Thursday, 21 March 2013

The Wealth Effect... and why now is the time to invest.

And perhaps more so now than anytime prevoiusly in our lifetime.
Here are the comments from an industry expert:
"Have you felt  the (Wealth Effect) lately?
The wealth effect... Do you know what the hell I'm talking about?'s not a bad thing, actually a pretty good, more than just a warm and fuzzy feeling. Please explain?
I will shortly.  But first...

Everyone knows I'm bullish on house prices this year.

The cycle has already turned, and the housing market is quickly gathering steam. It's a pretty common view now that 2013 will be a good year for capital growth, particularly through the second half of the year.

But at the same time I've been making it pretty clear in these posts that I don't see interest rates going anywhere anytime soon.

Someone asked me about this the other day. How do you square these two away? Normally if house prices are rising the RBA is gearing into a tightening cycle. Won't that be happening this time around?

That's a very good question. I'm glad you asked.

The answer is, No. Not this time. Interest rates will start edging up at some point down the track, but by then, house prices will be long out the gate.

Such sweet conditions like these don't come around every day. House prices are rising fast and interest rates are stuck on a super-stimulatory setting... But this can't go on forever either!

So how did we get here? To understand it, we need to pick apart the connection between house prices and interest rates a little bit.

In normal times, by which I mean the pre-GFC era, if house prices were rising quickly then interest rates were rising too. The lynch-pin was consumption.

It's called the 'wealth effect'. The basic idea is that if house prices were rising, households felt wealthier, and felt more inclined to consume.

And as consumption ramped up and the economy found another gear, the RBA started to get worried about inflation, and started pulling on the interest rate hand-brake.

That's "normally" how it goes. (Though when have things ever been truly "normal"?)

The actual size of the wealth effect is difficult to pin down. However, researchers at the University of Sydney published an interesting paper a few weeks ago that found that for every $100 increase in house prices, annual household consumption increased by around $8. The Fed published some similar numbers for the US.

So, say you had a house worth $300,000, and it increased 5 percent in value. That extra $15K in equity would, by itself, increase annual consumption by around $1200.

So, in the old world, rising house prices were a solid plus for the economy, and sooner or later, the RBA would try and throw ice on the party.

But that's how it used to be. It won't play out this way this time round.

One of the key findings from the USyd paper was that rising house prices increased consumption because they helped "relax household credit constraints".

That is, households who found they had more equity in their home often used it take on more debt, which helped fund higher consumption levels.

But following the GFC, attitudes to debt have done a full 360. Around the world actually.

People have become a lot more hesitant to take on more debt, especially to fund non-productive consumption of plasma TVs and so on.

In a speech a couple of days ago, RBA Assistant Governor Phil Lowe noted that Australian households were net dis-savers in the lead-up to the GFC, but are now saving more than 10 per cent of their disposable income.

That amounts to $90 billion a year that is now being saved, rather than spent.

This chart here, (taken from a speech by ex-BHP head Don Argus) shows just how much the game has changed.

Through the 90s and up to the GFC, household debt, as a percent of GDP, increased from a little under 50 percent to a peak of around 110 percent. Since the GFC though, it's pretty much been tracking sideways.

But with a household to debt ratio of over 100 percent, Australia still has the most indebted households in the OECD, and where debt ratios have come down across the world, they remain elevated in Australia.

This suggests that households are likely to continue deleveraging into the near term. And if house prices are rising, households will be using this increasing equity to pay down debt, rather than funnelling it into consumption.

All of which makes the wealth effect a thing of the past.

So imagine that the RBA keeps rates at record lows, but Australian business doesn't take the bait. Perhaps they're scared of the damage the high Aussie dollar is doing, and are reluctant to invest.

In that case, record low interest rates are feeding straight into asset prices, as people take the cheap and easy money and invest it in profitable assets, like property. The wall of money creates a super-surge in property prices.

But without a wealth effect, there's no pick up in consumption, and the 'heat' in the economy is unchanged.

The RBA then has no reason to raise rates, because there'll be no signs that the economy is over-heating. And an uncertain foreign situation will make them extra wary of pulling the trigger too early.

