Hindsight - The Foresight Saga E-Book

Terence O'Hallorann

• Herausgeber: Life Publications
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 371

Veröffentlichungsjahr: 2012

Beschreibung

There is something new in the financial planning world and it is explored to the point that the reader can exploit it in “Hindsight – The Foresight Saga.” Little has been written about the property market and its relationship with the equity markets or the coincidental relationship that that investment relationship has on bankers.

This book is aimed at the private investor but also the professional investment manager because it highlights the mechanism that provides for an almost continuous steady flow of positive returns on invested capital and regular savings.

The author is a well experienced, highly qualified strategic financial planner and the language used in the book is straightforward and down to earth. The classic market™ is identified as a circa fifteen year cycle of at one point inversely correlated market movements that works in direct contrast to a later phase in the classic market TM where property and equity movements are highly correlated in a downward slide. The first having an extremely positive effect on banking and the second, a devastating effect that contributed to bank collapses similar to those in 1979, 1992 and 2008.

Leseprobe

Hindsight – The Foresight Saga

BY

TERENCE P. O’HALLORAN F.C.I.I., B.Sc.

Chartered Financial Planner

The Work Copyright © 2010 rests with the Author

The rights of Terence P. O’Halloran as author of this work has been asserted in accordance with the Copyright, Design and Patents Act 1988.

All rights reserved.  No part of this publication may be reproduced, stored in a retrieval system,  or transmitted in any form whatsoever, or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior permission in writing from the publisher.

A catalogue record for this book is available from the British Library.

Design and layout by Life Publications Ltd Lincoln Front Cover artwork by Debbie Burke, Nottingham Editing by Brenda Crouch Graphics and layout by Jargonfree, Lincoln

All in conjunction with the author

Life Publications Limited St James Terrace 88 Newland Lincoln Lincolnshire LN1 1YA

www.lifepublications.co.uk  e-mail: [email protected]

CHAPTER SYNOPSES

CHAPTER 1  IT'S A FINANCIAL CYCLE – GET OVER IT: AND WIN.

2009 recession falling interest rates - rising prices.  Bewildering jargon - introduction the Classic Market - individual detachment from the stock market collapse property rise - bank support (2000-2004) - bank solvency margins - property value reductions their relationship with solvency margins -equity and property as the driving forces for gain and loss.

CHAPTER 2  PROPERTY – PERFORMANCE ANALYSED.

Property performance (2000-2006) compared to equities - timing - property history in 1992: 1993 -experience as a measure and the age of experience of a manager - the four elements of the market, equity, fixed interest, property and cash - the interrelationship - the bankers' dilemma and solvency margin strengths (2000-2006) and weaknesses (2007-2012).  Property and some of the tricks of the trade - case history of timing in the property market.

CHAPTER 3  A PICTURE AND A THOUSAND WORDS EQUALS   CONFUSION.

The deception of graphs - the perception of figures and their relevance - the really long view (1966-2003) - interpreting the figures - if you know the relationships you can use them especially as Chancellor of the Exchequer - the different philosophies for saving and investment - the route map for the future based on the past - the desire to keep up with the Joneses - house prices/inflation/wages - the advent of gazumping - the effects of inflation.

CHAPTER 4  FINANCIAL RELATIONSHIPS IN HISTORY.

The common man's awareness - a bull market a bear market defined.  The 1970s a world falling apart - the new millennium the same problem.  Short term desperation - the movement from equities to property - the avarice of the banks - the defective mortgage loan philosophy - an introduction to negative equity - actual values against real values.

CHAPTER 5  ASSET RATIOS AND SOLVENCY MARGINS   EXAMINED.

Rising property prices a boost for the bankers - solvency margins explained - pound cost averaging in action - the reversal of fortunes over time - a comparison with the guarantee of gilts - sometimes capital values just do not matter as much as income produced - Edna's case history - a real income from a low capital base.Bull markets - bear markets - 'who cares' markets - The world we want to know and the world we are pleased to ignore - positive equity with a plus sign - a collapsing stock market with a negative sign (the early 70s.)

CHAPTER 6  PERSONAL INSULATION FROM THE MARKET FORCES.

The self centred strategy that worked (case history).  The relationship between interest and interest rates - inflation and the 'real' outcome.  Bank multiples of lending (1970s) - the first latter-day property 'white elephant.' - Real asset values against actual market values.

CHAPTER 7  THE DIFFERENT STRATEGIES FOR INVESTMENT   AND SAVING.

