UK Mortgage Approvals – February 2010 Update

On Saturday I discussed why I might have been early in my call that we had potentially reached the ‘Return to “normal”’ phase of the UK house market. I would like to revisit this again as I continue seeing data that is potentially starting to point towards a further housing market correction.

The first chart is a repeat of that shown on Saturday. I described how the new interest rates secured on dwellings are still very low at 4.5% compared to the peak of 6.3% and have likely had a big effect on the market. What is of interest however is that this 4.5% increase is 7% more than the low of June 2009 and is trending in an upwards direction with no assistance from the Bank of England.

The second chart today also shows another interesting piece of data. The olive line is the most interesting which shows seasonally adjusted monthly mortgage approvals decreasing for the first time in 13 months dropping from 60,045 to 59,023 in December which is a decrease of 2%.

Rising mortgage interest rates will put pressure on those who have variable rates or are coming off fixed rates. It will also decrease the level of borrowing possible for a new person trying to enter the housing market. Additionally falling mortgage approvals suggests less competition in the market for each house that is for sale.

Could the rules of supply and demand finally start to work in the near future?

A tale of two Central Banks – Reserve Bank of Australia vs Bank of England

The Reserve Bank of Australia (RBA) announced today that they were keeping interest rates on hold at 3.75% after raising rates by 0.25% a month for 3 months in a row. According to the Financial Times this surprised most economists.

In my opinion the RBA seem to have timed their increases well. In September of 2009 the Australian Consumer Price Index (CPI) saw a low in this cycle of 1.26% and even though this was the case they started raising rates in October. We have now seen the RBA increase rates by 20% from their lows. It doesn’t seem unreasonable to me for them to take a pause to see what effect this is having given CPI is still only 2.1% and given the inflation target for the RBA is as follows:

“The Governor and the Treasurer have agreed that the appropriate target for monetary policy in Australia is to achieve an inflation rate of 2–3 per cent, on average, over the cycle. This is a rate of inflation sufficiently low that it does not materially distort economic decisions in the community. Seeking to achieve this rate, on average, provides discipline for monetary policy decision-making, and serves as an anchor for private-sector inflation expectations.”

This target was introduced in mid 2003 and since that time the arithmetic average has been 2.7% so to me as a simple Average Joe they seem to be doing a reasonable job.

Now to the contrast which is the Bank of England. They have kept the Official Bank Rate at a record low of 0.5% now since March 2009. The Bank of England also saw the UK Consumer Price Index (CPI) reach a low in this cycle in September of 2009 at a rate of 1.1%. However instead of following the lead of the RBA they have sat on their hands allowing CPI to reach 1.5% in October, 1.9% in November and we now have the CPI at 2.9% (with last month being the largest month on month increase in history) and the Retail Prices Index (RPI) at 2.4%. I can’t see how they can allow this to occur given the Monetary Policy Framework under which they operate includes:

“The Bank’s monetary policy objective is to deliver price stability – low inflation – and, subject to that, to support the Government’s economic objectives including those for growth and employment. Price stability is defined by the Government’s inflation target of 2%. The remit recognises the role of price stability in achieving economic stability more generally, and in providing the right conditions for sustainable growth in output and employment. The Government's inflation target is announced each year by the Chancellor of the Exchequer in the annual Budget statement.”

I think the Bank of England have now shown their hand and think they can control the inflation genie and allow “just a little bit of inflation”. I’m backing that they don’t raise interest rates this week. I guess only time will tell.

Australian Property Market – February 2010 Update

I intend to keep a close eye on Australian house prices as I build my retirement portfolio. This is because Australia is a very likely retirement possibility (if not sooner) for me.

The first chart shows the quarterly Real (adjusted for the Consumer Price Index) Brisbane and Real (again adjusted for CPI) Australian Eight Cities (Sydney, Melbourne, Brisbane, Adelaide, Perth, Hobart, Darwin & Canberra) House Price Index with data taken from the Australian Bureau of Statistics catalogue 6416.0 since 1991. This Index was reset in 2003/2004 and so I have “corrected” pre March 2002 data by taking the ratio’s of the pre and post September 2003 to June 2004 data as a multiplier. This chart carries data only until December 2010 and clearly shows a nice dip at the start of 2009 before the latest data point has taken house prices to new record real highs.

