While travelling this week to Newport Beach for PIMCO’s upcoming Cyclical Forum, I was pleasantly surprised to see “The Big Short” was one of the movie options on the plane. The story of a few bold investors who successfully bet against the U.S. housing market before the financial crisis hit, it got me thinking about the Australian property market and banks once again.
The ongoing debate in Australia about whether or not “The Big Short” is relevant for Australia’s property market remains fascinating. To come to any plausible conclusions, focusing on the facts is crucial.
- The Australian economic miracle is breaking records in terms of years without recession.
- Australian housing is expensive using global comparisons.
- The Australian consumer is among the most levered in the world. (See our analysis of household debt.)
So, what to do with these facts?
Taking huge short positions to bet against Australia’s property markets would be dramatic, but it would come with huge risk, as “The Big Short” shows so well. Instead, an important lesson from other investors who successfully navigated the global financial crisis is de-risk when you still have the choice and before prices adjust. Whether you believe in bubbles or not, Australian house prices remain near their peak, and now is an opportune time to consider de-risking by diversifying portfolios away from property.
How? If house prices are in fact bubbly, then the first derivative of the problem is in the property itself, so adding investment properties, in our opinion, to an already concentrated and levered portfolio should be completely avoided. Less direct ways to underweight residential property have already adjusted in price somewhat; for example, prices of bank shares and bank hybrids have dropped and now better reflect their risk.
In determining where to invest instead for income generation, many investors might be surprised to see the value available now in a high quality sector: global investment grade corporate bonds. Concern over global growth rates and the steep drop in oil prices have driven yields higher on corporate bonds across the board, including those with strong fundamentals, creating an investment opportunity at the right time for Australian investors. Global investment grade credit can potentially provide income and diversification away from both property and the Australian economy – an important consideration for believers in the Australian “big short.”