Pound cost averaging and Chas's savings plan - greed, fear and grief - the bank rate and gilt yield alongside inflation - Polly Peck and the fruit importer - Riding a good horse until it dies - comparing monthly and annual stands on investment data - the misrepresentation of 1987 - 19th October, a day I will never forget. A tragedy? - but only for the few.  A fickle property market. - The timing is essential.

CHAPTER 8  THE IMPORTANCE OF TIMING PROPERTY   TRANSACTIONS.

The various modes of selling a property - the crucial point of timing. - Case history and negative equity - A long recovery to property ownership. - You can make the same mistake twice - luck and inflation may get you out of a hole. 

CHAPTER 9  DIVERTING YOUR SAVINGS TO THE GOVERNMENT'S COFFERS.

We talked about how graphs and statistics can be distorted - an example of how hindsight was used against you, perhaps?  A play on the word 'save' as a diversionary tactic - real world or third world aspirations - using the knowledge of the classic market - diverting funds to government - a repeat performance of the 70s - the missing £32 billion and deposit account to keep it in - using regulation to divert money from the private sector to the public sector - 'real accounting' converting weakness into strength - The introduction of cheap long term government borrowing - the bringing down of the banks - a simple understanding of solvency margins.

CHAPTER 10  THE PLEASURE OF THE DOWNHILL RUN.

Experience: that most precious of all commodities - The lack of managerial experience in the banking system in 2003.  Has a lack of experience brought the house down and the banks with it?  Perception and pound cost averaging. - Pound cost averaging explored.  Goodbye banks; but not all of them.  Property's place in the banks' solvency margin - calculations.

CHAPTER 11  A GILT TRIP.

The relationship between gilts and interest rates.  The GILT myth: security of capital value.  A safe haven from the collapsing property and equity markets? - The relevance of bank solvency margins in the equation - The downward spiral of equity and property and the effect on interest rates.  The knock-on effect on fixed interest securities.  The third and crucial element to the success of long term investments.

CHAPTER 12  THE MONEY CYCLE TO RECESSION.

Money is not lost until you encash your investment - A case history of the 'right' or 'wrong' move in commercial property purchase - What is a recession? The cycle of money - 1987: the stock market crash had no effect on Julian.  1992 Julian's world collapsed.  A rolling time frame often suits an individual's purpose.

CHAPTER 13   WHY THE BANKS COLLAPSED (2008 - 1992 - 1978).

The part that government plays in the 'cycle.' -  A conspiracy theory - The diversion of money from private savings to government coffers - The sale of gold - The funding of government gilt edge securities - The Peston/Brown partnership - the demise of capitalism.  The relevance to this book and the classic market theory.  Academia versus vocational aspirations.

CHAPTER 14   REGULATION BASED ON THEORY AND HOPE.

The Academonisation of Practitioners - A quango culture one of the important spin doctors - The siphoning of money from pension schemes - The relationship between equities and gilts - a stockbroking relationship - long term and short term saving strategy.  The change in notional value over time - What is a billion? - The 'me too' attitude - The "it's different this time" philosophy - Timing in investment ignores political enterprise - Markets do what markets do. 

CHAPTER 15  FINANCING THE NATIONS STATE PENSIONS.

The three pillar approach: Civil Service first - Inflation proofing benefits - An attempt at a two tier State Pension scheme.  It worked.  The abandoning of SERPS.  An expensive exercise - The start of Superannuation Schemes government then major industries - Personal pensions. An international phenomenon - Pay as you go or funded?

CHAPTER 16  STATE AND COMMERCE COMBINE TO FUND THE LONG TERM.

A political dilemma - the need for state and commerce - investment strategies - a hard pill to swallow - the undeniable fact of the classic market. The experience of 'new' pension nations – a broadening market philosophy.

CHAPTER 17  SOCIO ECONOMIC STRATEGIES THAT WORK LONG TERM.

Commercial pensions - attractive funds - The need to understand the marketplace - the interaction of property and equities in particular - The role of the fund manager. The move to being out on a limb. Long, rather than short, termism - A solution to adopt.

CHAPTER 18  STORING CAPITAL TO PRODUCE PREDICTABLE   RETURNS.

The myth of gilt guarantees and the irony of fixed interest infatuation - The world as an international marketplace - is the world uniformly in synchronisation with the classic market? The consequences of disparities.

CHAPTER 19  A THROW OF THE DICE OR A CALCULATED   INVESTMENT DECISION.

Chance or system - different this time - THINK NOT - a conclusion imminent.

CHAPTER 20  THE CONCLUSION OF A VOYAGE OF DISCOVERY.

A relationship is evident - acknowledgment for the common good - the real 'classic market' relationship - a smoother ride for all – the simple solutions – exceptional returns.

GLOSSARY OF TERMS.