So until households deleverage back to more comfortable levels, and consumption picks up again, the main beneficiaries of record low interest rates are going to be the owners of assets - particularly property.

And so what we have, and what I reckon we'll see over the next 18 months or so, is a massive disconnect between property prices and interest rates...

... and this creates an incredible window of opportunity for investors.

You'll be enjoying a massive ramp up in capital, while your funding costs, tied to interest rates, will remain on the cheap.

Who could ask for more?

These are uncharted economic times. The rules of the game are changing. But that doesn't mean that there isn't money to be made, if you know what you're doing.

Stick with me. I'll show you where these opportunities are hiding.

Signed with Success,
Jon Giaan
Knowledge Source

 GIVE ME A ALL CALL... if you would like to know how and where to make the best of this opportunity.
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Graeme Clark

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Tuesday, 12 March 2013

A nice little story about Stamp Duty... if there is such a thing

Hi Graeme,

Look I don't mind paying tax... Really.

Yes seriously! I figured out many years ago that the more tax I paid, the more wealthy I am from an asset and wealth perspective.

So in effect I love paying tax... and looking to pay a lot more in the future.

But, there is one tax that is absolutely crazy and it is quit frankly holding the economy, first home buyers and property investors to ransom.

It's the stupid tax called, stamp duty.

But there is light at the end of the tunnel and its from a very unusual source.

 The ACT government, that hot-bed or radicals, has announced that it's going to phase out stamp duty on property transactions over the next 20 years.

Good on 'em. This will be good news for the property market, but the stamp duty on property itself is a stupid tax, and it's about time the States broke their addiction with it.

If you ask me, Stamp Duty on property is the Cane Toad of Australian taxation.

Cane Toads were brought over from South America to eat the Cane Beetles in Queensland. As it turns out, the beetles in Queensland lived up in the cane, rather than on the ground like they did in South America. So it's questionable as to whether the Cane Toad ever actually ate a single Cane Beetle.

But once cane toads were introduced, they quickly slipped the leash of their handlers. Now they've become a monster completely beyond anyone's control.

In a compelling parallel, Stamp Duties as a concept were first introduced in the Netherlands all the way back in 1624. It soon spread in popularity among the European aristocracy, always fond of finding new and creative ways to crush and punish the peasants. William and Mary started levying stamp duties in the England in 1694 as a way of funding the war with France.

In time, stamp duties were passed down through our legal DNA until 1886, when NSW introduced a stamp duty on property as way of funding a war with Victoria over the right to play rugby...seriously, google it.

But likewise stamp duties have long since slipped the leash of their handlers, and they have become a monster completely beyond anyone's control.

Now this isn't a rant against taxes in general. I can see that in the modern world, taxation and the public provision of some services is a good thing.

...and I said it earlier, I love paying it!

But some taxes are better (less bad?) than others, and the stamp duty on property is about as bad as it gets. It is a stupid and inefficient tax that is holding the property market back from its full potential.

I say it's time to crush this cane toad once and for all.

My biggest gripe with the stamp duty on property is that it becomes an incredibly prohibitive upfront cost. If you're looking at a bill of $20-30,000, particularly on your first home, this can really take the wind from your sails.

And for what? The Cane Toad started out as a simple filing fee - a small cost to have your documents branded with the governments stamp and become legally recognised.

Now I know the public service is inefficient, but you can't tell me that $20,000 is a reasonable fee to pay for processing - particularly since they phased out actual stamps!

I mean, one study found that the stamp duty in NSW accounted for about a quarter of upfront costs, including deposit, moving costs, and legal work.

The property market relies on a constant supply of new entrants in the housing market, beginning their journey from entry-level homes into the palaces of their dreams, to keep things kicking along.

We should be doing everything we can to encourage them. Slugging them with a massive fee, just to get started, is an incredibly stupid idea. If it wasn't part of our legal and cultural heritage, there's no way you could get anyone to buy into such a blunt and damaging tax today.

