Geopolitics and Housing Costs
Geopolitics
I've been told repeatedly over the last few months that there is world chaos, higher geopolitical risk, there is going to be more volatility and the world more macro driven. Markets have gone up and many trying to sell doom and gloom in droves over the last few months.
I question, does this matter? Lots of noise but what actually moves the needle?
Everything still goes on, geopolitics and chaos has always existed, and why should this change the outcome for earnings across the biggest businesses in the world?
We live in a lucky country so if something geopolitical won't stop you going into work tomorrow, then does it really matter?
Who cares about geopolitics!
We haven't had our average -10% market pull back yet this year, in my view that's what investors should be more focused on with regards to their portfolio and positioning!
How did you go bankrupt?
"Two ways. Gradually, then suddenly." per Hemingway.
His quote probably speaks to many trends that everyone looks at and talks about. But I think recognising a problem doesn't necessarily mean the trade exists when you observe a market issue. Some examples:
- The Japanese Yen troubles were predicted for decades, but the weakening has really only kicked in as inflation rears its head.
- A Chinese property bubble was covered for a decade before finally imploding.
- We all know about the US fiscal deficit but are the loud noises about this problem enough to justify a trade?
We can recognise the US deficit problem today, but does that mean you avoid investing in the US right now or try to make money from this trade somehow? And if you're reading this, I suspect you're overexposed to the US anyway through your global equities exposure.
Things happen gradually then suddenly.
I'm yet to be convinced that the deficit issues become a sudden problem in the near term, especially as the economy pumps along and profitability continues to increase. Is the US going bankrupt? Maybe gradually but definitely not suddenly. And being bearish doesn't pay well!
Housing costs
Implication is that the base cost of construction is up approximately 30%+ depending on region. Across Australia data is shown below (between 31%-34%). This is also largely reflected in the US cost of construction which is up 40% despite the US having a more mobile workforce.
My working theory is that as the cost base for every property has increased, the increase in home values is completely justified as replacement costs are 40% higher today and in some scenarios, home values have not caught up yet.
The other thing I'm beginning to think is that the rise in house prices to date is purely due to cost push pressures, not a demand side pull which we will see as new housing stock diminishes and population increases.
I think this is an important data point to acknowledge when thinking about house prices. Prices of homes being up 30-40% from Mar-2020 is somewhat justified with the increase of input costs and the higher cost of replacement of homes today. Also, that any anchoring of property values and construction costs to 4 years ago is not reasonable.
Details below:
Based on the RBA, the new dwelling investment deflator is a good indication of the cost of building a new home:
From Covid (Mar-20):
- Cost of alterations and additions +34.3%
- Cost of new homes +31.5%
Really important to note that once the investment deflator rises (i.e. cost of construction increases), any relief is short lived and the new level of prices is very sticky. I.e. the costs never go backwards.
US data is largely true for the Australian experience too: Cost of construction is +40% across the board.
