Update No. 138 – 17/11/13

I directed readers to Update No. 97 last week to point out my expectation that 2013 would likely be a good one for stock markets. I also talked about US housing starts (pdf), predicting around 1 million starts for 2013 to underpin the expected US growth in the economy and in reducing unemployment.

The housing starts have actually been more sluggish than I expected. To August 31, 615,800 homes have been started. This is an annualised 924,000 or so, quite a bit short of the 1 million, which was sort of a base for my range of expectations, so this is lower than I expected at this point. Perhaps there was more excess supply than I had factored for.

With nearly 1.5 million household formations a year, if the US does not continue to increase home building, then it risks what Australia has faced for some time, prices that tend to remain artificially high due to underbuilding (relative to new formations) distorting supply factors relative to demand.

The natural price of homes should approximately follow a ratio of average earnings (similar to P/E ratios for stocks). “Earnings” would comprise some combination of the average weekly wage and average rental prices (which are loosely driven by average weekly wage in any case). Obviously, like the stock market, periods of exuberance can lead to high pricing & pessimism to low pricing. Structural factors can occasionally lead to ‘one-off’ rebasing of prices over time. This happened as two income households became normal in Australia, underlying house-prices increased to reflect this information. In my opinion (despite bleating from those not yet in the housing market) Australian housing is not priced at bubble levels. It might be about 10 to 15% above its natural level due to the aforementioned supply issues, but unless you see a rapid resolution to the regulatory conditions that (primarily) lead to under-building in Australia, I wouldn’t count on a major house-price plunge, though there will always be sections of the media happy to sell you that story.

Back to the US and prices on the Case-Schiller 20 city index are up 17.3% in August 2013 from their January 2012 low. Sounds like a pretty impressive gain, but only returns the average US price to January 2003 levels. As I say, if building doesn’t pick-up markedly, the construction shortfall will likely go to prices of existing properties in the short-term, this could already be happening to some extent.

I think the extent of the economic recovery in the US is (still) being underestimated. The massive deficit that they have been running is contracting at an extraordinary rate. The 2013 deficit was $680 billion, down nearly 40% on the 2012 deficit of $1.1 trillion. This is one of the fastest deficit contractions in US history. The first month of US budget year 2014 saw a further 24% year on year decline, if that continues through 2014, the deficit would be about $500b in 2014, or about 3% of GDP at which point the debt/GDP ratio would start to decline thereafter. With debt declines occurring at that pace and an economy still growing, an employment situation still improving, the US economy looks to be in surprisingly good health. Since mid-2010, over 1.1 million Government jobs have been eliminated, yet a solid 200,000+ jobs per month have been added of late, so private employment increases are more than compensating for public employment declines. Eventually once the Government jobs stop being shed, unemployment will fall and more people will return to the labour force, a virtuous circle.

The point of this review of the world’s largest and most important economy is that 2014 looks also to be a very good year for the US. My ardent hope is that their Federal Reserve sees it this way also and quite rapidly ends the current monetary easing cycle. It will take at least a year or two after this has been reversed to really feel how the longer term effects of this extended easing action will affect the global economy – Tony Hansen 17/11/13

EGP Fund No. 1 Pty Ltd. Up by 19.63%, leading the benchmark by 4.87% since July 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 63.40%, leading the benchmark by 37.26% all-time (April 1^st 2011).

^{*1 after 31May 2013 dividend of 2.333 cents per share plus 1 cent per share Franking Credit}

^{*2 calculated based on dividends reinvested}