Mark Bouris tackles Harry Dent's bearish claims: Christopher Joye
In the past few weeks two major personalities – doomsday US commentator Harry Dent, who is spruiking a book, The Great Crash Ahead, and the telegenic star of Channel Nine’s The Apprentice show and founder of listed wealth manager Yellow Brick Road Mark Bouris – have gone head-to-head with their conflicting views of the world in high-profile presentations in Sydney and Brisbane.
The Dent-Bouris clash has coalesced around several predictably sensational forecasts from the US economist, including, of course, that Australian house prices will fall by 50% (which has led Dent to beseech Aussie families to sell their homes), that the global economy is set for a big crash, and that you should get out of risk asset classes and squirrel your money away in cash. Interestingly, while the protagonists disagree on much, they also find some common ground.
I was lucky enough to get access to Bouris’s presentation, and thought it was worthwhile reviewing in detail today.
The founder of Australia’s largest non-bank lender begins by assaulting the presumption that the world is set on an irreversible course towards recession simply because the US and Europe are in trouble.
More specifically, Bouris argues that there is too much financial market and media focus on the G7 economies, pointing out that they have accounted for less than 34% of global growth over the last decade.
The “developing world”, on the other hand, has been responsible for generating nearly half of all global GDP over this period.
Bouris tells us that this disconnect is projected to widen: according to the IMF, emerging and developing economies will account for more than 60% of global economic growth over the next five years (see his first two charts below). Click to enlarge
His critical insight here is that Australia is one of the few developed nations that is industrially leveraged to the much more propitious emerging world: 65% of all our exports go to developing countries, with 75% sent to Asia alone.
With this in mind, Bouris contends that notwithstanding the ineluctable vagaries of the business cycle, the urbanisation and industrialisation processes taking place in China and India – which collectively absorb one-third of all Australian exports – will inevitably continue.
Here he draws on his bete noir, the RBA (more on that later), quoting the latter’s estimates that 300 to 400 million Chinese will migrate out of country dwellings into urban cities over the next two decades. Another fascinating statistic he digs out in this context is that whereas there are 170 Chinese cities with more than one million residents, Europe, by comparison, has only 35.
In a dose of good fortune for the lucky country, it just so happens that the modernisation underway in “Chindia” is dependent on three things that we produce in abundance: steel (iron ore); energy (coal and LNG); and protein (agriculture). On the latter variable, Chinese protein consumption per head has exploded, as it typically does when per capita incomes rise.
Bouris explains that this is directly impacting Australia’s economy via an unprecedented, and mostly assured, wave of private investment. He presents data showing that the domestic capex that has already commenced, but is not yet complete, is currently worth about $105 billion, or 8% of 2011 GDP. If you then include the more speculative “planned” investment for 2011-12, total expected capex spending rises to a stunning $160 billion, or 12% of 2011-12 GDP using past “realisation ratios” (i.e., the share of planned capex that actually gets expended). The two charts below graphically outline this thesis. Click to enlarge
The message from the Wizard Home Loans founder is perhaps best paraphrased as: Yes, the North Atlantic economies will likely experience challenging economic times. But, the G7 is emphatically not the “global” economy; in fact, it will contribute less than 29% of global output in the next five years. So while difficult days could lie in wait, the world will not end, as our friend Dent insinuates.
The key take-away is that Australia is well-positioned to navigate any future turbulence given that most of our major commercial linkages are with those parts of the globe that represent the new world.
At this stage, Bouris temporarily digresses to critique the RBA. He thinks interest rates are being held too high by the RBA’s obsessive inflation focus, which, it must be said, is scorn that has attracted added weight in recent months. After initially reporting two scorchingly high headline and core inflation prints, the ABS has unusually revised down the underlying numbers to much more benign levels. Recent changes to the ABS’s weighting methodology also cast a more favourable light on the current inflation pulse. It would appear that the RBA is reluctantly moving towards this Boursisian view of the world, with its media proxies canvassing a once-off Melbourne Cup Day cut in the last couple of days.
While Bouris disagrees with Dent on the outlook for the Australian economy, he is more sympathetic to his portfolio construction preferences. In particular, he agrees with Dent that the emergence of people in the “baby boomer” demographic, which were in the “accumulation” phase of their life-cycles during the 1980s, 1990s and 2000s, drove demand for higher-returning (and higher-risk) investments like shares and real estate.
This effect was redoubled, Bouris notes, by the introduction of superannuation in 1992, which directed the vast bulk of household savings into volatile shares. As the baby boomers transition into retirement and start to “de-accumulate”, the demand for higher-growth assets will dissipate, which is a negative for equity returns. The main beneficiaries of this demographic dynamic will be those asset-classes that offer certainty and security; namely, cash and fixed-income.
