A Dairy Shockwave in March Could Pop Our Property Bubble

The things in life that damage you come from where you least expect.

Some years back, I bought a penthouse apartment overlooking the English Channel. I had it checked. About a year later, we discovered the ground floor apartment below leaked badly. Again, it was checked. Repointing the half-metre thick granite walls appeared to be the solution.

Yet, once the work commenced, the true problem emerged. The luxury apartments installed within the Victorian building lacked the correct membrane through the middle balconies (and above the ground floor living). The work, disruption, and cost involved became extensive.

To cut a long story short, I managed to sell, aided by the building’s unique position. But it was enormously stressful. At its zenith I was getting through a lot of wine each night.

Property problems were common there. Difficult to buy. Difficult to sell. Construction problems. When I lamented with friends at the pub and mentioned the wine, one of their best remarks was, ‘At least you got something out of it.

 

Difficulties where you least expect

As I watch news of the Australian economy and property market tanking, I worry about our little patch in New Zealand.

We’ve had a good run, and we’ve become complacent.

The ‘rock-star economy’ is tired, drugged up on debt, and starting to wobble on the stage. The property market, where we invested everything, now sits in a generational tug of war. There are those who need their equity to retire and those who need affordable prices to even have a chance of ownership.

Meanwhile, our trade depends on agricultural-based exports, particularly to China. Our dollar rises and falls on the price of milk. Domestically, tourism and migration keep the money turning.

 

Others have been at these crossroads before

The ‘Argentinian Paradox’ is one of the most fascinating studies in economics.

Here was a country in the late 1960s with GDP per capita ahead of most European countries and Japan. Like NZ, it had a fertile agricultural export sector. Like NZ, it had low population density. Like NZ, it depended on migration and foreign capital to offset a low rate of savings.

As I write, inflation in Argentina is now running at over 40%, and a significant portion of the economy lives in abject poverty. Mortgages run in excess of 60%. And it is difficult to buy property, not only due to the cost and availability of credit, but the fact that property is typically denominated in US dollars.

So you might think property prices in Buenos Aires would be stagnant. Last year, prices in many preferred suburbs surged by up to 16.5%. [openx slug=inpost]

 

Could we go the way of Argentina?

Unlike much of Latin America, we have relatively low levels of national debt. As a ratio of GDP, we currently owe about 22%, which is low, even within the OECD. Unlike much of Latin America, we also have a stable and flexible government.

In terms of public finances, we are in a good position. In 2018, Ratings agency Standard & Poors said of NZ: ‘The economy is wealthy and resilient, reflecting decades of structural reforms.’

However, we are far from the Switzerland of the South Pacific — an export-focused country that has also signed a free-trade agreement with China.

At a national level, the key risks for NZ concern its reliance on a very concentrated export base — in 2017, we depended on 17.4% tourism, 17.2% dairy, and 8.4% meat. In addition, China is the dominant trading partner, taking 34% of what we produce.

As we’ve seen with the Huawei fallout, New Zealand is not neutral. We have long-standing allies, in particular the US. So while we increasingly depend on a Chinese-focused agricultural export base, we are not immune from geopolitical tensions.

And we are not invulnerable to shocks.

It was external shocks, including low prices for agricultural commodities, that pulled Argentina into a deep and painful recession in 1998. One from which it found it hard to recover.

 

Household debt

As with Australia, household debt, especially mortgages, is an area of concern. Many people carry property debt in excess of five times their income; twice the amount usually recommended as a maximum level.

Over the past decade, hungry for foreign capital to offset our low savings rate, successive governments allowed our property to float on the world market and opened the borders to very high levels of per-capita migration. In 2017, we had the fastest-growing population in the OECD.

Auckland house prices steamed on the back of this. A generation had to take on mortgages too large while facing lower real wages.

Now we’re faced with an untenable situation, where only 1 in 4 people under 40 own a home. And as laidback as many Kiwis are, the politics are starting to turn very fast. We’ve had the foreign-buyer ban, bright-line test and tightening up on rental property. There’ll be more to come, including the likely scenario of a capital gains tax on second properties (but possibly not on farms or businesses).

The trouble in the eye of this storm is that we’ve invested too much in property and with too much debt.

Should a shock come — for example, a sudden reversal of our dairy fortunes — this will be felt throughout the economy.

A bubble in the milk could burst the property bubble. And that could be the domino that sets off a more concerning spiral.

 

So, what can you do as an investor?

Simply, when it comes to building a portfolio, NZ appears insufficiently diversified. You need to spread your risks further.

There are many strong companies that allow you to take advantage of other significant export sectors in the world.

As an example, diversified miner Rio Tinto is listed on both the ASX and LSE — [ASX:RIO], [LSE:RIO]. It has a diverse portfolio of products, supplying the world with the metals and minerals that help it grow. Its 47,000 staff work in 35 countries and are involved with aluminium, copper, diamonds, iron ore, and other minerals.

There are numerous risks when investing in other currencies and in cyclical commodity businesses like mining. So, as you build your portfolio, you may want to diversify against those sorts of risks.

However, in starting down this road in investing and leaving no stone unturned, you’ll likely develop a resilient base that can help you weather any storm that may come.

Regards,

Simon Angelo
Analyst, Money Morning New Zealand

Important disclosures

Simon Angelo owns shares in Rio Tinto [LSE:RIO] via wealth manager Vistafolio.


Simon is the editor of Wealth Morning and has been investing in the markets since he was 17. He recently spent a couple of years working in the hedge fund industry in Europe. Before this he owned an award-winning professional services business and online learning company in Auckland for 20 years. He has completed the Certificate in Discretionary Investment Management from the Personal Finance Society (UK), has written a bestselling book and manages global share portfolios.


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