Global Stagflation: for every investor

| April 20, 2007 | 0 Comments
Global Property - waiting for the correction

For a few years all the warning signs have been present - that the UK was moving out of a booming economic cycle, and that recession could threaten the UK.

Now the problem looming appears even worse - that of global stagflation.

I was speaking with a friend who runs a company providing overseas property investment opportunities. I asked which regions are expected to show better growth potential in the near future.

The reply was pretty shocking. He said none. He’s expecting a big fall in global property prices.

The problem is three-fold:

1. Oversupply
2. Runaway inflation
3. Global instability

Oversupply is a real problem. A lot of the previously emergent markets are simply glutted with property for sale. Not only is there too much, but there’s also a lot of poor quality housing on the market - rushed jobs completed for investors, not tenants.

People who jump in too fast are in serious danger of finding themselves wasting time engaging builders to make corrections to the property - not something a property investor really wants to have to dedicate time doing.

Additionally, a number of markets have already seen negative equity hit property investors in the short term. Bulgaria is one country where this has already been underlined, as the property cycle there is correcting for high growth over recent years.

Runaway inflation is another big problem - simply put, property has been increasingly over-valued.

Every time the general public reads about increases in property inflation, they presume the figures average across the general property market. I’ve already reported before that this simply cannot be used as an indicator, with huge variations not simply according to location, but also according to property type. And this is typical not simply of the UK, but also of foreign property markets.

Simply put - a reported 10% overall property inflation in any country is more likely to apply to flats and similar housing at the lower end of the property price spectrum - so people who fall into thinking this averaged growth applies to large detached villas have already entered the market with a serious over-valuation of growth prospects.

Global instability is probably the most serious issues, though. Despite G7 ministers trying to put a brave face on the state of the global economy while omitting any mention of current currency issues, whatever growth is being sustained at present is founded instabilities which are already turning negative.

Simply put, the growth of the global economy over the past few years has been founded on debt. It’s not a stable foundation, and already it’s falling apart.

Debt works fine while interest rates remain low - repayments are relatively easy to keep up with, and weak currencies and trade deficits have difficulty making a direct impact.

But now the tide is turning - inflationary pressure, originally begun with oil price rises in 2005, continues to rise as factory gate prices continue up.

And the combined impact of the interest rate rises to combat inflation inflames an already disturbing trend of falling consumer spending and rising unemployment. Yet as we’ve already seen, even the recent string of interest rate rises in the UK and US have done little to correct inflation, while continuing to inflame negative economic indicators.

Facing Global Stagflation

The property market has been one of the key engines of global economic growth. After the dotcom bubble burst, many investors sought safer opportunities, turning to property investment and buy to let markets.

The result was a sudden powering of global property prices which saw house prices in many areas around the world more than double over just 5 years.

With interest rates still relatively low, it made the property market especially attractive.

More daring speculators borrowed more heavily - a trend that started at the individual level, and then became a more common corporate practice - investing in long-term projects leveraging short-term low interest rates.

Finance houses took full advantage of this scenario, pushing aggressively for stronger growth in lending arms and product ranges, offering packages that appeared attractive while interest rates remained low.

But the inevitable turn around has been slowly happening across the major economic areas - the USA, UK, Europe, and even Japan have all been steadily raising interest rates.

The problem now is that a lot of major companies are carrying major debt. And things will continue to get worse for them as interest rates rise.

And interest rates will continue to rise because not only has inflation continued to push upwards, but also the property market behind it all has failed to lose all momentum.

The result is that US housing markets are already starting to crash, and bringing down smaller financial institutions with them, especially in the sub-prime mortgage sector.

Where momentum continues - such as in the UK - it has become less an issue of when, as much as if.

The Bank of England should take a lot of the blame for the existing momentum in property markets - they have milked every opportunity for growth while ignoring long-term effects. When property prices first ran away, the Bank of England actually lowered interest rates, compounding the issue. Then when it become a recognisable problem, they refused to apply the brakes.

