informational purposes only. This post is not intended to contain any type of financial advice and is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs.   

by Rajesh Sharma

I was recently asked to present on the topic of ‘Investments’ at the Bean for Bean Counters session organised by the Community of Finance Professionals of NSW Public Sector. My aim was to explain investments from a layman’s perspective by emphasising the critical role investment plays in shaping our life and the choices we make. What fascinates me is the impact investments have on our life regardless of our age. I still remember my enthusiasm and the satisfaction I got from investing $500 from my first pay into the Australian Stock market. Although I was earning very less (only adequate for basic living), I was very determined to save money to invest without realising that I was compromising my lifestyle today for a hope of a better tomorrow. No wonder I was sleeping with few layers of clothes including my jacket and jumpers to beat the cold, as I could not afford to buy a decent quilt. 

I did not realise it until someone pointed me to a quote from the great Dalai Lama who once said “Man surprised me most about humanity. Because he sacrifices his health in order to make money. Then he sacrifices money to recuperate his health. And then he is so anxious about the future that he does not enjoy the present; the result being that he does not live in the present or the future; he lives as if he is never going to die, and then dies having never really lived.”  A very powerful statement indeed from a great mind but the irony is, it does not seem like there is an easy way out. We are doomed if we do invest and we are doomed if we don’t. Average earners like us will certainly have to make compromises somewhere to cut down expenses to have the money to invest and if we do that perhaps we fall into the trap like Dalai Lama says. We may live all our youthful days saving and investing for a future that we may not even see. But on the other hand, the future looks scary enough if we do not have plans to get through our non-working life which seems to be lengthening as the average life expectancy keeps increasing.

I am not going into the details of what we should do or how much we should set aside every pay check to invest but invest we must (as Master Yoda would say) as the alternate is not an option. We all have different perspective on investments and we are intelligent enough to figure out when to start investing and how much to invest depending on what type of present and future we desire for ourselves and our family. Notwithstanding all these, I would like to make the case for investments by explaining two critical economic concepts that has shaped my investment thinking.

Inflation

The king of one liners Henny Youngman, a comedian by profession perhaps made the most impact on my investment thinking when he said “We all are getting stronger. Twenty years ago, it took two people to carry ten dollars’ worth of groceries. Today, a five-year-old can do it.” Henny being a comedian had a very peculiar yet powerful way of spreading his message to the general populace. It is very interesting that a quote from a comedian is perhaps the best definition of inflation you can ever come across. Sam Ewing, an American baseball player perhaps comes second best in defining inflation from a layman’s perspective when he said “Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair”. From an economist’s perspective, this means that the price of the goods and services increases over time or in other words purchasing power of the money you hold decreases over time and this my friends is the devil called inflation. If we put money under the mattress for a few years (savings), that money is worth less as it can purchase less quantity of goods and services than initially when you put it under the mattress. Unfortunately this phenomenon is ongoing as the economists advising the Government of the day believe that a healthy inflation is required to keep the economy growing. Putting this into the Australian context, we all are aware that Reserve Bank of Australia (RBA) is mandated to keep the inflation between 2-3%, this means if the RBA is successful in its goal, our mattress money is expected to lose between 2-3% every year. This means we have to find an alternate option than putting money under the mattress.  A lot of us believe investing money in the bank’s savings, fixed interest account is the safest solution. There is no doubt that bank accounts are perhaps one of the safest investments but when you think about it, it may not be the solution you are looking for as after tax interest earned on bank accounts may not be enough to beat inflation which means you are still losing your hard earn cash albeit at a slower rate than mattress approach. And for those risk takers, how many millionaires have you seen become wealthy by keeping money in the bank?

Fiat Currency

Have you ever wondered whether the money you hold today is the same as the money our parents held back in the 1960s? As ironic as this may sound but the money today may not be worth the paper it is printed on. On 15 August 1971, President Richard Nixon announced to the world that the United States (US) was abolishing the gold standards and freely floating the currency. This move which changed the money as we know it later became known as the Nixon Shock. What this meant was that the money or the US dollar was no longer backed up by gold or silver, it was backed up by nothing other than confidence of people that the US is able to pay its debt when due. This brilliant move by President Nixon allowed the United States to print as much money as it wanted as long as it had the confidence of the people around the world. This perhaps explains the trillions of dollars printed by the central banks since the 2008 global financial crises without impacting the purchasing power of the relevant currencies to the same extent.  Soon after the US, most of the western world followed and led to the development of modern fiat currencies that are freely floating and their purchasing power is determined by the confidence of people not the gold or silver deposits. Although this move has given Governments around the world greater flexibility in controlling their fiscal and monetary policies, it may be leading the world on a path of fiscal destruction. Imagine a day when the Government does something stupid, the confidence is lost and you wake up with a lot of paper worth absolutely nothing compared to what it was a day ago. People of Zimbabwe have certainly felt the shock. A lot of countries with continuous deficit budgets have been feeling the pressure and now perhaps the once mighty Britain is on the path to experience the same if the Brexit does not play out as per their plan (i.e. if Britain has a plan). I do not know what we can do to counter the risks from this but I certainly know that by investing in diversified income generating assets, I can certainly lessen the pain. I am not only talking about diversifying across income generating asset classes but diversifying across geography as well.