At this juncture, however, the back-slapping ends. Whereas Dent maintains a very pessimistic position on shares and real estate care of his prediction that the “great crash” is coming, Bouris’s views are founded on a more nuanced evaluation of risk.
Using 30 years worth of data, he shows that the total returns to 10-year Australian government bonds have outperformed both global equities and ASX-listed property trusts (LPTs). On a risk-adjusted basis, government bonds and cash (i.e., bank bills) leave Aussie shares, global shares and LPTs for dead (refer to the Sharpe Ratios, which divide the investment returns – less the risk-free rate – by the volatility, in the table below).
The story here is simply that cash and fixed-income have an important – not exclusive – role to play in properly diversified investment portfolios.
Bouris backs this up with much more sophisticated “portfolio optimisation” analysis across the major asset-classes over the last three decades (see next chart). He explains that if one were to “target” an expected nominal return of, say, 10% per annum (or inflation plus 4% to 5%), most of your money should have been invested in cash and fixed-income, with only a relatively small 10% to 20% weight to Aussie shares. Click to enlarge
Interestingly, in these optimisations global shares and LPTs don’t attract any capital at all because of their ultra-high correlations (or “beta”) with domestic shares, which means that allocating across all three assets just parlays up your risk with no performance benefits (since global shares and LPTs yield inferior returns).
Regular readers will know that I have made similar comments in this column over the years, and Bouris echoes my censure of Australian pension fund portfolios harnessing the latest OECD data. The OECD’s analysis demonstrates that Australian super funds have among the highest exposures to risky equities of any pension system in the world, which has propagated comparatively poor returns.
The final clash in the Bouris-Dent conflict takes place over the familiarly emotive territory of Australian house prices. In remarks on David Koch’s Sunrise program, Dent begged viewers to sell their homes before the 50% crash in prices arrived at their doorsteps. Dent’s argument appeared based solely on the claim that Australian dwelling values were “9.5 times family incomes”, and should, in his view, be about “half” this level.
As with many spruikers in search of a headline, Dent’s claim is incorrect. And Bouris was more than happy to set him straight. He starts by noting that while Australian interest rates are among the highest in the OECD, Australia’s mortgage default rates are a fraction of most peers. In particular, the latest RBA data finds that only 0.8% of the circa 4 to 5 million households with a mortgage are behind on their repayments. This is around one-tenth and one-quarter of US and UK ratios, respectively.
He then contrasts the long-term rise in the cost of Australian housing with house prices in a nation that has endured a sharp correction: the United Kingdom. During the GFC, UK house prices fell by 14% peak-to-trough, while the unemployment rate has soared to over 9%.
Despite the partial collapse of the UK banking system, extreme credit rationing and default rates multiples Australian levels, Bouris’s analysis shows that long-term house price growth in the two countries has been indistinguishable. It was, in fact, UK house prices that substantially overshot their Australian siblings in the five years before the GFC hit. And it has only been the recent crash that has brought them back in line Australian prices indexed since 1993.
Bouris extends this insight to a range of other countries again using RBA data. This confirms that the run-up in Aussie house prices in the period 2003 to 2007 was actually substantially less than that experienced in the US, UK, Spain, Ireland and France (see first chart below). Indeed, if there was any “bubble”, it would appear to be found in Australian commercial real estate (refer to the left-hand-side panel in this same chart), which has produced much stronger price appreciation than equivalent assets overseas. Click to enlarge
As the final chapter in the housing debate, Bouris directly attacks Dent’s proposition that Australian house prices are 9.5 times family incomes. He presents a chart released by the RBA in the latest Financial Stability Review (see below), which shows that their estimate of the correct house price-to-income ratio is, in fact, around four or five times (or, ironically, half Dent’s claims). With this information in hand, Bouris opines that “Australian house prices are not going to fall 50%, and your home should remain a solid, tax-effective store of wealth over the long-term.”
As you can tell, I find the Yellow Brick Road chairman’s view of the world more persuasive than Dent’s. Bouris left his listeners with a final thought, which I think is worth quoting in full:
“I believe we do indeed live in the ‘lucky country’, but the RBA cannot afford to roll the dice with our destinies in the name of pursuing some statistical abstraction. We are incredibly fortunate to be endowed with rich natural resources, and to be highly leveraged to that part of the world that is growing rapidly – the developing countries – rather than the old world that is stagnating. Having said that, it makes sense to prudently diversify your wealth to protect against adverse outcomes, and, subject to your risk preferences, you should have part of your portfolio invested in safer income-generating assets like cash and fixed-income.”
Harry Dent and Mark Bouris appeared at three-day Brisbane conference “Secure the Future”.
Christopher Joye is a leading financial economist. The above article is not investment advice.