Fergus and Judith Wilson: "Anyone with half a brain could do buy-to-let"

We are living in a different time where investors of buy-to-let is viewed as "evil landlords". Governments intend to control the rise of multiple home ownership so that prices can stay low enough for first time home buyers to jump on the ladder.

Going forward, commercial real estate, property development may be more profitable ventures.

Banks will still need to make a living lending money. It is their bread and butter, even more so ever since many central banks curb speculative activities of banks.

Banks also prefer secured loans, in order of financial assets first, real estate second. Financial assets are preferred over real estate because of the liquidity. However, the IRR for financial assets seldom surpass 10 - 15% because the loan to value ratio is usually no higher than 50%. If you are very good at investing in stocks and bonds, you can obtain 15 - 25% IRR. Anything higher will heighten the risk of margin call in bad times. For real estate it is easy to achieve 30 - 60% IRR, eyes closed. This is because 1) you can leverage up to 80% LTV without risking margin call, as long as you service your mortgages promptly. 2) you can add value to the property by making improvements such as an additional bathroom / room.

For stocks, you are a passive investor. You are hence like a surfer, riding on the wave with no control of where and when the wave goes.

However, there is another venture that can achieve over 60% IRR. It is to invest in companies in the Pre-IPO stage, developing the business and getting it ready for listing. I've known investors of Alibaba, and now Xiaomi, aiming for 100x return over 5 years. for example if you invested 100k in a venture, your stake can be worth over 10m in 5 years upon going IPO or through a reverse takeover (RTO). This represents an IRR of 151%! So there are ventures that are more attractive than property after all. It also doesn't require leverage so you are not at the mercy of banks. However, the risks are slightly higher.... About 25 - 50% of good businesses eventually fail. But if you hop on the right train, e.g. Xiaomi, Coassets (crowdfunding platform), Tripadviser,  you will see your wealth grow in large multiples.

July 11, 2014 3:41 pm

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‘Anyone with half a brain’ could do buy-to-let

By Emma Dunkley

©Rex

Property millionaires Judith and Fergus Wilson

Britain’s most renowned landlord never intended to own a thousand properties and plans to spend his retirement tending his lawn and writing more children’s books.

Fergus Wilson and his wife Judith announced this week that they were looking to sell their entire portfolio of homes in and around Kent, having previously tried to do so during the financial crisis.

 

The former maths teachers became the public faces of the buy-to-let revolution, but Mr Wilson, 65, told FT Money this week that they did not start with designs on such a grand portfolio. If anything, they were the ultimate accidental landlords. “We had a house to sell and another to buy, and so I thought with a fair wind, I could keep both at the time and rent one out,” says Mr Wilson. “But it wasn’t until the 1990s that I really started to grow the portfolio, attending property auctions. With the recession, prices started coming down.”

What really transformed things was the advent of buy-to-let mortgages in the mid-1990s. These provided cheap leverage for the Wilsons, who were easily able to acquire high loan-to-value, interest-only mortgages. “In early 2000, the main requirement for gaining a mortgage was the ability to sign your name – occasionally we ran out of ink,” Mr Wilson quipped. “It became a joke that mortgage providers gave you an upmarket pen. We had hundreds of them.”
 

As their properties started to appreciate in value, the Wilsons remortgaged again and again, drawing out equity and using it to buy more properties, mostly two and three-bed houses rather than flats.
“We used to collect them [houses] like stamp collectors,” Mr Wilson adds.

But in an era of tighter mortgage lending and suppressed yields, as rising capital values outstrip rental growth, would it even be possible for a landlord to build a similar empire today? “It will be far more difficult,” admits Mr Wilson. “But not impossible. Anyone with half a brain could do it.” (Given that residential property has become increasingly political, the future to real estate wealth could be in commercial properties).

However, he adds that his mathematical background certainly helped give him an edge; this is a man who used to lie in bed running through his 17 times tables. He also draws on maths and science to explain why he isn’t calling the top of the market, comparing the interplay between London and regional property markets to Archimedes’ principle. London is the proverbial overflowing bathtub, with displaced tenants and prospective homeowners spilling out all over the home counties. Satellite towns such as Ashford have benefited, especially because the town is on the high-speed HS1 rail link into the capital. “The market has not peaked, it will continue to rise,” he says. “Although Carney’s efforts will slow it down, I don’t expect it to fall.” (an acumen in maths and finance is important to be a successful investor).

So why sell now? Mr Wilson says he and his wife have wanted to exit the business for some time, but were unable to do so after the 2008 financial crisis caused a brief drop in house prices and a much bigger dip in transaction levels. “We battened down hatches,” Mr Wilson said. “From 2008 we didn’t sell any properties, and now we are looking to sell the whole portfolio.”

The couple are halfway through a six-month process to sell the entire portfolio. So far, professional football players, overseas investors and British pension funds have expressed interest. While Mr Wilson is keen to sell to the highest bidder, he hopes the portfolio will be sold to an onshore investor.

He aims to sell the whole portfolio complete with the tenants, many of whom have resided in the two and three-bedroom houses for ten years or more.

In terms of how the portfolio is positioned for sale, Mr Wilson said the loans amount to just under 60 per cent of the value of the properties. While he could not provide a specific yield, he noted his rental income for this year is around £12m. On sale of the portfolio, Mr Wilson expects to gain £200m before tax.

It has not all been plain sailing. The financial crisis didn’t just stop the couple selling the portfolio; it also caused cash flow problems for them and their tenants. By late 2008, the couple were left needing to finance around £350,000 a month in mortgage repayments at a time when many of their tenants were themselves getting into difficulties. (risks of buy to let). The Wilsons had factored in a maximum of 10 per cent of late payments in their cash flow planning, but in October 2008, nearly 40 per cent of tenants could not pay their rent.

The couple’s disputes with tenants have been well documented. This year, Mr Wilson sent 200 eviction notices to tenants on benefits. He has previously opined that eastern European migrants in work made better tenants than British citizens on benefits.

“What is the fix for those on benefits? Perhaps it is to get a job and come off benefits, and that will ensure a passport to being housed,” he wrote in an open letter this year. The Wilsons were thrown a lifeline in 2009, when the Bank of England cut its base rate to a 300-year low and their mortgage repayments fell with it. But that wasn’t the end of the mortgage issues. About half of their empire is mortgaged with Mortgage Express, once the buy-to-let arm of the Bradford & Bingley building society and now part of UK Asset Resolution, the state-owned vehicle set up to house the legacy business of B&B and Northern Rock.

