Mailbag: incl. Why is Australia so much better than Argentina? March 10, 2024

26:48And I'll add a couple of companies when they were contractive. And you absolutely would. But you could never mathematically choose an ASX 200 ETF over a component part of the ASX 200. What I have done and what I've recommended to our members is a couple of international ETFs from time to time. And I'm going to say outright, here's where you need to kind of take half a step back from perfection. I say this at the same all the time. When we recommended, last recommended an ASX, I think it was, sorry, S &P 500 ETF, I think we recommended. And it was impossible for that to be better value than any stock we find on the ASX.

27:25There must have been at least one stock on the ASX better value. Just because, again, I've talked about the average before, right? Similarly, there'd be better stocks on the US market in particular. So why do we recommend, if our job is to find the best idea, why did we recommend that ETF if there was a chance and a very very high likelihood something on the ASX was cheaper and the answer was we believe it's in our members best interests in general not not personally in general to have exposure to the US market international markets for the reasons of diversification and growth and everything else we've talked about in the past and so that's literally why we did it so we had exactly the conversation you're thinking about Jamie and the answer for us was it's and we've we talk about this regularly we think about there's almost a sort of a short list of ETFs always on our conversation every month, where we say, is now the right time to recommend another ETF?

28:10And we always say, it's never going to be the best idea. You know, financially, mathematically, if you did a DCF or everything, it's almost impossible for it to be the best idea. But it can be the best idea from a portfolio construction perspective, from a diversification perspective, from a, you know, the right way to build a dollar cost averaged long-term portfolio. It can be the best idea because you want to add exposure, in my view, to the US markets regularly. So that's kind of answering you out of both sides of my mouth, mate, but that's a very real example of exactly what you're going through, because exactly what we went through at the same time to try and work out exactly that.

28:45So it's also, by the way, why I really dislike thematic ETFs for the reasons you highlighted in terms of not going through and valuing every individual company. How do you say lithium looks good or cybersecurity looks good or gold looks good or Bitcoin looks good or whatever, just because you go, well, it kind of thematically sounds okay, and so maybe I should just buy the ETF instead of actually doing the work. If you're not going to do the work, buy a passive ETF. Buying an active ETF without doing the work is the worst of both worlds in my mind. You might get it right because you get lucky, but if you haven't done the work to value it and you're not getting passive low-cost exposure to a whole index, I really reckon that's, you know, that's the trying to cross a chasm with two short jumps.

29:24You just can't do it. Yep. i made one for um uh from jack i like this one hi scott and andrew greetings from geraldton wa nice i'm 28 years old bastard and about a year ago i went to a trip i went for a trip to argentina everything i know about inflation is either theory or watching the australian inflation rate increase a few percent but at the time argentina had an inflation rate of about 100 percent people were spending a lot because they held onto it it would become worthless anyway my question is as much as we talk bad about the aussie government and the cost of living do they deserve some sort of a bravo for the economy not getting as bad as other countries like argentina or is it as basic as that we simply had a stronger economy to begin with with less corruption many thanks jack i think first one if you if you don't mind because i please yeah i i'm no expert on on macroeconomics or long-term economic history but i am fascinated by it i'm a pretty keen student of history um i've read a book and i it's an economic history book and i can't remember its name it's literally something like the economic history of australia or something i can't remember anyway early i want to say early 1900s the australian argentinian economies looked almost identical in terms of their makeup in terms of wealth levels, the complexity or otherwise of the sectors, the made up the economy, the sorts of things, big beef industry in both countries, they look really, really similar.

30:56Can I just very quick interjection? A hundred years ago, Argentina was the richest country in the world per capita. There you go. And Australia was way up there as well. There you go. Very, very, very well-endowed country. And when you go there, you would see some beautiful old architecture that was built back in the day when they were super, super rich as a country. Sorry, go on. No, it's great. So that is a great setup, right? So you kind of think sliding doors, right? Which if you'd been able to choose one at that point, you might have chosen Argentina or you might have chosen Australia, but they weren't that dissimilar.

31:32And then, as the economies continue to develop, they develop really, really differently. Honestly, Jack, my understanding of it, again, I claim no absolute expertise. And if there are any economic historians listening uh firstly go and do something else but secondly if you have a view feel free to throw it at us um the the it came down to in this author's view the institutions in the different economies the way those institutions worked together uh to deliver the society that we have and it's a worthwhile i think it's a very very worthwhile thing to remember uh i'm not going to say australia is necessarily better although the numbers would suggest we have been and i'm not claiming no no nationalistic patriotic benefit credit out of that because i wasn't around and you weren't around and no one was around um things things evolved and they evolved differently and they're for the grace of god frankly go we we could be argentina they could be australia right now they're not we're not and we should be very very thankful for that i will quickly jump on the soapbox and say it is why the defense of our institutions is so incredibly incredibly important um if you if you take those for granted if you let them get eroded then you become Argentina?

