Protecting your wealth in a housing slump

But if you think there's nothing you can do to shore up your wealth against falling residential property prices, then think again. Previous slumps show that there are a number of strategies that can flourish even when the ceiling caves in on the housing market. By avoiding particular investments and loading up on others, you can grow your portfolio even while your home's value is plummeting – see 'Asset pries in housing crashes' above.

Gilts

The price of government bonds has done badly in every one of the past three house price crashes. After inflation, the FT Actuaries index of all UK gilts has fallen every time, although this ignores the interest they would have earned. During the last slump, 10-year UK government bonds did produce a positive total return after inflation of 55 per cent over the six-year period. The inflationary problems of today should warn us off government bonds, at least for now. A buying opportunity may occur in due course, but caution is the watchword for the moment.

Cash

Holding cash has done better. Only in the early 1970s meltdown did cash have a bad time, losing 25 per cent of its real value from start to finish. During the late 1970s and late 1980s crashes, investing cash at one-year deposit rates would have yielded a positive return both times. However, on each occasion nominal interest rates were high to start with, which is not the case this time. And, after inflation, today’s real return from cash is a mere 1.89 per cent.

But not commodities

Although house price crashes have tended to coincide with periods when the price of everything else goes up, commodities have done poorly during these episodes. The CRB spot commodity has produced negative annualised returns after inflation on each occasion. This may seem odd, as commodities have a reputation for doing well during periods when the general price level is rocketing. While the price of gold, oil, and the like are doing well for now, there's a clear lesson to be wary of these assets going forward.

Shares perform well

By contrast, shares have a great record during housing crashes. Assuming reinvestment of dividends, UK equities have increased their purchasing power in three of the four residential-property slumps since the second world war. Only during the early 1970s episode did they fail to go up in real terms. But, even then, they still did better than cash, bonds or commodities. However, while this asset class as a whole has done well, there have been marked differences in performance between the various sectors.

Certain industry groups have consistently done badly when British bricks-and-mortar was in crisis (see 'Winners and losers in the past three crashes' table, below). The real estate investment trust (Reit) sector has underperformed the wider market every time, along with general industrials, travel and leisure. All these industries are economically sensitive: when growth slows or turns negative, they feel the pinch more than the rest.

The most reliable winners during these periods have been pharmaceuticals, defence and tobacco. They've beaten the wider stock market every single time. These sectors all make products that are in demand whatever the state of the economy. There are also a number of sectors that have outperformed UK equities during two out of three of the last housing slumps. Some of these are really very surprising, including banks, software and general retailers.

One explanation for this could be that house-price crashes last a long time, much longer than an economic downturn or an equity bear market.

So, even if sectors do badly in the early stages of a housing collapse, they have plenty of time to recover before the property problems come to an end.

Sector performance has largely gone true to form since real house price growth turned negative last summer. Defence, tobacco and pharmaceuticals have all done better than the UK stock market, the first two also rising in absolute terms. At the same time, traditional losers such as industrial transport, travel & leisure and Reits have all had a bad time of it.

Not all industries have behaved as history would suggest, though. Thanks to the global commodities boom, mining, chemicals and oil equipment & services are all riding high, despite having underperformed during every previous housing slump. If a worldwide slowdown takes hold, these cyclical industries will be hard pressed to maintain their current strength.

The big issue for investors is whether they can continue to rely on the traditional house-price crash winners in the months and years ahead.

One key difference between today and the past is that tobacco and defence were not cheap going into the crash. This potentially leaves less scope for them to rally. If they outperform, it may well be simply because they fall less hard than the wider stock market. As in the past, the pharmaceuticals has entered the housing price crash looking cheap and could easily produce the best absolute returns of our three key sectors in the coming years.