Tuesday, June 15, 2010
Last night's UK RICS Housing Survey pointing to further strong gains in UK House Prices (see below chart) has left Team Macro Man collectively scratching their heads and is certain it is not alone in wondering why the fortunes of the UK housing market ("it's aliiiiivee!!!") have been so different to those of the US (which looks a bit like this parrot). Now, Team Macro Man does not possess a uniform view on this and would like to invite readers to present their own views in the comments, but for the sake of actually writing something today, will make an attempt to explain why UK House Prices are bid and may not actually have been as bubble-like as those in the US...Obviously, this latest jump can be blamed on HIP replacements planned by the new government, but even after that the balance is still pretty high. The first place to start is home affordability - in this case, the House Price-to-Earnings ratio (see chart below, white line), which obviously hit pretty bubblesque levels of 4.8x earnings in late-2007 before plummeting a low of 3.55x in mid-2009, but seems unable to plumb the "undervalued" levels of the mid-90s. Perhaps the answer here is the currency, London and the Eurozone crisis? Team Macro Man has heard many reports of strong interest from Europe, the Middle East, Russia and even China. The orange line in the below chart shows the house price-earnings ratio scaled by the EUR/GBP FX rate in order to see the attractiveness in EUR terms to Giorgio & Giuseppe, and you can clearly see it got to the "undervalued" levels and still hovers around the long-run average. While that's there, the foreign money will come into the top end of the market and drag everything else up...Team Macro Man was always taught never to underestimate the US Consumer, as they will always find some sort of bubble to finance their spending. The below chart shows Mortgage Equity Withdrawal (MEW - white line) and US Consumption growth (orange line): in the 1990s, consumption was first financed by the equity bubble, but from 2001 until 2008, in order to keep buying those Plasmas & Priuses, Joe Public took increasing amounts of equity out of his house, as can be seen by the correlation between the two series over that time period.
Now the Team has also been taught never to underestimate the stupidity of the UK Consumer, so they must've done the same, right? Err, no... guess there aren't as many hippies in Islington as there are in San Francisco. In the UK, while there was a similar amount of MEW (chart below, white line), it doesn't appear to have gone on consumption (orange line) at all, and there is very little relationship between the two series - in fact, consumption was actually quite a bit *lower* during the "bubble" than it was in the 1990s - until the economy fell off a cliff late-2008. So by definition this money must have gone into saving, and the only way to square that is inter-generational wealth transfer: young people taking on debt to buy their first houses and old people selling those houses to them, downsizing and booking the cash for their retirement. Now, that might not be a particularly socially cohesive situation to be in, but it doesn't imply that house prices are overvalued (once the government has taken its slice, that cash gets returned to the younger generation via inheritance).
For all the media talk of a buy-to-let-driven property market, the numbers still don't stack up. If that were the case, then you'd expect rental yields to have sharply fallen and though they have (chart below, rental yield index - white line), a quick comparison with 3yr Real Gilt yields (using trailing 1yr RPI, orange line) shows that this isn't really out of line with other assets. Perhaps the real answer is that real yields are plumbing 60yr lows... in which case, the answer to Bernanke's question about why Gold is going up is: "it's real yields, stupid!".
So given the persistence of UK inflation, perhaps Merv' is behind Joe Public's curve? Buy housing, sell Jun11 Short Sterling...
Talking about where property prices are going next is probably as contenious with our readers as mentioning Apple vs the rest of the world. But in this case, we really would like to hear the dichotomy of your views!