Today’s release of the fourth quarter house price index reminded me of last week’s Macquarie University Risk Day conference in Sydney. The audience heard from a number of distinguished academics, as well as the likes of Dr Luci Ellis from the RBA, and Christopher Joye from Smarter Money Investments. The hot topic is “bubbles”, with three of the six speakers (this writer included) using the b-word in their talk title, and another presentation on booms and busts.
This question is not only important to dwelling owners. Lending for housing makes up 50% to 60% of all big four banks loans. In turn, the finance sector represents just under half of the value of the Australia 200 index. If there is a housing market collapse, it will see bank shares trounced and the share market fall out of bed. Questions about the health of housing markets are important to almost all Australians.
Is there a bubble in the Australian housing market?
The short answer is “probably not”. Naturally, among regulators, academics and industry practitioners there were a number of different approaches to the question.
I’m giving myself away as a market tragic here, but I found APRA’s Heidi Richards fascinating in her discussion of the secret shopper style analysis that APRA performed on the banks’ mortgage assessment process. Using four personas, APRA submitted loan applications to each of the major banks. One of the applications was designed to fail.
APRA was largely pleased with the results, and Ms Richards presented data that showed the tightening of lending standards enacted last year is now in force, resulting in lower loan to valuation ratios.
Bubbles - A Behavioural Approach
Despite describing markets with numbers, they are not scientific or logical. Rather, they are a mass expression of opinion. This means markets are organic in nature, and can be as rational or irrational as we are as human beings. In examining market behaviour, I take the price action itserlf as the primary evidence.
The Three Conditions of a Bubble
The problem with market bubbles is identifying them in real time. Harry Hindsight can spot a bubble from a mile away, but knowing when one is about to burst can be very valuable to investors and traders.
In a broader look at bubbles, I identified three behavioural characteristics of bubbles:
- After a sustained rise, the gains accelerate and the price increase becomes steeper
- There is a divergence from traditional valuation, and a version of the “it’s different this time” argument. An example is the abandonment of cash flow valuation in the tech stock bubble that formed 1998-2000, and the willingness then to pay huge share prices for clicks and eyeballs.
- The price must perform a blow off top. This usually takes the form of a large rise, and then an immediate fall back, preferably in a single trading session. Traders have names for the chart patterns that may signify a blow off top – doji, shooting star, spinning top etc.
What Does the Data Say?
With these three conditions in mind, let’s turn to a chart of house prices. This is the Australian Bureau of Statistics house price index (the average), and its city based component indices:
Admittedly, this is a line chart, not a candle chart. Nonetheless, it is difficult to make the argument that there is a sustained and steepening price rise. The possible exception is Sydney, and given it size its fair to suggest most of the heat in the national index is coming from one property market.
So, possibly Sydney house prices are in a bubble. However, there is no sign of a “its different this time” argument. Consensus appears headed in the opposite direction, with many investors and commentators shying away from property.
And clearly, there is no blow off top formation.
There are no guarantees in life, and no-one can state with certainty which way a market will move. However, there is scant evidence to support the idea that there is a bubble in the Australian property market. Investors eying off the banks after the recent pullback and recovery in share prices can probably take a property market crash off their list of worries.
Perhaps the only bubble at the moment is in the use of the word bubble......