ACKNOWLEDGEMENTS

The Author is heavily indebted to the co-operation and support of the following individuals and organisations.

Janet Walford, Money Management

Hal Austin, Financial Adviser

Patrick Connolly, AWD Chase deVere

Ian Cowie, Daily Telegraph

Stephen Womack, Financial Mail on Sunday

Jeff Prestridge, Financial Mail on Sunday

Carl Emmerson, Institute For Fiscal Studies

The Bank of England

The Office of National Statistics

Members of the Russell Study Group

Members of the Midlands Professional Development Group

Hindsight

ICS

Deutsch Bank

Nationwide Building Society

Partners & Staff at O’Halloran & Co

M&G Fund Management

Invesco Perpetual Fund Management

Moneyfacts

Robin O’Grady DipPFS, Williams de Broe

Claire Markham DipPFS

Duncan Smart & Colin Smart, Walker Crips Weddle Beck Stockbrokers.

Stocks for the long run- By Jeremy J Sieger.  First and Fourth Editions. 

The Ascent of Money - By Professor Niall Ferguson

The Intelligent Investor – by Benjamin Graham

Chicken Licken

Mike Brown

David R. Kamerschen, Ph.D.  Professor of Economics

Who is the odd one out?

Sir Fred Goodwin: FORMER chief executive, RBS

Andy Hornby:FORMER chief executive, HBOS

Sir Tom McKillop:FORMER chairman, RBS

John McFall MP:FORMER chairman of Treasury Select Committee

Alastair Darling:FORMER Chancellor of the Exchequer

Gordon Brown:FORMER Prime Minister and FORMER Chancellor of the Exchequer

Sir Terry Wogan:FORMER presenter of Radio 2's Breakfast Show

IF you're thinking

Sir Terry Wogan,

THEN you're right.

However, the reason may surprise you...

Terry Wogan is the only one out of this motley crew who actually holdsANY formal banking qualification.

  Worrying, isn’t it!

Introduction to the book

It would be very easy to trivialise theclassic marketTM by just stating blandly: “this is the way it works and here are the indicators and now get on with it”. But it is not actually as simple as that.  There are many myths and misconceptions which, if they are not explored, investigated, explained and put in their place still persist in the background to encourage the well known phrase “it’s different this time” to prevail.

One of the primary objectives of this book is to prove that it is never different this time, or any other time.  Fundamentals, it seems, prevail.

Much has been said about the political influence that can override economics and change the character of markets.  Certainly political influence needs to be explored, analysed and its relevance noted. However, if politicians can use the classic market to their own political ends then the investor can do likewise by adopting simple analysis techniques and applying them in an appropriate way. “Hindsight -The Foresight Saga” endeavours to give you, the reader, the tools to make that work in your favour.

There may well be elements of the text that you feel are ‘over the top’ or irrelevant, hopefully they will be few and far between. If you do find any section too political, too forceful then all that is asked of you is: please persevere. A lot of thought has gone into the inclusion of every story, case history, political nuance, conspiracy theory and statistic.  It is all there to ensure that “it’s different this time” does not come into play in your thought process when it matters – at the point of investing or starting a savings plan (or at the conclusion of the investment/savings period). 

The success of your investment and your saving for your future and the optimisation of the returns that you are able to achieve are here for you to take on board and profit from.  Believe me, it is worth the effort to make your future a more certain and prosperous place.

Terence P. O'Halloran B.Sc.

Chartered financial planner

Fellow of the Chartered Insurance Institute

Associate of the Institute of Financial Planning

February 14th  2011  The 35th Anniversary of O’Halloran & Co

Other titles by Terence P.O’Halloran still available include:

Trusts - A Practical Guide  (2nd Edition)

Mountains out of Molehills

You Sign (the little cheque and we sign the big one)

If Only Politicians Had Brains

Building a Business on Bacon and eggs

The Fight for our Post Office

CHAPTER 1   -  It's a Financial Cycle - Get Over it: And Win

There is always a danger when setting out to change economic theory, or at least modify it significantly, that there is a bias towards the change that colours the view of the market overall.  You will need to read “Hindsight – The Foresight Saga” to judge whether that is the case here.  However, the figures are compelling and the three historic timescales used are sequential and confirmatory.  The driving force of any advanced economic culture is the banking system.  It is the pulse by which much of human economic activity thrives or fails.

What has been revealed in this book is the interrelationship between the property and equity markets and their indisputable effect on the banker’s ability to lend.  Those interactions and those interactions alone create a classic marketTMwhich is broadly a fifteen year cycle of equity and property movements that are brought about by the availability or dearth of the bank’s ability to support property purchases or support the expansion of commerce. Couple that with the emotional factors of greed, fear and grief that attend every market rise and fall over time and you have the basis for a predictable financial cycle.

