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NEWS: Property Investing and Real Estate In Australia

Why I’m Afraid Of Bubbles

Date: 04/03/2020

CoronavirusWhat an incredible time to be alive. I can’t help thinking that hundreds of years from now people will be studying the emergence of the coronavirus, and wondering what it was like to live through it, much like we wonder what it might have been like living through, say, the Black Plague or Spanish Flu.

Except of course, what we are currently facing is nothing like a plague nor a flu epidemic.

But don’t let the truth get in the way of hype. May the Lord protect anyone who needs toilet paper or bottled water in a hurry right now – the stores are sold out because of sudden panic buying.

Okay, I can sort of understand stocking up for essentials in case of an enforced 14-day self-quarantine period… but bottled water? This isn’t a cyclone where we need to be concerned that our water (renowned as being amongst the cleanest in the world) might get contaminated.

Sure, it’s wise to be informed and to take precautions. And if this virus mutates into something nastier, then it will truly be something to get worried about. But do we all need to rush out and buy a year’s supply of toilet paper? Surely not.

Now, while I’m concerned about the coronavirus, I am actually afraid of bubbles.

No, not the bath variety, but rather the asset and debt varieties.

Have you noticed the recent huge fluctuations on financial markets? The astounding rises, and falls, on world stockmarkets as people lurch from fear to greed and back again? This volatility scares me because if people act irrationally and stockpile toilet paper, how might they react when it comes to their financial nest eggs?

Recall the wisdom shared in the movie Men In Black (seriously!):

A person is smart. People are dumb, panicky dangerous animals and you know it.

Without wanting to be a false financial Cassandra, my ‘spider sense’ is tingling.

Did you know that US consumers are in more debt now than they were in the GFC? It’s true. They currently owe about US$14 trillion. That’s US$14,000,000,000,000 (see: https://www.debt.org/faqs/americans-in-debt/)

And corporates owe nearly as much again. Quoting from Forbes (emphasis added):

U.S. non-financial corporate debt of large companies now stands at about $10 trillion dollars, 48% of GDP. This represents a rise of 52% from its last peak the third quarter of 2008, when corporate debt was at $6.6 trillion, about 44% of 2008 GDP.

And the US government? The highest it has ever been. US$22trillion increasing day by day.

Perhaps you think things will be different here Australia. No. Here in the land of Oz we’re price takers, and so what happens on world markets will most certainly happen here.

So when you read that the solution to firing up the economy is to reduce interest rates to encourage people to borrow more and spend, you should be afraid. Very afraid. Not so much about the coronavirus, but about the crippling debt bubble that is inflating before our eyes that must certainly, eventually, pop. And when it does, the economic pain and associated social upheaval will be much, much worse than anything in living memory – even the GFC.

What should be our response? Well, so long as interest rates remain low it’s likely that asset values will continue to rise as cheap and easy money looks for opportunities to multiply (see my commentary on the latest property data here). As it does, the value proposition of assets will begin to look absurd, but people will invent excuses as reasons to justify why things are they way they are, and why prices must continue to rise.

Think tulips, or Internet stocks, or commercial real estate where right now average grade commercial property in Australia is selling at 6% returns. High grade on long leases is 4% to 5%.  Junk is 8%. This is just way too low (truly, historic lows not ever seen before) for the risk involved, but cheap interest rates make the returns enticing nonetheless, especially when you compare to residential where the leverage returns are mostly negative.

Honestly, it’s not fun being the only sober one at a party… until the following morning when everyone except you has a horrible hangover and a humongous headache. Think about it… how much lower can interest rates and unemployment go? Sooner or later the benefit from both must be fully realised, so without increases in income (not likely as wage growth is low), what will drive prices higher? Possibly innovation in debt products (think Afterpay for property), but aside from that, I’m not sure.

That’s tomorrow though. Viva La Vida! Let’s tap open another debt keg – or two, turn the music up louder and start dancing on the tables. Bottoms up!

