Asia/Pacific: Global Property Cycle Turns Down
Andy Xie (Hong Kong)
Summary and conclusions
The most important force in the global economy in the past five years has been the synchronized property boom. The demand spillover from the property boom has supported corporate earnings and, hence, equity markets through its effects on consumption and investment. The commodity boom also depends on its demand spillover.
It appears that all major property markets have peaked (Japan is the notable exception but may not be far behind). Inflation is picking up simultaneously around the world. As long as inflation remains a concern, major central banks are likely to raise rather than cut interest rates over the next 12 months. Overvaluation is already weighing down the global property cycle. Rising interest rates put it on a downward trend.
Even if there is a soft landing, the global economy is likely to surprise on the downside in 2007. Considering how fast and high the property cycle has risen, a burst is possible, which could cause a global recession in 2007.
Global financial markets have not woken up to the fragility of global demand that supports corporate earnings and demand for commodities. As global property turns down, commodity demand and corporate earnings are likely to surprise on the downside in 2007.
The global property cycle
The world has experienced a synchronized property cycle. Los Angeles, London, Mumbai, New York, Shanghai and Sydney have all seen property prices surge. Of course, not every city has joined the boom. We can call it a global cycle as major cities around the world that determine their national economic strengths have experienced the boom at the same time.
A property boom is usually a local phenomenon. A national bubble, let along a global one, is rare. Why has it happened? Is it just a coincidence that all the major cities have had a property boom at the same time?
Three factors have led to the global property bubble. First, property financing has become part of the global financial system. As part of globalization, mortgage products are being sold around the world, which has increased the correlation of property markets around the world.
Second, deflation shocks have allowed major central banks to sustain super-loose monetary policy. The resulting excess liquidity has surged into mortgage products and decreased property financing cost at the same time around the world.
Third, institutional property investors have become a significant portion of the global financial system. They have been able to shift capital into different cities according to relative valuation. Their behavior has increased the correlation of property markets around the world.
In short, the changes or innovations in the global financial system have led to a rising correlation of property markets to each other and to central bank policies. It has essentially turned deflation shocks of the past decade into a global property bubble.
Property downturn means global economic downturn
The mechanism for monetary stimulus to turn into demand in this cycle has been through property. Rising property construction is an important source of job creation. The wealth effect on consumption has also been very important in many economies (e.g., Australia, India and the US). Property could explain most of the above-trend growth in the global economy in this cycle, I believe.
As the global cycle turns down, the global economy could experience a period of below-trend growth symmetric to the above-trend growth in the past. My guesstimate is that the property bubble exaggerated the global growth rate by one percentage point in 2004 and 2005. The global economy could experience a 3% growth rate in 2007-08 on average.
Significant risk of global property hard landing
Property bubbles rarely have soft landings. The market consensus for a soft landing is expecting the exceptional. The market confidence for a soft landing stems from its enormous confidence in major central banks to fix problems.
Global property value has inflated enormously since 2000. US housing value rose to 173% of GDP in 2005 from 135% in 2000, Australias rose to 347% from 271%. If data could be collected for China and India, similar trends could be observed.
If the ratios between property value and GDP should go back to the 2000 level or even the 1997 level, it would involve significant price declines. If the market were rational, there would be a rush for the exit and steep price declines, causing a hard landing for property.
The seemingly soft landing in Australia and the UK in the past two years has lulled investors into believing that other markets will follow the same pattern. The difference is that these markets began to soften in a strong global economy. In my view, the global economy has peaked out and could provide little support for growth engines like China and the US when their property markets turn down.
If the global economy does experience a property hard landing, the global economy could experience a recession in the next two years, while average growth could still be 3%.
The cyclical bear market is here
The bear market for global property is at the heart of the bear market for other asset classes. The global property bubble has been a major factor in strong corporate earnings. For example, it has supported western consumers to spend without wage growth. As a result, the share of corporate earnings in GDP has risen across the world. When the ratios of property to GDP normalize, the ratios for corporate earnings to GDP should also normalize.
I believe that earnings expectation will be revised down substantially in the next six months. The most vulnerable sectors are financial and material sectors. The former has benefited from high credit growth due to the property and liquidity boom, the latter from commodity inflation.
Bonds are the first asset class to turn down in this cycle and remain a sell, in my view. Bonds were mispriced in the past five years, mistaking super-low inflation as permanent. The yield on G7 bonds could rise by another one percentage point.
Emerging market currencies have also entered a bear market. Ex-China and oil exporters, emerging economies have net foreign liability of $2.3 trillion. Much of the liability is liquid in stocks and bonds. As the risk reduction trade continues, part of the foreign money will be pulled back into the G7 economies.
Turkey appears to be the first emerging economy in a liquidity crisis. Several more could follow. The easy liquidity lulled a number of emerging economies into depending on portfolio inflows to fund their consumption through consumer credit. As the inflow stops, these economies will have to raise interest rates substantially to curtail their consumption.
