Category: Economics and Banking

Welcome to the Property Imperative weekly to the sixteenth of March 2019 – our digest of the latest finance and property news with a distinctively Australian flavour.   

Watch the show, or read the transcript.

The talk is now of more sustained property price falls, the RBA cutting rates, and risks in the broader economy building. The news just keeps on coming and reconfirming our central scenarios.  That said, it looks like the global economy will be stoked by more stimulus, for a time, so the question becomes will we be the first to crack?

Straight into the property markets first, with the CoreLogic Index to 14^th March falling another 0.13% in the past week.  Over the last 12 months, the index has fallen by 8.3%, driven by Sydney, Melbourne and Perth, and since the last peaks, dwelling values have fallen by 9.4%, led by Sydney (-13.6%), Melbourne (-9.9%) and Perth (-17.8%). And Auction clearance rates were weak again, on low volumes with the final clearance rate in Sydney sitting at 52.3%  and Melbourne at 49.2%, while the other states were around 29%, including Canberra.  And final auction clearances were still 9.9% (Sydney) and 21.6% (Melbourne) below the same weekend last year when dwelling values were also falling. Moreover, auction volumes were also down 28% and 52% respectively in both Sydney and Melbourne. No signs of a recovery here!

Taking a longer-term view, it’s worth reflecting on Corelogic’s latest Property Pulse which says that At a national level, since 1980 there have been eight separate housing market downturns. The current downturn which commenced after October 2017, has seen values fall by -6.8%. Although that may not seem like a substantial downturn, since the early 80’s there have only been two downturns which were larger, 2008-09 and 1982-83. National housing market downturns have also been generally fairly short-lived with the current downturn of 16 months already the second longest with the 2010-12 decline running two months longer than the current downturn.

The decline in values throughout the current downturn has been larger across the combined capital cities, with values now -8.6% lower. By next month, assuming the falls continue, this will be the largest downturn in the combined capital city index any time since 1980. The current downturn is also closing in on being the longest. With values having peaked in September 2017, they have now been falling for 17 months with the previous longest period of decline coinciding with the last recession, running for 20 months between 1989 and 1991.

Of course, it’s worth remembering this one is being driven by right-sizing credit, not rising interest rates or unemployment, but ahead, we do expect unemployment to turn upwards, and the RBA to cut the cash rate, but this may not automatically translate to lower mortgage rates. And if credit supply remains predicated on lower loan to income ratios, and more forensic analysis of income and expenditure, then prices will indeed continue to fall. We will get the odd “unnatural act” such as extra first-time buyer incentives, or ANZ’s loosening of terms for Interest Only loans (which we discussed in yesterdays post). But unless we go back to the illegal behaviour revealed through the Royal Commission, and lending standards drop substantially again, credit will remain tight.

And mortgage arrears continue to trend higher according to S&P Global Ratings’ latest edition of “RMBS Performance Watch: Australia.”.  Arrears on the mortgages underlying Australian residential mortgage-backed securities (RMBS) have increased year on year, while prepayment rates have slowed. In particular, arrears that are in an advanced stage (more than 90 plus days) reached a record high of 0.75% in December 2018. Arrears in this advanced stage now represent 55% of total loans, up from 40% five years ago. Prime mortgage arrears have increased to 1.38% in December 2018 from 1.30% in December 2017. Softening macroeconomic conditions are likely to keep arrears elevated over the next 12 months given that borrowers’ refinancing prospects, particularly in the current environment of tightened lending conditions, are more challenging. While we expect most borrowers to be able to manage these headwinds, loans in the more advanced arrears stages are less likely to cure in the current environment they say.

We are watching the apartment market in particular, as demand fades, and quality of construction question come to the fore. Indeed, the UBS property round table made the point that “apartments are increasingly out of the money. That’s where you get settlement issues. What’s happened to buyers now as they come to settlement, is bank valuations might come in 10 per cent or even 20 per cent below the contract price and the bank is also probably assessing you with more stringent expenses potentially hair-cutting any bonus or commission or other income a bit more. As they reassess you on tighter lending standards you might find that your borrowing capacity is significantly reduced particularly if you are a repeat buyer who already has other debts and they are realising that you are already on six or seven times debt to income.

And there are signs of construction of existing tower stalling, according to the AFR.  “An analysis by The Australian Financial Review of Cordell/CoreLogic data showed about 21,000 out of about 36,000 approved apartments in Melbourne worth about $6.5 billion over the two years have been categorised as “deferred” or “possible” but have not firmed up to go ahead. In Sydney, just over 10,000 out of 26,000 units with an end value of about $3 billion are in the same boat. And data from construction information provider BCI Australia confirmed the pattern in Sydney and Melbourne, adding that the ACT was the only state where almost all approvals in 2015 – while much fewer than NSW and Victoria – proceeded to construction.

