High property prices do no good to anyone. The best we can hope for is an orderly deflation. The signs are good, so far, writes The Motley Fool

The recovery seemed to be going so well. The S&P/ASX 200 jumped 3.6% on Tuesday, its biggest one-day gain since December 2008.

Panic buying replaced panic selling. How else do you explain a 35% one-day gain, on no news whatsoever, in rare earths exploration company Lynas Corporation Limited (ASX: LYC)?

Even Lynas director Kathleen Conlon joined in the action, her husband picking up 18,154 shares at $1.075. Regardless of her family’s faith in the company, it remains a highly speculative investment opportunity, and one we prefer to watch from the sidelines.

But that was then and this is now.

Overnight, the bear returned, sending U.S. and European markets down by between 1.5% and 2%. The Dow Jones closed just above the psychologically important – but totally irrelevant – 11,000 mark.

Dow Jones, September 28th 2011

U.S. markets matter because, like it or not, we slavishly follow their lead. Right on cue, the S&P/ASX 200 index has fallen 1.5%, back below 4,000.

Falling further, faster…
Except, we’ve fallen even further than U.S. markets.

Since the April high point of 2011, the S&P/ASX 200 index has slumped 18% versus the Dow’s fall of 11%.

Our market is dominated by resource companies and the big four banks.

The Age calls them, the “gang of six.” BHP Billiton (ASX: BHP), Rio Tinto Limited (ASX: RIO), Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corporation (ASX: WBC), Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank (ASX: NAB) account for just under 40 per cent of the S&P/ASX 200 in terms of index weighting.

After their meteoric rise, commodity prices are finally coming under pressure. Markets fear a double-dip global recession. No wonder BHP, Rio and Fortescue Metals Group (ASX: FMG), and the Aussie market as a whole, are on the nose.

Still, it doesn’t seem to worry the companies themselves. BHP has predicted Australia’s resources industry will need an extra 170,000 workers in the next five years. No bust for this mining boom…yet.

Triple whammy for banks
And then there are the banks. They’re getting it in the neck from all directions – fear of a global banking crisis, slowing lending growth, and falling house prices.

Here at The Motley Fool we’ve long been bearish on house prices. Put simply, at current levels, they are unaffordable. For investors, rental yields are pitiful, not even covering the mortgage.

Why be a slave to the mortgage? High and rising house prices do nothing for economy. We should all be hoping house prices fall, preferably in an orderly fashion, over a period of years.

The words ‘falling prices’ and ‘orderly’ are often mutually exclusive. They certainly are when it comes to shares – the sharemarket goes up by stairs, but down by elevator. As for house prices…we’ll find out in the coming months.

House prices to slowly deflate
So far, the signs are good for a soft landing for house prices.

Sign #1: According to the National Australia Bank Property Index, house prices fell for a second consecutive quarter and are expected to continue to decline as housing affordability becomes more of a factor for buyers.

Sign #2: According to ratings agency Moody’s, more Australians are falling behind on their home loans.

Moody’s senior analyst Arthur Karabatsos didn’t mince his words in The Sydney Morning Herald

”What I’m saying is: if you’re in mining, you’re sweet. If you’re not, you’re screwed.”

Screwed
I guess we’re screwed then. We better pack our tool-shed, sunscreen and deodorant and head for the Pilbara, where the Australian Financial Review reports a union push would result in West Australian labourers earning $137,000 a year.

But we digress.

Back to Mr Karabatsos. He said Sydney, the nation’s worst-performing mortgage market, was ”surrounded by a ring of fire” – suburbs where a high proportion of householders have fallen behind on their mortgages.

Uh oh.

We think we could grow to like Mr Karabatsos, although we are mindful of how ratings agencies, including Moody’s, totally blew the U.S. sub-prime crisis.

Of course, if Australian unemployment suddenly jumped higher, all orderly house-price bets would be off. They’d fall, and fall fast.

China to the rescue
We better hope China keeps buying our stuff. Whilst we might not like the two-speed economy the mining boom brings, it does cushion us from the effects of what is undoubtedly a slowing local economy.

The signs so far are good.

BHP is still predicting Chinese iron ore demand will continue to outpace supply.

Phew.

Source: Bloomberg. Steel China Iron Ore Fines USD/dry metric tonne

There’s nothing like a bullish iron ore executive to tell a good story about the red dirt.

Also in the AFR, BC Iron Limited (ASX: BCI) chief executive Mike Young said “People need to remember the context – iron ore prices are coming off historical highs. Even if China stopped growing, or even went recessionary, you would still have a significant amount of demand left.”

Hmmm…we wouldn’t be so sure.

A Chinese recession: we’d all be screwed
If China went into recession, we’d all be screwed, including BC Iron.

Still, while iron ore is selling for $180 a tonne and their cash costs are $45 to $45 per tonne, it remains happy days for BC Iron.

And simple days too. According to their own presentation, one of BC Iron’s points of difference is the simplicity of their operation…

Mine -> crush -> truck -> rail ->ship -> $$$

What could possibly go wrong? We’ll see you in the Pilbara.

Pesky sharemarkets
As for those pesky sharemarkets, they continue to dance to the tune of the European debt crisis.

“The market is on pins and needles over the whole European debt problem,” said Thomas Garcia on Bloomberg. “Every new rumour or little piece of news moves the market in one direction or the other a percent or two. It’s frustrating!”

Frustrating to who?

For potential buyers of shares, the lower share prices go, the better.

For potential sellers of shares, we hate to tell you this, but the time to sell was back in April. Or if you had even better timing, you’d have sold everything in October 2007, when the ASX/S&P 200 was trading at close to 7,000.

But you didn’t, otherwise you wouldn’t be reading this.

Don’t do this…
Instead, we look forward. But many investors don’t.

Motley Fool co-founder David Gardner recently talked about the “row boat” syndrome, where many investors buy high and sell low because they are looking backwards as they paddle down the river of time.

Buying high and selling low is the ruin of many investors.

Human nature means we react to what’s just happened. So just because shares have fallen, we expect them to keep falling.

The best way to succeed and beat the market is to not do what the rest of the world does and look at what’s already happened. Instead, ditch the row boat in favour of a canoe, and look ahead.

The Foolish bottom line

We’re optimistic realists here at The Motley Fool. Looking ahead, we think the Europeans will sort out the current debt crisis. We think the global economy will recover, albeit slowly, and with hiccups along the way.

And we think share prices are quite cheap, as witnessed by our ultimate high yield dividend portfolio.

But we wouldn’t suggest going all-in the sharemarket now. Investing is a game of patience.

You don’t win, or lose, over the course of a single day’s trading. But over time, if you commit to regularly investing in the sharemarket, you should win.

In the coming weeks, months and years, The Motley Fool, as it has done so far in its 18 years of existence, will be here to show you the way.

With markets down, now might be a great time to consider this one large company we think has some serious long-term potential. Get this free special report from the Motley Fool – The Best Stock For $100 Oil. Click here to sign up for free, now.

More reading:

Growth and income: The best of both investing worlds

The 4 step action plan if you’re fully invested

Amazon’s iPad killer?

Bruce Jackson has an interest in BHP, CBA, ANZ, Westpac, NAB. The Motley Fool’s disclosure policy never deflates.

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