The Burj Dubai and Real Estate Cycles

The Burj Dubai has been all over the press in the past couple of days as it had its grand opening. What an engineering spectacle! The tallest building in the world at over 800 metres tall with more than 160 stories and a luxury hotel designed by Giorgio Armani. So what do I think? I think of a great book entitled “The Secret Life of Real Estate : How it moves and why” by Phillip Anderson which states that “the world’s tallest buildings have a consistent habit of being completed right at the top of the real estate cycle ... producing for us – at least so far – the most reliable indicator of an approaching peak”.

Anderson also suggests a 24 Hour Real Estate Clock where hours 1 to 16 take approximately 14 years during which time property values rise reaching a peak and then hours 17 to 24 takes approximately 4 years during which time property values fall. I'll work through an example using a dataset that I’m closely following – raw (not adjusted for inflation) Nationwide UK Historical House Price shown in the chart above.

Anderson suggests that from the previous cycles low, the first 7 years will see property increase in price before a mid cycle recession. Using the Nationwide figures I'll call the low November 1992 and I'll call the recession start April 2000 which is 7 years and 6 months. During this period property increased in value by an average 6.5% per annum. So that fits.

I'll suggest using the Nationwide figures that there was a 6 month mid cycle recession during which time property increases slowed considerably and rose by 1.62% over that 6 months. Still positive as inflation for that 6 months was 0.9%. So that fits.

There is then a second 7 year cycle (completing the first 16 hours of the 24 hour clock) which starts from the onset of the mid cycle recession. During this second cycle property increases at a greater rate than during the first cycle. I'll call this peak October 2007 which is 7 years and 6 months. During this period property increased in value by an average 11.9% as predicted by the Anderson model. So that fits.

Now the fun begins with the 'Keynes crash phase' which runs for 4 years. Using this model we should come back and look at property in October 2011. What are highlights of this cycle - foreclosures and bankruptcies increase (yes!), stocks enter a bear market from past highs (yes!), credit creation institutions reverse policies (yes!), economic activity stalls (started but then QE began, I think we may still be here), wipe out of debts/stagnation (still needs to occur), wreckage is cleared away (still needs to occur) and finally stocks start climbing (they have but was it caused by QE and we are in for another big drop?) then the 18 year cycle can begin again.

As I’ve detailed previously I am yet to buy myself a flat or house. The above indicates that maybe I won’t get the opportunity until late 2011 or so...

2009 Yearly Retirement Investing Portfolio Review

Edited 06 June 2010: I have found more exact data allowing me to determine benchmark returns to the day.  I have therefore updated the data in this post to reflect this.  As the blog has developed I have also changed the method used to calculate the returns as I have learnt more accurate methods.  I started with:
- [assets at end of period – assets at start of period – new money entering portfolio] divided by [assets at start of period],
- then used the mid-point Dietz which was a more accurate method,
- and now use Excel's XIRR function for anual returns.  If it is not a full year I then adjust XIRR by the PRR (Personal Rate of Return) = [(1+XIRR Annualised Return)^(# of days/365)]–1.
In those post I also used incorrect weightings for the benchmark portfolio.  It should have been 72% stocks/28% bonds as per here.
Apologies for the confusion but I'm learning here too.
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2008 was a bad year for my investment portfolio and by year end the 02 January 2009 I was -19.7% -15.7% using [assets at end of period – assets at start of period – new money entering portfolio] divided by [assets at start of period] as my return calculation method. 2009 also started badly and at one point in March my portfolio was -12.4% and we weren’t even a quarter of the way through the year. As everyone knows the markets then started recovering and I rode the wave to end the year at period 02 January 2009 to 31 December 2009 at +21.5% +24.9% including fees.

Gold Within My Retirement Investing Strategy – January 2009 Update

Within my Retirement Investing Strategy I currently hold 2.6% of my portfolio in gold with a targeted holding of 5%. Gold is the only portion of my portfolio that does not provide some sort of yield (dividends, interest etc). So why do I hold it?

The first chart shows the Real price of gold since 1968 with it becoming quickly obvious that it can be a wild ride. The first reason I hold gold is demonstrated by drawing a trend line through the dataset which provides the formula Real Price = 1.37 x Year -2120. This suggests a trend Real price in 1968 of $573 and a trend real price in 2010 of $630. So provided you don’t buy during one of the scary boom periods this suggests that gold has the potential as a good long term place for me to protect myself from inflation.