32:39Is it corruption directly? I don't know that it's corruption. It probably is, I would speculate, but it doesn't need to be. Just the institutions that allow for the thriving of an economy, that allow for... It's a bit of compounding, but it's better than compounding because it's kind of the interplay, right? I compound mine, Andrew compounds his, but we do it by compounding each other's. I deal with him, he deals with me. The ability to trade, to cooperate, to trust. I want to say trust, I don't necessarily mean implicitly. I actually and explicitly in terms of the government structures, the legal systems, the currency, all those things that happen that give businesses confidence to grow, we take them for granted a bit.

33:16And I think when people say, oh, capitalism sucks, it's not working for us, maybe socialism or communism will be better or that kind of thing, I get the sense that people feel underserved by the current system. And I get the feeling that maybe a utopian alternative might be better. There are those who say less regulation will be better. Again, possibly right. But I would also suggest that Argentinians, if you could say, if they could go back to 1900 and say, can we have Australia's institutions, please, and then see what happens? You have a very, very different future. So, mate, you're right. I think you've absolutely nailed it.

33:48We didn't have a stronger economy, but we did have much, much stronger, more cohesive institutions. And that, from most reports, seems to have made the difference. I'm going to 100 % agree with you. It is exactly, but I'll be more specific. It's the money, stupid. it's the money so at the money that the argent um i'm gonna do what what is the argentinian is it the peso i forget the peso yep right um is you know is a is a shared fiction that works very well um except it wasn't managed very well you know so so basically you had rent and corruption is mixed into it but institutional rigor is perhaps the better way to sort of put it you You had these things evolve, as you say, over long periods of time.

34:35And it's just like, you know, the government spent well beyond its means. It had to try and fund itself. It ultimately found that the only way to fund itself was to print more money. More and more money went into circulation. It became less and less valuable. Inflation took off. It happened so many times in Argentina. This is not the first time it's happened. It's happened again. And they've had to reset and reset and reset. And every time they reset, it's the poor people that get screwed over. All the rich people have their money in property and hard assets and things like that. And the cycle continues.

35:09This is the problem. Why is Australia different? The short answer is we had better institutions. I mean, could they be better? Yes. But to me, this is – I mean, I don't want to pivot into where everyone is assuming I'm going to pivot. Oh, we were assuming. These are the weakness. You know, it's the best thing that we had up until recently, but was just the reliance on trust in our institutions. And institutions are full of people. People are fallible. They're weak-minded. They're gullible. They're naive. They're all the things that define the human condition that's as true to me and as to everyone else.

35:47And if they get it wrong, if an ideology takes over, if greed or corruption takes over, it ruins everything. Once the money breaks, I mean, we call it inflation and we sort of focus too myopically on certain aspects of it. But the money breaks and then the society breaks around it. And here's something interesting. I mean, Argentina is not this weird fringe case. There's 160 fiat currencies out there. This is the normal scenario. When you take away the US dollar, the euro, and I think the top 10 currencies, I think all of them go through the longest, the average survivability of the currency, something like 20 to 30 years before there is some kind of forced reset and capital controls and all of these very scary kinds of things and ultimately reduced standard of living and inflation.

36:32Just this week, Egypt gave up the ghost and just said, we're just going to let our currency free float on the market. And the whole thing collapsed. People's savings just evaporated overnight. another country with poor institutions um poor controls uh the money just got out of control the money broke and everything else broke what's interesting is what when you go to these places so you think wait a second that sounds very mad max kind of scenario but anyone who's backpacked through those scenarios like you can still get a coffee you still get a room yeah society still function like badly badly and there's all kinds of um impacts but why does it function well i i'm sure the the listener knows the answer is like they always use u.s dollars it's called gresham's law you know when you've got ultimate alternate forms of money available to you you will you will save in the hardest currency available to you and you will get rid of as quickly as you can if anyone pays you an argentanian piece i'm going to spend that right now because tomorrow it's going to be worth 20 % less.

37:33And the wealthy, even if it's sort of the middle or upper middle class and above in those societies, they're holding things like tether these days on their phones and they've got US dollars stuffed under the mattress. If you're a doctor or someone of relatively high standing in those currencies, you can guarantee you there's a safe somewhere in that house full of physical paper US dollars. And that's how things survive. And again, it's much, much, much, much worse for those at the bottom of the pile. But that's the only way it's sourced because people, the market naturally seeks a better alternative.

