Investing During Extreme Uncertainty
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Investing During Extreme Uncertainty

How understanding risk influences investing.

By Paul Miron
Wed, Jun 8, 2022 11:26amGrey Clock 3 min

OPINION

 

As we return to work after a Federal Election and welcome a new government, there still seems to be no end in sight regarding the war in Ukraine, a worldwide energy crisis, food shortages, supply chain issue, COVID-19 and rising costs of living alongside the prospect of further interest rate hikes.

It seems that our economic future has never been more uncertain. Or are things really all that bad for investors?

Amidst the macroeconomic upheaval in the global economy, the question remains, “How does one remain calm, continue to be invested strongly, and actually take advantage of these changes in the global economic cycle?”

 

How Heightened Risk Can Increase Market Awareness

 

An analogy can be drawn from a social experiment conducted some years ago in Drachten, Holland, by a traffic engineer named Hans Monderman. He removed all traffic signs, speed control, and traffic lights in this city. Naturally, you would expect complete chaos to have ensued. Almost completely counter-intuitively, both fatality rates and car accidents reduced, while traffic flows improved.

It all comes down to personal risk assessment; when drivers have a constant level of heightened risk awareness, they become better judges of risk more careful and prudent in an environment with fewer road signs and other traffic measures.

The same concept applies to investing. When investors are constantly thinking about risk, being self-reliant and filtering through market noise cautiously, investor behaviour changes for the better.

It also demonstrates an essential truth about life and investing – risk is a constant — what changes is both our attitude and reaction to risk.

 

Macroeconomic Forecasts

 

Investors are often lulled into a false sense of security based on what other people are forecasting and thinking, they are caught up in speculative investment trends, often with undesirable outcomes.

The most pressing economic issue impacting all investors is the nexus between inflation and interest rates. How far will the RBA go in raising interest rates to curb inflation? This is now the centrepiece of all forecasts and market predictions. If rates are raised too quickly and aggressively, it increases the risk of an exceptionally prolonged recession. If our central bank is too lax, the inflation we are experiencing may morph into something more disturbing, such as stagflation, deflation, or even hyperinflation.

Thus, the question becomes: how reliant are we on forecasts when making investment decisions?

Below are the Big Four bank economists giving their best attempt at a forecast. Interestingly the CBA and financial market forecasts would differ significantly regarding overall asset prices, from notions of a modest correction to a full-fledged market collapse.

Taking the conservative estimate, if the CBA predictions are accurate, mortgage holders’ monthly repayments will increase by 14.6%, which is aligned with the last time we experienced a rise in the interest rate between 2002 and 2008.

However, if they take the forecasts priced in by the financial market, mortgage payers would be making 39.7% higher monthly repayments.

 

Risk Tolerance

Msquared’s view is aligned with the CBA forecast; that is, we would anticipate property prices falling 15%. However, our risk tolerance towards new opportunities is more conservative as we continue to prioritise asset preservation and have adjusted our risk profile to reflect an extreme decline in property prices.

As Voltaire said, “uncertainty is an uncomfortable position. But certainty is absurd”.

Embracing the volatile world we live in enables an investor to prepare and navigate uncertainty effectively.

The one thing that is certain is Mark Twain’s dire warning that “History does not repeat itself, but it often rhymes”. Market cycles have been around since the advent of money, largely a result of people’s emotions/sentiments. In other words, the market is not driven solely by economic fundamentals.

What is certain and predictable is that market busts will inevitably be followed by market booms, and vice versa. These cycles will continue so long as people make decisions regarding money – that is – forever.

 

Paul Miron has more than 20 years experience in banking and commercial finance. After rising to senior positions for various Big Four banks, he started his own financial services business in 2004.

MSQ Capital

msqcapital.com

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Investor buying of homes tumbled 30% in the third quarter, a sign that the rise in borrowing rates and high home prices that pushed traditional buyers to the sidelines are causing these firms to pull back, too.