Restore faith in pensions to fix the housing crisis

There has been speculation that the Wilsons are being pressured to pay back the loans in the view the rising market makes the portfolio ripe for sale, especially ahead of any increase in interest rates.
Mr Wilson says Mortgage Express came to be so dominant through the firm acquiring the loan books of other lenders – the couple are exposed to 14 lenders in total – and maintains that it “can’t call in” his loans.

However, he acknowledged that the aim of UKAR is to wind down the company and repay taxpayers by “helping” borrowers repay their loans or remortgage with alternative providers.
Since nationalisation, the lender has “been unable to extend mortgage terms” for interest-only customers, which could lead to repossession if landlords do not repay the full amount by the agreed date.

But Mr Wilson maintains that it is the meteoric capital gains over the past five years that have enabled the couple to exit at this opportune point in the market. “We’ve never made money like we’ve made in the last five years,” he said. “God knows how much we’ve made daily on capital value.”

So what next for the former maths teachers? Mr Wilson says he will tend to the lawn in his large house south of Maidstone, which he has “neglected” for a good few decades, and will also continue to write children’s books; he is the co-author of a series of books about Larry the Liger, a cross between a lion and a tiger created by a mad professor at a private zoo.
Although he’ll be sad to retire, he concedes now is an opportune time, even if the market has further to run.
-------------------------------------------
Who will buy it?

©Getty

Olympic Village, Stratford, east London

Rental property is an area of growing interest for pensions funds and other institutional investors seeking assets that deliver stable returns over the long term, writes James Pickford. However, many are focused on large-scale developments in single locations, such as the 1,439 flats planned for rent at the Olympic Village in Stratford, east London, by developer Delancey and Qatari Diar, the property arm of the Qatari sovereign wealth fund.

Andrew Allen, head of global property research at Aberdeen Asset Management, said there may well be keen interest in the market in the Wilsons’ properties, but it was not the type of portfolio that major institutions had recently been focusing on. “I suspect the majority of preferences for wholesale investors is to go for single blocks rather than a disaggregated portfolio.”

He added that any buyer would also need to take “a pretty strong view” about the future direction of UK house prices. “They are going to need to be comfortable with it because the residential market in the UK doesn’t produce high income.”

Alex Greaves, residential fund manager at M&G Real Estate, said the offer would attract interest since portfolios on this scale seldom came on to the market. “One of the challenges of the sector is trying to find critical mass.”

Nonetheless, he said it would be “a surprise” if it went to an institutional buyer, because of the risks of geographical concentration and the fragmented management demands of the portfolio.

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High Yield Bond Sector

Default risk of HY bonds will start to trend up in late 2016 onwards, all the way to 2018. This coincides with a global recession that I'm expecting either in 2016 / 17. There will be a dramatic increase in HY refinancing from 2016 onwards. Yields may spike even higher if the global economy is still chugging along slower. Also, with the Fed expected to hike rates from mid 2015 onwards, the higher geared HY issuers may feel the stress.

I will keep my tenors very short and try exposures to HY bond funds instead of individual bonds. Over 10 years, a good HY bond fund will achieve around 6% returns. The volatility is around half of equities, meaning I expect a drawdown of around 25 - 30% in the next crisis. But the recovery of value back to the peak will be swift, with most investors who bought at the peak and subsequently faced a crisis, able to reclaim the peak within 2 years. This is much better than the equity markets which on average took 6 - 7 years to reclaim the 2007 peak.

Why Are Riskier Bond Yields On The Rise?

Following the rise in riskier bond yields, we look at different segments of the high yield market to identify why this has occurred.

iFAST Research Team December 24, 2014

• 

Even as global bond yields have fallen in 4Q 14 so far (the US 10-year Government Bond yield declined from 2.49% at the start of the quarter to 2.15% presently, as of 23 December 2014), high yield bonds have not had a good run, with segments like Asia High Yield, US High Yield and EM High Yield all posting losses so far in 4Q 14 (as of 22 December 2014, see Table 1). Consequently, this has hurt the performance of funds invested in high yield bonds, with the FSMI – High Yield Bonds, an index tracking the average performance of high yield bond funds on the platform, posting a mere 1.8% year-to-date return after a -1% decline in 4Q 14 (as of 22 December 2014). In this update, we look at events which have driven the recent underperformance in the US and EM High Yield segments.

Table 1 - Year-to-date Performance of Riskier Bonds

	YTD*	First 3Q 14	4Q 14*
Asia IG	8.8%	6.8%	1.8%
Asia	8.1%	6.9%	1.2%
Europe HY	5.4%	4.8%	0.5%
EM IG	7.7%	7.3%	0.4%
IG Corporates	2.5%	2.6%	-0.2%
Global Bonds	1.8%	2.2%	-0.4%
EM HC	5.6%	6.9%	-1.1%
Asia HY	5.4%	6.8%	-1.3%
US High Yield	1.2%	3.5%	-2.3%
EM HY	0.1%	5.6%	-5.2%
Source: Bloomberg, *as of 22 Dec 14; returns in USD terms except for Europe HY in EUR

US High Yield

Investors have been fleeing US HY funds

With a -2.3% return in 4Q 14 so far (as of 22 December 2014), the US High Yield sector has not been a popular segment of the fixed income market in recent times, with Investment Company Institute data indicating that a hefty –USD 39.5 billion was withdrawn from high yield bond fund strategies over the past six months (May to October 2014, see Chart 1). Consequently, yields for the sector recently rose to some of the highest levels since 2012 (see Chart 2); the yield on the BofA Merrill Lynch US High Yield Master II was recently at 7.28% (as of 16 December 2014), significantly above the 2014-low of 5.16% registered in June.

Chart 1: US HY seeing sizable investor outflows

Chart 2: Yields have spiked

Energy has been the main culprit

The recent sell-off in US High Yield bonds has not been indiscriminate, but has been primarily due to weakness in the Energy sector which has been hurt by a precipitous drop in global oil prices. This is evident from Chart 3, which shows the massive widening of US High Yield Energy bond spreads; other segments of the US High Yield bond market appear to be less affected, although spreads have also generally widened in recent months.

Chart 3: Energy spreads driving overall US HY

How much bad news has been priced in?