38:06And yeah, it is a humanitarian tragedy, no less, is what I would say. I think it's right, mate. I think, I will say my view is it's slightly bigger than just the money. It's the institutions that go around, not just the cash, but the rule of law and other things that, you know, they cross over money on the way through and back and all that big overlap in the venn diagrams but yeah totally but but yes that that kind of idea and by the way can i just finish by saying a lot of luck um because i i would suspect that both times it's likely i don't know the argentinian history that well but i suspect at some point it's likely that people thought they're doing the right thing or maybe we're acting out of self-interest in both cases but either way that one's happened to work better than the other one so uh in some cases uh yes we can look at absolutes and say we made these right choices or they made those bad choices in other cases like well hey how about that we thought we're doing the right thing so today we just got lucky look at the greeks count luck right like everyone who works in the public you should have a right to a comfortable retirement in thanks for your years of hard service i mean hard to argue against all of that but it's just like you know politicians miss the economic long-term reality of things like that's great too i agree but we've got to fund it somehow we need to balance the books and and and it's when that that distortion lasts and it lasts for a long time that's when you get you get to a point where it's sort of like the maths get it's a tipping point very very much so in the sense that you get to a point where there's actually not much you can do and that's when you have weimar germany and hyperinflation it just because like like it's happening in egypt right now there's like well we what do we do it's like trying to put out the fire with more with more gasoline you know yeah and by the way it's also why utopias don't work.

39:52And I kind of, you know, I am a passionate defender of democratic capitalism, not because it's the best thing ever, because it's the least worst thing ever. And I mean, literally ever. And so can it be improved? Yes. Should we improve it? Absolutely. When the, this sucks, we should change it. We should blow this thing up. Or, shout out to the modern monetary theorists out there. When you say we can just not worry about debt or we can not worry about that. Those are lovely sentiments. Yeah, thank you. That's a better word. They're lovely sentiments. And honestly, we're not going to ignore it, but MMT could work in some forms managed appropriately.

40:27A hyper-intelligent general AI would make it work. Yes, or a benevolent dictator with no other vested interest. MMT is the same as communism. It's the same as central banking. It all rests. If you have the right people who are super smart and super generous and super egalitarian, then yes, yes, it will work. In any other real situation, no, it's going to fail miserably. And so that's kind of, you know, I want to live with that point, mate, because it's, you know, I get why people want other things to be true because it'd be lovely if it was. If communism could work, that'd be fantastic for everybody.

41:02Honestly, I'd be banging the drum, right, because I'm some horrible red under the bed. No, because if everyone had enough, that'd be really nice. You know, I think we could all agree that prosperity and, you know, more equal sharing would be lovely. Name one communist country that you want to move to today. I'll wait. I'll wait for you to answer. And by the way, not just go there for a holiday because it looks like a fall, but actually stay there and deal with food shortages and medical treatment available and all sorts of other things. It's just, yeah, you don't want it. Motley Fool Money. For more, subscribe to the free newsletter at fool.com.au forward slash listener.

41:39Sam has a very good and short question, mate. He simply says, good day, sirs. Can you please explain in layman's terms how the market prices in interest rate cuts? I understand that bonds of varying maturity have different yields, but this statement I read so often in the media is not abundantly clear to me. Perhaps I'm not the only one. Thank you. Cheers, Sam. In Brexit, it may or may not be my real name. Just joking. Is it? Or is it? That is from Sam. So this is what I'm apparently, we think. Could be Samuel. It could be a Samantha. You don't know. Well, exactly. It might just be Sam. Yeah, it could be.

42:20How does the market price and interest rates, right? So you've got to be aware of these two markets. There's the primary market where the people who create the bonds, let's call them for what they are, IOUs. Here's an IOU who wants it. I'll take it. Okay. In exchange, I'll promise to pay you these interest payments over the years, and then at the end of the period, I'll pay you all back. Great. Now that person's got it. Now that person can trade it on the secondary market. So it's just like, I didn't create the bond. I'm entitled to whatever benefits it represents, but I can give it to someone else for cash if I want to.

42:50And so if I've bought a bond off you and you've promised over the next 10 years to pay me 10 % per year, but interest rates more broadly in the economy or whatever the central bank is doing, or just change and I can now get 15 % elsewhere, the same equivalent risk, I'll do that. And no one would buy my bond off me, right? So the only way I can make that compelling is to lower the price and therefore, because it's an inverse relationship, increase the yield. So it works backwards as well. I don't know how the maths works. I'll put that out there right at the beginning. But you can do some maths to basically look at current bond pricing and infer what that says about expectations of interest rates.

43:30Because how those people price those interest rates in the secondary market is very much dependent on interest rates because it's the opportunity cost. I've got this thing that's paying me a set amount, and there's another thing that's over there. And if I think that the general rates of the economy are going to increase significantly, well, I'm going to reflect that expectation by selling my bonds. Right. Yeah. Does that make sense? I don't know how the math works. Maybe you can explain it. Well, yeah. So it's basically the calculation that says dollar value times interest rate equals payment.

44:05And if you reverse that, you can work out the interest rate. If you've got a certain payment, a certain dollar value of the asset, what's left is the implied interest rate. So I'm going to just add one more bit of colour, Ram, to your answer just to make it a bit clearer. If it wasn't clear already, it should be, but if it wasn't. When you buy a bond, you don't really buy a bond and get 5%. You buy a bond and you get a dollar value. Now, that is a percentage by definition when you buy it, but that's why it can change. Because to Ram's explanation, I just want to add to that, mate, to your explanation.

