By Christopher Joye, cross-posted with permission from The AFR:
I welcome perma-bear Steve Keen’s commentary on my recent analysis of the asset-class, and his apparent comfort with my conclusions. It is, however, worthwhile clearing-up some misunderstandings as to how I arrived at them.
It is doubtless frustrating for folks like Dr Keen, who claimed that Australian house prices would slump 40 per cent in nominal terms in 2008, to see that they are actually 22 per cent above their pre-global financial crisis peak today.
Let me put that stark contrast another way. In March 2008 the national median dwelling price across all regions was $367,500. Dr Keen evidently believed it would fall to $220,500. The median dwelling price of $450,000 today is thus more than double his predicted outcome. On any benchmark, that is a massive miss.
As is well known, I vocally maintained during the GFC that any house price falls would likely be modest, which proved to be the case, and anticipated the 2009-10 rebound, just as I did the present recovery. The latter commenced in June 2012 and gathered real pace in second half of 2013.
The fact is that the cyclical shifts in Australian housing conditions since 2008 should not have been surprising to anyone with an open mind.
Dr Keen questions why I was comfortable with Australian housing valuations in 2010 whereas I am concerned about where valuation fundamentals are heading today.
In 2010 I argued that house price growth that year would track disposable incomes, which was what happened. In August 2013 I called double-digit house price growth, running at three times household incomes, which is again what we got.
In 2010 I said if we were hit with multiple rate hikes, we could see house prices lose altitude over 2011. The hikes materialised, with an especially painful “double-tap” in November 2010, and prices duly fell in 2011.
In fact, they fell by a bit more than I was expecting – almost 8 per cent on a peak-to-trough basis, which was a record over the 30 or so years of reliable data that we have access to.
The crucial point here is that in mid 2010 Australia’s house price-to-income ratio, which is one valuation guide the Reserve Bank of Australia references, was falling – and it continued to taper to a decade-low through to until late 2011. But in the second half of 2013 and 2014, Australia’s house price-to-income ratio has been rapidly rising, and is approaching a new record.
Since August last year I’ve warned that if the RBA keeps borrowing rates at lifetime lows, Australian housing valuations could burst through their high-water marks.
We’re headed into unchartered territory
When I started thumping the table in 2013, some commentators, including the RBA, responded that the alarm-bells were premature. Yet after house prices have jumped 11 per cent – with Sydney prices up 16 per cent – despite very low income growth, most folks are being forced to change their tune.
So as valuation dynamics vary during a cycle my views adjust accordingly. I think the house price-to-income ratio will shortly head into unchartered territory and when the RBA eventually normalises rates, I believe house prices will fall, just like they did after the hikes in 2007-08 and 2009-10.
Last year I was careful to emphasise that I did not think there was a bubble – but rather that valuations were “priced for perfection” and we could not afford a sustained period of double-digit capital growth.
We have now experienced house prices inflating at three times the rate of incomes for a year, which is stretching valuations to a worrying degree. In the past week I’ve said that the market is probably overvalued by about 10 per cent – and that this disconnect widens every day.
I don’t see why this should compel pundits into hyperbolic conniptions. As the biggest source of household wealth it is absolutely appropriate and reasonable for home owners to have real-time perspectives on the valuation integrity of the residential property market, which inevitably fluctuates over time.
When I talk to fund managers overseeing equities portfolios, the smarter guys have no trouble calling an overvalued sharemarket. I think we need to develop a similar amount of composure about housing conditions, notwithstanding the deep emotional investment that many have in bricks and mortar.
In 2008 I relentlessly questioned Steve Keen about his silly calls for 40 per cent house price falls. In late 2010 I pitched the US money manager, Jeremy Grantham, a three-year, $100 million bet on Australian house prices after he also declared the market was in the grips of the mother of all bubbles.
Had Mr Grantham put his money where his mouth was, he would have lost north of $5 million based on the change in the RP Data-Rismark index between December 2010 and December 2013 (and more if he had accepted the “total return” index that accounts for rents).
In response to my recent analysis, some commentators have tried to attract attention by challenging me to a bet that house prices will not fall by 20 per cent. But I’ve never predicted they will decline by this margin.
I’ve simply stated that the market looks expensive, and if the RBA normalises its cash rate, prices will, on the balance of probabilities, fall. How much they deflate by is an open question, and depends on how high the cash rate goes, which nobody, including the RBA, knows right now.
A simple model of house prices, incomes, and mortgage rates suggests, however, that Australian home values could fall by between 8 per cent and 17 per cent if discounted variable mortgage rates rise as far as 7 to 8 per cent.
