Australian property bubble - What would Ray Dalio think?
What’s on our mind: What is a bubble? Is the Australian property market in a bubble? What would Ray Dalio say?
What happened this week: New Zealand increased its cash rate to 2.5%. Canada increased its cash rate to 2.5%. US Inflation hit 9.1%. Australian unemployment is at a 40-year low of 3.5%.
What are we watching next week: RBA monetary policy minutes, Phillip Lowe's speech on Wednesday. NAB business confidence survey.
Prelude:
What’s on our mind:
The inspiration for today’s article comes from US investor Ray Dalio.
But before we get into this week's article, who is Ray Dalio?
Ray Dalio is the founder of the world's biggest hedge fund, US-based Bridgewater Associates, which manages $154 billion.
Ray has been a global macro investor for more than 50 years and is also the author of the following #1 bestselling books:
Principles: Life & Work
Principles for Navigating Big Debt Crises (Focus of today's article)
Principles for Dealing with The Changing World Order
In 1975 Dalio started Bridgewater out of his two-bedroom apartment in NYC.
Over the next 47 years, he grew it into the fifth most important private company in the U.S.
Importantly, Ray is also a macroeconomic advisor to many policymakers worldwide.
Ray has extensively written about the global economy, but it is one quote that sticks with us and forms the basis for today’s article.
“It is that things that haven't happened before in our lifetimes have happened many times in history before.”
Ray believes “studying history can help leaders better understand and predict challenges to come.”
Here is the TLDR of Ray explaining this in “Principles for navigating big debt crises”:
[After repeatedly being bit by events I never encountered before, I was driven to go beyond my own personal experiences to examine all the big economic and market movements in history.
Ray personally experienced the bursting of the Japanese bubble of the late 1980s, the global debt bubbles in 2000-2001, and again in 2008. By overlaying his study of economic history, Ray developed a set of principles by which he would analyse future economic cycles.
These learnings allowed Bridgewater to prepare better for storms that had never happened to us before, just as one who studies 100-year floods or plagues can more easily see them coming and be better prepared.]
With that in mind, let's get into today's article.
How to spot a bubble:
In his book “Principles for Navigating Big Debt Crises”, Ray sets out a clear and concise framework for spotting a bubble.
He claims that most bubbles tend to display the following characteristics:
Prices are high relative to traditional measures.
Prices are discounting future rapid price appreciation from these high levels.
There is broad bullish sentiment.
Purchases are being financed by high leverage.
Buyers have made extended forward purchases to speculate or to protect themselves against future price gains.
New buyers (those who weren’t previously in the market) have entered the market.
Stimulative monetary policy threatens to inflate the bubble even more (and tight policy to cause its popping).
Ray then applied this framework to 10 different bubbles that burst in history to see how many of these were applicable.
The image below shows that three distinct bubbles met every single one of these measures laid out by Ray as part of his framework.
These were:
The Japanese housing bubble in 1989 - Where prices fell 80% from their peak.
The US dot-com bubble in 2000 - Where sharemarkets fell almost 80% from the peak.
The US housing bubble in 2007 - Where prices fell 30-40% from the peak.
There are other notable bubbles, like the US 1929 (also known as the Great Depression), where price falls were much worse, but we all get the point.
The more of Ray’s framework was applicable, the higher likelihood that something was in a bubble.
When those bubbles burst, the losses were catastrophic.
How does the Australian property market stack up against this framework?
Now let's apply this framework to the Australian property market and see whether or not any of these criteria apply.
1) Prices are high relative to traditional measures ✅
The median property price in Sydney is currently at ~16x the average household income and in Melbourne at ~13x the average household income.
Based on this metric, Sydney ranks as the 2nd most expensive property market in the world, with Melbourne coming in at 5th.
2) Prices are discounting future rapid price appreciation from these high levels ✅
Prices were up ~24% in 2021 compared to the average growth rate over the last ten years of just 5.61% per annum.
Almost 5 x the average yearly growth rate.
A clear sign that purchasers were paying for future price appreciation in advance.
