Sunday 2 October 2022

The Constant Rate Hikes in US is creating a property and insurance problem in Singapore

 That's my thought based on the following facts I have learnt during my time in the market:

(i) A rising interst rate reduces bond prices

(ii) A rising rate reduces share prices due to an increase in discounting rate

(iii) A rising rate increases interest expense

The Property Problem

To summarise, there are many local funds leveraged to the hilt during the era of low interest. A group of them are property workshops that have attracted many "wanna get rich" people. The idea is simple- (a) buy a property, (b) max the leverage pay the low interest of 1.8-2%, (c) get rental yield, pocket the difference of interest (c) and (d) while waiting for your property to appreciate, (e) repeat Step (a) to (d) by buying another property.

Here is the problem, the Fed's hike is creating (b) a higher interest expense while (c) is not rising fast enough. It will come a time where holding a property is loss making and with leverage so high, margin calls may come. A wave of property selling is due and with it a spiral down in housing prices and margin calls. This is why the government has altered the projected interest rates in TDSR projections as they want owners to be prudent.

Singapore has been remarkly resilient. Our risk free rates (SORA) have risen by only 2.0% (from 0.2% to 2.2%), while other countries like US has seen a 3% interest hike. This is not going to hold forever. Globally the risk free rate is 3.25% now and Singapore is an "interest rate taker" due to the economics principle of impossible trinity. T-bills which are more senstive to global movements are now priced at 3.2% which tells you the actual interest rates Singapore should be. Our country's interest rate is growing slower by 1% which defies the logic of being an "interest rate taker".

Eventually Singapore interest rate will catch up with the global rate increase. With US fed rates expected to be at 4.25% at year end. I expect in 2023, we will see SORA rates moving from 2.2% to 4%. With  property owners here on high leverage, a higher interest expense will mean less money in their pockets, reducing their consumptions.

The Insurance Problem

Many of us own whole life, endowment and savings insurance plans. Such policies have a non guranteed annual return which is based on the value of investments in property, bond and shares.

Referencng to the 3 facts, it follows: properties are down, bonds are down, shares are down. This means for this year and probably the next, insurance funds are drawing down on its smoothing reserves to generate returns to policyholders. This is because their investment returns are likely negative. While inflation remains high, insurance returns will be low; indicating the real returns for insurance policy holders are negative. For policy holders holding insurance products, it is a bad time to die or surrender policies during these few years.