Asset Prices : From Soaring Heights To Bitter Reality
Asset prices have generally gone in an upward direction over the past century. Take the Vanguard Index Chart in the previous post as an example. After booms and busts, they appear as minor blips barely noticeable when zoomed out.
Financial pundits and investment products often emphasize that past performance does not guarantee future results, acknowledging the need for caution.
Throughout the last century, asset prices in the stock market have delivered remarkable returns. Property investors in Australia, specifically, have enjoyed a splendid decade. Furthermore, Bitcoin has emerged as the best-performing asset in history.
As individuals striving for a better future, are we placing excessive certainty on past performances?
Warren Buffett illustrates an enlightening example from 1999, where he notes that the Dow Jones Industrial Average advanced from 11 to 11,497 during the 20th century. Although this gain seems substantial, it equates to a modest 5.3% annual compound growth rate. Investors who held the Dow during this period benefited from generous dividend returns.
Buffett’s illustration holds significance even today. To match this 5.3% return, the Dow would need to reach approximately 2,000,000 by December 31, 2099.
If we continue to expect 10% equity returns in this century, comprising 2% dividends and 8% price appreciation, we would project the Dow to reach 24,000,000 by the end of 2100. However, Warren Buffett doubts the likelihood of such an outcome.
Considering these factors, are we headed towards a sobering reality in terms of asset prices?
Stock Asset Prices
In recent decades, the stock market has historically provided consistent 10% returns, making it a superior asset class. Investors have amassed significant wealth through stocks, which often involve a transfer of wealth during market fluctuations.
However, as Warren Buffett elucidates, the sustained exceptional performance of the stock market becomes increasingly improbable from a mathematical standpoint.
Let’s consider the ASX200 as an example, heavily concentrated in financial and material businesses. Personally, I’m not inclined to invest in this index due to its lack of diversification compared to other global indexes.
Over the past decade, the four major retail banks in Australia have seen minimal capital appreciation, even during the nation’s booming property market. Moreover, dividends from these banks have either remained stagnant or decreased. To imagine how a business not being able to capitalise on a booming property market eludes me.
Mining companies also hold a substantial portion of the ASX index. While they have experienced significant growth in the last 30 years, it remains uncertain whether this growth is sustainable, particularly considering the potential decline in China’s demand for our natural resources.
In contrast to other markets, Australia’s stock market offers higher dividend yields but lower capital appreciation. To sustain ongoing double-digit returns, consistent growth in earnings is essential, accompanied by modest increases in asset prices.
The crucial question revolves around the ability of commodity prices to sustain their high levels and the potential for increased demand for our resources. Additionally, we must consider whether our banks can maintain both earnings growth and business expansion. Personally, I have some reservations regarding the latter aspect.
Property Asset Prices
It’s common knowledge that Australians have a strong affinity for property, as a significant portion of their net wealth is tied to their homes. According to the 2018 Australian Council of Social Service, 39% of household wealth is in owner-occupier housing, followed by 15% in investment properties. Superannuation accounts for 21%, while stocks, financial instruments, and non-financial assets represent 20% and 9%, respectively.
Housing dominates the asset landscape for Australians. However, we must address a crucial concern. While many Australians may be considered “asset rich,” what is the actual impact on their financial well-being?
In a previous post, I highlighted how a single salary was sufficient to purchase a family home in 1990. However, now it takes the combined income of two full-time earners to afford the same property.
While house prices have skyrocketed, this financialization of housing has not improved our societal prosperity. Housing affordability has drastically changed compared to three decades ago.
The ones who have truly benefitted are the older generations who purchased their first homes when property prices were only 3-5 times their earnings. Nowadays, we face the challenge of property prices being 10-15 times our salaries.
In 1990, interest rates were much higher at 17%, whereas they currently stand at 4%. Yet, new homeowners are struggling with the rise in interest rates. This situation should serve as a warning sign of unsustainable asset prices.
Even a five-year-old can understand the mathematical implications. If property prices continue to outpace wage growth for another decade, the majority of Australians will be unable to afford a home.
Over the past two decades, wage growth has been around 3%, while property prices have averaged 7%. It doesn’t take a genius to realize that if property continues to outpace wage growth, it might require the income of three individuals to purchase a home.
Furthermore, the majority of investment properties offer negative returns on yield, relying on the hope of selling at a higher price in the future. Eventually, the market will reveal who has been exposed without a safety net.
What Should We Do?
It’s essential to maintain a balanced perspective. While future returns from the stock and property markets may not match past levels, there is still potential for asset prices to soar.
Although I don’t hold a bullish view on the ASX200 index, I remain optimistic about individual companies within the Australian stock market. While blue-chip stocks may not be top performers, smaller companies possess significant growth potential.
While the overall Australian market may not deliver double-digit growth, numerous companies have the potential to achieve remarkable returns. Some of these companies may even surpass the dominance of big banks and mining firms to secure positions in the top 10%.
Alternatively, considering a global stock market index or the Nasdaq 100 index may be worthwhile. In my opinion, these index funds are more likely to offer slightly better long-term performance.
Despite the Australian obsession with property investment, I view housing primarily as a necessity. Affordable housing is crucial for ensuring security and fostering a prosperous nation.
However, it’s unlikely that government policies will change the advantages given to property investors and similar entities. This is because a housing market crash in Australia would have significant repercussions on the global financial system.
How to invest lies strictly on your own discipline and thoughts. The investment landscape is forever changing, stick to what you know best and all we can expect is for our investments to outpace inflation.
Key Takeaways
- While the stock market historically provided consistent returns, sustained exceptional performance is increasingly improbable. As a passive investor this is a risk that you need to be comfortable to accept.
- Skyrocketing house prices have worsened housing affordability, benefiting older generations but making it difficult for the majority to afford a home. Unsustainable asset prices and negative returns on investment properties pose risks in the future.
- It’s important to stick to what you know best and aim for investments that outpace inflation.
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