Are You “Worth Less” Than You Thought?

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Another week, another step into the record books for the markets. “Share investors boost wealth,” reads a headline at the Herald Sun. “A $10,000 investment in the ASX 200 index fund four years ago, just before U.S. forces invaded Iraq, would have more than doubled by now to more than $22,000.

What does the U.S. invasion of Iraq have to do with Australia’s bull market? Nothing obvious, but perhaps it’s this: buying at the point of maximum social anxiety is as lucrative as it is counter-intuitive. The problem for an investor looking for adversity today is that it’s really hard to find. With so much cash in the world chasing so few assets, you don’t even get rewarded for taking that much risk. All assets, at least in terms of risk, appear to be valued equally. And all of them are going up.

Yet despite all that money chasing the same stocks, bonds, and property, the share market-at least here in sunny Australia-isn’t wildly over-valued relative to earnings. “Commonweatlh Securities analyst Craig James expects aggregate December-half corporate profits to have risen between 12 and 14 percent,” reports today’s Australian. Twelve to fourteen percent profit growth isn’t bad, though the syntax of the sentence itself leaves something to be desired.

Everything we’ve ever read about cycles and investment returns suggests that this string of double digit profit growth and astounding share market returns just can’t go on. You can’t continue to pay too much for earnings that may never materialize and not get burned, sooner or later.

It may be later, though. Much later. “Resource stocks are once again expected to be the best performers in the half-year results season that kicks off this week with profits for Rio Tinto (ASX: RIO), its subsidiary Coal & Allied (ASX: CNA), and Alumina Ltd (ASX: AWC) – despite volatility in commodity markets through the last six months of 2006.

It appears to be a contest between earnings growth and new sources of liquidity for the markets. If the supply of new credit and cash chasing stocks grows a lot faster than corporate earnings, shares will soon be overvalued. But as long as earnings keep chugging along-and other kinds of assets pop up to absorb new liquidity-the share market may be spared from overflowing…and then crashing.

There are plenty of other assets besides shares, and some of them you can pick right up off the ground, if you’re in Singapore. “Thefts of drain covers, prayer urns, copper cables, and other metal items doubled in Singapore last year…While the overall crime rate in Singapore dropped 10 per cent last year, metal-related thefts jumped, with 1,092 cases in 2006 compared with 566 cases in the previous year,” reports Reuters. And this despite the 40% correction in copper prices from their July high of last year.

If you don’t feel like stealing storm drain covers or prayer urns, you could try buying a house in Australia, but frankly becoming a legal homeowner in Australia may be more difficult than becoming an illegal copper-possessor in Singapore. The average first time Australian home buyer now needs, “in excess of 30 per cent of their disposable income to service minimum monthly payments on a new mortgage,” according to the Housing Industry Association.

The Association’s news release on the affordability crisis reports that, “The monthly loan repayment needed on a typical first-home mortgage rose from $2,194 to $2,132, an increase of 6.3 per cent. Mortgage payments now account for 30.7 per cent of total first home buyer income…As a proportion of disposable income, the ratio was up by 1.8 percentage points.”

Do you get the feeling that the age-old wisdom of buying a home when you’re young may be fatally challenged by rising home prices? What is a young family to do? Loaded with debt from university, your would-be homeowner can’t afford to sock away enough for a down-payment to begin with. But assuming he could, he’d then have to live like a pauper in order to pay his mortgage. Is this a good trade, trading a balance sheet asset for a real-world liability and effectively becoming an indentured servant to the bank for the next thirty years?

You might be better of renting and then investing what you would have payed on a mortgage in some of those go-go assets driving the share market to record highs. Of course the stock market is not a saving account any more than a house is. But a man has to do something with his money doesn’t he? And if you can’t get richer buying a house or buying stocks, how *can* you get rich?

Scary answer? Maybe, for the average guy, you can’t, at least not doing the average thing. “America’s median household income is lower than in 2000, despite the economy growing by 12% in real terms. The median income has barely shifted since 1973 but inequality has increased,” reports James Mawson in an article forwarded to us. The obvious conclusion here is that while people feel richer as home-owners with big mortgages, their take home income is about the same today, in nominal terms, as it was in 1973.

Normally we are suspicious when we see statistics like this. After all, when you look around you people seem richer. They drive newer, bigger cars (which they pay loans on.) They live in bigger houses (which are heavily mortgaged.) And they fill those houses with things by ‘withdrawing’ equity from the house. Look around you and people seem to be richer than 33 years ago. The economy is bigger, there are more gadgets, more choices, bigger portions, and greater signs of enormous wealth.

But it’s beginning to look like globalisation has made the very rich in the West much richer and the very poor in Asia much richer. But the middle-class Westerners…we’re not so sure. They have more debt and less equity. They can buy more things cheaply, but they must do so with credit. And job security is as antiquated a term in Western capitalism as “please and thank you” at the family dinner table. Families don’t eat dinner together anymore. They are too busy working.

What does it all mean? In a symbol of just how financialized our age is, everything depends on interest rates. As long as they are low, middle-class debt and the lifestyle it affords are sustainable. If they rise…watch out. That’s when all sociological hell breaks lose, as people suddenly find they are “worth” less than they thought.

Dan Denning
for The Daily Reckoning Australia

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Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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