Indeed, we are seeing a smattering of building companies now. As the ABC reported, Two more South Australian building companies are facing collapse amid ongoing pressure from the national housing downturn. An application to wind up Cubic Homes, based in Kilburn, will be heard later this month and JML Home Constructions, which operates the Onkaparinga GJ Gardner franchise, has closed its doors. It follows the recent demise of a string of local companies, including ODM Group, OAS Group and Platinum Fine Homes. Master Builders SA chief executive Ian Markos said low population growth, reluctant bank lending, planning laws and inefficient land release had created a perfect storm.

And something else to bear in mind is the rise of AirBnB type short term letting. As the New Daily reported, “Airbnb spends a lot of time saying they have no impact on markets. What this paper shows is that they do,” University of Sydney professor, Peter Phibbs said, referring to the recent RBA modelling.  The RBA report found that vacancy rates are the “strongest predictor” of rents, Professor Phibbs said, and while that in itself seems “pretty obvious”, it also shows the conversion of long-term rental stock into Airbnb-style tourist accommodation is reducing rental stock, and subsequently reducing vacancy rates. “Hobart is the standout because they have the lowest vacancy rates in the country and they’ve probably also got the highest uptake of Airbnb”.

We know from our surveys that household are expecting home prices to fall further, as revealed in our latest data out this week – see “What Are Households Thinking Now?”  Demand for credit is easing, too. And we know from our earlier surveys that mortgage stress is rising as income remain constrained as costs rise.  WA is being hard hit, as reported in the West Australian. “In January and February alone, 112 people sought help from Legal Aid WA after defaulting on their home loan repayments, more than a third of the number of people who sought assistance in 2018. The 2018 figures saw Legal Aid support 301 people — a 550 per cent increase from 2013 when only 46 people required help. The dramatic jump in cases has prompted Legal Aid WA to launch outreach facilities of the Statewide Mortgage Hardship Service in three locations in Perth’s worst affected suburbs.   LAWA’s director of civil law Justin Stevenson said… “Concerningly the ongoing financial hardship in the West Australian community, with a sustained softening of property prices, unemployment and an end to interest-only loans mean we are only going to see more struggle to pay their mortgage in 2019… Without assistance from LAWA, homelessness is a real consequence for these West Australians”…

Meantime, the economic indicators worsen. For example, Roy Morgan’s alternative unemployment indicators of 9.6% for February is significantly higher than the current ABS estimate for January 2019 of 5.0% although Roy Morgan’s under-employment estimate of 8.6% is comparable to the current ABS underemployment estimate of 8.1%.     According to the ABS definition, a person who has worked for one hour or more for payment or someone who has worked without pay in a family business, is considered employed regardless of whether they consider themselves employed or not.     The ABS definition also details that if a respondent is not actively looking for work (ie: applying for work, answering job advertisements, being registered with Centre-link or tendering for work), they are not considered to be unemployed. The Roy Morgan survey, in contrast, defines any respondent who is not employed full or part-time and who is looking for paid employment as being unemployed.    Since Roy Morgan uses a broader definition of unemployment than the ABS, it necessarily reports a higher unemployment figure. In addition, Roy Morgan’s measure tends to be far more volatile, owing to the fact that it draws on a smaller sample than the ABS and is not seasonally adjusted.

 The impact of the Royal Commission into the Financal Services sector continues to be watered down, as Josh Frydenberg walked away from his plan to ban mortgage broker trailing commissions, pushing the issue to a review in 2022. The Treasurer said the government had backflipped on its crackdown on the industry because it wanted to keep competition in the mortgage market, amid concerns that only the largest banks could afford to pay steeper bonuses to brokers. The issue will be reviewed in three years if the Coalition remains in power by the Australian Competition and Consumer Commission and the Council of Federal Financial Relations. There is a real issue of competition, here, but remember the underlying issues is the conflict arising when a Broker is paid more for recommending a larger loan. Once again, consumers loose to political expiedency!

And the data this week continues the bad news, as nicely summarised by Westpac.  Markets are now giving about a 50% chance of an RBA cut by June, up from a 40% chance immediately following the December quarter GDP release. Westpac continues to favour moves coming later in the year – August and November the likeliest timing – with the Bank still seeming reluctant to cut and likely to require more evidence around the ‘consumer-housing nexus’ and the labour market outlook before taking action.

