The Singapore property market has been receding slowly since 2013. It has bottomed and will rise. There are a number of factors behind this.

The Singapore economy is stabilizing and will accelerate from this year onwards. No economy slides for multiple years without recovery. The Singapore economy is an uncommonly trade oriented economy with imports and exports together accounting for over 400% of GDP. International trade weakened from 2011 to 2016 as the world engaged in a Trade Cold War. In every trend there is a respite and international trade has rebounded. The impact on Singapore has been and will be positive. The oil sector is another significant component of the Singapore economy. Oil prices were 110 in late 2013 and have tracked lower till 2016. Since then they have stabilized providing some relief to the oil sector in Singapore. These two factors alone are sufficient to support the economy in the short term.

Interest rates (SIBOR) which rose sharply from across 2015 have now stalled. SIBOR is influenced by USD LIBOR and the SGD exchange rate, the latter being subject to central bank policy. The weakness of USD and the lack of inflation in the US has dampened the rate of ascent of interest rates. There is still a risk, however, that rates will climb. SIBOR was 0.4% in 2013/2014 and rose sharply to 1.25% in 2015. It then fell back to 0.88% in mid-2016. Since then it has risen slightly again, so this factor is not without its risks. More on this later.

Inventory build will start to weaken from 2018. Real estate is a very stationary and auto correlated industry. Low frequency of building and transaction data make planning and production slow to calibrate to demand and as a result the industry is prone to periods of over and under supply. The housing boom from 2005 – 2013 was prompted by undersupply but since then developers’ have over produced in expectation of extrapolated demand. As prices fell, developers cut back on production and the inventory build is now being eroded.

The expectation that Singapore real estate will appreciate is therefore built on sound, fundamental pillars. Demand and supply imbalances are being eroded. The cost of financing is low. The economy is in a recovery phase. Given the stationarity of real estate prices, one would argue that we are at the beginning of a 3 to 5 year upswing.

There are, however, risks to the investment thesis.

Property curbs remain in place. The limitations on household indebtedness and debt service are prudent measures which improve the stability of the banks and the housing market. Any relaxation of these measures might provide a short term boost to the property market but would contribute to future instability. Government policy may seek to moderate any increases in housing prices on social as well as economic fronts. If the situation in Hong Kong is a guide it demonstrates what can happen if house prices are allowed to rise without bound. Inequality of wealth and income in Hong Kong is acute and at risk of precipitating social discontent.

Housing as a source of wealth generation and accumulation may crowd out effort and enterprise. If people regard the provision of labour or engagement in enterprise as relatively inefficient generators of wealth compared with real estate investment, it may crowd out labour productivity and diversification of investment. The government may wish to discourage an over allocation of resources and focus to a single segment of the economy.

Interest rates are low. This may be counterintuitive but one should buy property when rates are high, and sell when they are low. This is perfectly intuitive when one replaces property with any ultra-long duration asset. An additional complication is that when interest rates are as low as they are, 1.4% for a floating rate SGD mortgage, 1.25% if you are a good customer, then debt service is very negatively convex. Consider that if interest rates were 5% and rose to 6%, the interest element of monthly payments would rise by a 20% whereas if rates rose from 1.25% to 2.00%, the interest element would rise by 60%. On a risk adjusted basis, the financing risk of such a long duration asset can be considerable. Even for those able to finance their purchase entirely in cash up front, the risk remains since if neighbours are weak holders, their transactions and indeed the valuations of potential buyers will impact the general valuations across the market.

The Singapore economy is a volatile one. Whereas quarter on quarter growth of the US economy tends to range from 1% – 3%, the Singapore economy’s quarter on quarter growth ranges between 0% – 10%. The volatility of the Singapore economy comes from a number of sources. Lack of domestic demand and a dependence on international trade means that the implied leverage of the economy is high. Also, international trade is less within the control of economic policy than a more domestically based economy. The government’s control variable is the SGD exchange rate and not interest rates, making interest rates a state variable which is not under the control of policy. At some point the real estate debt service of the nation may become a complication to economic policy.

Another source of leverage is the substantial size of the financial sector in the Singapore economy, some 13% of GDP. For comparison, financial services are less than 8.5% of the US economy, and less than 7.5% of the UK economy. The high leverage of the financial services industry pulls up the leverage of the Singapore economy making it sensitive to credit conditions and interest rates. This adds to the volatility of the economy as a whole.

