House prices hit a record high last month according to both the Halifax and Nationwide, whilst UK equities remain well below pre-pandemic levels. Property, then, has been nice protection against stock market losses.
Which poses the question: is a portfolio of property and equities always well-diversified?
The question matters because house prices might not stay so strong. Part of their recent rise is due to a lack of supply and to the stamp duty holiday - but holidays of course come to an end. There’s a danger that rising unemployment and ongoing uncertainty will depress prices in coming months. If housing has been protection against stock market losses recently, therefore, the boot might be on the other foot next year: we might need equities to protect us from falling house prices. But are they up to the job?
History suggests so, to some extent.
There is, though, a problem here. House prices and shares respond differently to hard economic times. When these hit us, shares fall suddenly and sharply. House prices, however, are stickier. Owners are slow to cut asking prices and so transactions tend to dry whilst prices hold up for a while. Such different dynamics give the impression that house prices are more resilient than shares, when in fact they are just slower to move.
To overcome this problem, we can look at price changes over longer periods, such as three years. Doing so shows a small negative correlation between the Nationwide’s house price index and the All-share index – of minus 0.18 since 1991. Yes, both house prices and equities did badly during the financial crisis, but on other occasions they have moved in opposite directions. In the mid 90s and in 2010-13 house prices did badly whilst equities did well, but house prices did well in the early 00s whilst equities fell.
Such episodes tell us that valuations matter a lot. Houses and equities tend to be over- or under-priced at different times, which generates different dynamics and hence potential for a portfolio of both assets to be reasonably well diversified.
This matters. It’s quite possible that UK equities are under-valued. They are low relative to overseas ones: the All-share has underperformed not just the S&P so far this year but also Germany’s Dax index by twenty percentage points. And the dividend yield is above its long-term average even factoring in likely dividend cuts – a fact which has historically been a strong predictor of good returns. Few people, however, believe houses are cheap on average: the best that can be said is that prices are sustainable if interest rates stay low.
It’s plausible therefore that equities will offer some protection from losses on property.
But there’s an even better protector – foreign currency. My chart shows that there has been a strong correlation between house prices and the $/£ rate. In particular, when house prices do badly, so too does the pound.
Which means that profits on US dollars (and in fact other currencies such as euros) can offset losses on housing. Yes, some of you find it difficult to open foreign currency accounts, but there’s an alternative here. Gold in sterling terms is also negatively correlated with house prices.
There are good reasons for this. House prices and sterling both depend upon the UK economic outlook so when this deteriorates both fall, giving us profits on foreign currency. Also, sterling is a risky asset and so falls in bad times for the world economy such as in 2008 – which are also times when house prices come under pressure.
A well diversified portfolio of equities, foreign currency and gold might well therefore protect us from a fall in house prices. And being liquid assets, they also protect us from the fact that property is hard to sell in bad times.
Except. All this assumes that the price of your properties fluctuate in the same way as Nationwide’s index. Even if this has been true in the past, it might not be in the future. If working from home becomes permanent, we’ll see people move out of cramped city centre flats and houses and move into villages or small towns. Even if house prices hold up in aggregate we could therefore see some big falls in particular types of property – especially those that buy-to-let investors have traditionally favoured. It’s not at all guaranteed that financial assets must protect us from such a sectoral shift. This fact – more than a concern about a few sandwich shops – might explain why the government is so keen to get us back into offices.