3) There is broad bullish sentiment ✅
This one is a little bit more difficult to measure with statistics.
Our way of measuring this is simple, and it pertains to the FOMO (Fear of Missing Out) narrative we saw perpetuated by real estate agents in 2021.
That FOMO-driven buying which led to 24% price growth in 2021, tells us all we need to know.
We still remember auctions that would have multiple the number of bidders we see right now, with almost all properties being bid up above their reserve figures by 10-20%.
4) Purchases are being financed by high leverage ✅
The average loan size in Victoria has increased from $498,570 in 2020 to $618,602 in 2021.
An increase of 24% in just 12 months.
With almost all home purchases financed via 70% loan to value ratio (LVR) mortgages, the property market, by design, is the most leveraged asset class relative to things like bonds or equities.
5) Buyers have made extended forward purchases to speculate or to protect themselves against future price gains. ✅
2021 spurred by the homebuilder grants saw record home building across Sydney and Melbourne.
Both cities started building new homes at record levels, with land subdivision projects selling out within minutes of being put on the market.
Anecdotally we witnessed buyers in Melbourne's outer suburbs logging onto land sales events, refreshing 3-4 devices trying to secure multiple lots simultaneously.
Almost all of these purchases were being made with the anticipation that by the time they were ready for settlement, the prices would have increased, and they could flip them for a cash profit.
The increased demand for new builds and developments has even led to what the builders call a “profitless boom” (More on this in a future article).
6) New buyers (those who weren’t previously in the market) have entered the market. ✅
In the outer suburbs, domestic buyers joined the party, purchasing vacant land lots and building new homes, most to sell for a profit.
Internally we call 2021 the year that brought about a new occupation - “ The part-time property developer”.
7) Stimulative monetary policy threatens to inflate the bubble even more (and tight policy to cause its popping). ✅
The two years post-COVID (2020 and 2021) saw some of the most stimulative monetary policies we are likely to see in our lifetimes.
We wrote about that wild stimulative ride in a previous article which you can read here:
The federal government pumped ~$507 billion of stimulus into the economy, of which ~$257 billion was direct economic support.
On top of this, the RBA cut interest rates twice in the same month (March 2020) from 0.5% to a record low of 0.1% and then followed it up by offering the big four banks a “term funding facility”, which ended up providing $188 billion in funding at a 0.1% interest rate over a 3-year fixed term.
The result of all of this? Even more stimulus into the economy.
That fits the “stimulative monetary policy threatening to inflate the bubble” bill.
Things have changed drastically since then, with the Reserve Bank Of Australia doing a complete 180 on accommodative monetary policy.
The cash rate has increased from record lows of 0.1% to now sitting at 1.35%, and the RBA is guiding several more rate hikes going into the end of the year.
With the RBA expected to hike rates several more times before the end of the year, we are now witnessing the “tight policy to cause its popping” part of the framework.
So is the Australian property market in a bubble?
Applying the framework, there is a strong argument for all of these characteristics concerning the Sydney and Melbourne property markets.
An argument that sees all seven characteristics Dalio lists as part of his bubble spotting framework satisfied.
So the only question is, how do we know when we are at the top of the bubble?
Here is Ray’s definition of the “top” of a bubble:
1. “When prices have been driven by a lot of leveraged buying and the market gets fully long and overpriced, it becomes ripe for a reversal.”
(Sound like 2020-2021 to anyone?)
2. “This reflects a general principle: When things are so good that they can’t get better—yet everyone believes that they will get better—tops of markets are being made.”
(Again - 2021?)
3. “While tops are triggered by different events, most often they occur when the central bank starts to tighten, and interest rates rise.”
(Does this sound like 2022?)
4. “In some cases, the tightening is brought about by the bubble itself because growth and inflation are rising while capacity constraints are beginning to pinch.”
(It almost sounds like Ray is describing the east coast Australian property market)
Australian property is so obviously a bubble, and has been for so long, I'm dumbfounded and amused at all the politicians, economic commentators and participants dancing around the word.