44:31Yeah, it's not a promise to pay 5%. It's a promise to pay$5 per coupon. That's right. So if I buy a$100 bond and I get$5, and then rates, because that is 5%, right? We know that. If interest rates go to 10%, for example, right? I paid$100, I get$5 a year, but I can go and get, if I were to get$5 a year, I've only got to pay$50 now because I'm getting a 10 % rate over there. So what does that do? My$5 a year payment is now only worth 50 bucks. And just to really slow that down for anyone who's doing the maths, if you get 10 % anywhere else in the market, and I want to sell my bond, who's going to buy it from me?

45:06Only someone who's getting what they could otherwise get in the market. If you get 10%, if Ram's offering you 10 % and you get a$5, 5 % bond, you're going to take that money. So what happens is the bond prices, the price of the, not the interest rate, but the price of the bond moves to make sure that the coupon rate, in other words, the$5, is a 10 % return. And so that's when the bond prices will crash from 100 to 50 to represent the current prevailing interest rate, which is 10%. I know that's really, it's very, very hard to get your head around, very super hard to do it on audio, but hopefully that's given it some decent answer.

45:42So Ram's answer was exactly right, by the way. I just want to add the dollar value because that's why they reprice because you can't get more than 5 % of your purchase price, but you can sell it for a lower price and increase the interest rate as a result or the yield as a result. The other thing to bear in mind is that these are the bets of people. Yes, that's right. You know, maybe sophisticated Wall Street traders or whatever, but what the market is implying will change. So the mistake that you don't want to make is to say, oh, the market's implying that rates are going to do this over the year and then take that as red.

46:16No, things change and then the market will change and then it'll apply a new one. It's a reasonable, all it tells you is, and this is where it's useful is to say, well, what does the market think? The market thinks this. Now, my market might be completely wrong, but at least you know what it thinks by going through that process. Yeah, great summary. And when we say the market, what we're really saying is just simply the price implied by everyone doing the trades. So, you know, if everyone was saying, well, and sorry, just to finish off actually, Sam, how does it price it in? What it says is, hey, in future, we think the market, the rates are going to go down.

46:51So we're going to buy or sell bonds at a price that assumes that's going to happen. Yeah. So when we talk about it pricing in, again, Ram's summary was perfect. But looking forward, it says, well, rates are going to fall. So I'm going to pay less for that bond. I'll pay more for that bond, get a lower interest rate. And so when you talk about it, so you might say a bond might mature in August 2024. We're recording this in early March. So if the rates are going to fall between now and then, the bond yield will fall, the price of the bond will go up. And so we can say, well, actually, traders are selling and buying August 2024 bonds with this implied yield.

47:27And that's what we're talking about pricing. And they're basically allowed for the fact that at that point, they believe official rates will be lower. And so they're reflecting that in the prices they are paying for bonds that mature at that point. I hope that kind of finalizes it. Yeah. And very quick segue. This is how so many of the US regionals got, and European banks for that matter, got into, and Chinese banks for that matter, got themselves into trouble, whereas they had a lot of capital tied up in bonds and then interest rates spiked. And so for that, just what we discussed played out.

48:00It meant that all their bond portfolio on a mark to market basis, in terms of if they had to sell those bonds, they're carrying them on their balance sheet, they're worth this much. But if they had to sell them, they'd be much, much lower. So technically insolvent for a lot of this. So the Fed Reserve had to come in with the, I forget the name, the BTFD, whatever it was, emergency bailout. Let's call it what it is, a bailout. And now we actually saw a regional bank just folded this week. Similar kind of concept with exposure to commercial property over there, which is very much viewed and valued in the same way as bonds.

48:35Again, I've got this property. I was paying so much rent. It gives me so much of a yield. oops all of a sudden interest rates change even if not my capacity and and occupancy and whatever doesn't sort of change that that opportunity cost analysis of what i can get elsewhere will impact the carrying value of that and it can wipe people out and does regularly and in big institutions too so yeah that's gonna be that's gonna be interesting to play out i mean we've there's a there's a lot of property developers in china whose bonds aren't worth the paper they're printed on you know it's It's a very, you've got to remember, there's always another party to the trade.

49:09Someone's losing here somewhere. Correct. Yes, I have my issues with marking to market for the purposes of doing that, but that's a whole different conversation. We'll probably leave for another time. It is a different one, yeah. Mate, Kate, a female listener. Thank you, Kate, for sending in a question. She says, hi, Scott and Andrew. When I was in my 20s, I invested in Macquarie Managed Funds. This bought our first house. Fast forward 30 years and I am now newly divorced. Sorry to hear that, Kate. I've invested in Macquarie Australian shares and Macquarie small companies with the vision to hold for seven years.

