Interest rates and collective thinking
Many will be feeling the pinch right now. I can imagine the conversations around the dinner table tonight as the RBA raised interest rates a further 0.25%, “I didn’t sign up for this”.
Let’s rewind to Christmas 2021. Aside from a few blips, Australian property prices had been going up for the last 25 years. The property bubble had become extreme, pumped up by stupidly low interest rates. While in the US you could buy a home for 4-5 times the annual salary, in Australia you needed 10 times the average annual salary! Yet inexplicably people kept buying into this madness. When covid hit I thought, “surely this is it”. I thought the bubble would pop. Instead the government opened the flood gates, splashing money all over the economy and into people’s pockets. The result, house prices surged a further 20%.
Something had to give. That something was inflation, which like a sleeping dragon we managed to wake up after much poking.
So as I sat there with my extended family at Christmas lunch, I tried to explain all this and that in my view we were in for a big correction in the housing market (and bitcoin).
The reaction caught me by surprise, it can only be described as hostile. You would have thought I had just individually insulted everyone at the table. It struck me at that moment how deep this thing ran. People had become so convinced that property prices only ever go up, it had become such a part of their lives and psyche, what they worked for and aimed towards. Any suggestion that might undermine those beliefs was to be eliminated.
Then again who was I to make a call? I was still working in a regular job and had no track record investing. (I still don’t have much of a track record) So in fairness, my call was easy to dismiss. But as it turns out, I was (unfortunately) right.
So is this an “I told you so” post? Well a little, but it has a point beyond that.
It got me to thinking, how could a whole population get caught up in this bubble? And how do you avoid getting caught up in collective thinking.
In behavioural economics there is a concept called recency bias. We tend to believe that what has happened lately will continue. So in the case of house prices, with each year of increases that went by, people became more and more convinced that they would continue on upwards indefinitely.
Until they didn’t. The average house price has fallen by 10% in just a few months.
Nobody can ever predict the future, but if you study history, you can at least be prepared. And you don’t have to go back that far. You could have looked at what happened during the GFC in the US, where house prices got decimated. Or back to 1994 in Australia where there was a steep correction.
The same applies for other infrequent but potentially devastating events, like a pandemic. Sure you don’t want to be thinking about all those things on a daily basis, but I think it’s good to have an idea of what could happen and be somewhat prepared for it.
There are some great history books out there, my favourite which is a short but excellent book is: The Story of Civilization - Will and Ariel Durant. If reading isn’t your thing, talk to your grandparents, they will tell you all about the twists and turns of history. It’s so easy to get caught up in the latest news, but the real gold is what happened before.
There is a silver lining here for people who haven’t been able to buy a home all this time. Houses are becoming more affordable and salaries are going up.
In my view, it’s a good time to be putting money aside. At some point we will reach a normalised level in Australia where housing will be more affordable on the average salary. How long that takes is anybody’s guess. I’m done making predictions for now. But history tells us, it will happen at some point. If you look at things with a long term view, you can be prepared and when the time is right, make your move.