Global Equity - Correction? What Correction?

Source : The Business Times, December 5, 2007

GLOBAL equity markets have been volatile in the past few months. Losses on sub-prime mortgages have morphed into a more general credit crunch problem arising from the loss of confidence within the global financial system.

Due to the lack of transparency, banks find it difficult to determine what sub-prime exposure banking counterparties have, although this has become more apparent recently as more billion dollar mea culpas emerge. Indeed, each announcement brings the problem closer to a close as the ultimate loss is a fairly deterministic amount (US$200-300 billion).

Moreover, a bailout by the US government is highly probable as 2008 is an election year and no politician is interested in throwing four million Americans out of their homes. Unlike the Asian Financial Crisis, where borrowers had to find US dollars to repay, the US has full control over its monetary printing presses. What is interesting is the cause of all this - an oversupplied real estate market which responded to excessive demand stoked by easy credit and lax lending standards. Indeed, this appears very much like what we had in Singapore in 1996.

Before we discuss the Singapore residential property market, let's examine the US situation.

Is there a US bottom? Too much supply relative to demand and inventories bloat and prices fall. For prices to bottom, inventories must stabilise. Will US home inventories stabilise soon, then?

Core demand is a function of demographics and jobs (one needs to service the mortgage). The US has a growing population. As for jobs, the weak US dollar has boosted exports. It has also reduced imports, thus allowing local US companies to regain market share and create even more jobs. The chart on new home sales show that the support level stands at around 800,000 annualised units for single-family homes, which is about the rate of new household formation. Interestingly, new home sales for single-family homes are running around 750,000 annualised units.

On the supply side, housing starts are falling as developers cut back rapidly. At the margin, this supply is needed to meet the needs of new households and replacement housing. From the accompanying chart support stands at around 1.1 million units. Currently, starts have fallen to around this level on an annualised basis, of which 880,000 are single-family homes. Thus, inventories appear to be stabilising - which has been the case in the past few months.

Indeed, when asked in Congress as to when he expected housing to bottom, Fed chairman Ben Bernanke was quite forthright - 2Q2008. His reason: US demographics and falling housing starts. Indeed, if his prediction is correct, the stock market which forecasts events 6 to 12 months ahead, would be putting a bottom on US home builders soon (currently trading at 0.65 times book value!). This could only be good for all equity markets.

Is Singapore peaking?

There has been a hiatus in the residential property market in the past few months, but is this the peak or the pause that refreshes? For the market to go down, supply must overwhelm demand. Let's look at demand first. Demand is expected to be very firm. Singapore will have a growing population and labour force (mainly foreign-sourced); and strong job creation growth over the next five years. Strong investment flows (especially exciting are those in alternative energy) amounting to at least 3 to 5 per cent of GDP annually over the next three to five years are your kicker. This would translate to at least 5 to 7 per cent real GDP growth over next five years.

This would not only ensure full employment but real increases in wages as well as additional foreign labour imports. Indeed, the need is now to restrain further stimulus because of economic overheating. Maybe we should send 50 per cent of the Economic Development Board on sabbatical. The bottom line is that the demand for housing and better housing would be sustained at current high levels.

On the supply side, the URA data shows that the vacancy rate appears to be steadying at a low level of 5 per cent in 3Q2007 (against 10 per cent three years ago). The vacancy rate measures the availability of existing private residences and it cannot go to zero because some homes will always be vacant at any one time. Five per cent tells us that the current supply is not plentiful and that's why rents continue to rise. But what about the future supply? Will there be a glut in two to three years?

'Inventory', which I define as 'unsold homes which are completed or under construction', continues to fall from 9,284 units to 8,443 units in 3Q2007, according to the URA. The rest of the 29,570 'uncompleted' units is potential (uncertain) supply - they have planning approval but construction has not started. Indeed, as construction has not started, they would not count as 'inventory'. This is because developers, whose cash flows are fairly strong, will defer projects (even with leasehold land) when demand becomes uncertain.

We have seen them doing this in the past and current media reports indicate that this is indeed occurring. Should only two-thirds of the 29,570 come on stream in the next three years and if current demand levels prevail, there will be no glut. For those waiting for a significant price correction in the next three years, I fear the wait would be futile.

The author is CEO of financial adviser New Independent. He welcomes feedback at josephchong@ni.com.sg. This article is for information only. Readers should seek independent advice before making any investment decisions.