In my business, you have your ear to the ground. And you assemble the pieces of a wider puzzle.

You analyse, study, consider the upside and downside. Then you invest.

Let me share with you a few events and conversations over the past couple of weeks that could point to where we’re heading.

 

Sign at my local wine shop. Source: Author

 

Inflation shy

 

I’m standing at the school pick-up. A friend who has just left the building trade is complaining about the price of timber. It’s up 12% recently.

And I think of another friend’s modest sleep-out addition to his North Shore yard. It cost $200,000 to build — with $20,000 of that in council compliance costs. (His brother-in-law apparently built an entire house in Europe for $200,000 and $5,000 in compliance).

My cup of coffee costs 10% more. Hamburger choice 20%. Fuel for the car 9% more. Let alone the budgetary carnage I am bracing for when the Auckland rates bill comes soon. Meanwhile, business compliance — such as audit costs — seem to be jumping.

I see inflation everywhere. And I’m not the only one:

 

‘We are seeing very substantial inflation… It’s very interesting. We are raising prices. People are raising prices to us and it’s being accepted.’

—Warren Buffett, May 2021

 

Yes, this was reported before some of the more recent commodity price fall-off. But that fall-off could also be due to machinations in those markets care of the Chinese government. Which I am sensing could be short-lived.

So, next morning, my forex orders for GBP have all filled at a relatively low rate. Unexpectedly. The Bank of England announced they ‘expect the strength of Britain’s economic recovery to push inflation above 3% by the end of the year before falling back in 2022 as the post-Covid boom slows down.’

Despite an expectation of inflation in the order of 3% (UK housing has already inflated 11% — though second-hand housing is not included in the CPI) the BoE voted to leave the base rate at 0.1%.

Here in New Zealand, we have experienced house price inflation in the order of 30% (REINZ May 2021 to May 2021). Even the huge US home market saw a blistering 24% (National Association of Realtors) over the same period.

New Zealanders (and Americans) aren’t stupid. They know one of the best hedges against inflation is housing. At least while interest rates are below the CPI. And certainly below perceived inflation.

Our OCR sits at 0.25%. Mortgage rates around 2.2% (LVR under 80%) fixed for a year. But inflation looks to be heading toward 3% also.

Obviously, if you can borrow at 2.2% and receive 30% in capital growth, that’s a get-rich-quick scheme that parallels few others.

 

Housing nightmare

 

Our choice of inflation hedge has also generated a nightmare. A conversation with a friend put this into stark perspective:

 

‘I was looking to buy a home on the North Shore before Covid. I’m now faced with having to spend $300,000 more. My salary has not increased. It is totally and utterly depressing.’

—First-home buyer

 

The government seems to be throwing all they have at this issue, targeting property investors. But the change will come from interest rates and building.

If central banks do finally come to agree with inflation-wary investors and consumers, there will be catch-up to do. And interest rates could rise quickly.

The next OCR announcement here is due 14th of July. These announcements (and options for rate change) come about every 6 weeks.

People have been fighting for houses (and bidding up prices) because they can service large amounts of debt. Servicing has been at some of the lowest rates ever seen.

And it is the servicing equation that ultimately affects what most of the market will pay for housing.

If central banks need to quickly hike up base rates like the OCR to get on top of rampant inflation they did not see (or did not want to see coming), you are finally at risk of hitting the bubble. A bit too hard.

 

 

Regards,

Simon Angelo

Editor, Wealth Morning

(This article is general in nature and should not be construed as any financial or investment advice. To obtain guidance for your specific situation, please seek independent financial advice.)