Regional competition is another risk to Singapore. Singapore’s rise has been rapid as it moved from third world to first, but having made this transition it faces first world problems including inequality, accelerating aspirations relative to potential, and a natural slowdown as the economy reaches potential and achieves terminal velocity. The property market gains of the 1970s to 2000s were compensation for frontier to emerging market risk, plus an economy catching up to developed market status. Singapore is now a developed market facing the dearth of ideas and demographic and developmental speed limits of any developed market. All around it the region is catching up and offering new opportunities for development and growth.

Finally, a risk that is generic to real estate and not to Singapore alone: real estate is not liquid. To compensate for this, returns should be high. Illiquid investments are best undertaken in countries with a long history of stability, where institutions have persisted across multiple and diverse generations of government, where rule of law is immutable and durable and has persisted across multiple and diverse generations of government. Otherwise, liquidity, transferability, portability are qualities which could become valuable, qualities which cannot be found in real estate.

Mutual funds have a bad name, and yet, they remain a useful investment tool. Here are some of the advantages of investing through mutual funds.

1. They provide instant diversification. By pooling the assets of numerous investors, mutual funds allow an individual to invest an amount of capital which would be impossible to diversify if they did it themselves, alone. A mutual fund pooling the collective assets of a group of investors is able to achieve sufficient size so that it can invest in a diversified portfolio.
2. They provide access to markets which may be difficult to get access to. Buying US equities or European equities is one thing but trying to buy high yield bonds, leveraged loans, CLOs, mortgage-backed-securities, or other less accessible assets can be difficult to do. Mutual funds provide access and exposure in a single instrument making them ideal for asset allocators.
3. Mutual funds are professionally managed. This doesn’t guarantee a benchmark beating performance but at least it means that your investments aren’t being frivolously invested without some form of management experience and expertise.

And here are some disadvantages:

1. They are often expensive, especially for smaller or less sophisticated investors who may not have access to institutional share classes (bearing lower fees)
2. They tend to underperform their benchmarks. This is closely related to the fee issue. Since all funds charge fees, and the average fund achieves the benchmark performance, the average fund must generate the benchmark performance, less fees, thus underperforming. ETFs are cheaper, but do check the exact fees and expenses. Not all ETFs are cheap
3. Liquidity may be mismatched. A fund may invest in illiquid investments yet advertise daily liquidity, or redemption terms which it cannot deliver. Such funds face difficulties when too many investors want their money back at the same time, which is usually when the market is falling quickly. Liquidity may be mismatched in other ways, such as when the underlying investments are very liquid. Even the most liquid funds typically redeem at the close of business on a daily basis whereas their underlying investments trade in real time intraday.

Mutual funds are neither good nor bad. Investors have to know how to use them effectively and to have realistic expectations.

1. Do use them to access markets that are difficult to access such as bonds, loans, ABS, structured credit, emerging markets, foreign markets.
2. Do use them for instant diversification.
3. Do make sure that you know what the investment objective of the fund is. Only then can you use them effectively in your portfolio to attain your objectives.
4. Don’t expect them to beat their benchmarks consistently. They may outperform for a time but more than 2 to 3 years is a gift. For the most part, expect them to underperform to the extent of the fees, but invest anyway because access, execution and organization has a cost.
5. Do your homework. It’s your money and you want to know what you are getting into to avoid disappointment and making poor decisions when prices rise, or fall.
6. When investing in absolute return funds or hegde funds, the choice of portfolio manager is very important. It is the portfolio manager who is responsible for profits and losses, not so much the market.
7. When investing in long only, benchmark driven funds, the choice of strategy or market is very important. It is the market which is responsible for profits and losses, not so much the portfolio manager.

The ideal conditions for a country with a large national debt is high inflation. Inflation is a threat to purchasing power and can drive interest rates and debt service higher. Ideally therefore, what a highly indebted nation requires is high asset price inflation and low consumer price inflation. These are the prevailing conditions in the US where the national debt is over 100% of GDP, interest rates are low, inflation is weak but equity and corporate bond prices are inflated. The conditions seem almost ideal.

Low interest rates can drive inflation lower. Neo Fisherism predicts such a relationship based on the long term inertia of the real interest rate and thus a positive relation between inflation and the nominal interest rate, but a more concrete example, and one that can be extended to include labour markets, is that low interest rates encourage over-investment and encourages over-capacity which is ultimately disinflationary. Raising interest rates could slow investment and reduce excess capacity resulting in greater pricing power or rising inflation. In a low interest rate world, labour is relatively expensive compared with the financing cost of fixed capital. Raising interest rates would render fixed capital relatively more expensive compared with labour, discouraging capital expenditure in favour of employing more labour. It also raises the price of labour in sympathy with the relative increase in cost of capital.

