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.