Does it take almost 300 pages to explain the theory?  Certainly not, but it probably takes that number of pages to explain that there is no such thing as “it is different this time” because the conclusion that the research draws is that: it never is “different this time.” 

We have to conclude that politics is a powerful force which can accentuate the rise and fall, along with the duration, of any particular aspect of the market cycle but, what it cannot do and does not do, is change the cyclical integrity of the financial markets.  The same ‘pattern’ emerges whatever the external forces appear to contribute.

If proof were needed then proof is here in this publication. The classic market makes financial fortune-telling a serious consideration with very real benefits in increased returns.  What acknowledgement and, hopefully, adoption of the principals described here might also do is to smooth out the excesses in the movement of equity and property markets and thus lessen the effects of the ‘boom and bust’ syndrome that is associated with them. Bankers will become more pragmatic in their lending practices

There are pressures geared to performance and financial targets which manifest themselves in various ways, for investors and providers of financial products alike.

………………

 The date was late October 2009. Autumn was closing in, the leaves were falling, the value of shares rising. The recession was in evidence (the longest recession since 1955) and the last ‘structured product’ liable to offer 7.5% per annum return as an income over the next five years was on my desk.

There are a number of trustees, with Family Trusts, desperate to find a reasonable return on their investments without ‘undue risk’.  There are quite a number of individuals who in September, 2008 were earning 5% per annum on their deposits with banks and are now lucky to achieve 0.3%.  Where can depositors, investors, turn with any certainty?

The correct word might not be “desperate” to find a better return, but rather more “anxious;” (perhaps bordering on “desperate”).  When you have a duty to perform, as trustees do, things can get ‘anxious.’  The trustees want to perform, however they are used to a ‘status quo.’ Banks provide deposit accounts and (usually) pay a reasonable rate of return to depositors.  Banks are ‘safe.’  Capital is available on request.  Deposit accounts are what you and I, and trustees, are familiar with.  However, what happens, psychologically, when things change is inertia sets in.

Can you remember the euphoria as you drove around “the corner” and discovered the petrol station that had reduced petrol prices to below £1 a litre?  How soon we forget that the price was 65 pence a litre and that the government is taking a huge ‘turn’ on our money.  We got used to paying £1.12 per litre in a relatively short time span.

And now?  It is forecast to rise to over £1.30 per litre.

I was listening to Radio 4 recently and they were reviewing how they should accurately forecast the weather.  The topic of the conversation centred on, “should we be stating Fahrenheit or should the temperature for the forecast be in Centigrade?”

The broadcasters raised an interesting point: the weatherman said, that whether the temperature was given in º F or º C only mattered at the extremes. In other words, when it was very cold, minus two

(-2ºC) Centigrade was more relevant to our psyche (how we understand numbers and relate them to reality) than twenty seven degrees Fahrenheit (27ºF). 

On the other hand twenty two degrees centigrade (22ºC) did not relate to how warm it was when compared to seventy two degrees Fahrenheit (72ºF).  This is the result of perception despite both being the same level of coldness and warmth respectively.

So it is with market comparison.  Many people are bewildered by terms that they are perhaps unfamiliar with and nervous of:

The FTSE 100

The house valuation index (Nationwide Building Society or Halifax Bank (HBOS))

The S&P GSCI-ER index (commodities)

The FTSE EPRA/NAREIT Developed Europe Index (Property)

From the sublime to the ‘cor blimey’ I had never heard of the last one until that late October day when the leaves were falling and my mind was racing to understand more about how an element of ‘certainty’ could be instilled into providing the returns people required to fulfil their obligations.

What had been placed on my desk was an opportunity to satisfy the needs of the trustees and those anxious individuals within a very brief window.  Here was an opportunity to utilise my knowledge of the market. Here was the relevance of ‘timing’ and the certainty that an opportunity lost was an opportunity gone; not for ever, but gone, for probably twelve to fifteen years. 

Let me explain. 

This period of time (2009 – 2011) constitutes the last throes of a classic market.  The classic market is something that I have defined personally in conjunction with many well rehearsed and learned economists and commentators ‘giving forth’ on market cycles.  The classic market is primarily a relationship between property and equity price performance – they are inextricably linked, as this book will illustrate to your advantage.

A fundamental link also exists between the stock market and property values and the lending power of the banks.

When you go into a new town and you get off the train, (bus, plane, or boat) and you walk out of the station; do you feel apprehensive in a new environment - a kind of nervous feeling?  So it is when a new financial idea is ‘floated’ for your consideration.