49:42I am also waiting for a term deposit to mature to invest in the Vanguard Global ETF. Should I sell my funds and invest that money in these ETFs? Have managed funds lost their mojo? I know the fees are higher, but surely you're paying for a specialised service. I know you don't give financial advice, but in all the podcasts I've listened to, you only mention ETFs, which I only heard about four months ago. Keep potting on. From avid listener Kate, she describes herself as. She's in my neck of the woods too, so good, Kate. Thank you for your question. Great question, mate. Why do we not talk about managed funds, and what should we think about when we're comparing an ETF against a managed fund?

50:26Yeah, it always ruffles a few feathers, but you've got to remember we can only speak generally. Yes. And this is just unequivocal. I don't think it shouldn't be a controversial statement, but when you look at the sector at large, it tends to underperform the index and tends to underperform low-cost passive ETFs because of the fees. Kate's absolutely right. I mean, the promise is that we'll do better than the market after fees. And credit where it's due, there are funds out there that have done that. And that's no guarantee that they will continue to do that. Look at Magellan. You know, look at, there's a whole bunch of examples that are sort of there.

51:02But that's the hard part of it. I think if you can have, and I don't know how you build a lot of confidence in this other than it's like someone with an incredibly impeccable record. But if you sincerely believe that you can pay the extra fees and still outperform, then yeah, it's a perfectly rational decision. The advantage, I suppose, of the ETFs is that you'd not, as we said in the previous answer along these lines is you just, you're taking it out of the equation. The bet is what will outperform, goes from what will outperform the market to just give me the market. Yeah. So it's a different kind of calculus.

51:40So it's sort of like that's there for free for one of a better term, as far as a free lunch you can kind of get, that you can choose from the buffet. But if you've got confidence that actually this is another alternative I can do better, in the same way as you might think I can do better directly in a share or in Bitcoin or whatever, a property, it doesn't matter. Whatever alternatives that I've got out there, can I do better? So I tend to think given the track record, you might have some stats at hand, I don't know, Scott, but it's not like 51 % outperform and 49 % underperform type thing. It's sort of like 70 % of active fund managers underperform after fees.

52:17After fees, I think it's closer to 80 % or 85 % most years. It depends on the year, it depends on the fund. It depends on how they're choosing to actively manage, what strategy they're following. But yeah, it tends to be about those numbers, mate. And this is why, Kate, it's a tough one.

52:33We all kind of tend to default our own experience. So if you've invested in managed funds that's done well, you're like, man, managed funds are amazing. Look at what I got for the money. And if you've done badly, managed funds suck and that's terrible. Our approach generally, and as Ram says, we can't give you personal advice, but our approach generally is that you want to put the odds in your favor. and if you said to me i've got a bet for you uh you can invest in managed fund but four out of five of them will lose do you want to roll the dice on that like well hang on if i buy one there's a chance i'm gonna get the wrong one if i invest in five of them one might outperform uh now maybe maybe i it doesn't mean you have to the odds don't always work out at an individual level maybe you pick three out of the five that outperform maybe you only buy one and that does outperform and you think wow i'm a genius i picked the right one the hardest part is is knowing which ones are going to Now, by the way, the Motley Fool picks stocks for a living.

53:18I would say the same about our industry as about managed funds, which is we say we are going to try and beat the market if you would like us to help you do that. And we either do it or we don't. So far, so good for ShareAdvisor. I've been running that for, jeez, 12 years now. Time goes fast. We're having fun. We're beating the market, which is great. By the way, terms and conditions, blah, blah, blah. Past performance, no guarantee. But we could have easily been losing to the market. Others in our space will be currently losing to the market. Now, that's fine. In fact, one of our services is, actually, by the way.

53:48So there you go. Just to be really honest up front. That's the choice you make, as Ram says. You either choose to get the market return unless it's a tiny fee, or you try and beat the market, knowing you could lose to the market instead. And that's why I love ETFs. And it's why, honestly, I don't love managed funds, generally speaking, because if you've got a great fund manager who has a great director called Warren Buffett's company that owns shares in Berkshire Hathaway is effectively a closed-end managed fund, right? Because you're investing in his investment wisdom, his ability to allocate money and beat the market with that company.

54:24That's exactly what you're doing. Now, if you're Buffett and you're investing with Buffett, I'm pretty happy with that. If it's Jane Bloggs and she's been doing it for three years or the fund's been up for 10 years but they have three different fund managers during that time, how much confidence do I have that Jane or John Bloggs is going to beat the market? And should I have that confidence? When I always say, people, how much confidence do you have? Oh, lots. And so it's the wrong question. What I say, how much confidence should you have based on the evidence? And if your answer is still lots, because here's what's happened, and this fund manager has run it 15 years, they've done this, they've done that, and this is why they're great, then I'm happy to say, well, probabilistically, if they've got a special source, then go for it.

55:03But to Ram's point, if four out of five of them don't, then the odds aren't great. And that's why ETFs are so fantastic. I am a massive fan. now to be very clear as i've said many times i'm talking specifically about that subset of etfs which are the super low cost broadly diversified index based etfs right the vanguard asx 300 etf although i think it's a blackrock asx 200 an s &p 500 etf or a vanguard global etf i think they're wonderful things i own some of those um not all i own some of them um by the way i can't influence the price because the market maker sets the price based on the asset value so it doesn't matter if I mentioned or not, but for the full disclosure, I always do.