The banking system is the plumbing of the economy. The past 7 years have seen this plumbing system undergo extensive repair works. While repair and upgrading works are ongoing, capacity has to be turned down and alternative infrastructure employed. Regulators like the Fed have to ensure that such alternative infrastructure is created or supported. The bond market is the back up infrastructure and has done an excellent job. Successive rounds of QE have kept base rates low and total debt costs manageable.

For the banks, the upgrading works are almost over. It may be time to review or upgrade the bond market, hence the talk of normalizing the Fed balance sheet. For the banks, it will soon be business as usual.

The current public debt levels in the US have risen from 60% of GDP to over 100% since 2008. World War II saw public debt levels rise from 45% to 120%. The latest crisis control has cost the US government half of the cost of WWII.

US Federal Debt as % of GDP:

2008 bailouts cost European governments as well. Some countries managed to rein in their balance sheets but others have just kept going (Italy and the UK). Don’t bring up Japan. They are leading by miles with national debt at 2.5X GDP.

What does a government do in a financial crisis? Bail out the financial system, which includes the banks and their expensive managers and executives, since a failure of the financial system would inflict serious damage on the real economy, on output, employment and wages. Some compare this to Wall Street using Main Street as a human shield. And how does a government fund it?

Like this:

US Federal Debt Outstanding:

Thank goodness cost of debt was manageable. Imagine if the bond vigilantes had sold off US treasuries. But how does a government hold down the cost of borrowing?

Like this:

US Fed Balance Sheet:

If you face a buyers’ strike, there is nothing like buying your own bonds yourself. If you give it a scientific sounding name like quantitative easing (QE) and support it with academic research and the endorsement of renowned academics, it likely to appear less fraudulent.

9 years after the crisis and the economy has picked up and the justification for accommodative policy is receding. The Fed has begun (in 2015) to raise rates gradually and is considering normalizing its balance sheet. To what extent and how quickly can it normalize its balance sheet? It increased its balance sheet from just under a trillion USD to 4.4 trillion USD in the last 9 years. There will be limits to how much and how quickly it can reduce its balance sheet.

Here is one reason:

US Budget Balance as % of GDP:

If the current President’s plans to cut taxes and spend on infrastructure and defence are successful, the deficit will deepen, and it will need to be financed with more debt issuance.

The US needs to inflate away its national debt. However, rising inflation could threaten its long term funding costs which would force the Fed to remain underwriter for US treasuries. Ideally, the US would like to see asset inflation so that its asset to liability ratio improves in real terms, but low CPI inflation so that funding costs don’t rise excessively. This has been precisely what the economy has experienced these past 9 years. It is either a fortuitous coincidence or exceptional management by the Fed and Treasury.

Best guess predictions:

The Fed will raise rates gradually. They will also pay attention to market credit spreads which determine the actual cost of funding for the real economy.

The Fed will want buoyant asset markets as this debases the national debt. The Fed will therefore be sensitive to equity market and credit market stability, not just real economy data.

The Fed will go quite slowly in reducing its balance sheet. It cannot afford for interest rates to rise too far as it will impact the debt service costs of the government. Bond yields are likely to be range bound. The trading range and cycle will be influenced by central bank guidance and high frequency data.

There is significant risk from inflation. If inflation picks up it could impact the ability of the government to refinance itself.

Long term fundamental problems which will have to wait:

There does not appear to be any intention to decrease the national debt. This places the government under constant financial pressure which means it cannot invest in infrastructure or undertake reform which may have short term costs.

The size of the national debt puts pressure on the Fed and Treasury to keep rates low which in turn encourages the private sector to borrow and increases the level of leverage in the economy. If rates are artificially suppressed both government and private debt levels will not have a reason to recede.

With a persistently high and increasing or non-receding level of debt, both the private sector and the government has every motivation to keep rates contained or low. Low rates provide the government and the private sector every motivation to borrow more.

The above feedback loop implies that interest rates will be kept low until such time it is impossible to keep them low. But what could precipitate such an eventuality?

Possibly, inflation accelerates, in which case the Fed will have to be extra vigilant, a stance which could invert the yield curve, a position associated with recessions. A recession could throw asset inflation in reverse thus increasing the relative size of the total debt. Any loss of confidence could also throw asset markets in reverse with similar effect.

A loss of confidence could introduce a risk premium into US treasuries, currently a remote concept, but such is the modern economy that most assets and markets derive a significant portion of their value from confidence.

Not about to be paid down soon:

• all chart data sourced from Bloomberg