It is true to say that when you have been in certain circumstances once or twice you become quite confident in the knowledge of where you are, and how to proceed. However, what if it is some time since you have been to Mansfield or Dublin, Lewes or Newcastle, Edinburgh or Gibraltar?  You know what I mean? The confidence evaporates and you look out of the car; or walk out of the station. The familiar territory has changed. That is what happens over the course of a classic market; familiar territory changes constantly, but as I hope to convey throughout this book, the changes conform to a recognisable and predictable pattern.

If you know where you are (in time) you can be confident. A feature of the classic market is that in some stages it is a ‘capital’ orientated environment.  Investors are chasing capital gains.  The stock market has usually moved ahead quite dramatically, like the January sales - everybody suddenly starts heading for the bargain basement except that the storekeeper has very often ‘seen you coming,’ waited for the rush and changed the products on the shelf. 

The bargains are not that good value anymore, but still people buy them on the basis of perception rather than fact; after all it is a sale, therefore the items must be good value – better value because after the sale the price will rise.  A bubble can easily be created and when the bubble bursts individuals, still convinced there are bargains to be had, look elsewhere.

Property is usually the target of a professional investor’s attention when the stock market looks vulnerable.  The experienced eye will detect any market alteration first.  When the bargain basement of shares is shunned by the experienced shopper, the novice remains and even intensifies their position in that marketplace.  They buy more shares because recent history shows the price rising to confirm to the novice that gains can be made.

The property market will have been static, for a long period perhaps four or five years and then it starts to rise exerting itself for reasons that we will discuss later on.  However, the ‘chase is on’ and the ‘bargains’ become irresistible.

As the stock market careers downwards, so the residential property market initially, and the commercial property market in its wake, move inexorably upwards, supported, and even encouraged, by the banks - and of course governments, because both banks and governments love the people to have the ‘feel good factor’ that owning something of value imparts. 

Does this all sound familiar? 

Possibly not; because, as I will explain, a lot of people, a lot of the time, are just not in that mental space that makes any of this relevant to them.  The stock market is not something that they, as individuals, consider themselves invested in, not consciously anyway.  The residential property market is irrelevant to young adults who may still live with their parents or are content in rented accommodation because they may be involved in higher education or require the flexibility to move to a fresh location at short notice with their work.

There are many individuals who did “all that” long ago. They are firmly in their home; it is all paid for and everything else is irrelevant to them.  Property values only become relevant when the incumbents want to move from their own home or they want to exercise ‘equity release’ and raise money from their home.  Equity Release is something that we will discuss later.

The real driver in this leap for capital growth through property ownership, particularly where commercial property is concerned, is the rental income generated by the property through increasingly reliable tenants chasing low levels of rent for new or expanding business propositions that banks will support through short term loans and overdraft facilities (often secured on the private dwelling of the entrepreneur).

In this part of the classic market then, there is an inverse relationship between shares and property. As shares are going down in value the property market may be going up. Why would that be so?

The collapse of the stock market during this phase of the cycle is not about mainstream business failure.  No, it is about the adjustment of the market value of the shares in businesses following a period of mild hysteria that drives share prices beyond their ‘real (perceived) value.’

Businesses can function at a normal level in this environment because the banks have the financial capacity to provide them with financial support using their property as security not necessarily for individual bank customer loans but because of the collective, universal multiplying counterbalance of property values and the knock-on effect that has on bank asset ratios (the banks’ solvency margins). 

At any point in time a bank could multiply its cash asset base and lend out everything it had on deposit eleven times, and count the equity in real property in for the multiplier.  The equity in this case is the difference between the loan (mortgage) and the underlying asset value.

As the property market rises the security held within the banking system grows in value. The bank has more and more resource (money) to lend out.  Thus support or even an upward spiral presents itself as a mechanism of business expansion even though the stock market would be in free-fall.

Why was it different in 2008; at the other end of the classic market? The catalyst for that change of focus was linked to property values.

The UK banking system had simply lent too much secured onto a now shrinking value base.

It is perhaps at this point that it becomes apparent to people in authority, who really should have known better, that a reduction in property prices affects the ability of banks to lend money. It also affects the support for the banks’ own balance sheets in the process (the banks’ solvency margins).

Banks lend money on the basis of a multiple of their ‘cash’ asset base.  In other words for every pound that the bank has physically, or by way of equity in security as a mortgage, or other collateral agreement, the bank could lend that money out eleven times, up until September 2008.  The rules are tighter now.