To wrap up then… Friends, sober won’t necessarily make you popular when everyone else is acting irrationally. But it will keep you safe, and it will help you make smart and sound financial decisions (and especially help you not to make stupid choices that drunk people make so willingly but regret so readily later). Sober right now means having a realistic strategy, and following it, without getting caught up in the hype.

If you want to hoard anything right now, cash is surely a better option than toilet paper. One can buy the other, and can also be used to purchase assets that may become available if values slip irrationally lower should panic selling set in. The other can only be used one way, and then flushed forever.

What do you think? Share your thoughts below.

Profile photo of Steve McKnight

By Steve McKnight

Steve McKnight, the founder of PropertyInvesting.com, is a respected property investing authority as well as Australia's #1 best-selling business author.

Comments

  1. Ryan Lewis

    Last year when prices were dropping, it was doom and gloom.
    Now this year property is up and its still doom and gloom lol.

    • Tim Banks

      The virus has entered Africa, Game over! This will be a multi decade problem that will kill a billion people. If it is a confirmed bio weapon released by accident, there will be a revolution in China. We are living in the early stages of one of the greatest events in human history. Countries and Governments will fall. Civil wars will outbreak all over the globe, currencies and markets will fail. Global trade will break down. Everything as we know it will change in this decade. By the end of the decade the world will look vastly different a lot of people who are unknown at the moment and have been waiting for change will step up and change the world.

      • Juerg Nydegger

        Was it an accident?
        Who really knows?
        It seems to me like this whole schamozzle is a giant chees game!
        I agree that cash is king….but so is bullion for the prevailing interest rates are pretty much useless anyhow. Further is your cash safe with bail in laws and cash limits just around the corner?
        Interesting times indeed!

      • Mike

        Maybe, or a vaccination will be developed, and / or the fatality rate will remain well below that in influenza, and / or people will change their hygiene and travel habits. Or it could be really bad. The point is… the situation will either get better, worse, or stay the same. Have a financial plan that works in all cases. We may think we know what’s going to happen, from reading the news, but we just don’t know.

  2. Jimmy

    Hi Steve,
    I did actually turn my super to cash two days ago, as I believe the media hype will create panic globally and stocks will fall.

    Interesting though, as they seem to be going up haha.

    Hmm

  3. John

    Like Jimmy I switched a large chunk of my super to cash, mid-last week. Until we have news of a viable vaccine it seems to me all the risks are on the downside.

    Reminds me of that Chinese curse “may you live in interesting times”.

    • Bubbles

      Rum Rebellion were advocating dumping shares for cash in the bank only the other day. Interesting times indeed.

  4. Julius

    June/July is the key time where those big US corps and firms are due for paying the interests and debts they borrowed. Can they borrow more? Sure can. We will keep seeing this irrational behaviors until the bubbles start to pop. Sit tight and embrace for impact!

  5. Juerg Nydegger

    Was it an accident?
    Who really knows?
    It seems to me like this whole schamozzle is a giant chees game!
    I agree that cash is king….but so is bullion for the prevailing interest rates are pretty much useless anyhow. Further is your cash safe with bail in laws and cash limits just around the corner?
    Interesting times indeed!

  6. Jenna

    From what I’ve read, corona virus tends to be most dangerous for the elderly. No children have died from it, as far as I understand, and only a small percentage of people under forty years of age have passed away. Majority recover. I think overall death rate for those that contract the virus is 2.3% at the moment. So even if we all get it 97.7% of us will live! That’s pretty good! Of course the virus can mutate but so can the 100s of other virus’s out there.

    I think it’s great to be really cautious and have Corona outbreak plans in place, and to be extra vigilant with hand hygiene… but I don’t see the need to panic. Healthcare rather than finances is more my field of knowledge… yet I think the bubble kind of sphere that’s worrying Steve sounds much more of a logical concern than this viral variety!

  7. Profile photo of 5c1eb9d2

    Steve, Thank you. This bubble has been due to pop for way more years than I anticipated. Sticking to strategy means that we now have an opportunity in front of us to use some of this cash. What are you planning to spend it on in the next 6 months?

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