The Energy sector makes up approximately 15% of the US High Yield bond market, making it one of the largest single-sectors for most US High Yield bond funds (see Chart 4). Given the significant widening of credit spreads in the Energy high yield space, it is perhaps worth digging deeper into the sector to see how much bad news the market has priced in at this juncture.

Chart 4: Sector Breakdown (US High Yield Bond Market)

As shown in Table 2, the worst-hit segments of the US Energy High Yield market appear to be Coal Operations, Oil & Gas Services & Equipment, as well as Exploration & Production (which makes up more than half the US Energy High Yield universe by market weight). It is worth noting that the average yield-to-maturity levels for these sectors are between 14.3% and 20.6%, representing fairly distressed levels. Stripping out the 20 most distressed Energy sector securities (from a universe of 294 names), average yields for Exploration & Production and Oil & Gas Services & Equipment (sectors which tend to be more vulnerable to oil price declines) are still fairly elevated (see Table 2), suggesting that a significant level of negativity has been priced into the Energy sector.
Viewed in the context of expected default rates, the sector’s 941bps spread against risk-free Treasuries suggests that investors are pricing in a 15.7% probability of default* for higher-yielding Energy companies in the US (based on a 40% recovery rate assumption), which is a fairly aggressive assumption in the context of the range of historical speculative-grade issuer default rates (the previous peak was 13.1% for 2009, according to Moody’s data). Granted, the Energy sector faces strong headwinds at the moment following the tumble in global oil prices, although it appears that bond yields in the sector have already moved higher in conjunction with lower crude oil prices.
*Estimated based on Spread/(1 – Recovery Rate of 40%)

Table 2 - US HY Energy Sector Breakdown

Sub-sector	Weight	Average Sector Decline (since end-June 14)	Average YTM	Average YTM (excluding distressed)*
Exploration & Production	57.3%	-21.3%	15.8%	10.4%
Pipeline	23.8%	-5.7%	6.2%	6.2%
Coal Operations	8.5%	-31.2%	20.6%	9.6%
Oil & Gas Services & Equipment	6.7%	-28.3%	14.3%	13.8%
Refining & Marketing	3.5%	-5.8%	6.5%	6.5%
Integrated Oils	0.2%	-7.7%	7.0%	7.0%
Source: Bloomberg; data as of 22 Dec 14, *excludes 20 highest-yielding securities in the Energy HY universe

Improving US economy positive for US High Yield

At this juncture, both yields and spreads are not far from their highest levels in 2014, with the US High Yield market currently offering a yield of 6.71% (as of 22 December 2014, based on the BofA Merrill Lynch US High Yield Master II), representing a 538bps spread against US Treasuries. As guided in our Key Investment Themes and 2015 Outlook, we expect the Federal Reserve to take a gradual, measured approach to hiking interest rates in 2015, with a fragile global economy and muted inflation (on lower energy prices) likely to weigh against improvements in the US economy.
Recently released 3Q 14 GDP figures saw quarterly growth revised higher to a 5% annualised rate, the quickest rate since 2003, with consumer spending growing at a 3.2% annual pace. Lower energy prices should continue to support consumption going forward, which suggests that a more positive US economic outlook for 2015 is on the cards; this will ultimately provide a boost to the business prospects of high yield issuers. A combination of more stable Treasury yields (on a more measured pace of Fed rate hikes) alongside a resurgence in US economic growth provides a fairly positive environment for the US High Yield sector and we think the latest rise in yields in the sector represents a decent buying opportunity for investors willing to undertake higher risk in the fixed income market in exchange for stronger potential returns.

EM High Yield

Russian woes

Faring worse than their US counterparts have been the non-investment grade corporate issuers in the EM space, with a -5.2% quarter-to-date decline (as of 22 December 2014), sending yields in the segment to levels in excess of 10% (as of 22 December 2014) – correspondingly, the yield on BB-rated EM corporate debt was at 7% (see Chart 5).

Chart 5: Yields spiking

With Russia being a major component of the EM non-investment grade corporate bond universe (see Chart 6), geopolitics and the slump in energy prices have combined to fuel a sharp plunge in the Russian rouble so far in 2014, which has raised concerns over the ability of Russian corporations to service their external (USD-denominated) debt. Not surprisingly, non-investment Russian corporate bonds have lost an average of -27.7% of their value in 2H 14 (as of 22 December 2014), while yields have risen by nearly 13 percentage points on average (see Table 3). In contrast, yields for other major countries in the EM non-investment grade space (like Brazil and Mexico) have not risen by the same magnitude, although there has still been a general broad-based increase in yields across both countries and sectors (see Table 4), suggesting heightened investor risk aversion.

Chart 6: Country breakdown (EM High Yield)

Table 3 - Selected country breakdown (EM HY Corporates)

Country	Average Yield Change (Since June 2014)	Country Weight (%)
UKRAINE	16.8	1.3
VENEZUELA	13.2	4.2
RUSSIAN FEDERATION	13.0	16.9
CYPRUS	10.3	0.6
INDONESIA	7.0	4.9
KAZAKHSTAN	4.5	2.3
COLOMBIA	3.0	3.9
MONGOLIA	2.7	0.2
JAMAICA	2.6	2.9
NIGERIA	2.3	1.3
KOREA, REPUBLIC OF	1.9	0.1
BRAZIL	1.5	17.7
VIET NAM	1.4	0.3
EL SALVADOR	1.4	0.3
SOUTH AFRICA	1.2	4.0
BAHAMAS	1.0	0.1
BERMUDA	0.9	0.3
MEXICO	0.8	9.6
CHILE	0.8	2.3
DOMINICAN REPUBLIC	0.7	0.3
SSource: Bloomberg, iFAST compilations as of 22 December 2014

Table 4 - Sector breakdown (EM HY Corporates)

Sector	Sector Weight (%)	Average Yield Change (Since June 2014)
Health Care	0.2	NA
Energy	11.6	9.3
Consumer Discretionary	4.1	7.0
Industrials	5.4	3.7
Financials	32.3	3.4
Communications	12.9	3.3
Materials	20.4	2.7
Technology	1.0	1.9
Consumer Staples	8.9	1.6
Utilities	3.2	0.7
SSource: Bloomberg, iFAST compilations as of 22 December 2014

EM spreads have widened against their US counterparts

Following the recent happenings in the High Yield bond market, yields on both EM and US High Yield bonds have spiked, offering investors higher potential returns as compared to mid-2014. As Chart 7 indicates, yield increases have been swifter in the EM corporate space, which has resulted in a widening of the spread between the two - as of 22 December 2014, similarly-rated EM corporate bonds yielded 1.92% more than their US counterparts, near some of the widest points since 2011.

