Bubble Watch: A White Paper
You don’t have to be a Nobel Prize-winning economist to notice there’s been a lot of talk on bubbles lately. In this subscriber-only White Paper, Roger Montgomery takes a closer look at just what’s happening with asset prices.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that 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 and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
INVEST WITH MONTGOMERY
David Michie
:
Hi Roger, as I understand it from the PDS The Montgomery Fund can go higher than the 30% cash allocation if the investible universe is unappealing and “in
anticipation of extreme market dislocation”. Do you alert investors in TMF when you go beyond the 30% cash allocation and when you implement protective measures such as buying put options over the ASX200 index?
Roger Montgomery
:
Hi David,
The performance reports we publish, and provide our investors, shows the cash weighting.
John
:
Hi Roger,
People believe stock markets will always go up.(over the longer term)
Why is Japan still down some 70 per cent from highs in 1990 and we are 24 years on.
Could this scenario happen in Australia?
Roger Montgomery
:
Anything can happen when management is poor or demographics are against you.
philip jaffe
:
Your concluding paragraph to the question everyone’s asking: are we in a bubble and I quote from the article “… should be dancing very close to the door at this time.” is of concern. Are you suggesting an equity correction or a GFC crash and has The Montgomery Fund increased its cash holdings to the maximum level permit table?
As an aside I attended the Morningstar Investor Conference last Friday and Hamish Douglass CIO of Magellan Financial Group said in his address it he was investing his money today he would not rush into an investment in his fund! He would rather wait six months than invest in Magellan NOW!
Roger Montgomery
:
Hi Philip, I am less willing to be as precise about timing because so many variables and influences can change in either their nature or in the way market participants interpret them. That said, we are actually reasonably bullish but we believe you need to keep an eye on long bond yields and/or signs of stagnation….
JasonLWalsh1
:
Hi Phillip, is that quote verbatim? Do you know the presentations are online?
A.Somner
:
Just to reply about the Irving Fisher comment about how bond’s cannot form a bubble. I am not sure if Fisher could foresee a world of a floating exchange rate, or where the reserve currency of the world is a bond (US Treasuries), or where the bulk of tier 1 capital reserves are bonds or where bonds have been in a bull market for 33 years and are about to reach the final rally with interest rates going negative! I would have to ask is it possible that Fisher was wrong just like he was in 1929 when he stated “stock prices have reached what looks like a permanently high level.”? I am also not sure if you were referencing the 1994 bond market crash as a comparison to what happened during the 1931 soveriegn debt crisis. 94 was simply a spike in interest rates caused by Clinton reducing 30 year bond issuences by 50% which created a glut of short term notes which caused the yield curve to invert and a panic followed. 1931 was a default event where money simply vanished and debt deflation occurred which is what Fisher witnessed. This is why I asked if there is anyone alive who has witnessed a real meltdown in the bond market not simply a spike in interest rates.
neal hogg
:
Great article, thanks Roger
John
:
Let me summarise the gist of all this :-
If you invest in government bonds the government may default and you will lose all your bond value and for good measure that will precipitate a 1929 type of depression.
If you invest in shares the company may go bankrupt and you will lose all your share money.
If you buy realestate the worst case scenario based on the U.S. crash is it could lose 70% to 80% of its value. However where that happened the lending was to people with no income, no assets and no requirement to pay the loans so they walked out without losing any money themselves. The present situation in Australia is completely different.
At the moment it is almost certain there is an over supply of units coming into at least the Sydney, Melbourne and Perth markets.The main buyers are overseas investors and if/when they lose their value I don’t think there will be too many Australians in tears.
Roger Montgomery
:
That all sounds a bit depressing John. Great businesses bought at rational prices will add economic value and the share prices will always ultimately reflect that.
Kenneth Beer
:
Less fuel for asset bubbles:
Expenses of investing in property and business equity should not be allowed as a deduction from income earned from employment and investment. Expenses from investing in property and business equity should be restricted to a deduction from income earned from employment and investment. When there is a net loss from owning an investment in any one year then that net loss is carried forward to be offset against a future net gain.
Kenneth Beer
:
The only way I am aware of editing my post is by replying to it (if I am correct then I submit a suggestion for improvement):
Less fuel for asset bubbles:
Expenses of investing in property and business equity should not be allowed as a deduction from income earned from employment and investment. Expenses from investing in property and business equity should be restricted to a deduction from income earned from investment. When there is a net loss from owning an investment in any one year then that net loss is carried forward to be offset against a future net gain.
Peter Murphy
:
Hi Roger,
Thank you once again for a thorough and detailed analysis covering the macro landscape and the potential implications for us here in Australia.
In trying to identify what could possible be the tipping point I have found the best analogy to be the sand pile which slowly builds up and eventually develops a critical mass. At this point there is no predicting when or which further “grain of sand” will cause the avalanche.
For what it’s worth I don’t think we will be waiting much longer to see what the consequences of central bank policy will have on asset prices!
Regards,
Peter
Joan James
:
As the rising number of participants in any investment market would seem to contribute to investment “bubbles”, does anyone else think that the superannuation system may have tipped far too great a proportion of the population into the “participant” role in investing?
Roger Montgomery
:
Perhaps Joan, but like all other ‘apparent’ massive weights of money supporting the market; they don’t and they haven’t.
