This article first appeared on The Constant Investor website at this link: It is behind a paywall for subscribers only https://theconstantinvestor.com/stephen-koukoulas-overview-170114/#Whydosofewpeoplenegativegearstocks
Why do so few people negative gear stocks?
In recent times, a lot of the focus of public policy has been on negative gearing and how the associated tax rules encourage ‘excessive’ investment in the housing market. This in turn, it is argued, pushes up house prices and freezes first home buyers out of the market. There is something in that argument which will no doubt carry on in 2017 and probably beyond.
What is often overlooked in the debate is the fact that negative gearing investment strategies also apply for shares, in the form of margin lending and related products. So why is it that the overwhelming focus of investors when they negative gear is dwellings and not shares?
Over the past decade or so, as property investment borrowing has boomed, margin lending for stocks has slumped.
According to data from the RBA, outstanding credit for investor housing stood at $562 billion in November 2016. This was up a staggering 319% from the level in December 2007 when it stood at $134 billion.
Margin lending for stocks, on the other hand, has crashed. In December 2007, margin lending stood at $41.6 billion which was 30 per cent of the level of borrowing for investment dwellings at that time. Fast forward to the latest RBA data for September 2016 and the level of margin lending is a staggeringly low $11.6 billion, down 72% from the peak. Borrowing (negative gearing) for stock market investing is equivalent to just 2% of the outstanding borrowing for property.
If the ratio of stock-to-dwelling lending had remained at 30 per cent (the level in 2007), margin lending would be close to $170 billion today rather than $11.6 billion and no doubt the share market would be markedly higher.
There are a couple of points to note when looking at these trends. Investors have collectively made the right decision. Since December 2007, Australian house prices have risen 49% while the ASX200 remains around 9% below the end 2007 peak. These figures do not take account of rent or dividends.
In other words, an investor who put $100 into housing at the end of 2007 would now have underlying capital of $149, while the stock investor would have just $91. This no doubt helps to explain the divergence in investor appetite for borrowing for housing relative to stocks. It has proven to be prudent to gear up into housing and stay away from the stock market.
There’s on old saying that every investor knows but does not always follow – “buy low, sell high”. It is important to emphasise that what follows is NOT investment advice – see your financial adviser before making any investment decisions.
But a cold hard look at stocks versus dwellings suggests that the price of stocks is low at least relative to the price of residential property. Perhaps it will stay that way for a few more years – there are certainly plenty of people still upbeat on housing based on strong underlying demand from demographic changes. Stocks, at the same time, remain vulnerable to a US pull-back and risks of US/China economic tensions as Donald Trump implements some of his policy agenda.
But in a scenario when investor appetite for dwellings as an investment destination tapers off, as the likely cooling in housing unfolds and investors use their leverage to get into shares, the ASX could and probably will outperform residential property in the years ahead.