The “Wall Street Journal” ran an article after the collapse of the Doha Summit, illustrating that whilst the correlation between oil and the real estate markets in the US had been 0.3 last year, it was — 0.1 over a 26-year period. Thus demonstrating conclusively that there was no link between oil and that of real estate prices over a longer period of time.
If that is the case, then why is it that real estate prices on a global scale have effectively stagnated or started to decline, especially at the top end of the spectrum, even as economic growth continues to show signs of moderate growth? Data, as usual, provides the answer, that partly helps disprove some of the pessimism pervading the marketplace, especially in the region.
And aids in crystallising the road map ahead for investors and policymakers alike.
With more than 25 countries in the developed world now having zero to negative interest rates (the number rises to over 50 when we look at real, as opposed to nominal interest rates), a number of academic papers have proliferated showing a strong positive correlation between inflation and asset prices, and therefore the level of interest rates and asset prices.
This may sound counter-intuitive at first, but on closer inspection, stands to reason. Asset prices are positively correlated to inflation and interest rate levels over the longer term, as they serve as the best hedge against inflation. With inflation levels now decelerating (with many countries even experiencing deflation), asset price increases have stagnated.
These concerns have proliferated in the last year as concerns have mounted that central banks the world over have lost their effectiveness in combating deflationary forces. Recent ECB data reveal that the level of loans given to the private sector has essentially remained flat since early 2014, despite the huge amount of monetary stimulus that has been injected.
However, what this data fails to reveal is the rising amount of liquidity inherent in the banking system that remains available to channelise to the economy through fiscal policy stimuli, an initiative that has not yet materialised. While it is clear that there is a logical limit to the amount of quantitate easing that can be injected into the economy (negative interest rates are already proving counterproductive what with withdrawals and a surge in demand for safe deposit lockers for individuals to place cash), there remains considerable scope for fiscal policy tools to be utilised by way of increased government spending.
It is this phenomena of a proactive fiscal policy that is starting to be witnessed throughout the Middle East. While all eyes remain on Saudi Arabia to unveil their economic overhaul programme, it is worthwhile to note that Dubai has already stolen the march by announcing a budget that called for an increase in budgetary spending, thereby utilising some of the surplus liquidity. This way it sought to counteract the contractionary effect of lower oil prices and the downstream impact it has had in the form of job cuts, predominantly in the banking sector.
What we are witnessing is a reallocation of resources. Both in the private sector as it readjusts to an era of lower oil based spending into other consumer-oriented areas of the economy, as well as in the government sector throughout the region, as infrastructure spending continues to increase.
This has and will be done through fiscal reform (removal of subsidies as well as implementation of indirect taxes and possible immigration reform), which will automatically cause inflation to rise. In addition, there will be the channelising of liquidity through increased investment in infrastructure programmes through a combination of debt funding as well as SWF disinvestment programmes.
This galvanisation will sustain the job engine, thereby perpetuating the transition towards a domestic consumer oriented economy that is underway. Markets in the region have already started anticipating this, with equity markets bouncing off their lows, again led by Dubai.
More specifically, in the real estate sector, transaction levels have already started to rise, and has been led by the end user, even as investors for the most part have thus far remained on the sidelines. It is a phenomena that is likely to change in the course of the next few months as investors gain increasing confidence in the visibility of the fiscal spending programme.
Dubai has already demonstrated to the region as well as the world economy that the heavy lifting is now essentially a fiscal policy construct. With the region now following suit, it is inevitable that this increased spending profile will not only counter the headwinds of deflation, but lead to a gradual increase in asset prices.
Investors will not only discern the winds of change but start to allocate to assets where the decline has been overdone.
The writer is the Managing Director of Global Capital Partners.
