Bricks, mortar and a tale of a hurricane

Marketwatch had cause to think back to October 1987 in England.  He well remembers watching the evening news on the television, followed, as always, by a cheerful weather forecaster trying to put a brave face on a mildly wet but otherwise uneventful week.  Looking forward to a day in the vegetable patch, he took himself off for a dreamless night.

When Marketwatch leapt from his bed in the morning, excited at the prospect of another working day, he and his family were greeted by the fact that overnight a massive storm with hurricane force winds had passed through England.  The damage was massive and it was estimated that about 15 million trees were blown down.  Marketwatch can verify that a lot indeed were blown over.  That was the day he acquired, and operated, his first chain saw.

Needless to say, the Meteorological Office received a fair number of adverse comments.  Although probably justified, it served as a hard lesson that forecasting, particularly where there are many variables, owes more to the dark arts of divination than it does to the science of knowledge.

So Marketwatch’s interest was piqued by the recent media reports on house prices.

The Commonwealth Bank (CBA), our largest lender, ran a series of stress tests assuming a worst case assumption that prices would fall 32%.  Having initially concluded that there would be a 10% fall in capital city prices, this was subsequently revised to 6% after pandemic containment efforts.  The exception to this forecast was Melbourne where CBA warned that the price fall would be twice the level of elsewhere.  The bank is also forecasting that property prices will start to recover towards the end of 2021 with a modest 3% improvement.

Westpac weighed in the other day with an initial 10% price fall, now reduced to 5% for the same reason.  Melbourne keeps its spot in the sin bin.  However, the bank is forecasting a 15% rebound in prices over the period June 2021-June 2023.  Property prices in the short term will suffer as loan repayment holidays end and short term financial distress increases.

On the other hand, Fitch, one of the leading ratings agencies, is forecasting a price drop of 5-10% over the next 12 to 18 months.  This fall is less associated with the effects of the pandemic and is attributed more to a fall in immigration which had already started before the pandemic.  The agency forecasts that the reduction in immigration implies a reduction of demand for housing of about 76,000 dwellings.

The Reserve Bank of Australia (RBA) recently produced research on what would happen if house prices fell by 40%.  Although banks would survive, because even with that level of reduction the RBA does not believe that defaults will be that high.  All fine so far.  But, and it’s a big but, there is a very significant forecast impact on household spending and employment.  The economic decline this causes is also significant.  Although this was not technically a forecast, but “research”, the RBA describes the scenario as “extreme but plausible”.

Now Marketwatch is not saying that these forecasts are right or wrong.  The problem he has is that he doesn’t know.  But neither does anyone else really.  These scenarios are created using sophisticated models but are based on assumptions.  If those assumptions come true then the forecaster can pat himself or herself on the back.  But because there are so many assumptions to include, it is rare for all of them to eventuate.  This is why forecasts rarely ever come true.  But markets expect them, the media report them as fact, so they get produced.

Are there lessons we can take from this?

The first is that we can generalise all of the above with a simple statement; property prices will probably fall in the short-medium term and then they will go up.  Not very revolutionary or massively insightful but that’s as near to reality you will get.

The second, and more important, lesson to remember is that, over an extended period, property prices have grown.  Measuring property prices is not easy because of the wide range of property types and values.  The Australian Bureau of Statistics started a quarterly residential property price index in 2003.  The index value for Perth was at that time 48.3.  In June 2020 it was 99.5.  This is a pretty good increase.  Now it does include inflation, but a quick calculation says that the property index has increased by 106% and inflation by 45%.  Alright, you might have made more money out of the stock market, but equally you could have lost just as much.

Over the years Marketwatch has seen many forecasts come and go.  Every time he feels his spirits rise or sink, he thinks back to that unannounced hurricane and the chainsaw he had to buy.

Of course, crises can be made much more bearable if you are able to nurse a decent red.  Marketwatch has secured a supply of the Schild Estate Shiraz.  The 2018 will go for several years but can be drunk now.  It’s not expensive ($18-20 a bottle) and is an enjoyable drop.  Just don’t flood the cellar.

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