Aaron Somner
:
I must say Roger that I very much enjoy your insight’s and comment’s on both this blog and your appearances on sky. I also agree that John Kenneth Gailbraith’s book on the great depression is a must read, however not for the same reason’s that you hinted at. Gailbraith failed to define a bubble in any kind of practical manner. Bubble’s occur when capital concentrate’s into a particular market. The capital must be international, such as the Nikkie in 89, or real estate in 07 or stock’s in 1929. What really kick’s a bubble into overdrive particularly in the modern world of the floating exchange rate system is when that market’s denominated currency is rising relative to all other’s. I would also like to raise a question as to the validity of Julian Robertson’s comment’s about a double bubble. Could he point to a single event in all of history where a double bubble occured? It defies the definition of a bubble. When tulip mania broke out was there some other bubble at the same time? Only one maket can be in a bubble at any one time! We are clearly in a bond market bubble where capital is simply parking in currency that pay’s interest. Which raises a most pertanent question. Has any body alive ever witnessed a bond bubble? When was the last time? What happened the last time there was a real panic meltdown in the bond market? Which is what inspired me to comment when you referenced Gailbraith at the opening of your “Bubble watch report”. In his book there is simply no reference to the 1931 soveriegn debt crises. This event was what defined the depression and made it so great. How could someone researching the depression completely ommit the fact that Germany, Austria, Turkey, Greece, China (to name but a few) all defaulted on their bonds creating mass deflation and havoc in the banking sector? Simply amazing! Can you imagine those countries defaulting on their bonds today. In 1931 it was the same event! Which is why Hebert Hoover the US president at the time described it as a financial hurricane! So I think it would be good to look at this bubble in bonds in a practical fashion. The worlds total bond market cap is around 150 Trillion dollars! If the bond market declined by a third (50 trillion) that is the equivalent of the worlds total stock market cap! A decline of this percentage is rather mild in terms of bubble declines. This is a massive amount of capital. So when the tide goes out and the pendulum swing’s the other way it wont be the band who stops playing it will be the bond that stops paying and it will be the money that is exposed! However this must raise the question of where will all of this capital that is looking for the exit going to go? All that is left is stocks, commodities and real estate. MMM…. the next bubble? So to sum up I believe that Gailbraith did not want to admit that the depression was created by a failure in government. As we look across the oceans of the world we see government’s who can’t possibly meet their obligation’s when the next recession hit’s and their tax reciept’s decline. Interest rates thanks to the bond bubble are at historic low’s and they are having trouble keeping up! Isn’t it funny how history repeats! Maybe it’s because history is not accurately recorded?
Roger Montgomery
:
By Fisher’s definition you can never have a bond bubble. Perhaps we should allow ourselves to accept crashes without subsequent bubbles in bonds then (1994).
John
:
Is it best to be very guarded at the moment high in Preservation strategy Instead of being in say Growth, Balanced , Shares and International , Instead be in Property, Conservative, Defensive, Fixed interest, Bonds ,and Cash.
If there is a long prolonged downturn deflationary period and one is drawing down then Defensive is the way to go ? For those say in their 60s the weightings is the key as you draw down, there is no way of making it up in what’s coming in a long down turn, so it’s about preserving your capital.
John
Roger Montgomery
:
When inner city Melbourne residential units are selling for $12,000/sqm and a commercial building with Westpac as a ten year tenant is ‘only’ valued at $6000/sqm, I certainly wouldn’t say that property is defensive. Business that have competitive advantages, especially the ability to raise prices for their products, will do well. For more guidance, study japan….
John
:
There is quite a bit to take in with this discussion.
Has the reserve bank considered investors are investing in realestate because the other investment options, i.e. shares and interest bearing deposits are not attractive?
With realestate there is a real asset backing up the investment rather than a bit of paper with numbers on it. In a period of uncertainty that real security makes realestate investing attractive.
Also, the government has been hammering anyone with penalty tax rates if they earns more than a pittance so no wonder animal spirits for investing and effort have disappeared.
The reason first home buyers have left the market is because they are becoming first home investors instead. It doesn’t make sense to buy a house to live in when you can rent at a cost less than interest cost and then buy a tax deductable investment.
It is hard not to feel negative about the Australian economy with both sides of parliament trashing our industries by allowing dumping of overseas goods and taxing and over regulating the bejeevers out of anyone trying to earn a living.
The Australian governments need to allow the deserving to be properly rewarded for effort. The liberals have turned into a mob of high taxing lefties and Australians need a real alternative to get this country back on track.
Roger Montgomery
:
You might be right when you say “With realestate there is a real asset backing up the investment rather than a bit of paper with numbers on it”, but the “real” asset also existed in the US and it still fell, in some cases, 70-80%. The fall in wealth was indeed very real too. price is what you pay but value is what you get!!!
tony santoro
:
I have been a real estate agent for the last 33 years. I have see markets similar
to the current real estate market on three occasions in my time. Sort of ties in with the ten year cycle people talk about. They ended in tears for a large number of people,and a very prosperous period for others.I would suggest extreme caution particularly if buying an investment property at the moment
Happy investing to all.
Roger Montgomery
:
Thanks for the warnings Tony.