My second chart shows Real Annual Changes in price from 1995 to present. In Real terms over this period Brisbane has seen average increases of 5.3% (up from an average of 5.2% last quarter) and the Australian Eight Cities has seen average increases of 4.9% (up from an average of 4.8% last quarter). Unfortunately for me though the trend lines (particularly for Brisbane) continue to head upwards.

In non-inflation adjusted terms over the period Brisbane prices have seen average increases of 8.1% and the Australian Eight Cities prices have seen average increases of 7.8% (up from an average 7.6% last quarter). Unfortunately if you don’t already own a property you continue to be priced out when compared with average earnings. Using the Australian Bureau of Statistics catalogue 6302.0 (extrapolating the last quarter as the data is not released to the 25 February) which looks at average weekly earnings shows that while house prices have had their long run averages increase this quarter, Total Weekly Earnings have stagnated at a yearly 3.8% and Total Full Time Adult Earnings at 4.3%.

My third chart shows what happens when house prices continue to rise at a rate greater than salaries. Over this period affordability of Brisbane houses when compared to Adult Full Time Weekly Earnings has gone from a low of 0.063 to 0.121 meaning affordability has halved and the Median Eight Cities houses have gone from a low of 0.064 to 0.112 which is a huge reduction. This type of shift is just not sustainable but when/if will the market return to a more sustainable equilibrium.

Looking at the big increases this quarter I can’t help wonder if the data is ‘reliable’ and I would like to see how the histograms have changed since 2008. This is because the government has brought forward demand and changed the dynamic in the market by offering first home buyer grants with changing values depending on the date. If I had have bought before 14 October 2008 I would have received $7,000. Using this as a 5% deposit would mean I could borrow $140,000. If I had have bought a new house between 14 October 2008 and 30 September 2009 I would have received $21,000 which again with a 5% deposit would mean I could borrow $420,000. That has to change the supply and demand dynamic in the market. This ‘stimulus’ has now been gradually withdrawn with first new home buyers being reduced to $14,000 between 01 October 2009 to 31 December 2009. Finally, since 01 January 2010 first home buyers are back to $7,000 meaning we’re back to that $140,000.

So if I was a first home buyer I would have bought between October and September with first home buyer stragglers buying also in October to December. I would now be out of the market. I think the Housing Industry Association (HIA) may have seen in this when they reported that new home sales are down 4.6% in December 2009.

It will be very interesting to see what happens next. Australia has rising interest rates and if supply and demand works (assuming no government intervention) second home buyers may now struggle to sell without reducing prices as their pool of buyers has been reduced, along with the pool that remains having smaller deposits. This should reduce prices going forward. This should then flow through the rest of the market. Interesting times ahead...

My allocation to international equities

Tim Hale in his book ‘Smarter Investing : Simpler Decisions For Better Results’ states that ‘investing in a range of developed equity markets such as those in North America, the European Union, Japan and Australasia, provides the potential to deliver comparable returns, given similar levels of risk, long term rates of economic growth and reasonably comparable levels of governance, law, political stability and capitalist economics...’

However, he also mentions that investing in developed international equity markets can expose you to economic cycles / pressures that are out of sync and currency exchange rates. These types of effects can be clearly seen by looking at the chart above which has been prepared using the Yahoo Finance website. The period used is December 1989 to the present day with the red line being the S&P 500 (USA), the blue line being the FTSE 100 (United Kingdom) and the green line being the Nikkei 225 (Japan).

It is these types of effects that I am looking to take advantage of in my retirement investing strategy by regularly balancing back to my desired regional allocation within my international equities allocation. This is exactly the same principle I am using with my total low charge portfolio allowing me to buy when the market is low and sell when the market is high.