Chart 7: EM spread widens

Risks have increased, but higher yields mean investors are getting compensated

With the onset of lower energy prices alongside external funding concerns in selected Emerging Markets, investors have now taken a dimmer view of the outlook for High Yield bonds, evidenced by the rise in spreads and yields for both US and EM High Yield bonds. While the situation in Russia remains fluid, latest happenings suggest that legislation is underway to stabilise the Russian banking system while measures have also been undertaken to stabilise the rouble; these should go some way in preventing a wave of defaults by Russian corporate issuers. In the case of the US, the energy sector will likely remain under pressure, although the positives accruing from lower energy prices should be a boon for the US economy, as well as for a fairly large proportion of the US High Yield market.
Against this environment of heightened risk aversion, investors are now getting better compensation (in the form of higher yields) for their exposure to riskier bonds. It is also worth highlighting that while the two are generally viewed as major components within their respective sectors, the proportion of US High Yield Energy companies and Russian corporations are still fairly small in the context of a well-diversified US High Yield or Emerging Market debt fund.

Investors who are seeking to capitalise on the latest upward move in yields may wish to consider our recommended US High Yield fund, the Allianz US High Yield AM Dis H2-SGD which offers fairly diversified exposure to US High Yield bonds. In addition to our recommended Emerging Market bond fund, the United Emerging Markets Bond Fund, investors who want exposure to the EM corporate bond space can choose from the Deutsche Invest I Emg Mkt Corp LDMH SGD, LionGlobal Emg Mkt Bond A SGD Hedged, Neuberger Berman EM Corp Debt A SGD-H mdis or the Threadneedle (Lux) EM Co Bd Cl ASH SGD, which are all SGD-hedged share classes of Emerging Market corporate bond strategies.
 

Teetering on the Brink

2015 will be pivotal. I believe either 2015 or 16 is where a major financial crisis will occur, and a transfer of wealth from the foolish to the wise will happen. A global recession either in 2016 or 17 is highly likely. What can trigger a global recession?

1. China's corporate loan bubble bursting, causing a systemic failure like the Asian crisis of 1998. In this case the developed countries may survive just like they did in 1998. However, all markets peaked in 2000, two years later....

2. Over leveraging of financial instruments caused by cheap money. Private bank clients and hedge funds over borrowed to buy stocks and bonds. A rise in interest rates will cause unwinding, triggering a chain reaction. If your bond tenor is less than 3 years, you should be ok.

3. Asian developers getting into trouble due to unsold units. I'm very concerned that residential property prices are over 20x of income, far higher than London's 16x, or Manhattan's 9x. Many of the developers are over leveraged and may fail.

4. As wages rise in the US, inflation rises above 2%, forcing the Fed to hike rates to 1% - 1.5% end 15, and 2% - 3% end 16. The yield curve will invert at some point because it will cause some corporates to burst. Remember that after QE, most companies would have over borrowed due to cheap money. Many of these companies will quickly unravel once the debt burden becomes heavier. Once inflation is above 2.5%, it is very difficult for the Fed to fire QE4. The US could enter into a stagflation like in the 1970s....

2015 is a very crucial year for me, because major investments number 4, 5 and 6 will mature. I will be able to securitise at least 1 property in London and pocket over 150k. In the US, the Colony American Home will probably IPO and I can pocket a hefty amount. I can easily generate around 15 - 20k of net cashflow a year from dividends and another 20 - 30k of net cashflow (after servicing mortgages) from rentals. It sets the stage for 2016 and beyond because I will shift to become a private equity partner by the end of this decade.

End of the Year Review of Hits and Misses

I shall we review several of my predictions at end of 2014.

Stocks:

1. The US stock market shall power on. This is most definitely true. I added exposure to Fidelity America and made over 15% of return.

2. Tech sector will outperform. I invested in Henderson Tech and made over 12% for 2014.

3. Mining / Energy sector is recovering. This is a large miss. I invested into First State Global Resources at 1.00. Saw it rise to around 1.19 only to cut at 1.03. The mining sector was a miss. But the energy sector appears ripe for a rebound. I'm holding on to 25% of my First State fund since Nov.

4. Chinese stocks will rebound. I made a call to buy First State Regional China. It achieved around 6% return. However, it lagged behind the ETF 2823 HK, which shot up by over 30%.

5. Overall, my CPF OA portfolio is up 6%, and CPF SA portfolio is up 3%.

I was hoping for over 15% of returns after fees for my OA and > 10% for SA. Obviously there's room for improvement but I've managed to beat inflation.

Currencies:

I made over 15% in FX trading. The hits and misses are:

1. I shorted AUDUSD from 1.00 all the way down to 0.80. This trade shocked me because I was not bearish on the AUD until around May 14.

2. I shorted EURUSD from 1.35 in June to 1.219 now. This is the biggest trade that was totally expected.

3. I long USDJPY from 105 to 120 now. Again this trade was totally expected due to the QE in Japan.

4. I long USDSGD from 1.26 to 1.32 now. This is expected as the US announced their tapering last year and the Singapore inflation remained below 3%. No pressure to strengthen SGD.

Property:

1. Negative on Singapore property, but I still bought one in District 14. I had to do it for the collective sale potential in the next 5 years in the area. it was a landed property. I shall be on a look out for deals in Singapore end 15 all the way till 2017. Singapore's property is going to get a lot worse when interest rates start rising from mid 2015 and plunge when we fall into a recession in 2016 or 17.

2. Bullish on London property. Bought 2 units. Only regret is I failed to buy 2 more. Achieved over 130% ROE in 2 years, or around 40 - 50% IRR.

3. I am still not sure about my purchases in Melbourne and Brisbane. I bought them cheap. An apartment with a sea view in St Kilda and a town house 13km from CBD in Brisbane. However, I think there's oversupply in Melbourne and Brisbane CBD for units. Also, the restriction on foreigners buying resale properties meant there's an unfair advantage to locals. I ended up paying 15 - 20% above median for St Kilda and 10 - 15% for Tingalpa.