The crazy thing is that it's not that great for the government either. Since it is a marginal tax, the fee is determined on the value of the property. However, the amount of revenue the government actually receives is a function of property values and the volume of property transactions in a given year.

Trouble is, the volume of transactions can swing wildly. I remember back in 2007 and 2008. The number of properties sold in Sydney fell a massive 19 percent. As a result, the amount of stamp duty raised in NSW fell 30 percent, smashing a whopping $1.2 billion hole into the budget.

So what this means is that in the presences of cycles (which are an constant feature of the housing market), the stamp duty needs to be higher than it otherwise would be, to compensate for the years when volumes, and revenue, fall.

It's just adding worse to bad...

The other trouble with stamp duty is that it is a transactional tax. In the principles of efficient tax design, you always try to minimise the impact on the number of transactions taking place.

(The obvious exception is the case where you're targeting a particular 'bad', such as smoking for example, where the point is to actually reduce use.)

But otherwise, economic transactions are the very life-force of the economy. In general, you want to keep the engine as lubricated as possible.

A big fat ugly stamp duty on selling your home, creates a massive obstacle for efficient market functioning. And the downsides of these market inefficiencies can play out in all sorts of way.

Not only does it deter new entrants to the market, as I said before, but it also stops the market adjusting to changes in conditions. Say for example the kids move out and your thinking of moving into something a bit smaller, closer to the beach. Or you get a new job on the other side of town.

Or maybe you feel a bit overstretched on your current mortgage and want to wind it back a bit.

A transactional tax like a stamp duty will mean that people hold off on making these decision for longer than they otherwise would have. The market is slow to react.

And when a market is slow to react, boom and bust cycles become exaggerated, which, as I said, exaggerates swings in government revenue.

So the case against is pretty compelling. The real trouble though is that the States are completely hooked on licking the cane toad. Stamp duty now accounts for about a full third of State taxation revenue every year.

That's why the ACT is giving itself a good twenty years to slowly wean itself off the habit.

Thankfully, there are other options. The 2010 Henry tax review suggested shifting more weight to existing land tax regimes, and scrapping stamp duty altogether.

Land tax avoids a lot of the traps stamp duty falls into. In particular, the same amount of revenue could be spread over the life of property ownership, rather than being front-loaded into the purchase price. This would therefore improve affordability and take some of the burden off first home buyers.

But whatever the case, the other states need to follow ACT's lead and break their addiction to property stamp duty.

And then perhaps we can be rid of this ugly cane toad once and for all.

Signed with Success,

Jon Giaan
Knowledge Source

Wednesday, 6 March 2013

Big Money is Moving ...and you'll be shocked where it's going!

Las Vegas.

Proof that all that glitters ain't gold.

Elvis impersonators, flashy lights, pretty girls with costumes made up of more feathers than fabric... it's got it all.

And every casino in Vegas is crammed to the rafters with suckers looking for an entertaining way to throw all their hard-earned money away.

You roll past the poker, the black-jack, the roulette wheel. But hang on, who's that over there? It is! It's Warren Buffet!

What's he doing in Vegas? You don't become the world's third richest man by backing a rigged game - unless you know the game is rigged in your favour.

And who's that sitting next to him? It's old boy Larry Fink, the chief of Blackrock - the largest money-management firm in the world. And to his left is John Angelo, from Angelo, Gordon and Co.

Together, these guys control more wealth than many nation states. So what are they doing in Vegas? What game are these guys backing?


What, are they crazy? Everybody knows the US property market is a disaster zone. Sure, there have been some solid signs lately, but property prices nationally are still 30% lower than they were at the peak almost 6 years ago, way back in mid 2006.

And a lot of Americans still find themselves financially deep underwater.

But as you're scratching your head, you remember the golden rule of investing.

Buy low, sell high.

And that's exactly what these guys are doing. If you follow the big money in America right now, it will show you that the serious investors believe that the property market has bottomed, and we're launching into an upswing dynamic.

And if you follow the scale of funds being directed into property, it tells you that these guys believe that a lot of property markets over-corrected in a big way in the downturn. That is, prices fell too far and a lot of high-performing properties are massively undervalued.

