In short, value is difficult to find

Roger Montgomery

Asset prices across all investment classes are at record highs, including and perhaps especially assets that produce no income. That takes in items such as the two-digit New South Wales numberplate that sold for $745,000 and the Basquiat painting sold this week for $US110.5 million — a record for post-1980 art and for an American artist.

It’s not surprising, then, that precious few assets are trading at prices that represent good value. When asset prices are high, returns will be low. The higher asset prices go, the lower future returns will be for the buyer. Therefore, these are the times when a strategy that can profit from falling asset prices makes perfect sense.

Consider the many industries in Australia that are being disrupted or are at cyclical turning points. Starting with residential property developers, we can see that a 23 per cent fall in residential approvals will lead to similar, if not larger, falls in construction activity.

This will have negative consequences for owners of businesses that profit from building and selling houses. With yields pushed to record lows, future returns on long-term commercial real estate assets are now unappetising when compared to cash returns.

Cash, however, is still seen as a liability and so people are exiting in droves. At the very time investors should be more cautious, they’re the most enthusiastic. This is common to the end of all booms.

An oversupply of apartments will lead to a collapse in construction activity, putting many tradespeople out of work or with less work. The construction industry employees about 9 per cent of Australia’s workforce, so any change to activity could have serious economic consequences.

When you factor in that mortgage, household and credit card debt are all at record highs, it’s easy to determine that rising construction industry underemployment will lead to a decline in retail sales.

The collapse of fashion retailers from Rhodes & Beckett to Pumpkin Patch and Topshop is a sign that unemployment in the sector will only continue to rise. And what of retailers who supply appliances and furniture to fit out all those shiny new apartments and houses? A slump in housing activity always leads to falling demand for additions and alterations.

The lag is about 10 months, so at some point in the next year retailers from Bunnings to Nick Scali could see a slide in same-store sales growth. That will put an end to the increasing employment dreams of those retailers.

If unemployment rises, the hundreds of thousands of property investors with mortgages will be forced to reduce their rents or lose tenants. It follows that financial stress will also hurt retail sales and the desire to borrow for asset purchases. That brings me to the banks.

The big four banks are all ready under pressure from regulators to slow the growth of investor loans. The banks have used a variety of techniques including raising deposit requirements, Blacklisting entire suburbs or simply raising interest rates, to quell the insatiable demand of unwitting property speculators. Well the banks may yet be shown to have prevented a much bigger bubble and subsequent mess, they cannot avoid the fact that their growth rates Will be slower than the recent past.

From builders to retailers, Car sellers to furniture sellers from electronics and white goods retailers to the banks the ground for profitable shortselling opportunities is fertile. And if the scenario I have articulated puts pressure on the Australian dollar the pressure on importers could ramp up very quickly. Perhaps that’s why at Montgomery, not unlike other managers that offer market neutral funds or funds that short sell, we have seen an increasing level of enquiry from sophisticated investors who see short selling not as a high risk alternative but as a very necessary part of their portfolio for the new post bubble era.


Roger Montgomery

Roger Montgomery founded Montgomery Investment Management, www.montinvest.com in 2010. Roger brings more than two decades of investment, financial market experience and knowledge. Roger also authored the best-selling investment book, Value.able.

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