2015 Predictions:

Stocks:

1. Very little upside left for US and I definitely won't buy Europe.

2. Emerging Market equities look good to accumulate. It has been sideways for the last 4 years since 2010! Valuations are cheap again.

3. Tech sector and Chinese equities are still a strong buy.

4. Be very careful as we approach the tail end of the bull run. At some point I will sell half my equities, even for those that I'm Overweight in! Things will turn even more difficult in second half 2015 as the higher discount rate kicks in and valuations get harder to justify.

Bonds:

1. Asian and Emerging Market HY bonds appear shaky now, but if you buy short tenor ones at 5 - 7%, you should be fine. Chinese developer bonds may be shaky but only around 1 - 5% of them will fail. The Chinese government is rich enough to bail out most. It won't affect the bonds but will affect the stocks due to dilution. This rescue is necessary to prevent a systematic failure of Chinese banks. Do religiously look at credit scores and raise the bar starting 2015, and further from mid 2015.

2. Russian bonds like VTB will almost collapse, but survive for 2015.... Russia has enough reserves to prevent a default like in 1998. It will be a very volatile ride, even more so than China corporate bonds.

3. Oil and Gas sector will recover. Oil will start to rebound above USD60 / bbl, hover between 60 - 70 for the year. Demand should recover, supply won't increase as much as some deep water exploration projects get delayed. I don't believe default rates of HY oil and gas corporates will exceed 5%. Ezion will survive for sure.

4. European perpetuals are a good buy provided you can hedge against EUR currency loss. The old style perps are past their call dates and have to be called in the next 2 years and many are trading below par.

5. Still too soon to buy investment grade bonds. I went along with B rated bonds in 2014, but will up it to BB rated in 2015. By Mid 2015, I will be pushing for BBB rated bonds with short tenors. Most investment grade bonds that are AAA rated will still languish below par if they have long tenors. UST 10 may rise between 2.5 - 3% by end 15. Fed Funds rate probably reach 1.5%. Inflation rate could rise above 2.5% in the US in 2015. No yield curve inversion in 2015 but we could see it in 2016. Fed Funds rate could reach 2.5% in 2016 as rising wages of 2015 push inflation up above 3% in 2016. The UST10 could suddenly dip below 2% momentarily causing the yield curve to invert. The end could start by 2017. But we could see a global peak in stocks in early 2016.

Currencies:

1. A very obvious short will be the EURUSD and EURGBP. The Eurozone is still struggling with a recession and ECB is well behind the curve.

2. AUDUSD could plunge to 0.725, AUDSGD plunge to 1.00. The reason is twofold: the mining construction industry is dead. China is slowing down its demand for mining. Even if China maintains the same demand, the construction phase of mining is over. It is now in the production phase, which doesn't create as many jobs. Unemployment will rise in Australia as it restructures its economy towards more service and manufacturing, away from mining.

3. USDSGD could rise above 1.35. Not much upside left.

4. USDJPY could shoot past 120 towards 130. Until Japan achieves its inflation target of 2%.

Properties:

Ahhhh, my favourite sector. It made me the most money in the last 5 years.

1. Singapore property will continue the drop, especially in second half 2015. Mortgage rates will rise. Shoebox units outside CCR will plunge in price as rentals are weak. OCR rentals will fall another 5- 10%. Prices will fall around 10% as the bulk of the supply is in OCR. RCR will fall 5 - 10%. Rents will fall 5 - 10% %. CCR will see prices will probably fall by 5%. Rents fall 2.5 - 7.5%. 

2. Singapore retail rents will continue to fall due to a structural shift to online shopping. The only retail that will thrive are those with F&B.

3. Office rents and price will peak.  Time to offload.

4. Industrial will fall as more Singapore companies shift their logistics and low level manufacturing functions to Iskandar (note that these are low value add services).

5. Malaysia: The entire Malaysian property market will fall even more sharply than Singapore. The oversupply in Iskandar is 10x worse than Singapore and we could see around 15 - 25% fall in prices, 10% fall in rental.

6. KL is the second best property market for residential. It will still fall around 10 - 15% in the outskirts and 5 - 10% in the KLCC area. There is much oversupply and speculation.

7. Penang is the best market to invest in. The island is transformed by the opposition party leader Lim Guan Eng. Residential property price will be flat or drop by 5%. But rents will rise by 5% because there is little supply in the mature landscape.

8. Australia will be a mixed bag. I shall not dwell in it because there is already much honest commentaries by analysts. Do NOT buy from exhibition and Spruikers in Singapore.

9. The US market will chug along. The East and West coast cities will rise by 10 - 20%.

10. London will slow down due to affordability issues. It will not fall because the shortage is acute. Time to look west because the East and along the south of River Thames where Battersea is will see large new developments springing up.

11. European real estate, like in Athens, Madrid, Barcelona, Dublin, Milan, Turin, Roma, Lisbon will recover. The upside won't be fantastic due to the weak economy.

12. Overall nothing much to buy in 2015.... I may just add 1 to my portfolio in the second half of 2015 but I haven't decided where to.

Conclusion:

2015 is a good time to cash up, meaning draw some equity out of your property portfolio, liquidate some shares or at least maintain your shareholding, building up cash. Opportunities may present in the second half of 2015 and 2016....

China's Property Bubble

There is little doubt that China has a residential property bubble. Some shopping malls may even fail. The big question mark is whether they will enter a deep bear market, with prices down by 30 - 50% in tier 4 cities, 20 - 40% in tier 3 cities, 15 - 30% in tier 2 cities and 10 - 20% in tier 1 cities in the next 4 - 5 years...

The impact on the commodity countries will be severe. Australia and Indonesia will see their export values drop. The AUDUSD has a lot more downside to go, possibly until 0.80. I've made quite a bundle shorting this currency in 2014.

Any recovery of the coal, iron, steel, copper and other metals needed for infrastructure, will be elusive.

Global stocks are very near the edge of a sell call. When it happens I will have to make large shifts in my portfolio, like selling half my equity funds and shifting them to money market funds. I may keep my balanced funds, but I haven't decided.

WHAT WE CAN LEARN FROM CHINA’S PROPERTY BUST

• Michael Yardney
 
• Michael Yardney's Commentary, Property Investment
• December 7, 2014

They said it would never happen there…

Don’t worry that they’re building so many empty properties, in fact vacant ghost towns, it’s different in China!

All property booms come to an end and some with more of a bust than others.

