Risk is in the eye of the beholder, just like beauty, and to judge from global asset prices, the beholders are rather generous. Global asset prices are extremely expensive, pushed up by a sea of liquidity and waves of unabated optimism. Stocks keep going up, real estate prices are exuberant in a great number of countries, apartments in Cannes, Madrid, houses in London, are sold for absurd prices that are only possible due to the buyer being convinced that the price can only go up. Or maybe because the buyer’s money has been made easily, benefiting from the proliferation of financial deals in an economy that is more and more based on financial flows.
For every buyer there is a seller, and it remains to be seen if the sellers are reinvesting into the bubble or taking the money of the table. As long as money keeps coming in, prices will keep going up. The day the music stops, it will be a rush to see who takes the free chairs.
We at Swissdom suspect that D day is very close, and we are paying attention to what can make the market move. A property investment in Switzerland is the best protection against a global readjustment of asset prices, as one can conclude from the following analysis.
1. The carry trade
According to Barclays Capital, we are at a high of 34 billion USD of such trades, a high since the Russian financial crisis in 1998. This time the crisis will not be Russian, since Russia is not up to its neck in debt. The crisis will be financial and probably quite global. It is difficult to say what will make the carry trade unwind, but let us look at a few figures:
If the global position in those trades is 34 billion USD, this probably means that the yearly income generated by the trades is around 5% a year, which is the interest rate differential between a basket of high yielding currencies (USD, GBP, EUR, AUD, NZD, MXN, BRL to mention only a few) and a basket of two low yielding currencies (CHF and JPY). The 5% correspond to approximately 1.7 billion USD a year of revenue for the traders/investors, plus whatever capital gains have occurred since the trades were started. The traders that have put in the trades lately are of course the most fragile, since they came into the game late. That number of late players is rather large. We suspect that an increase in 4% in the value of the CHF and/or the JPY against any of the placement currencies will be sufficient to start a panic.
In the event of a panic, we will quickly get to EUR/CHF prices of 1.55 or lower, and the way down will be much more rapid than the climb. It took 4 years to go from 1.45 to 1.62. To go from 1.62 to 1.50 it can be a matter of months. It has happened before. The Norwegian Kroner was used as a carry trade placement from 1999 to 2003. It moved from 9.2 to 7.3 in 4 years. 12 months after the low of 7.3 it was up at 8.9?.
The fact that investors are willing to buy overvalued currencies and sell undervalued currencies, to gain 3%, 5% a year, is an indication that risk aversion is low. The fact that there are record bets against the CHF when the world is more and more unstable, is also an indication of a global disregard for risk.
2. Global financial asset prices
Stocks are expensive just about everywhere, because interest rates are still low in many countries, and that allows for massive borrowing that is invested all over the world. Prices will come down, starting with the less liquid markets, namely the emerging markets. Some markets may have signaled the move in advance, namely the stock markets in Saudi Arabia, UAE, and so on. The UAE benchmark NBAD index dropped 40% in 2006. It is difficult to determine what will fall and when, but when there are drops in the market, liquidity dries up, and that favors further drops. Since markets are interconnected, a big drop in one market can be the catalyst for a global drop.
3. Real estate price distortions
The prices of land in a large number of first world and third world capitals, cities and suburbs are much higher than in Switzerland. This occurs because local and international speculators make the price go up. In Switzerland such price pressure is limited due to restrictions to the purchase of property by non resident foreigners. If those restrictions did not exist, prices would be much higher. Switzerland has been spared a bubble, due to its laws. To have an idea what an avalanche of money can do to real estate price it suffices to take a look at some fashionable places like Verbier, where waiting lists for the legal registration of property reach into 2009, and prices are stratospheric. In Swiss towns that are either not fashionable, or where the law is not as flexible, assets have not benefited from that liquidity, and therefore remain reasonably priced. Smart investors are increasingly looking at Switzerland, as a suitable place to park money, buying hotels, offices, and of course homes. Many are moving into Switzerland, discretely but steadily.
Our thesis is that the Swiss Franc is undervalued, property in Switzerland is undervalued and globally traded financial and real estate assets are overvalued relatively to Swiss real estate assets. We consider the following events as being likely to occur over the next few years:
a) Reduction of restrictions to non resident foreigner holding of residential property in Switzerland;
b) Unwinding of the carry trade, forcing an increase in value of the CHF in particular against the GBP and EUR;
c) Major unpleasant geopolitical event, which will reinforce Switzerland’s attractiveness;
d) Social instability in several EU countries, increasing migration towards Switzerland:
Consequently, we should see both a strengthening of the Swiss Franc and an increase in residential property prices. Top end properties will most likely go up first. In the more internationalized parts of Switzerland, such as the Lake Leman area, prices have already increased, although they are still reasonable both in CHF terms and EUR terms.