The scenario was like a car running out of control down a hill. The Bank of England enjoyed the speed and even applied the gas. It was only after approaching real hazards that they even considered applying the brakes - and even then, only very slowly and softly - and much too late.

The UK government has already taken corrective steps in an attempt to help clear the economy from immediate impact - the recent legislation with SIPPs and REITS allows for further investment in the UK property market, to help continue momentum and prevent a crash.

But as the property market - already long warned as overvalued by the OEDC and World Bank - is a key part of the overall problem anyway, the UK government and Bank of England are hedging their bets that some other more easily manageable risk factor will take the heat from this area.

The Global Property Market

So returning to my conversation with my friend in overseas development - what’s the core problem for investors?

Well, in countries where property inflation has run rampant, people have borrowed against their growth in home equity to invest - in other property. Buy-to-let at home and abroad has become a huge market, supported by a range of TV programs feeding the interest in property investment overall.

The serious danger is that these investments are dependent on UK property retaining value from all previous growth. And now that we’re leaving the realm of low interest rates, existing borrowers are really being hit in the pocket.

Already, UK banks and building societies have begun withdrawing fixed rate mortgage offers - the rats are preparing to leave a sinking ship, as they try to protect their own profits, and the fruits of their own overselling from crippling themselves with debt in what is now becoming a rapidly changing market.

And this is something we’re seeing increasingly abroad - property as realised as over-valued and over-supplied in many overseas investment locations.

The expert property investors have already either stopped investing, or have even already begun liquidating capital assets for profit-taking on previous few years growth and re-investing on stock market equities instead, leaving one falling wave to catch another rising.

Global Stagnation - the problem

So what is stagflation?

High interest rates, high inflation, low consumer spending - no obvious way to combat any to increase growth because of negative feedback loops built into the existing economic model.

Simply put, after the car has rolled out of control down the hill, it reaches the bottom, hits something, stalls - and can’t be restarted

We’re already seeing rising interest rates married to rising inflation - an immediate danger signal.

But the biggest danger signal is the huge amount of debt underpinning previous growth, which is extremely vulnerable to the continued rise in interest rates.

As this debt slowly rips apart company profits and individual’s equity, less cash filters through to investors, and individuals already tied to heavy debts can afford less.

Consumer spending continues to fall, but inflation tied to energy markets continues steady, leaving national banks pressured to raise interest rates to combat rates even if it means continued falls in consumer spending that is required to stimulate an economy.

The situation now

We’ve not yet reached a stage of global economic stagflation. But the danger indicators are already there, and even worse, these indicators are growing bigger. Global economic stability is increasingly unstable.

We may not reach a point of stagflation in the near future - positive economic conditions arising in one sector can positively impact others. But the rule of economic cycles tells us that growth comes at a price, and we haven’t yet paid that due.

Are house prices going to crash? That’s probably too dramatic a term. What we should expect to see is a continued threat of negative property inflation, which we could see increasing over the next 12-24 months. Such deflation need not be dramatic, especially in the UK, where supply and private investment via SIPPs and REITS can only help to buoy it.

However, as global economic conditions around the world become worse, and threats of stagflation continue to taunt us, the UK will never remain isolated of any such worldwide economic developments.

The bottom line is that we are living in an era of unprecedented economic vulnerability, and the situation is increasingly worse.

All the more reason for individuals and companies to stop taking such a short term view of growth and profits, and instead look to the longer term to protect their assets.

After all, even if stagflation does occur - globally or locally - it remains yet another element in an ongoing economic cycle. While dark days may threaten, should they ever arise, we can be sure to come out of it at some point.

That’s when those with longer term investment strategies can look at the strength of their own portfolios, and how well they weathered, when those chasing gains with short-sighted vision try to pick up their pieces and try again.

Meanwhile, I’m going to pass on investing in global property. After all, after the conversation with my friend, if those experienced in these markets are waiting for a correction, I’d be a fool to leap where even risk-takers fear to tread.

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