IT SEEMS SOME INTERESTING THINGS ARE HAPPENING IN CHINA

WA Today report that China’s property developers are so desperate to sell new apartments  they are offering ridiculous gimmicks and fat incentives.

In one case, a developer in the city of Nanning offered 1000 live chickens to people who turned up at an opening.

“Within 15 minutes all that was left of the promotion were piles of chicken feathers and a few lost shoes.” 

“Mayhem ensued when the developer let the chickens loose and eager locals scrambled to grab as many as possible.”

But in the event there were more people than chickens, but not more buyers, as locals moved in to get a free meal.

BUY ONE, GET TWO FREE

In the south-western city of Kunming, host to one of China’s famous “ghost towns” of row upon row of new, empty apartments, some developers are offering “buy one floor, get two floors free” deals, according to WA Today.

AND THEN THERE ARE THE BUYBACK OFFERS

In the city of Hangzhou, Shanheng Real Estate is giving home buyers an option to sell back their apartments in five years for 40 per cent above the purchase price, the China Daily reports.

Of course this is more a sign of the developer’s desperation than their confidence in future price rises.

PRICE OF PROPERTY IS FALLING

The property sector is the biggest industry in China, and China has been the biggest source of growth in the world economy.

But the average price of new homes in China fell in November for the seventh consecutive month, according to the firm China Real Estate Index System. Of 100 cities surveyed, prices fell in 76.

The government is trying to prop the market up. It has eased mortgage restrictions and cut official interest rates.

And China boosters still rush to assert that all will be well, that the country’s unique features will sustain the real estate market for many years to come.

This is always the way with every vast real estate or sharemarket boom in history.

There is always a factor that makes this boom different. It will never collapse like those that went before.

In the China boom, the unique factor is urbanisation, the mass migration of country folk into the cities.

Urbanisation is real and will continue. But the boom in prices and supply far outstripped demand. Market forces are simply forcing a correction.

HOW MANY VACANT HOMES ARE THERE?

The number of empty homes in China is estimated at between 20 million and even up to 64.5 million on an extreme estimate.

On top of that, the government is building another 36 million homes over five years as part of its affordable housing plan.

CHINA HAS HAD REAL-ESTATE SLOWDOWNS BEFORE

It was three years ago that a developer got headlines around the world for giving away a new BMW with every apartment sold.

The government has stepped in with new stimulus each time and the market has rallied somewhat. Until the next downturn.

The simple reality is that China’s recent growth is based on an investment surge of enormous historical proportions. And that surge is now exhausting itself.

This is standard; it happened in Japan in the 1960′s to 1980′s, closely imitated by South Korea and then Taiwan and then by the economies of south-east Asia.

Growth was achieved by adding new dollars of investment, rather than better productivity in the way those dollars were deployed.

THIS ACCUMULATION PATH TO GROWTH IS VERY SUCCESSFUL UNTIL IT REACHES MATURITY

Then it exhausts itself. Always.

Of course there’s a lesson to be learned by Australian property investors from this – all booms end in a downturn and if the boom is BIG, it’s likely to BUST

At the same time Australia, which has been very dependent on China’s economic growth, needs to find other sources of growth otherwise our long period of economic growth without a recession will come to halt.

We can’t be complacent and say – this time it’s different.

The evidence is mounting that future returns of US stocks will be very poor. We might see a 40 - 50% down turn of US stocks soon. I then ran through the history of MSCI Asia x Japan to see if there were points in time when Asian / Emerging Market stocks rose while US stocks fell. I could find nothing.

There were periods where Asia x J was sideways while US rose: 1994 - 1997, 2011 - 2013. There was even a period, during the Asian Crisis in 1997 - 98 when Asia crashed while the US continued to rise. There were periods when Asia x J outperformed US stocks in a bull run. But never have I seen Asia / EM stocks rise when US fall.

Perhaps we are still export driven and dependent on the consumption of OECD countries. Perhaps the majority of our institutional funds come from the west and if they pull their money out, we have no "spine" to our markets.

Things may change the next time US crashes, but I'll remain extremely cautious for the next 12 - 24 months.

Stocks Are Now So Fantastically Expensive That They Will Likely Have Negative Returns For Years

Henry Blodget in 3 hours Bookmark 9

As regular readers know, I am increasingly worried about the level of stock prices.
So far, this concern has seemed unwarranted. And I hope it will remain so. (I own stocks, and I’m not selling them.)
But my concern has not diminished.
On the contrary, it grows by the day.
I’ve discussed the logic behind my concern in detail here. Today, I’ll just focus on the primary element of it:
Price.
Stocks are now more expensive than at any time in history, with the brief (and very temporary) exceptions of 1929 and 2000.
Importantly, today’s high prices do not mean that stock prices can’t go even higher. They can. And they might. What it does mean is that, at some point, unless it is truly “different this time,” stock prices are likely to come crashing back down, likely well below today’s levels. Just as they did after those two historic market peaks.
(I unfortunately know this especially well. Because I was one of the people hoping it was “different this time” in 1999 and 2000. For many years, it did seem different — and stocks just kept going up. But then they crashed all the way back down, erasing three whole years of gains. This was a searing lesson for me, as it was for many other people. It was also a lesson that cost me and others a boatload of money.)
Anyway, here are three charts for you…
First, a look at price-earnings ratios over 130 years. The man who created this chart, Professor Robert Shiller of Yale, uses an unusual but historically predictive method to calculate P/Es, one that attempts to mute the impact of the business cycle. Importantly, this method is consistent over the whole 130 years.
As you can see, today’s P/E, 27X, is higher than any P/E in history except for the ones in 1929 and 2000. And you can also see how quickly and violently those P/Es reverted toward the mean:

Second, a chart from fund manager John Hussman showing the performance predictions for 7 different historically predictive valuation measures, including the “Shiller P/E” shown above. Those who want to remain bullish often attack the Shiller P/E measure, pointing out that it is useless as a timing tool (which it is). Those folks may also want to note that the 6 other measures in the chart below, including Warren Buffett’s favourite measure, same almost exactly the same thing.

Third, a table from the fund management firm GMO showing predictions for the annual returns of various asset classes over the next 7 years.
As you can see, the outlook for all stocks, but especially U.S. stocks, is bleak. Specifically, GMO foresees negative real returns for U.S. stocks for the next 7 years. Even after adding back the firm’s inflation assumption of 2.2% per year, the returns for most stocks are expected to be flat or negative. The lone bright(er) spot is “high quality” stocks — the stocks of companies that have high cash flow and low debt. Those are expected to return only a couple of per cent per year. (Returns for international stocks are expected to be modestly better, but still far below average).

