Fresh back from a whirlwind trip to Adelaide to see Victoria smash South Australia in cricket and watch the Tour Down Under up close, your editor finds the financial markets in a state of acute anxiety, while investors, according to a survey, are keeping on the sunny side of life. Reality is keeping a low profile these days. But let’s see if we can find some clues about where he’s hiding out.
He (Mr. Reality) left a calling card in New York on Friday, that’s for sure. Stocks in New York fell 2.09% on the Dow. Wall Street has realised that it’s become the political whipping boy for a President who needs a popular enemy. It’s all probably a bunch of bluster to get the President some political momentum.
But if anything has momentum, it’s the volatility index. It’s up 55% in the last three days (see chart) The VIX measures implied volatility on the S&P 500. It’s nominally a measure of the cost of options on the U.S. exchange. It goes up when uncertainty increases. It does that because options are a way of hedging against future outcomes (positive and negative). When the future becomes more uncertain, the cost of insuring against it (at least in the stock market) goes up.
It’s all basic supply and demand really. But in this case, demand for uncertainty insurance is rising because the supply of uncertainty is soaring. The U.S. economy, the Japanese economy, the European currency, the Chinese bubble, the Australia resource super cycle…these are all part of the complex adaptive system that is the global economy. Hmm.
84% of Australians think house prices will rise in the next twelve months, according to the January Westpac-Melbourne Institute Consumer Sentiment Survey. Mr. Reality is clearly giving these Australians a wide berth. Twenty one percent of those surveyed believe house prices will rise by 10% or more in the next twelve months.
Doing a little back of the envelope math, and if our calculations are correct, a $450k property compounding at 10% a year for 10 years would turn into a $1.16 million dollar property. It would be a gain of 160%. And one million dollars would be the new median house price in Australia.
Now you have to assume a lot of income growth from here for affordability to remain the same with house prices at those levels. Or you’d have to assume much lower interest rates. That would be a stupid assumption, though, given that interest rates are headed up at the moment, and that we are likely at the low end of the interest rate cycle.
Perhaps the 21% of people believe house prices will go up by 10% a year are all real estate agents and bankers. Or perhaps they are functionally illiterate in the financial sense. Either way, it’s a large percentage of people surveyed to believe such clap trap. It’s this kind of belief that is the rocket fuel for the blow off stage of a bubble.
But we’re not going to win that debate this week. We’d just like to point out that this is whole point of the Daily Reckoning really, to scrutinise received thinking and conventional wisdom. Whether it’s the housing bubble, the economy, or global warming, your best defence against a world full of bogus thinking is to question it.
Of course that doesn’t mean you’ll always be right. For example, we’re obviously not a climatologist. The mail bag was full of some choice words for the comments we published last week (Burn More Coal). The polite synopsis is that we were told to stick to our knitting.
But calling out mainstream thought IS our knitting. And climate change is fair game because the financial stakes are extremely high. Indeed, all the stakes are high (political too). We’re not going to rehash the argument here. However, if you don’t like uncomfortable ideas, don’t read them!
Don’t worry though. We will say, yes, most of the time our beat here is investing. And there is plenty to think and write about on that score. So we’ll get back to the main game this week. Until tomorrow!
Dan Denning
for The Daily Reckoning Australia
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