What do falling house prices mean for equity investors?

October 19, 2018

 

Leading economists have all tipped that the housing markets in all major cities will fall. Despite years of low interest rates – good for mortgage holders but not so good for retirees – many people will find themselves in a home where not much equity is held.

 

So why have house prices fallen and what lessons can be learned from this?

 

There are too many reasons to list in this short piece but some of the factors include:

 

  • Banks being under pressure from regulators to tighten their lending standards. Less people buying = lower prices (just like the share market)

  • Rising supply, especially in the apartment space. More product on the market with fewer buyers = lower prices (just like the share market)

  • Interest only loans being switched to principal and interest loans. More expensive associated costs = lower prices (just like the share market)

  • The unknown issue around what the government will do around Capital Gains Tax and negative gearing. Uncertainty and an inability to plan = lower prices (just like the share market)

 

The media has been writing about this for some time but investors must remember that all markets operate in cycles.

 

In equity terms, what part of the cycle are we in now?

 

We all know we are in a bull market at the moment and as we approach the end stages of the cycle we will see low levels of unemployment (employment figures released on Wednesday quoted the current number at 5%, the lowest level since April 2012), higher cash rates and a flattening yield curve.

 

So what stocks fare better in this environment?

 

At the end of September, the Glennon Small Companies Limited (ASX: GC1) portfolio was made up of the following sectors:

 

Although we are overweight industrials, our stocks in this sector (such as Alliance Aviation, CML Group and Emeco) are all up on our average buy-prices.

 

Traditionally, technology stocks do better earlier in the cycle but using past assumptions for this ever-evolving (and increasingly needed) sector just doesn’t cut the mustard anymore. We feel an 8% weighting at this time is appropriate.

 

Many of our holdings are what we consider to be all-weather stocks, meaning they will fare somewhat equally regardless of the economic cycle. This is due to the proprietary way in which we analyse each stock – both pre-purchase and consistently thereafter - which considers a multitude of factors and ensures that our purchase/holding price is less than what we believe to be the true value. The margin of safety this creates should be reassuring to our investors regardless of what is at play in the economy.

 

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