The real bummer for investors, as GMO’s chart also makes clear, is that no other major class offers compelling returns, either. The outlook for bonds and cash is lousy, too. This puts investors in a real predicament. The only asset class forecasted to provide compelling returns over the next 7 years is… timber. And most of us can’t go out and buy trees.
To be crystal clear:
There is only one way that stocks will keep rising from this level and stay permanently above this level. That is if it really is “different this time,” and all the historically valid valuation measures described above are no longer relevant.
It is possible that it is different this time.
It is not likely, however.
And one thing to keep in mind as you listen to everyone explain why it’s different this time is that one of the things everyone does when stocks get this expensive is attempt to explain the high prices (and justify even higher ones) by looking for reasons why it’s different this time.
That’s what most of us did in 1999 and 2000.
For a while, we seemed “right,” and we were heroes because of it.
But then, suddenly, without much warning, we were drastically, violently wrong.
And we — or me, at least — learned that searing lesson that I referred to above: That it’s almost never “different this time.”

People Don't Like It When I Say Stocks Might 'Crash,' So I Won't Use That Word, But...

Henry Blodget Sep 25 2014, 11:52 PM Bookmark

•                  

For the past year, I have been worrying out loud about US stock valuations and suggesting that a decline of 40%-50% would not be a surprise.
I haven’t predicted a drop like this, though I certainly think one is possible. I also haven’t made a specific timing call: I have no idea what the market will do over the next year or two. But I do think it is highly likely that stocks will deliver way below-average returns for the next 7-10 years.
So far, the market has shrugged off these concerns: The S&P 500 is up about 8% from from last fall’s 1,850 level.
That’s good for me, because I own stocks. But my concerns haven’t changed. And I’m not expecting this performance to continue.
I am feeling increasingly alone, however. Over the past year, one by one, most cautious pundits have capitulated and started arguing that valuations don’t matter, that the US economic recovery is only just really getting started, and that stocks are going to keep going up for years.
I hope so.
But it’s not just price that concerns me.
There are three reasons I think future stock performance will be lousy:

• Stocks are very expensive on almost all historically predictive measures
• Corporate profit margins are still near record highs
• The Fed is now tightening

Below, I’ll discuss those concerns one at a time.
Before I do, though, a quick note: Sometimes people are confused by my still owning stocks while getting increasingly worried about a sharp price decline. If I think the market might drop, they ask, why don’t I sell? Here’s why I don’t sell:

1. I’m a long-term investor,
2. I’m a taxable investor, which means that if I sell I have to pay taxes on gains,
3. I don’t know for sure what the market will do (no one knows for sure, and the bulls might be right),
4. I think market timing is a dumb strategy
5. I’m mentally prepared for a sharp decline (I won’t get spooked into selling if stocks crash — on the contrary, I’ll buy more),
6. I think stocks will eventually recover, and
7. There’s nothing else I want to invest in (every other major asset class is also priced so high that they will all likely deliver lousy returns)

Yes, if stock prices decline 40%-50% over the next couple of years and then we enter a Japan-like scenario in which they continue to drop for two decades, I’ll feel like an idiot. But otherwise, I’m ok with sharp price declines. I’m a long-term bull. And crashes create the opportunity to buy stocks with much higher likely future returns.
Here’s more on those three big concerns…

Price: Stocks are very expensive

In the past year or two, stocks have moved from being “expensive” to “very expensive.” In fact, according to one historically valid measure, stocks are now more expensive than they have been at any time in the past 130 years with the exception of 1929 and 2000 (and we know what happened in those years).

The chart below is from Yale professor Robert Shiller. It shows the cyclically adjusted price-earnings ratio of the S&P 500 for the last 130 years. As you can see, today’s PE ratio of 26X is miles above the long-term average of 15X. In fact, it’s higher than at any point in the 20th century with the exception of the months that preceded the two biggest stock-market crashes in history.

Does a high PE mean the market is going to crash? No. Sometimes, as in 2000, the PE just keeps getting higher for a while. But, eventually, gravity takes hold. And in the past, without exception, a PE as high as today’s has foreshadowed lousy returns for the next 7-10 years.
But is it “different this time?”
Now, it’s possible that it’s “different this time.” The words “it’s different this time” aren’t always the most expensive words in the English language. Sometimes things do change, and investors clinging to old measures that are no longer valid miss decades of market gains before they realise their mistake.
One example of this is the famous bond yield / stock yield inversion in the 1950s. For decades, stock yields had been higher than bond yields. This seemed to make sense: Stocks were more risky than bonds, so of course they should have higher yields. But then stock prices rose so much that stock yields dropped below bond yields. This caused many panicked investors to rush to the sidelines. Alas, stock yields stayed below bond yields for half a century. And the bears got clobbered by inflation and missed decades of gains.
Why did the stock yield / bond yield relationship no longer work? Because the US had gone off the gold standard. For the first time in the country’s history, inflation became the norm. And inflation clobbers the value of bonds.
That fundamental change was obvious in hindsight. But it wasn’t obvious at the time.
So is it possible that it’s different this time, too, that Professor Shiller’s PE ratio is no longer valid? Yes, it’s possible. A smart market analyst, the anonymous financial blogger “Jesse Livermore,” analysed Professor Shiller’s PE last year and made a compelling argument that it’s no longer valid because accounting rules have changed. Livermore makes a persuasive point. It certainly seems possible that the future average of Professor Shiller’s PE ratio will be significantly higher than it has been in the past 130 years. But it would take a major change indeed for the average PE ratio to shift upwards by, say, 50%.
So, yes, it’s possible that it’s a bit different this time. But I doubt it’s entirely different.
While we’re at it, please note something else in the chart above. Please note that, sometimes — as in the entire first 70 years of the last century — PEs (blue line) can be low even when interest rates (red line) are low. That’s worth noting because, today, you often hear bulls say that today’s high PEs are justified by today’s low interest rates. Even if this were true — even if history did not clearly show that you can have low PEs with low rates — this argument would not protect you from future losses, because today’s low rates could eventually regress upwards to normal. But it’s also just not true that low rates always mean high PEs.
And in case some of your bullish friends have convinced you that Professor Shiller’s P/E analysis is otherwise flawed, check out the chart below. It’s from fund manager John Hussman. It shows six valuation measures in addition to the Shiller PE that have been highly predictive of future returns. The left scale shows the predicted 10-year return for stocks according to each valuation measure. The coloured lines (except green) show the predicted return for each measure at any given time. The green line is the actual return over the 10 years from that point (it ends 10 years ago). Today, the average expected return for the next 10 years is slightly positive — just under 2% a year. That’s not horrible. But it’s a far cry from the 10% long-term average.

