Is this another signal that a bubble is forming?
From skirt lengths, to magazine covers to public protests and the rise of ant-establishment voting, signals are everywhere. And, as investors, we need to pay attention to them. Which is why the imminent sale of the long-held Soul Pattinson building in Sydney’s Pitt Street Mall caught our eye. To us, it’s yet another signal that asset prices are over-stretched.
We know low interest rates have corrupted the perception of risk and consequently pushed asset prices up. This of course has been the central banks’ aim – synthetically producing a wealth effect that might spur spending and investment.
With US 10-year bond rates below the levels of the 1930s Great Depression, 30 per cent of global sovereign bonds at negative yields and 80 per cent below 1 per cent, investors are bidding up assets in the pursuit of yield, believing these low rates are the ‘new normal’. But this is anything but normal!
The lowest rates of the epoch are not the result of the buying and selling of rational, risk-averse and profit-motivated investors, but purely by the action of central banks.
High asset prices are of course justified if there is solid growth, but rising payout ratios and exceedingly high debt means growth cannot come from retained earnings nor from leveraging the balance sheet.
As a result, we believe investors will look back on this time aghast that they and their institutions committed to long-duration investments at high prices and absurdly low rates of return.
We believe, that one of three scenarios will play out over the next three or so years.
The first scenario is best summarised by the ‘lower-for-longer’ mantra. The higher the price you pay, the lower your returns. Paying the asset prices of the day will lock you in to low returns.
The second scenario is that eventually bonds fall and long rates normalise (perhaps the historical record high level of CCC-rated junk bond corporate credit due to be refinanced in 2019 and 2020 will be the catalyst) and asset prices correct, producing lower returns for everyone but with more violence.
The third scenario is that negative yields on a growing cohort of sovereign bonds drives investors into US bonds – the lowest risk sovereign bonds, which are still offering positive returns – driving their price up, lowering their yields and causing a boom in stocks and assets, amounting to a ‘blow-off top’.
There are other scenarios of course, including that economic growth rates start to strengthen without inflation emerging and asset prices gradually rise without any correction. This goldilocks scenario is viewed by an increasing number of highly successful global investors as a fairytale.
“we are unlikely…to end this cycle without a bubble* (*2300 in the S&P500) in US equity markets”
Jeremy Grantham, GMO.
“Sell everything, nothing here looks good”
Jeffrey Gundlach, DoubleLine Capital August 2016.
“I don’t like bonds; I don’t like most stocks; I don’t like private equity…The obvious answer is to reduce risk”
Bill Gross, July 2016 Janus Capital
One of Australia’s most successful and respected investors is the patriarch of listed investment firm Washington H Soul Pattinson (ASX:SOL), Rob Millner.
By way of background, Washington H Soul Pattinson is one of the oldest companies listed on the ASX, and interestingly, the third ever customer of the National Australia Bank.
Established by Caleb Soul and his son Washington in 1872 the company was subsequently taken over by pharmacist Lewy Pattinson, the great grandfather of Rob Millner and great, great grandfather of Tom Millner, now the head of the listed BKI Investment Company (ASX:BKI).
The group’s diverse portfolio of businesses and assets, amounting to $5.5bn, is still managed by the same family.
With such a long pedigree, as well as a history of holding assets for the very long term, rather than selling, it’s worth paying attention when something is being sold.
So what is being sold?
The only remaining investment from the original business – the 1290 sqm building fronting Pitt Street Mall in Sydney is being “divested” for what is believed to be $100 million. The head office and pharmacy of the company has operated at 160 Pitt Street since 1885.
Commercial Real Estate Agent JLL’s Simon Rooney estimates that Pitt Street Mall generates annual sales of $1.4 billion equivalent to $14,000 a square metre. With rents recently attracting $12,000 to $15,000 per sqm one has to wonder at the sustainability of margins for retailers.
Perhaps unsurprisingly then Millner and WHSP is selling and the advertisement says it’s a “Once in a Century Retail Investment Opportunity”. Indeed it is, but perhaps for the vendor.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
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.
Tim lane
:
The real issue is that the decision to not invest is still an investment decision with consequence ie if I long term leave my money in cash at say 2 % after tax and inflation I am creatin a real loss. We all know the actual inflation rate faced by retirees is much more than quoted (for example private health insurance increase is normally double the inflation rate) therefore the risk of staying out of the market is actually worse. The real question is the relative risk I face. So when you sit with a client and discuss this (and they get it don’t worry) saying its to risky to be in the market won’t work.!