Las Vegas is a case in point.

In the run up to the housing peak, Las Vegas and Nevada led the country is housing construction, and it was one of the hottest housing markets in the country.

Then the bubble burst.

Between 2006 and early 2012, house prices in the city of lights fell a staggering 62%. It was the biggest fall in any US metropolitan centre, and the real estate market was smashed to pieces.

But while it was clear that prices were over-valued before the crash, prices seem undervalued now. A lot of people got very badly burnt in the crash, and as the saying goes, once burnt, twice shy. This is keeping a lid on demand for what are now, very cheaply priced homes.

And this gap in demand is being filled by Buffett and the boys. They know that the market has overcorrected on the down-side - and there are some awesome bargains to be found.

And so large investment funds have been snapping up land and properties in Las Vegas and other cheap markets across the country. They've also been very active in the foreclosed property market, where they've been snaffling up some incredible bargains.

They're not bound by sentimentality and fear, and just see an investment for what it is - the promise of a particular return at a particular price.

And though the eyes of a cold-blooded accountant, investing in US property makes a lot of sense right now.

This is all a classic play for Warren Buffett. He's not a short-term, get in and out quickly kind of investor. He's made his fortune by backing major macro trends, and keeping an eye on the big picture. He's a master at positioning.

And he's also done it by keeping a level head, and knowing when the market has lost touch with reality. He gets out when things are too hot and people are too excited, and he gets in when people become too pessimistic and the market is undervalued.

He zigs when they zag.

And this is just what he's doing in property. He's buying up bargains because people just don't trust property right now - for no good reason. Just fear.

Fear that the normal cycle in housing is somehow busted. That the good times will never return. Sure it was the mother of all downturns, but in Buffett's words, "housing will come back - you can be sure of that."

That's why Buffet has been aggressively bidding for billions of dollars of distressed loans and underwater properties. He's also buying up mortgage brokers and their loan portfolios, real-estate vendors, and even brick-making companies.

Brick-making companies.

He's going all out to take on a massive exposure to the US property market.

And will he be right?

Well, no one knows the future. But I can tell you one thing: no one has made much money betting against Warren Buffett in the past 50 years!

And while it does seem clear that some markets in the US are massively undervalued, there are also some tried and tested recovery dynamics on his side.

In a cyclical market like housing, it all comes down to supply and demand.

On the supply side, the crash knocked out a lot of supply. A lot of real-estate vendors and homebuilders went underwater. This is holding back the markets ability to respond to increasing demand, which therefore gets translated into increasing prices.

Sure, there was probably an over-supply of houses during the peak. But that was six years ago. The market is a lot tighter than what it was.

The other key factor is demand. The US economy is holding up and confidence is returning.  During the GFC, a lot of young people returned to the nest, creating 'doubled-up' households.

In 1985, only11 percent of 25-34 year olds lived with their parents. In 2010, that percentage had almost doubled to 21.6 percent.

I remember being 25 and I remember being 30. I guarantee you this is about economic necessity, not choice.

So as America's economic fortunes continue to improve, and as young people feel more and more financially secure, they'll be super-keen to head out on their own. They'll be eager to form a household of their own.

Between 2008 and 2011, America added an average 650,000 households a year. In the year to September 2012, that had spiked to 1.2 million households.

This translates into a huge pickup in demand. And with supply still constrained, that will quickly translate into an increase in prices.

These are the fundamentals that are pulling the big money to the table.

...and with that  momentum, remember you can't pick bottom. Well at least I can't.

But, I'm not silly enough not to recognise momentum and we now have it in the USA market.

You can sit on the side-lines and watch, be a spectator and miss yet another opportunity or you can get on your bike and pedal like crazy...

I know what I will be doing.

What will you do?

There is also a yield play, and an exchange rate play for Aussie investors, but more about that another time..

Signed with Success,

Jon Giaan

Independent, Insightful, And Profit-Driven Muses From
A Self-Educated Multi-Millionaire Investor, Jon Giaan