The NAB business survey indicates that both business conditions and business confidence weakened in February – with both at below average levels. The business conditions index fell by 3pts to +4, down sharply from the average +18 read over the first half of 2018. Business confidence also fell by 2pts to +2. We see the soft business update as a significant development. The February read is less affected by holiday season volatility, and is a clearer confirmation that the sharp loss of economic momentum since mid-2018 has extended into 2019. That is consistent with Westpac’s view of GDP growth running at a below trend 2.2% pace in 2019. The detail shows particularly weak conditions for retail, the December–February period marking the weakest three month run since 2013, and construction which saw conditions dip into contractionary territory. The state breakdown continues to show a sharp loss of momentum in NSW and Victoria. All of this is consistent with increasing negative spillovers from the Sydney and Melbourne housing corrections. Importantly, the shift is clearly starting to affect businesses willingness to hire and invest. While the employment component of the survey moved sideways in the February month, at +5 it continues to show a clear easing from the +11 averaged over the first nine months of 2018. Meanwhile, the March survey points to downside risks around investment, with capacity utilisation falling to below average levels and capital expenditure plans down to a three year low.

Consumer confidence is also starting to falter. The WestpacMelbourne Institute Consumer Sentiment Index fell 4.8% to 98.8 in March from 103.8 in February. The move takes the index back below 100, indicating pessimists again outnumber optimists, in contrast to the ‘cautiously optimistic’ reads that prevailed throughout 2018. At 98.8, the index is still only ‘cautiously pessimistic’ and comfortably above the average level recorded in 2017. However, the March fall looks likely to be sustained with the survey detail indicating the poorer run of economic news is starting to weigh more heavily. Indeed, responses collected after the March 6 GDP release were much weaker, consistent with an Index level of 92.7. We suspect that the national accounts release clarified what were previously somewhat mixed signals about the extent of Australia’s growth slowdown. As such this aspect of the March weakening in consumer sentiment looks likely to be sustained. Other aspects of the March consumer sentiment survey also suggest the shift is starting to have a bearing on decisions. Job loss concerns rose sharply in the month, the WestpacMelbourne Institute Unemployment Expectations Index recorded an 8.9% jump, indicating more consumers expect unemployment to rise in the year ahead. Responses to additional questions on the ‘wisest place for savings’ also show risk aversion rising to extremely elevated levels. Two thirds of consumers favouring safe options – bank deposits, superannuation or paying down debt – and just 17% nominating risky options such as real estate and shares. The mix is more risk averse than at the height of the global financial crisis.

We can assume significant stimulus in the upcoming budget, but then that could all get swept away with an election due soon after and the chance of a change to Labor, which would reset the agenda to some extent. So its safe to say, we just keep on keeping on.

So to the markets.

A wave of green washed over U.S. stocks after on Friday, led by technology companies, as a report on progress in U.S.-China trade talks lifted sentiment, pushing the S&P 500 to its best week since November. The Dow racked up gains on Friday, snapping a two-week losing streak.

China’s state-run Xinhua news agency said Washington and Beijing were making substantive progress on trade talks, providing relief after news that a summit to seal a deal between the two sides would not happen at March-end. Many investors expect a deal will eventually happen.

But U.S. data showed manufacturing output fell for a second straight month in February and factory activity in New York state was weaker than expected this month. That followed a batch of weak data this week that lent support to the Federal Reserve’s dovish stance on future interest rate hikes.

The S&P 500 posted its best weekly gain since the end of November and Nasdaq had its best weekly gain so far this year. For the week, the S&P 500 was up 2.9 percent, the Nasdaq was up 3.8 percent, and the Dow was up 1.6 percent.

Brexit of course rumbled on with the date extended but little else firming up. And in China, Policy targets announced at the start of China’s 13th National People’s Congress (NPC) on 5 March underscore the policy challenges facing the government as it seeks to support growth without adding significantly to economic imbalances. The 2019 GDP growth target was lowered to 6%-6.5% from “around 6.5%” in 2017 and 2018, and against actual growth outturns of 6.9% and 6.6%, respectively.

As Fitch pointed out, the adoption of a lower growth target reflects, an acceptance by the government that medium-term growth is slowing, to perhaps a medium-term potential growth at around 5.5%, a significant decline from historical trends as the economy rebalances towards consumption and away from capital accumulation. Import growth turned negative in yoy terms at the end of 2018, reflecting a slowdown in domestic investment and private consumption. The official manufacturing purchasing managers’ index dropped to its lowest in three years in February to 49.2, a third consecutive month below 50, indicating contraction. As Australia’s major trading partner, this could impact the local economy ahead.

So, standing back, it seems to me that international markets are being supported by hopes of more stimulus and trade agreements, which then puts the acid back on the local Australian economy. In fact it may be that Australia becomes one of the first victims of this current economic cycle, and the fact is, most of the risk has been created by poor government, and policy failure. There is no blaming some third party, this is a home based problem – in every sense of the word. Finally, a quick reminder that our next live event will be on Tuesday 19^th March at 20:00 Sydney time. As usual we will take questions live via the chat, or ahead of time. You can send me questions via the DFA Blog. I look forward to seeing you then.