By the end of 2008 the government was in the process of changing the rules. Basel III was on the table as Basel I and II had been held to have failed. The Regulator had tightened the screws, property values were sliding with increasing speed and businesses in difficulty found their financial support from the banks evaporating.  Businesses during this phase of the market cycle were experiencing a shrinking market, shrinking asset values and shrinking support from the banks accompanied by panic at government level.  Armageddon was imminent!

In reality it was not Armageddon. This was a normal, predictable set of circumstances repeating themselves, but who could remember that far back: to the last time.  Hindsight had become ‘short sight.’  For every million pounds that property values sank the banks had to ‘claw back’ £11 million in cash to support their own balance sheets. 

The result was a complete correlated drop in value of both property and equity prices largely due to the fact that banks headed the financial sector in the main share index and as the bank shares dropped, confidence in the market as a whole waned therefore other share values followed suit.  The market sentiment changed so rapidly many institutions were caught out.

What has that got to do with a late autumn day in October, 2009?  - Everything!

The opportunity that arose on that October morning stems from the fact that somebody had been smart enough, astute enough, lucky enough, to have put together a structured (we will talk about the definition of that later) product that had an underlying interest rate of 7.5% per annum paid monthly as a very tax efficient income source.  The contract was linked to any one of three indices (measures of price movement within a particular market):

One linked to the possible fall in share prices, by 50% or commodities or property under the same terms.

What was on offer was a contract, paying 7.5% per annum on a monthly basis over the five years, subject to certain market criteria.  The banks and building societies were paying less than 1.4% at the time.

Was there a possibility of any of those indices, shares commodities or property devaluing by half (50%) during the five year period?

The odds had changed the view of the future and the structure of the products was moving into a different regime.  This was not gambling, it was a carefully calculated mechanism put in place, with a set of known returns being juxtapositioned against a statistically probable outcome in order to generate a defined return.

First of all: the structure was based upon a five year term.  The second premise was the possibility of a 50% reduction in the FTSE 100 index (shares).  This was unlikely but possible. Was the FTSE 100 INDEX still something that people could put some trust in?  Let me explain:

In March 2003 and similarly in March 2009, the FTSE 100 index had ‘bottomed out’ at around 3250.  In chartist terms 3250 was a very firm base below which it would be very difficult for the index to fall.  That is the theory.  The theory does tend to hold up in practice. 

In October 2009 the index of 100 leading shares, the FTSE 100, was moving between 5200 and 5300 with every likelihood of it then moving ahead quite rapidly. 

Fig 1.1

But what of property?

Fig 1.2 Commercial property reduced in value by half.  Could it halve again? The great thing about property is that at the bottom of its market, it becomes moribund, it plateaus out. The graphic representation shows that property values become very flat, uninteresting, and a ‘safe’ but poor value as an investment, for a protracted period of time. 

A great number of people lose extraordinary amounts of capital through the effects of negative equity, the forced sale of ‘buy to let’ properties of being caught in property funds that moved to a ‘penalty price’ so they were ‘locked into’ the investment for six or twelve months. Hence few people want to venture back into an inflexible environment. “Once bitten twice shy.”  The trust in property and the reliance upon the adage that; “one cannot lose money in property,” are all but lost to a significant market influence.

FIG 1.3 – property prices

This commercial property situation (a flat market) can last six to eight years, therefore the likelihood of a 50% further drop in value when that market is confirmed to be “at the bottom,” is almost non-existent.  The likelihood of any damaging reduction in the property index (REIT) over a five year period puts the prospect of a 7½% income per annum for five years, against the security of the European Property Index, firmly in the frame as a ‘buy’ signal.

As we go through this book I will expand on what I have tried to say in paraphrase in this opening Chapter.  Hopefully the graphics will help and, as we progress, the jargon will become more and more familiar; and more relevant to your particular savings or investment situation.  Please persevere, it is worth the effort.

The message that this book (Hindsight – The Foresight Saga) is conveying is that ‘timing is very important’.  Yes one can take a twenty, thirty, or forty  year view and be invested for that length of time and allow invested capital to move up and down with the markets. That is okay, indeed it is a fundamental of how you should work your long term aspirations to build up funds in order to pay off a house purchase, create an income in retirement, and so on. 

The short term view has to concentrate on where the markets are in relationship to where they are expected to go, and be ‘of the moment.’ The timing of entry into an investment optimises the return.

However, I shall illustrate that ‘optimising returns’ depends largely on what is happening with the property market and the equity market specifically. It is their inter relationship with each other over a twelve to fifteen year time span, that is really important in providing you with guidance and the “markets” with vitality.

Whether you are in a ‘capital’ orientated market; where people are running for growth and a quick return, or in the ‘income’ phase, where quite the opposite dynamic is in play; consolidation, comfort and a reasonable return with a medium to long term view, has to be decided – and adhered to - at the point where an investment or savings decision is made.  Your future depends upon it.

