In a recent post, “From Mayfair To Boardwalk,” I pointed to the vast similarities between London and New York City as places of desire for the global real estate investor. The verdict is in: when assessing our previous closing argument that most U.S. cities appeared to be inexpensive compared to other metropolitan areas, our conclusion has been accurate. As anticipated, 2014 was a record year for most real estate, with Manhattan condo prices having risen to their highest level on record.
The important message is not that most of us forgot to go apartment hunting, but rather the fact that price increases in NYC real estate (and London, for that matter) continue to be driven by a strong influx of foreign money and the ultra-wealthy. It is not a coincidence that New York Magazine, in a 2014 cover story, proclaimed that NYC real estate has become the “new Swiss bank account;” and the fact that a large number of apartments in Manhattan’s high-end properties are often empty, with spaces being used as pieds-à-terre, gives further basis to many of my previous arguments. What do the super-rich know (or not) that we may want to consider?
Several years ago, we created a simple model to assess the value of stocks as an inflation hedge, based on the argument that the purchasing power of fiat money, over long periods of time, would erode, while investments in stocks of companies (with real underlying assets) should hold value. We analyzed the purchasing power of the S&P 500 in relation to the price of a basket of “essential goods:” equal parts of oil, poultry, timber, and gold. Our definition of “essential” was rather straightforward, as it seemed agreeable that people need to eat, move around, build, and store value in some form of historically accepted tender.
Our model considers the index level of the S&P 500 TR (Total Return, accounting for price plus dividends) as one purchasing unit relative to our basket of goods. The findings, when applying this method, are rather interesting: At the pre-crisis peak of the market, in May 2007 (using monthly data), the S&P 500 TR would have bought 2.4x our basket; the next time the S&P 500 TR/Basket Index reached this level again (in February of 2012), our purchasing unit was only enough to buy 1.1x our basket; and, to find the best value reached over the last 20 years, we had to go back to near the peak of the dotcom bubble, in August of 2000, when the S&P 500 TR bought nearly 3.9x our basket.
Arguably, the “roaring” dotcom mania of the late nineties led to overinflated stock prices, providing better purchasing power of stocks compared to other assets; however, even with years of consolidation in many commodities and an all-time high in stock prices today, the value of our purchasing unit is only back to 2007 levels at about 2.3x (slightly above the long-term average of 2x). While one may argue with our model on the basis of chosen “essentials” or timeframe, the point being raised is important: It is no coincidence that the loss of purchasing power has occurred over a time period marked by aggressively accommodative central bank policies.
We know the counterarguments well: mainly that other, more officially recognized items to calculate inflation have not substantially risen in price; and, yet, we also know that the ever-increasing costs of education and healthcare have left many Americans “behind.” To revisit our earlier example, the commonly accepted idea of a Swiss Bank Account is (or was) to maintain purchasing power (often associated with an investment in a stable currency), aside from participating in a legally sound and secure sovereign framework. With global central banks now compromising this choice or, even better, the concept of free price formation, it should not come as a surprise that capital will seek other stores of value.
In conclusion, there are several aspects to consider: 1) the “bid” for real estate, especially with high-end price tags, is likely linked to the ultra-wealthy (and others’) conclusion that accommodative policy measures will impact purchasing power in the long-run; 2) commodities will not stay inexpensive for long, especially “essential” goods, such as agricultural items, water, energy, etc.; 3) “excess” wealth, with only 1% of the global population now owning nearly 50% of all assets, will diversify: real estate, as before, is a critically important asset class, and New York and other U.S. cities, in global comparison, remain inexpensive; and, 4) an investment in stocks will maintain purchasing power better than cash and other investment choices, but will not “ring fence” the effects of the current monetary experiment of unprecedented proportions.
Matthias Paul Kuhlmey is a Partner and Head of Global Investment Solutions (GIS) at HighTower Advisors. He serves as wealth manager to High Net Worth and Ultra-High Net Worth Individuals, Family Offices, and Institutions.