Roger Montgomery
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Hi Tim, Please read our article about cash. Holding a lot for a long time is not a viable or sensible option. In the short run however it is an option over lower prices with no strike price or expiry date. Here’s the link http://rogermontgomery.com/cash-is-king-when-the-market-holds-the-aces-2/
Richard Vidal
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Messages of the impending financial Armageddon variety are almost a daily occurrence now……….surely that golden thing that they dig out the ground with no apparent “value” will provide a decent hedge for 5-10% of the portfolio since nothing else financial makes any sense these days?
Pippa Malmgren
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Hey Roger,
I wonder if you’ve seen my boom, Signals: How Everyday Signs can help us Navigate the World’s Turbulent Economy but I talk about hemlines, magazine covers and anti-establishment voting as economic signals! I totally agree that the sale of iconic property is also a signal. But is it a good one or a bad one? It could be a sale at the top. But, if inflation unfolds, the buyer might have gotten it cheap. The RBA seems fully committed to doing whatever is necessary to push the inflation rate up. I think inflation in Australia is just getting started. I’d argue that over a beer in Sydney or Melbourne (which costs $10 – but there’s no inflation. Nope. None). Best, Pippa
Roger Montgomery
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Hi Pippa yes, hemlines is one example of a signal that has been well documented. We covered magazine covers here at the blog too back in 2013 http://rogermontgomery.com/a-little-archeology-always-helps/. I do believe one that is less well-covered is the incidence of finance stories leading commercial radio news breaks, particularly commercial radio stations not known for their financial market awareness. The Arab Spring, the right-wing voting in the US and Austria are all examples of signals and other which we love to discuss here. I’ve not read your book but it has received some excellent independent recommendations so have purchased my own copy and look forward to reading it soon. My views on asset prices and inflation lean towards the historic evidence that inflation and high asset prices don’t mix. I sent an email to you taking you up on your offer. feel free to reply when convenient.
Karl D.
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Hi Roger I really appreciate your articles in this space – I think history will look favourably on your reflections.
I’d be curious on your views (perhaps in a new article) on the Bank of Japan’s asset buying program – what could be referred to as a defacto nationalisation of the private sector. Is this the path the Reserve Bank of Australia is on if faced with higher unemployment and/or an unacceptably high exchange rate? And what impact does the BoJs buying program have on likelihood of your scenarios?
Roger Montgomery
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The BOJ is now reaching the limit so I don’t think it will become a trend. And it’s not working anyway. Mind you, the ineffectiveness of a strategy (e.g.:ZIRP) doesn’t seem to have prevented others from having a go!
Chris
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Roger, I understand it as this:
The first scenario assumes that nothing else happens, that everything ambles along in the same holding pattern. That, over the longer term, is completely unrealistic (really) because we all know that over the longer term, the market never stays in a holding pattern like that.
The second is more likely, most of all because rates will HAVE to normalise (just like everything else); like the pendulum on a clock, many things may entertain being at extremes, but never be there permanently. However, my understanding is that rates would only go up if things were going well economically OR if there was a different catalyst, e.g. the USD / RMB became unpegged from each other….also, rates are used as a blunt instrument to contain inflation, which currently, is low, and people are being urged to spend money (i.e. the opposite of inflationary conditions).
The third is just a continuation of what is happening now; if that happened, then the first scenario still holds because the price paid in both scenarios 1 and 3 means that assets are overpaid for anyway.
It also feeds back into the second scenario being true, because regardless of the reason WHY bonds fall (be it because of rising interest rates lowering existing bond prices and therefore yields) and/or because people overpay for assets (be they bonds, which remember, are not going to generate the same return as these new ones or that they overpaid for assets for yield in the absence of bonds, i.e. the dividend payers like TLS).
The return will still be ‘lower for longer’ regardless of the asset type you hold, especially if share prices do correct (which, the higher they go, the more likely they are to do, given that they are much higher than they should be in some parts of the world, e.g. USA) and interest rates increase.
It is almost a ‘forced demand’ situation (e.g. for those of us with a non-SMSF super fund) whereby you have to put money into “something”, but everything is equally as expensive. Cash is all very well and good, but the market can remain irrational longer than you can stay solvent (and long-term cash is not going to generate the capital growth I need, as a younger investor).
Roger Montgomery
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As pointed out here on the blog recently: If I am being told I have to accept very low returns, why invest at all? Indeed.
Kelvin Ng
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Yes that’s true.
Kelvin Ng
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Hi Roger, the flip side to these arguments is that it will, in large part, depend on what the catalyst for higher bond yields eventually is. If it is because inflation is spiking higher (as suggested by a number of smart analysts), potentially in response to helicopter money, that should be good for equities as an inflation hedge.
Kelvin
Roger Montgomery
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History says inflation has not been kind to equities.