When choosing what regions to invest in I wanted to also ensure that my allocations were large enough to make a difference within my total low charge portfolio. For example my nominal allocation (before allowing for corrections in line with PE10 ratios) to international equities is 15%. If within my international equities I have an allocation to a region at 20% then this will affect 3% of the total portfolio which matters. If I went down as low as 5% then the total affect would be only 0.75%. A 10% swing in stock market prices in this region would then only make a difference of 0.075% to the total portfolio which in my opinion is insignificant.

So what regions am I allocating to my international equities asset allocation? I’ve kept it really simple with desired allocations of:
- 40% United States
- 40% Developed Europe (France, Germany, Italy, Spain, Netherlands, Switzerland etc)
- 20% Japan

My current asset allocation is:
- 38% United States
- 38% Developed Europe
- 21% Japan
- 3% Other

Others include South & Central America, Emerging Europe, Middle East & Africa and Developed Asia. These other regions have not been deliberately chosen but are merely the by product of buying low cost funds that cover a little more than the regions I am interested in.
Sectors within these regions include energy, materials, industrials, consumer discretionary, consumer staples, health care, financials and information technology.

As always DYOR.

UK Property Market – January 2010 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 that in my opinion UK house prices are still overvalued by a huge margin. Yesterday the Nationwide reported that average house prices had risen from £162,103 to £163,481, a rise of 0.8%, in a single month pushing house prices to yet more highs of un-affordability.

Chart 1 shows the Nationwide Historical House Prices in Real (ie inflation adjusted) terms. The Real increase is much less than that reported by the Nationwide with prices rising from only £163,140 to £163,481 as the UK Retail Prices Index (RPI) also increased by a high of 0.6% in a single month.

This chart also demonstrates that compared to average earnings property is very expensive when a ratio is created of the 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 ratio stands at 1,172. If we were to return to that number the average house using the Nationwide Index would be £84,670. Will we ever get that low again?

Last month I questioned whether we may have been at the point of the ‘Return to “normal”’ phase kicking in. Chart 2 today highlights why I may have been early in my call. The red line shows the monthly average of UK resident banks interest rate of new loans secured on dwellings to households. I have taken the average of five data sets which are the floating rate, fixation <=1year, fixation >1year<=5years, fixation >5year<=10years and the fixation >10years. This interest rate had been as high as 6.3% in September 2008 (before the Bank of England panicked and lowered the Official Bank Rate to a record low of 0.5%) and then had reduced to a low of 4.2% by June 2009.

This has meant for new loans the average interest payable has reduced by a 1/3. So when a typical person walks in to a bank and asks for the maximum they can borrow the low interest rate is going to mean they can borrow more principle which will then push up house prices. The good news however is that even though the Bank of England has not moved, the Official Bank Rate the interest paid on loans is starting to increase from the low of 4.2% to 4.5% in November 2009. This will reduce affordability which unless peoples earnings start to increase should start to push house prices back down again and there is little the Bank of England can do unless they completely ignore inflation and drop interest rates even further or perform more Quantitative Easing. They clearly won’t be able to do this without risking a bond strike or hyperinflation however personally I do think they won’t raise interest rates even though inflation is rising quickly when they meet in a few days.

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 November 2009. It shows that the annual change in earnings is now around 1.4% which is significantly less than the Retail Prices Index (RPI) and the increases being seen in house prices.

So in summary house prices are increasing in nominal and to a lesser extent in Real inflation adjusted terms. However in my opinion I suggest that these increases will be short lived. Salaries are increasing at a rate which is less than both inflation and house prices. Bank mortgage rates are starting to increase from their lows which will reduce the level of principle that can be borrowed. The Bank of England and government are powerless to do anything about it without risking the country as a whole. The only fear I have now is that the Bank of England holds interest rates allowing inflation to rise quickly (I think they will) resulting in nominal house price increases but stagnation in Real inflation adjusted house prices. This will be dependent on whether salaries start to increase in line with inflation. The private sector doesn’t seem in a position to do this however while government borrowing is at record highs I fear the government will listen to the Unions requests for big increases as they have an election win to try and buy.

For now I’m staying out of the housing market.

As always DYOR

Assumptions:
LNMM data is extrapolated for December ’09 and January ’10.