55:40Yeah. So I think ETFs are great. I don't have no view on the Macquarie managed funds, by the way, Kate, at all. I haven't looked at them, haven't studied them. Are they going to beat the market in the next five years? Don't know. But if I knew I could get the market return five years with effectively zero risk or as close to zero risk as you get and with a really tiny fee, would I back? By definition, the average managed fund doesn't beat the market. So almost again, by definition, there's your answer if you wanted to um if you wanted to maximize your chance of getting the average return you would go with etf and that's why i love them that's why i talk about them a lot that's why i recommend them to people if they are looking for a hands-off investment um yeah if the if the fund is going to beat you then so that that's great uh or beat the market sorry but if if they're not or you don't know then i would say if you're not sure if you're going to beat the average go with the average because at least you know you're going to get that one nice should we finish with property question ram sure i didn't promise a bitcoin question i'm not going to get there i know i'm sorry mate it's the question after next but uh we might have to hold that over next week it is literally i'm scrolling it's right right here um highscott and ram says anonymous it's one for you mate mike it's not bitcoin but it's close my question is what are your thoughts on house prices hitting a ceiling i think i know ram's thoughts lol but can you tell me what I'm missing.

57:01If most people get a loan from a bank to buy, then wouldn't wages dictate home prices? Say, for instance, most people's wages only allow them to borrow a million bucks. Then how can house prices keep going up without real wage growth? Also, it seems like investors have already priced in future gains into their current purchase prices because anyone who purchased in the last few years are cash flow negative. He says loan repayments, maintenance, etc are way higher than the rent even people renting can only pay so much before it's unaffordable so how can rents keep rising i've heard it all this is our questioner supply and demand houses always go up you can't lose on property but unless wages go up how can people pay more with most businesses struggling with inflation and productivity low how can businesses pay higher wages it seems to me we pull every lever we can to push them to a peak and our questioner lists dual income unemployment at record lows negative gearing immigration a record high bank squeezing every bit of borrowing capacity and no real recession in 30 or 40 years apart from inheritance how is the average australian going to break into the market i really can't wrap my head around how it is going to keep going up thank you for your time anonymous easy um so people will desire this thing um obviously um there's a huge and unending demand for it there's limited supply um so that's what the balls will point to and they're dead right to do that so provides a very big flaw but ultimately if if you're expecting prices to increase and let's go let's be specific here increase beyond a rate of inflation so increase in real terms, in value, on a net basis after management costs and fees and taxes, which, I mean, why wouldn't you include that, right?

58:53You need to have, well, three things. The first is wages. So anonymous is 100 % right. But what I missed, and I think a lot of people missed, was the proportion of our wages we're happy to spend on housing. The Green Senator made the point in their press club rant the other day, which was excellent, by the way, that when Anthony Albanese bought his place in Merrickville, it was five times the average wage. The same house, well, not specifically the same house, but the same type of house in the same suburb is 20 times income. So incomes have grown, yeah, but they've not grown anywhere near the degree of house prices.

59:32And that's just it. We have elected to people who are buying, probably because they were forced to, frankly, because of the lack of supply, just said, you know, a previous generation said, I think five times my salary is what I can afford to bear. And that's just what we sort of went with. And now it's 20 times in some places and more. So you've got to ask yourself, oh, and the third prong is access to credit. And that's a big part of the longer arc of the property bubble, if I can call it that, which is we just had much easier access and much lower cost of finance that was available to us. So when we were cashed up and able to – we were earning well.

1:00:14We hadn't had a recession for ages. More people in the house are working, and we've just decided that, well, if we want a house, I guess we just have to pay 10 times our income. And I remember having chats with you, mate, when it was 10 times average income going, this is so unsustainable. And it is. Mathematically, it is. I stand by the statement. What I think is surprising was that – actually, I know it's gone to 20. Now, does that mean it can't go to 30? No, it could go to 40. I don't know. At some point it caps out, right? And that's the point that I want to underscore with Anonymous is that, yeah, I mean, you can't go – you can go to 100%.

1:00:48Well, you can't even go to 100 % because you've got to eat and there are other things that you need in life, right? You can all get massive pay rises, but that is going to assume insane levels of productivity boosting that are probably not liable. And an extension of credit, which is still possible, particularly if rates come down. But let's not forget the bank's balance sheets are all like at least three quarters of associated with residential property. Every man and his dog is up to the eyeballs in debt. It's like, well, yeah, you know, you're going to have to really make the debt better. And this is the path they're going.