And, lastly, lest you’re tempted to dismiss both Shiller and Hussman as party-pooping idiots, here’s one more chart. This one’s from James Montier at GMO. Montier, one of Wall Street’s smartest strategists, is also very concerned about today’s valuations. He does not think it’s “different this time.”
Montier’s chart shows that another of the common arguments used to debunk Professor Shiller’s PE chart is bogus. Bulls often say that Professor Shiller’s PE is flawed because it includes the crappy earnings year during the financial crisis. Montier shows that this criticism is misplaced. Even when you include 2009 earnings (purple), Montier observes, 10-year average corporate earnings (blue) are well above trend (orange). This suggests that, far from overstating how expensive stocks are, Prof. Shiller’s chart might be understating it.

In short, Montier thinks that all the arguments you hear about why today’s stock prices are actually cheap are just the same kinds of bogus arguments you always hear in the years leading up to market peaks: Seemingly sophisticated attempts to justify more buying by those who have a vested interest in more buying.
So, go ahead and tell yourself that stocks aren’t expensive. But be aware of what you’re likely doing. What you’re likely doing is what others who persuaded themselves to buy stocks near previous market peaks (as I did in 2000) were doing: Saying, “it’s different this time.”
That’s price. Next comes profit margins.

Today’s profit margins are extremely, abnormally high

One reason many investors think stocks are reasonably priced is that they are comparing today’s stock prices to this year’s earnings and next year’s expected earnings. In some years, when profit margins are normal, this valuation measure is meaningful. In other years, however — at the peak or trough of the business cycle — comparing prices to one year’s earnings can produce a very misleading sense of value.
Profit margins tend to be “mean-reverting,” meaning that they go through periods of being above or below average but eventually — sometimes violently — regress toward the mean. As a result, it is dangerous to conclude that one year of earnings is a fair measure of long-term “earning power.” If you look at a year of high earnings and conclude these high earnings will go on forever, for example, you can get clobbered.
(It works the other way, too. In years with depressed earnings, stocks can look artificially expensive. That’s one reason a lot of investors missed the buying opportunity during the financial crisis. Measured on 2009′s clobbered earnings, stocks looked expensive. But they weren’t. They were actually undervalued.)
Have a glance at this recent chart of profits as a per cent of the economy. Today’s profit margins are the highest in history, by a mile. Note that, in every previous instance in which profit margins have reached extreme levels like today’s — high and low — they have subsequently reverted to (or beyond) the mean. And when profit margins have reverted, so have stock prices.

After-tax profits as a per cent of GDP.

Now, again, you can tell yourself stories about why, this time, profit margins have reached a “permanently high plateau,” as a famous economist remarked about stock prices just before the crash in 1929. And, unlike that economist, you might be right. But as you are telling yourself these stories, please recognise that what you are really saying is “It’s different this time.”

And then there’s Fed tightening…

For the last five years, the Fed has been frantically pumping more and more money into Wall Street, keeping interest rates low to encourage hedge funds and other investors to borrow and speculate. This free money, and the resulting speculation, has helped drive stocks to their current very expensive levels.
But now the Fed is starting to “take away the punch bowl,” as Wall Street is fond of saying.
Specifically, the Fed is beginning to reduce the amount of money that it is pumping into Wall Street.
To be sure, for now, the Fed is still pumping oceans of money into Wall Street. And if you limit your definition of “tightening” to “raising interest rates,” the Fed is not yet tightening. Yet. But, in the past, it has been the change in direction of Fed money-pumping that has been important to the stock market, not the absolute level.
In the past, major changes in direction of Fed money-pumping have often been followed by changes in direction of stock prices. Not immediately. And not always. But often.
Let’s go to the history …
Here’s a look at the last 50 years. The blue line is the Fed Funds rate (a proxy for the level of Fed money-pumping.) The red line is the S&P 500. We’ll zoom in on specific periods in a moment. Just note that Fed policy goes through “tightening” and “easing” phases, just as stocks go through bull and bear markets. And sometimes these phases are correlated.

Now, lets zoom in. In many of these time periods, you’ll see that sustained Fed tightening has often been followed by a decline in stock prices. Again, not immediately, and not always, but often. You’ll also see that most major declines in stock prices over this period have been preceded by Fed tightening.
Here’s the first period, 1964 to 1980. There were three big tightening phases during this period (blue line) … and three big stock drops (red line). Good correlation!

Now 1975 to 1982. The Fed started tightening in 1976, at which point the market declined and then flattened for four years. Steeper tightening cycles in 1979 and 1980 were also followed by price drops.

From 1978 to 1990, we see the two drawdowns described above, as well as another tightening cycle followed by flattening stock prices in the late 1980s. Again, tightening precedes crashes.

And, lastly, 1990 to 2014. For those who want to believe that Fed tightening is irrelevant, there’s good news here: A sharp tightening cycle in the mid-1990s did not lead to a crash! Alas, two other tightening cycles, one in 1999 to 2000 and the other from 2004 to 2007 were followed by major stock market crashes.

One of the oldest sayings on Wall Street is “Don’t fight the Fed.” This saying has meaning in both directions, when the Fed is easing and when it is tightening. A glance at these charts shows why.
On the positive side, the Fed’s tightening phases have often lasted a year or two before stock prices peaked and began to drop. So even if you’re convinced that sustained Fed tightening now will likely lead to a sharp stock-price pullback at some point, the bull market might still have a ways to run.

In conclusion…

I’m still nervous about stock prices and think stocks will likely deliver lousy returns over the next 7-10 years. I also would not be surprised to see the stock market drop sharply from this level, perhaps as much as 30%-50% over a couple of years.
None of this means for sure that the market will crash or that you should sell stocks (Again — I own stocks, and I’m not selling them.) It does mean, however, that you should be mentally prepared for the possibility of a major pullback and lousy long-term returns.