Hopefully I have whetted your appetite. Simplicity is difficult, but I will endeavour to make the task of examining history and using it to improve and enhance your future, easy for you.

CHAPTER 2   -  Property Performance Analysed

The market in 2004 was starting to ‘overheat’, residential property prices had doubled and doubled again - just as they had in 1971 to 1976.  The circumstances were markedly different in 2004, there were low interest rates just starting to rise.  There was also low inflation - and, according to Government sources, getting lower (a view not shared by the populace as a whole, and particularly the elderly).  On the face of it there seemed quite a contrast to the 1970s yet at this same stage in the “classic market” as its predecessor the relationship between property values and equity performance was remarkably consistent. Could there be a link?

PROPERTY “BUY TO LET”

Whenever “Make some money by investing in ‘buy to let’ property” seminars appear along with a proliferation of glossy leaflets through the post, you know - or should know - that it is the beginning of the end of the viability of that particular market for future short to medium term returns on investment.  And so it was – even the TV programme producers adopted the ‘buy to let’ and “make money” mould and produced a number of compelling programmes.

By 2006 the average landlord held 3 to 4 properties in the buy to let portfolio.  Banks were joining the wave of enthusiasm for the capital growth projects based upon the (false) premise that the “rent will pay the loan interest and the capital growth would be the icing.”

Fig. 2.1  property v equity  2000 – 2011

The stock markets were recovering strongly from the March 2003 low and financial institutions were making money on the back of property based lending.  Record profits and a re-discovered commercial property market pushed residential ‘buy to let’ and commercial properties to higher values and excited the “me too” people who - by now - were certain that the “gold rush” was passing them by, even when they had little or no capital of their own to commit to property purchases.  They were right - the “gold rush,” had all but gone, however the financial institutions were still offering multiples of rental income on 100% or even greater mortgages.

Why is it that 90% of investors invest at the top of the market?  Any market?  The quest for certainty is perhaps the rationale, but, TIMING IS EVERYTHING.  The situation in 2006 had started to look ominous in 2004, but few viewers were in evidence. Few people appear to be watching the signs and even fewer taking any notice of them.

There are some interesting factors that played a massive part in the eventual outcome of this manifestly crass farce.

The banks and building societies’ upper/middle management were aged between 34 and 44 in 2009.  What age would they have been in 1992-93?  17 to 27 say.  Many of the mature managers had been ‘retired early’ under a specific redundancy programme in the mid 1990s, to allow ‘progress’ in a new age; Oh! and to save the senior managers’ higher salaries.

What experience of the effects of the “propped up” property market (1989-93) and the after-effects of a direct assault on bank solvency margins caused by collapsing asset values (that constitute a large portion of bank asset value through individual “charges” held against lending as security) would those managers have?

The whole thing about financial forecasting is much like predicting winter in the previous spring: we still get snow in April or June.  Life has a habit of ‘throwing up’ the unexpected. 

Having spent the largest part of my life (40 years and more) anticipating rather than predicting the financial trends, and generally getting them right, noting the odd spectacular exception, I do feel confident about anticipating the future in a reasonably assured way.  War wounds do heal but they leave scars and provided we learn from those scars then I guess that one can say they were worth the anxiety and pain acquiring them in the first place. Hindsight is a learning tool.

Many years ago now I identified and named a specific phenomenon in the financial market as ‘the classic market.’ 

In that ‘market’ there are four major primary players:

Equities, (company shares).Fixed interest (gilts [government loans], and corporate bonds).Property (both commercial and residential) together withCash.

There are of course many sub divisions and non correlated oddities which sit outside of those four generic ‘heads’ but those four are the main players for the majority of people.  The two main ‘players’ in my book are equities and property because they tend to inter relate; a fact which most commentators appear to have missed, or ignored as irrelevant.

The intricacies of any inter relationship are not to be explored in any detail at this point but it suffices to say that the second market slide of equities in this ‘classic market’ is invariably brought about by the collapse of asset property prices.  Residential properties lose value first and then, historically, commercial properties follow by what can be 12 to 18 months. In 2005 through 2008 both markets went into decline at around the same time. 

Let us assume that you are a banker at the point at which the first stock market downturn was occurring, noting that the property market had been subdued for some 7 or 8 years and was starting to exert itself.  Would you perhaps anticipate that values were going to rise significantly giving you really good ‘cover’ as an asset base for any mortgage that you might agree - and therefore be tempted to lend 100%, or even 110% or 120% of loan to value to stimulate the market and drive the economy forward?