The second and very important reason I hold gold is that the correlation between the Real S&P 500 (also displayed on the first chart) and Real gold is negative at -0.34. The second chart provides the ratio of the S&P 500 to gold demonstrating just how far apart the two can vary. So my thought here is that there will be some opportunities where stocks will be overvalued but gold will be cheap (and I can buy) and vice versa. Over the long term maybe I can then squeeze some more performance out of my portfolio.

For the moment I don’t know what to do with gold. I’m certainly not selling what I already own as it’s a long way from its historic Real highs however I’m not sure whether to buy any more as it’s also a long way above its historic trend line...

Stock Market History – The Great Depression Compared with Today

So a second great depression has been avoided... Most countries are out of recession... The stock markets are headed upwards again...

All wonderful stuff except I just don’t feel comfortable with the above chart showing progress from the Real (prices adjusted for inflation to present day) peak in 1929 taken from the Shiller dataset and comparing that with the Real (again inflation adjusted) peak in 2000 for the S&P 500. The correlation between these two periods is currently sitting at 0.65.

Is the stock market out of the woods yet?

UK Property Market – December 2009 Update

I am yet to buy myself a flat or house even though the ownership of one is important to my retirement investing strategy in the longer term. The reason for this is in my opinion UK property is overvalued by a huge margin. Although given the press reports I sometimes feel as though I am the only one in the UK who thinks property can go up as well as down. Chart 1 shows compared to average earnings that property is very expensive when a ratio is created of the Real Nationwide Historical House Prices to the Average Earnings Index (LNMM) and it is for this reason I have yet to buy. In 1996 this ratio was as low as 607 and today the ration stands at 1,188. If we were to return to that number the average house using the Nationwide Index would be £82,929. Will we ever get that low again?

Yesterdays BBC headline states ‘House prices rise by 5.9% in 2009, says Nationwide’. I guess it depends on how you look at the data. According to my interpretation of the Nationwide data set house prices fell by £661 over the past month.

Chart 1 also shows Nationwide Historical House Prices in Real (ie inflation adjusted) terms. I’d like to compare it to Chart 2 above. Is this small decrease a one off or is it the ‘Return to “normal”’ phase of Chart 2 kicking in? Only time will tell but I’m still out for now.
Chart 3 shows the annual change in Nationwide property prices and compares this with the change in the average earnings index extrapolated a couple of months to match the Nationwide time period as LNMM is still only released to October 2009. It shows that on an annualised basis average earnings have turned negative at -1.7% while house prices continue upwards at that BBC quoted 5.9%.

That said, I think Chart 3 also shows clearly the problem we have. Since 1991 the UK Retail Prices Index (RPI) has averaged 2.8% annually. The Average Earning Index has averaged 4.1% for a real increase over inflation of 1.3%. What justifies this 1.3% - have we become more efficient? Now here’s the problem. The Nationwide dataset has increased by 5.8% annually for a real increase of 3% over inflation. How can this be? Has it become so expensive to build a new house? I believe the answer is no. It is pure asset price inflation. Of note also is that as time has progressed the trend line for house prices is heading in an upwards direction.

What’s causing this? I believe that when an economy is run with too loose a monetary policy you will see increases in one of two places – either inflation for goods / services will kick in or you will get asset price inflation. Our supposed experts who control the economy only look for the first one and control interest rates based on this. What we saw this economic cycle was inflation controlled with no care for the huge asset price inflation that was occurring. This has meant extraordinary bubbles in property, share markets and even commodities (what was oil $147 barrel?). These markets then started correcting themselves and we started to see asset price deflation. How have our experts responded? With even looser monetary policy which is resulting in new bubbles inflating in share markets (I showed yesterday that the S&P 500 is already at its 80th percentile based on historic data) and property. Why do they not try and control inflation with interest rates but value asset prices (for example, the Shiller PE10 has a good correlation with prices and could be used for share markets, ratio of prices to earnings could be used for property) and control this by, say, changing banks minimum capital ratios as suggested by Smithers? Maybe this would stop the large boom and busts we have seen in recent years.

With inflation now kicking off will the Bank of England increase interest rates and stop this property boom or will they allow inflation to occur at the expense of savers? Right now I’m backing the second and so I will protect myself with inflation linked products wherever possible.