Companies bought around 66,000 homes in the 40 markets tracked by real-estate brokerage Redfin during the third quarter, compared with 94,000 homes during the same quarter a year ago. The percentage decline in investor purchases was the largest in a quarter since the subprime crisis, save for the second quarter of 2020 when the pandemic shut down most home buying.

The investor pullback represents a turnaround from months ago when their purchases were still rising fast. These firms bought homes in record numbers last year and earlier this year, helping to supercharge the housing market.

Now, investors are reducing their buying activity in line with the decline in overall home sales, which have slumped with mortgage rates rising fast. But with investors’ large cash positions, and with big firms such as JPMorgan Chase & Co. planning to increase its exposure to the home-buying business, investors are poised to resume more aggressive buying when rates or home prices begin to ease.

These firms have seized on a pandemic-driven rise in demand for houses in suburban areas. These owners rented out the homes and increased rents on homes by double-digit percentages. By the first quarter of 2022, investors accounted for one in every five home purchases nationally.

But ballooning borrowing costs have kept investors from buying as much recently, said John Pawlowski, an analyst at Green Street. Buyers and sellers are also agreeing less often on pricing, stifling sales.

“It leads to a lot of people just putting down the pen,” Mr. Pawlowski said.

Rent growth has also begun to slow. Rents for single-family homes rose 10.1% year over year in September, down from 13.9% in April, according to housing data firm CoreLogic.

That rate of growth is still very high by historical standards, however, and much stronger than in the apartment market. Multifamily rent increases are now much lower by most measures. Near record-high rental prices are failing to attract as many new tenants, and demand in the third quarter fell to its lowest level in 13 years.

Demand for rental houses has held up better, in part because many of these homes are leased to relatively high-earning people who have found the for-sale market too expensive to buy, some analysts say.

That rent growth for single-family owners hasn’t translated into stock-market gains this year. Investors have lumped these owners in with home builders and sold many of them. Shares for the three largest publicly traded owners, Invitation Homes, American Homes 4 Rent and Tricon Residential, are each down more than 25% year to date, underperforming the S&P 500 over that period.

Rental landlords also face headwinds from rising property tax assessments that have come alongside enormous increases in home-price appreciation.

At the same time, large rental landlords are coming under greater scrutiny from federal and local governments. Congressional Democrats have hosted a series of hearings focused on eviction practices and rent increases. Three Congress members from California this month introduced a bill called the “Stop Wall Street Landlords Act,” which proposes levying new taxes on single-family landlords. It would prevent government-sponsored enterprises like Freddie Mac from acquiring and securitising their debt.

Many of the places where investors have eased purchasing are the same cities where they had counted for an outsize share of total sales. That includes Las Vegas and Phoenix, where investor sales dropped more than 44% in the third quarter compared with a year ago.

Fewer purchases by online house-flippers, or iBuyers, may have contributed to those declines, according to Redfin. Redfin decided to close its own home-flipping business, RedfinNow, earlier this month.

Nationally, investors still accounted for 17.5% of all home sales in the third quarter, a higher share than they held at any time before the pandemic, by Redfin’s count.

That share seems likely to rise again. Builders with unsold homes due to widespread cancellations by traditional buyers have been looking to sell in bulk to rental landlords.

Meanwhile, some institutional investors are now readying large funds to snap up homes. J.P. Morgan’s asset-management business said this month it had formed a joint venture with rental landlord Haven Realty Capital to purchase and develop $1 billion in houses. A unit of real-estate firm JLL’s LaSalle Investment Management, in partnership with the landlord Amherst Group, said it plans to buy $500 million of homes over the next two years.

Tricon has nearly $3 billion it plans to tap to buy and build homes. “We will lean in and deploy that capital when the time is right,” Tricon’s Chief Executive Gary Berman said on a November earnings call.

While a recession could bring down borrowing rates, it would likely be accompanied by higher unemployment, making it difficult for traditional buyers to take advantage, said Daryl Fairweather, Redfin’s chief economist. For investors, however, that could offer an opportunity to acquire homes at favourable prices.

“An investor may have more resources to jump in at exactly the moment when rates decline,” Ms. Fairweather said.

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