1:01:18And so we're now having 40 year mortgages and intergenerational mortgages and cross collateralized sort of mortgages. It's just, it's, I think that you can make a very objective statement that just, well, I don't know when or how, but that is unsustainable. I think that is true. It is a different thing. And people usually jump to this. Oh, so you think property is all going to crash tomorrow? Well, it could, but I'm not shorting housing, right? I don't think it's a lock. I'm certainly not that silly to do it. It could get crazier still. and it's the thing you always learn about bull markets and in bear markets whether it's shares or property whatever is the gains can always go you can look at the share and think this is insane right like we've talked about this with pro medicus before it's like great companies like my god it's 60 dollars it felt like just like eye-wateringly expensive and it got much more expensive you know and when things drop you think how much further can it go well it can it can keep going right and and and i think that's the observation that needs to be made here is that when I just bought a house, right?

1:02:21Like, so I get it, right? But if you're predicating things on faster than system, faster than inflation, real after costs gains, then you have to implicitly have a view on one of those three factors, credit, wages, or the proportion of wages that's thrown to it. And then in all cases, the net impact of all of the whatever assumptions you use has to be that's going to allow people to bid up to higher prices? Because without that, I mean, I'm all is. What else happens without that? It doesn't mean a crash mine. Maybe like Alan Kohler says, it just goes sideways for a long, long time. I suspect that's probably likely because the demand is so strong.

1:03:01But yeah, I don't get it either. And I'll tell you also for the record, as much as I poo-poo property, if I could buy a house that gave me a net yield, four or 5%, and I could do it without stretching myself to the utter limit or I'm living on two-minute noodles just to sort of make repayment, I'm doing a heartbeat. It's an incredible investment. Who's critical of that? The criticism comes from the person who's actively gushing cash out the door on this belief that this thing will compound at 7%, 8%, 9%, 10 % per annum for the foreseeable future. And maybe it will, and they'll do very well if it does, but maybe it won't.

1:03:38And it doesn't have to be a 30 % crash. It just needs to be, oh, no, it only grew at 3 % per annum over the last five years, and all I've done is bleed cash. And if I sell now, I might walk away break even on a nominal basis. I think a lot of people are facing recent investors. I think that's what they're staring down, frankly. Yeah, I think that's right, mate. And that's where we need to be a little bit careful with our language. You're talking about unsustainable. I think you mean the prices are not necessarily unsustainable. The growth from here is unsustainable. Is that what I'm all right there?

1:04:07Yeah, I mean, trees don't grow to the sky. I mean, prices could just stay flat. But I mean, you just do the logical mental exercise of pick a number, I don't know, go 10%. Well, you roll that forward fast enough and the Australian property market is bigger than global GDP at a point. Maybe that's 100 years off, but my point is that the trajectory is clearly unsustainable. Yeah, no, for sure. And in forward, I completely 100 % agree with that. I think the impact of all of those things you've highlighted are exactly the right issues, the right questions, the right concerns. You've got to start by saying we are in a position where those things seem to be relatively maxed out.

1:04:45Doesn't mean they can't go up, but the rate of growth, the things that got us here won't get us there. The house prices for centuries went up roughly the rate of wages until the late, mid-70s, something like that. And then the 40 years after that, they went relatively vertical. The growth was astonishing. And it was because of all the things that you've exactly talked about with your question, Anonymous. the availability of credit second incomes bank loan to valuation ratios interest rates themselves all those things compounded to to push prices higher frankly one of the biggest ones is just second incomes in households which is you know for everything else we talk about the cost of money the five times income to ten times income well if you go from five times one income to five times two incomes you get to ten times income so it's not of a surprise that that when second incomes have been applied to paying off mortgages, that has increased prices.

1:05:35It almost should have by definition. Now, in a perfect world, we'd all be smart enough to say, let's actually use that second income for things other than capitalizing in the house prices. But we didn't as a group. And there's no one made us do those things, by the way. We all chose to outbid each other at auction, either directly at auction or the slow moving auction that is the perpetual sales process of housing. We could have all just said, no, we're gonna stick with five times one income, thanks. And that would have changed what happened. So no one made us do that, but that's how you get to here, which is fine, but unless you're going to have a third income in your household, unless interest rates go negative, unless banks want to lend you 110 % of the value, but again, you've still got to pay it back.

1:06:10So you do the maths on that. Yes, you could maybe, you know, cut back on Netflix and put an extra$10 a month into the repayments, but at some point, that just stretches far enough and doesn't have to snap back. It just can't keep growing at that rate. I think wage will keep going up. That's the only thing I would take a slight, not exception to, but you talk about productivity and you're right, it's low productivity, I think it's really unlikely we don't have, let me put it positive, I think it's very likely wage continues to grow. So house prices will continue to grow in all likelihood over time.

1:06:40It doesn't mean they won't fall in the meantime. It's never a straight line. But if wages compound at 2%, 3%, 4%, then it's not unreasonable. Property would do something similar, almost by definition, without any of those other things needing to change, which is kind of exactly your point when you ask about what else can be different. But that's just what you would expect, right? Rents go up because people can afford to pay more rent. Prices go up because people can afford to pay more on property. But again, as a portion of income, they don't become any less or more affordable. They just all go up at the same rate of wages, which is fine.

