Trail 39 — House of Cards
Written by — Aashish Singh; Editor — Sylvia Lo
Risk sentiment recovered slightly this week but hawkish tone from central bankers continues to weigh on Markets. Bitcoin, a good gauge of risk sentiment (if nothing else), is around the $20K level, its previous cycle high. As monetary tightening intensifies, this support level will be tested. Bitcoin / Tech stocks / Meme stocks down 70%, Equities more broadly down ~20%. That should have impacted household wealth. But the household sentiment only really sours once housing starts to fall. The warning signs in real estate are flashing. Central bankers, mindful of what happens when leveraged investments fail, will look to avoid a deep correction in house prices. Scrapping of certain regulations such as affordability tests in England are attempts to counter the rate rise shock. But when you have valuations such as a $10 trillion Australian residential land value supported by a ~$2.5 trillion GDP, its akin to holding a mesh between a blower and a house of cards.
Separately, the Ruble hit the highest in 7 years despite sanctions, Germany warned of a Lehman like event in energy markets if Russia cuts off its natural gas supply to Europe and Investors cranked up bets on BoJ surrendering yield curve controls.
Right where he wants them
Federal Reserve Chair Jerome Powell believes that monetary policy is carried out through financial conditions, and for the time being he seems to like where they stand. As he told lawmakers Wednesday, “the market has been reading our reaction function reasonably well.”
That markets and the Fed are on the same page is good news for near-term volatility, but Powell’s words also contain a veiled threat: If financial assets recover too far from the recent selloff, he has ways of putting them back in their place. Investors adjust Powell’s dial at their own peril.
Stocks, Crypto down; Real Estate next?
The most excessive speculation has already been washed out of the system. Those warning of bubbles in bitcoin and other cryptocurrencies, meme stocks, or the growth tech companies owned by the ARK Innovation ETF certainly seem to have had a point. What we need to know is whether further accidents lie in the future. And that to a large extent depends on leverage. When unleveraged investments fall, the people holding them lose some of their wealth. When leveraged investments fall, companies and their lenders can go bust. The need to pay off the debt can prompt fire sales elsewhere. If there is one asset that should come under scrutiny, it is real estate, whose life blood is credit.
Frothy Valuations
As if economic policy makers around the world already didn’t have enough to worry about, here comes another: bubbly house prices are stoking worries of another crash. The most aggressive monetary policy tightening cycle in decades is slowing demand for homes, cooling prices, and in some cases already triggering material declines. New analysis by Bloomberg Economics shows that 19 OECD countries have combined price-to-rent and home price-to-income ratios that are higher today than they were ahead of the 2008 financial crisis — an indication that prices have moved out of line with fundamentals.
Scrapping tests
The Bank of England has been accused of putting first-time homebuyers at risk by relaxing its mortgage lending rules just as rising interest rates threaten to crash the property market. The central bank’s Financial Policy Committee said Monday it will scrap affordability tests from Aug. 1, making it easier for purchasers to borrow.
Charles Goodhart, a former rate setter at the BOE, said it’s “an extraordinary moment to relax affordability constraints” and that it looked like the BOE had come “under political pressure” to support government plans to increase home ownership.
Australia Land value to GDP
ABC finance host Alan Kohler has shared a “scary” chart to illustrate Australia’s housing bubble — likening the current situation to Japan before the “lost decade” crash that saw prices drop 70 per cent. “And finally another scary, depressing way to look at house prices in Australia,” Kohler said at the end of Wednesday’s segment. “As a percentage of GDP, all residential land in Australia is now worth more than all Japanese land was in 1989 — and that was one of the great bubbles of all time, followed by one of the great crashes of all time.”
Until next week.
Financial markets are fascinating, and I see them amalgamating the subjective and objective worlds. They are constantly evolving, follow no predetermined path and much like humans and society in general, their behaviour at most times is irrational. Yet, their day to day functioning is seemingly driven by facts and reasoning. They are filled with plenty of stories of triumph, tragedy and comedy. Every day they are thoroughly analysed and tried to make sense of. Yet, their future steps or directions cannot be predicted based on history. They follow a random walk. Therein lies their beauty.
If enjoying making sense of their randomness is as appealing to you as it is to me, each week, I briefly recap a few stories that captured my interest, with embedded source links available for those who wish to read more.
