Wild stock market swings and property

Global stock markets have swung wildly in the past two weeks or so, since United States lawmakers decided at the eleventh hour to raise the debt ceiling on Aug 2. On Aug 5, Standard & Poor’s downgraded the US credit rating from AAA to AA+ and, on Aug 8, it followed with a downgrade of mortgage lenders Fannie Mae and Freddie Mac as well as other agencies linked to long-term US debt.

Adding fuel to the fire was the European Central Bank’s purchase of Italian and Spanish bonds in a bid to contain the mounting debt problems within the euro zone.

Then on Aug 9, the US Federal Reserve announced it would keep interest rates low until at least mid-2013. And surprise, surprise, the markets cheered! Federal funds rates have been at nearly zero per cent for the last two years and even with all-time low borrowing costs, the US economy has struggled to recover.

Following the Fed’s statement, some economists and investment strategists have immediately started talking about one more round of monetary stimulus, or QE3 (third round of quantitative easing).

I wonder, after the trillions of dollars spent on QE1 and QE2, how much more money can the US print for QE3? With the global markets already flush with so much cash, how will printing more money help the US economy? Meanwhile, not enough is being done about cutting back on federal spending.

When you hit the limit on one credit card, you quickly apply for a new one to allow you to continue spending and when that one has reached its limit, you apply for a third one. One day you declare that you are bankrupt and walk away from your debt obligations. Now, isn’t that a good plan? Or should you be thinking about a reduction in spending?

The 2008 crisis was one of ballooning private debt – both consumers and institutional. Big government stepped in to limit the fallout by buying up toxic stuff and issuing more debt in return. The 2011 crisis is one of government debt, in particular the US and several European ones. Who can be the backstop this time round? Will China and Japan continue to support US and European debt? How much more can China and Japan take on?

Meanwhile, S&P’s downgrades are not over yet. There may be more downgrades at the state level in the US and of more European government debt. The impact of the S&P downgrades of US mortgage institutions will hurt sentiment of American home buyers as housing loans become more expensive.

I would give the US residential market a miss for a while, until the dust settles on the debt situation and home prices there stop falling.

Back home, I am guessing that Singapore will benefit as a triple-A rated safe haven and we will see more funds flowing in. With the printing of money in the US, the Singapore dollar may strengthen further, making it even more attractive to US dollar- and euro-based investors.

Interest rates here will remain at least as low, perhaps even lower, than today. Investors will have to live with scant returns from their fixed deposits and savings, which are much lower than the inflation rate, so effectively those holding cash will see diminished returns.

The good news is: Home mortgage rates will remain low, most likely below 1 per cent for at least the next two years – because if the US federal funds rate remain at near zero, Singapore’s interest rates are unlikely to head upwards.

With equities and commodities so volatile given the uncertainties in many of the major economies, what should we do if we have cash? I am sticking to my usual recommendation: Buy a property that comes with a good tenancy contract at between 2.5 and 5 per cent per annum yield. With 60 to 70 per cent financing, taking advantage of the low interest rates over the next two years, you will get a cash-on-cash return that is around 4 to 10 per cent per year. (“Cash-on-cash returns” refer to the net annual cash income divided by the initial cash outlay including stamp duty and legal fees.)

This sort of returns will allow investors to beat inflation and shelter from the turbulence of the global economy over the next two years. If by then, the economy has recovered and interest rates rise, rentals should also increase. In between, remember to save some of the cash returns in case of vacancies between tenants.

By Ku Swee Yong – founder of real estate agency International Property Advisor

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