1:07:07But there's no wealth being meaningfully created in that process. That is the longer term driver. I think whenever I've read a study of very, very long term trends in prices, whether it comes from Amsterdam going back to the 1600s or various other places around the world, it tends to match wage growth. and it makes sense right like it just sort of it doesn't this is where so many people go wrong when they say i only paid this much back in 19 dickity do or whatever it was the more the way that just standardizes that to make it a more realistic comparison is like how many years of labor did i have to give up for for this asset and that that is that is um people will have a changing propensity sort of over time but that's the only like you know if anyone's familiar with physics, there's all the different forces, the strong nuclear force, the weak nuclear force, electromagnetism, gravity.

1:08:00They're all very different. But at close distances, it's all about the other forces. At larger distance, the only thing that matters is gravity. And I would say wage growth is the gravity of property markets writ large when you look at decade-long timescales, which again, points to just a moderation of expectation, I think, for a lot of people, given that the other levers of proportion of income and credit have already been pulled so tight. You're right, mate. I agree with you. Wages will continue to grow, and that will be an underlying gravitational pull for property. But wages ain't growing at 7 % per annum.

1:08:35Let me tell you that right now. And even if they do, the relative wealth that gets created is still – the wealth creation is only worth it if it grows faster than wages. Otherwise, it's effectively the same thing. the dollar value of what you can buy with that money assuming other prices go up at the same rate if wage goes up at 3 % property goes up at 3 % price goes up at 3 % on everything else we can buy with money it's kind of the same at some point it nets out at the same thing so yeah you end up in rough at the same spot it's days of oversized gains I won't say they're over because who knows as Ram says the way we got here is relatively logical it made it be overly rationalist choices as a society if we'd all got together as a group and said here's what we should do we all go stupid let's not do that But we did.

1:09:18And so the way we got here is rationally explainable and logically estimable. And you can almost do the math work. In fact, I did the math once for a Motley Fool article. I kind of literally got the piece of paper out and went, okay, well, if incomes have gone up by this much and female participation has gone up by this much and rates have gone down by that much, that's roughly what you should expect. And it was very back of the envelope, but I got really close to the average increase in prices, which is fine. But then you ask yourself, which one of those is going to continue to grow from here?

1:09:42as I said, short of third incomes or, you know, in a household, send the kids to the salt mines. There's always so much more that can push prices higher, meaningfully, sustainably, for an extended period of time. Yep. Nailed it. Can we hold the Bitcoin question over until next week, Ram? Well, next week, we're at an all-time high now, and I just know that it being what it is, that opportunity will pass by next week. So I'm reluctantly gripping my teeth and saying, okay. Quick anecdote. I was on Twitter and one of those Twitter spaces came up saying, Bitcoin hits all-time high, what's next? And I literally went across the Bitcoin share price chart on Google.

1:10:19Bitcoin price on Google was at 7.5%. I couldn't resist. I was like, oh, guys, you literally asked for that. What next? Oh, it fell. Do you know what's super frustrating? The darn thing's up like 200 % over the last year, like absolute zero from the mainstream media. Yeah, yeah, yeah. It touches an all-time, it's well over an all-time high in Aussie dollar terms and British pounds and the rest of it. But in the US dollar, it kind of got there and then it had an 8 % sell-off. And then everyone's writing articles about it. It's like, hang on, can we have a little bit of context? And by the way, as I speak to you now, that dip is gone.

1:10:53I'm not trying to make any point of it, but it's funny the bias of it. It's just sort of like, not interesting, not interesting. Oh, wait a second, this aligns with our prejudice. Well, let's report that. It's so funny. To be fair, it's the same as$40 billion wiped off the market. They don't write the$40 billion wiped on the market articles either. It's something about the media and losses. And we like car crashes, don't we? Yeah, crypto crashing. People are going to click on that. You know, it's sort of like, turns out that this thing's got massive adoption. Wall Street's here. It's going to, you know, all-time highs in every country.

1:11:25But hey, that's not of interest. It blows my mind. But anyway. I'm sure you can hold on that frustration for another seven days, Ram. It's not new for you. Yeah, exactly. You were very smart not to raise it earlier in the podcast because that's all we would have talked about. Oh, no. Literally, I kid you not, mate. Literally, I'm looking at my list of questions. Literally, the next question on my list. I looked at the time and went, if I start this now, I'm here for another 20 minutes. You're right. Probably better for all of us. 20 minutes if you're lucky. Yeah, exactly. All right, mate. Well, can you come back on Friday and we'll talk about Bitcoin next week?

1:11:54Well, if you say that, I am on the heaven and earth to be back here. That's how we keep him on the hook, listeners. Until next Friday, have a great weekend and full on. Cheers. The Motley Fool and people appearing in this program may have positions in the companies mentioned. General advice only. Please speak to your financial professional to understand how it may pertain to your situation. Subscribe to the free newsletter at fool.com.au forward slash listener. The Motley Fool operates under Financial Services Licence 400691.