If you were that same banker some 2-3 years later with a burgeoning property market and a resurgent stock market running behind it, would you not think it prudent to gradually ease back your lending criteria to ‘dampen’ the property and possibly the equity market, and protect your own asset base by reducing the ‘loan to value’ from 100% to 95%, to 90%, to 85% and down to perhaps to 80% loan to value for any new mortgages? 

The housing market would slow gradually; the bankers’ own asset base (which is crucial to their solvency margin) would be protected from at least a 20% drop in the underlying value of the properties the bank had lent money against. Shares would also probably just ease back a little as funds could be diverted to commercial property to support businesses in building their own asset base for longevity.

What happened in reality was that bankers started off in 1970 and the mid 1980s and in 1997 with 80% loan to value and then as the underlying asset value in residential property powered ahead, the banks then lent 85%, then 90% then 95% and then 100% and, in the latest round of confused optimism; up to 125 % of loan to value (LTV).

Not only was the LTV increased, instead of cutting back, as one would suppose, on the amount of salary that could be made available from the borrower for the house purchase in order to create a balancing effect on the mortgage structure; the lending institutions actually moved the income criteria from 3.5 as a multiple of earnings to 6, 7 - and in the worse case that we know of; 8 times earnings, (EIGHT!) to allow people to buy their own house, OR WORSE to rent to someone else!

Wouldn’t you think that an intelligent regulator, made up largely of ex-bankers, Bank of England bankers, charged with protecting the public, would have made the same observation that we have made for the last 3 years of the upward moving property cycle, that the latter model was untenable and the former far more desirable? Anyone’s guess

‘Ah, but, interest rates and inflation were lower,’ they said.

Interest rates in 1991 were 12-15% - inflation was still high but reducing.  The dynamics were the same:  it was the ambient forces that were different, in quantum.  The over-used and over-simplistic expression that: “It is different this time” was repeated “ad nauseam.”

The truth is that the classic market fundamentals were no different with interest rates at 3% and inflation at 2% per annum because property prices had moved beyond sensible borrowing limits with regard to the average home owner’s earnings.  The ‘buy to let’ market was also ‘suspect’ to say the least - especially when rental incomes dropped. There was an over supply of rental properties and many were too expensive to run, especially after government tax changes which included a levy on landlords.

Professional landlords had started off-loading (selling) their portfolios in 2003-2004 to naïve investors - some in their early 20’s, for instance university students (or their parents), or perhaps those disenchanted with the equity market crash that sought a more certain investment future; many at, or near to the top of the market. 

Fig 2.2 Property Decline; and Bank Shares 2003 - 2010 After all: “You can’t lose by investing in property; can you?”  Buying a property near to a university worked for some. However in the general market, some (including people I know, in London) lost considerable amounts of money for others.

There are number of real ‘giveaways’ as evidence of the impending reversal, at the tail end of a classic market if one cares to observe carefully what was going on.

Official statistics work on the sale price of the property.  But is the sale price the whole answer when you get to a situation where you perhaps have an £180,000 home which you are looking to sell?  A builder has a £280,000 home on a development site that he needs to ‘shift’, because the bank is pressing him to get his overdraft down.  The builder takes a £50,000 cut in the price of the property by discounting it to £230,000 and takes the purchaser’s house in part exchange.  What has actually happened?  Fran and Stewart felt that they had worked this to ‘their advantage’ to obtain a larger home.

The property probably cost the builder £150,000 to erect, equip with a kitchen, put carpets down and present as a new home (not a house).  It is that £150,000 that is ‘out’ to the bank, as the builder’s overdraft, secured by the builder’s development properties. 

At £280,000 he could put £130,000 into the bank but he knows that the market prices have collapsed by at least 15%.  By collecting £50,000 from the purchaser, plus their house, the builder still has a house to sell, but  it is a cheaper house, further down the market chain on an established estate that he can discount. 

The builder has received £50,000 that he can put back into the bank, reducing the £150,000 that he owes to the bank, to £100,000, easily secured by the exchange property which stands him at £180,000 which he can now discount to £150,000 and sell reasonably quickly, paying off £100,000 to the bank leaving him £50,000 profit, on the double deal.

The effect of the foregoing is to reduce the market value of new houses (£50,000 on £280,000 - a reduction of 17.8%) and also to discount the houses in the next tier down; £180,000 to £150,000 a 16.7% drop.

That is one of the mechanisms that pushes the market down (deflation) and the buyers think they have got a good deal.  And possibly they have.  The bank has its need for ‘money in’ satisfied, however, it is a deflationary exercise, and eventually affects the property market as a whole until the margins become too thin for the ruse to work effectively, or the market grinds to a relative halt.