Country by country macro update, part 2, September 2014

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Yesterday, I did a broad overview of four markets of interest to global investors. And I wanted to continue my thoughts on this here with a few more markets and with a deeper dive into some of my thinking about the UK.

Britain, Part 2: I want to take the UK on first, because I am doing a headline story on the UK today on Boom Bust, where I am filling in as host. Here’s what I said/will say on TV:

In the United Kingdom, all eyes are on the Scottish referendum to secede from the UK. But today, a significant piece of news snuck under the radar. Britain’s Office for National Statistics released data showing UK house prices at a record over 272,000 pounds on average. That’s almost $450,000. In the London capital, the average is over 500,000 pounds, which equates to about $800,000.

This is crazy.

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Now, let’s remember that the UK is growing smartly. 2014 GDP is expected to grow over 3%, which compares favourably to the US where you can cut that figure in half. And the Eurozone is barely growing. But all of this begs the question whether a robust economy is pushing up house prices or whether Britain’s growth is predicated on a housing bubble.

Now, if you go back to December 2008, just after the global housing bubble burst, you see some eye-popping numbers in many of the economies that were hit the hardest. According to data from the Economist, Ireland led the way with house prices climbing 201% between 1997 and 2008. Spain saw prices rise 191% and Britain saw prices rise 168%. The US, with an 85% increase in house prices looks tame by comparison.

But it all came unstuck in the bust and subsequent crisis. We saw steep declines in all of these countries as well as in the Netherlands and Denmark. The debt stress associated with the decline in house prices produced an epic round of household deleveraging, making these countries some of the worst performers in the developed world. That’s mostly behind us. But in the UK in particular, it’s really in the rear view mirror.

Take a look at the data today.

Global House Prices Q2 2014

If you measure house price appreciation since the first quarter of 2008, prices in Britain are only up 9.7%. That’s a lot less than the 27.7% in Germany, 26.5% in Canada, the 26.4% in Australia, or 15.2% in Sweden.

But the other former bubble markets have tanked in that time: Ireland down 42.2%, Spain down 31.6% and the US treading water at 1.8% down. These markets are fair value.

Not Britain. On a price to income basis or using a price to rent yard stick, house prices in the UK are between 24 and 43% overvalued.

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And a lot of that overvaluation is centered in London, where prices have increased a staggering 19% in the last year alone.

Entrants on the property ladder are really having to gear up to get into the market. First-time home buyers paid prices in July that were 13.5% higher on average than last July.

This is unsustainable.

I have used the Economist data to compare the busted markets in the US and the UK with the still elevating market and Sweden. And the UK is the winner for real price appreciation in the last 15 years, by a wide margin. Prices have more than doubled in inflation-adjusted terms.

Sweden UK and US

Now, this is a great thing for politicians looking for wealthier homeowners to increase consumption. And it probably feels good to the average homeowner in the UK. But in terms of financial fragility, this kind of house price inflation is toxic. It leaves British households’ balance sheets stretched and makes Britain susceptible to another deleveraging wave when the economy turns down.

Bottom line: The bad ol’ days of Britain’s Boom Bust economy are not behind us. With house prices through the roof, boom bust in the UK is alive and well.

France. This is an interesting case. No one is talking about the connection between house prices and economic weakness in France. But French house prices are down 1.5% since Q1 2008 in unadjusted terms, more in real terms. Every major economy in the developed world with a national housing market down in nominal terms since 2008 has had an economic crisis, consumer price deflation or both. We’re talking about Ireland, Spain, Italy, Greece, the US, Japan, the Netherlands, Denmark…and France. French house prices are 30% overvalued on a price to rent and price to income basis even after the decline in prices. That tells you downward pressure on prices is likely to remain. I believe France is a weak link in the Eurozone. Along with Italy, France will make or break the next crisis in Europe.

Italy. Italy is a completely different animal here. Rewind to 2005 and compare Italy to the periphery on house prices. From 1997 to 2005, we saw 69% appreciation in Italy, but 192% in Ireland and 145% in Spain. By December 2008, those numbers were 104% from 1997 for Italy, 201% for Spain and 191% for Ireland. But since the crisis, Italian house prices are down 15.2% and represent fair value on both a price to rent and price to income basis. So, there was no housing bubble in Italy.

Italy’s problem is no growth in the context of a fixed currency union and an already-high government debt burden. In a recent column at Breugel, Ashoka Mody and Emily Riley point to poor marks on innovation, education and demographics as key elements holding Italy back. To that list, I would add waste, corruption and political instability because governance issues in Italy make it completely unrealistic to expect any measurable structural reform to overcome the lack of growth. Italy is in a holding pattern that means government debt will increase relative to GDP until something breaks. And at that point, just as in 2011, the eurozone will have an existential crisis because an Italian default is unthinkable.

Greece. I have said many a positive word about Greece over the past two years, first about bonds as an investment in 2013 and then in terms of the real economy this year. But we should be under no illusion that Greece is in good shape. Total credit in Greece shrank 4.9% year-on-year in July, with government-extended credit down 13.3%. Industrial output was down 2.1% year-on-year in July, with the PMI shrinking to its lowest level in nine months. Somehow, these data points coming out over the last month hasn’t deterred the ratings agencies from raising Greece’s sovereign credit rating. Moody’s raised its rating by two notches from Caa3 to Caa1. S&P upped Greece to B from B- earlier this month. While Fitch gives Greece a B credit rating. Greece has an economy that is now decelerating, prices have declined for 18 months on the trot, and government debt is unsustainable without an ECB backstop at 175% of GDP. Any economic hiccup will mean serious negative consequences for Greece. The bull market in Greek assets is over.

Argentina. My prediction at the beginning of the year is that Argentina would default and take over the mantel from Venezuela as the country with the worst inflation. Post-default, Argentina’s government is intervening to prevent a balance of payments crisis but the intervention is crushing business confidence and deepening an inflationary depression that is building.

I am on Argentina’s side in the government debt default fiasco. Nevertheless, in the weeks since Argentina defaulted, the Fernandez government has put restrictions on hard currency available to importers, boosted subsidies to prevent inflation from biting into real incomes further, and concocted proposals to plan and direct private companies’ production plans. Argentina has become a command and control economy – and none of this is going to save the country. It is going to make a bad situation worse.

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