Andy Xie (Hong Kong)
Summary and conclusions
The most important force in the global economy in the past five years has been the synchronized property boom. The demand spillover from the property boom has supported corporate earnings and, hence, equity markets through its effects on consumption and investment. The commodity boom also depends on its demand spillover.
It appears that all major property markets have peaked (Japan is the notable exception but may not be far behind). Inflation is picking up simultaneously around the world. As long as inflation remains a concern, major central banks are likely to raise rather than cut interest rates over the next 12 months. Overvaluation is already weighing down the global property cycle. Rising interest rates put it on a downward trend.
Even if there is a soft landing, the global economy is likely to surprise on the downside in 2007. Considering how fast and high the property cycle has risen, a burst is possible, which could cause a global recession in 2007.
Global financial markets have not woken up to the fragility of global demand that supports corporate earnings and demand for commodities. As global property turns down, commodity demand and corporate earnings are likely to surprise on the downside in 2007.
The global property cycle
The world has experienced a synchronized property cycle. Los Angeles, London, Mumbai, New York, Shanghai and Sydney have all seen property prices surge. Of course, not every city has joined the boom. We can call it a global cycle as major cities around the world that determine their national economic strengths have experienced the boom at the same time.
A property boom is usually a local phenomenon. A national bubble, let along a global one, is rare. Why has it happened? Is it just a coincidence that all the major cities have had a property boom at the same time?
Three factors have led to the global property bubble. First, property financing has become part of the global financial system. As part of globalization, mortgage products are being sold around the world, which has increased the correlation of property markets around the world.
Second, deflation shocks have allowed major central banks to sustain super-loose monetary policy. The resulting excess liquidity has surged into mortgage products and decreased property financing cost at the same time around the world.
Third, institutional property investors have become a significant portion of the global financial system. They have been able to shift capital into different cities according to relative valuation. Their behavior has increased the correlation of property markets around the world.
In short, the changes or innovations in the global financial system have led to a rising correlation of property markets to each other and to central bank policies. It has essentially turned deflation shocks of the past decade into a global property bubble.
Property downturn means global economic downturn
The mechanism for monetary stimulus to turn into demand in this cycle has been through property. Rising property construction is an important source of job creation. The wealth effect on consumption has also been very important in many economies (e.g., Australia, India and the US). Property could explain most of the above-trend growth in the global economy in this cycle, I believe.
As the global cycle turns down, the global economy could experience a period of below-trend growth symmetric to the above-trend growth in the past. My guesstimate is that the property bubble exaggerated the global growth rate by one percentage point in 2004 and 2005. The global economy could experience a 3% growth rate in 2007-08 on average.
Significant risk of global property hard landing
Property bubbles rarely have soft landings. The market consensus for a soft landing is expecting the exceptional. The market confidence for a soft landing stems from its enormous confidence in major central banks to fix problems.
Global property value has inflated enormously since 2000. US housing value rose to 173% of GDP in 2005 from 135% in 2000, Australias rose to 347% from 271%. If data could be collected for China and India, similar trends could be observed.
If the ratios between property value and GDP should go back to the 2000 level or even the 1997 level, it would involve significant price declines. If the market were rational, there would be a rush for the exit and steep price declines, causing a hard landing for property.
The seemingly soft landing in Australia and the UK in the past two years has lulled investors into believing that other markets will follow the same pattern. The difference is that these markets began to soften in a strong global economy. In my view, the global economy has peaked out and could provide little support for growth engines like China and the US when their property markets turn down.
If the global economy does experience a property hard landing, the global economy could experience a recession in the next two years, while average growth could still be 3%.
The cyclical bear market is here
The bear market for global property is at the heart of the bear market for other asset classes. The global property bubble has been a major factor in strong corporate earnings. For example, it has supported western consumers to spend without wage growth. As a result, the share of corporate earnings in GDP has risen across the world. When the ratios of property to GDP normalize, the ratios for corporate earnings to GDP should also normalize.
I believe that earnings expectation will be revised down substantially in the next six months. The most vulnerable sectors are financial and material sectors. The former has benefited from high credit growth due to the property and liquidity boom, the latter from commodity inflation.
Bonds are the first asset class to turn down in this cycle and remain a sell, in my view. Bonds were mispriced in the past five years, mistaking super-low inflation as permanent. The yield on G7 bonds could rise by another one percentage point.
Emerging market currencies have also entered a bear market. Ex-China and oil exporters, emerging economies have net foreign liability of $2.3 trillion. Much of the liability is liquid in stocks and bonds. As the risk reduction trade continues, part of the foreign money will be pulled back into the G7 economies.
Turkey appears to be the first emerging economy in a liquidity crisis. Several more could follow. The easy liquidity lulled a number of emerging economies into depending on portfolio inflows to fund their consumption through consumer credit. As the inflow stops, these economies will have to raise interest rates substantially to curtail their consumption.