Think about these two concepts and think about whether you have any strategy in place to manage the risks raised above. If you are thinking in the same line as me, we not only need to invest to maintain the purchasing power of our savings but we need to invest in a very diversified way to reduce the risk from Government’s decisions that may one day wipe out significantly the purchasing power of our home currency leaving us struggling to buy any goods or services. The solution may not be as simple as investing in properties which comes to mind as the no brainer solution. It perhaps is much more complex than that and we like it or not we may need to seek other options including the stock market around the world. I know I cannot control the decisions of the Governments but I can certainly control what I do with my money and that is INVEST I MUST.

Please provide your comments, feedback on this article through our Facebook page. Please like our page Blue Marble Financials and follow us on Twitter

This post was contributed by Rajesh Sharma, Director Mortgage Advising at Blue Marble Financials and is for informational purposes only. This post is not intended to contain any type of financial advice and is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs.   

by Rajesh Sharma

I was at the Chartered Accountant’s Business Forum recently where Bill Evans, Westpac Bank’s Managing Director & Global Head of Economics & Research presented on the current state of Australian economy. I was particularly intrigued by one of the slide that compared Reserve Bank of Australia’s (RBA) current and expected cash rate to the United States’ Federal Reserve rate, which I have reproduced below for reference.

Westpac in the above table is forecasting a reduction in the RBA’s cash rate of 0.25% by the end of 2016 and expects the rate to remain lower for longer with no movement forecasted for 2017. Very good news indeed for people like us who have mortgages. As per Blue Marble Financial’s internal research, the current interest rate we are paying is in the range between 3.85% - 4.20% that is approximately 2.1% – 2.5% premium to the RBA’s cash rate. If Westpac’s prediction comes true and the banks dance in tandem with the RBA, celebrations ahead as the interest rate will be further reduced by 0.25%.

However, from a bank’s perspective, moving in tandem with the RBA’s movement in cash rate is not a simple decision. Although the banks would like to reduce the cash rate in line with RBA’s decision and, more often than not they do move in unison with the RBA, there are other variables that impact its funding costs. As odd as it may sound, two critical variables that impact a bank’s funding cost are;

1.     Australia’s credit rating and,

2.     US Federal Reserve rate

Australia’s credit rating

Rating agencies like Standard & Poor’s, Moodys and Fitch provide a credit rating to almost everything from countries to financial/business institutions that have borrowing requirements. The credit rating reflects the risk of the country or financial/business institutions defaulting on its financial commitments. This rating determines the country or its bank’s funding cost, as investors of funds demand a risk premium based on credit ratings. The lower the rating the higher the risk of default, hence higher the funding cost.  

Currently Australia enjoys highest credit rating and is AAA rated country. This means that Australia is seen to have a very high credit quality and investors demand a lower risk premium when Australia borrows funds in both the domestic and international market.  Australian banks also enjoy one of the highest credit ratings (AA-) among financial institutions compared to its peers overseas. This can all change very soon as the country’s AAA rating is again being questioned by rating agencies warning that Australia would be at risk of a downgrade if it cannot find a sustainable footing towards balancing the budget. We all know that the recent budget and the forward estimates put balancing the budget to the never never.

Although the ratings of the banks are separate to the country’s, they are heavily influenced by the country’s ratings as the state of the Australian economy and its future direction is seen as a barometer of the banking sector’s performance. This means that there is a reasonable possibility that our bank’s ratings may be downgraded as a result of downgrade in the country’s ratings. If the downgrade materialises, bank’s funding costs will increase and history suggests that the banks will pass those increased costs to us through increase in our mortgage interest rate. Since our cost of mortgage depends on the Australian economy and the economy is heavily dependent on the Government’s policies, please think very carefully before you exercise your right as a citizen in choosing your Government as it can directly impact your hip pocket through rising interest costs among others.

US Federal Reserve rate

Going back to the table above, Westpac believes that the US Fed will raise its interest rate by 0.25% by the end of 2016 and again by 0.50% by the end of 2017. Let me explain how US Fed rate can impact our mortgage interest rate by way of a graph compiled by Macrobusiness.

Australian bank’s addiction to borrow funds in the international market is clearly evident in the above graph. United States with its enormous financial market represents a significant portion of our bank’s overseas borrowings. The nexus of how US Fed rate rise will impact our bank’s cost of funding is very clear as the cost of borrowing in the overall US market increases with the Fed rate increase. Now going back to the table above, if you believe the US Fed will increase its interest rate in the near future by higher per centage than our RBA’s reduction in interest rate, do you really think we can pop a champagne when RBA makes it next move lower? I rest my case.

Please provide your comments, feedback on this article through our Facebook page. Please like our page Blue Marble Financials and follow us on Twitter

This post was contributed by Rajesh Sharma, Director Mortgage Advising at Blue Marble Financials and is for informational purposes only. This post is not intended to contain any type of financial advice and is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs.