Welcome to the Property Imperative weekly to the nineteenth January 2019, our digest of the latest finance and property news with a distinctively Australian flavour.
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Financial markets are now on an up-trip as we predicted, and the latest results from the US were pretty positive, despite the Brexit chaos, the US shutdown and slowing global growth. But locally, the news continues to go more negative. Is this a brief break in the clouds, or something more?
Today we start with the markets. On the local market, the ASX 100 finished up 0.46% on Friday to 4,853, and has clearly started the year on a strong run if from a low base. As we will see, we are mirroring the US markets in this respect. As the markets have moved higher the local volatility index eased back further, down 2.48% on Friday to 12.26, the lowest level since October last year. The ASX financials index also run higher, up 0.53% to 5,790 and is mirroring the overall indices. Among the majors ANZ rose 0.5% to 26,07, CBA was up 0.63% to 73.23 despite their disclosures of $169m of write downs in the upcoming results thanks to losses and gains on mergers and hedging losses. NAB was up 0.32% to end at 24.89 and Westpac was up 0.31% to 26.15. Among the regionals, Bank of Queensland fell 0.39% to 10.33, Suncorp was up 1.57% to 12.90, and Bendigo and Adelaide Bank was off 0.72% on Friday to 11.06. AMP moved up 1.53% to 2.66 and Macquarie Group rose 0.87% to 118.20. Lenders Mortgage Insurer Genworth was flat at 2.20, and Mortgage Aggregator Mortgage Choice ended at 99 cents. The Aussie ended the week at 71.68, having touched 72.00 earlier in the week, still lower than a year back, and with a prospect of lower ahead in my view.
In reaction to the markets, the gold Aussie cross eased back 0.40% to 1,789, and the Bitcoin Aussie cross was down 2.20% to 4,992.
Looking across the international markets, The U.S. dollar traded higher against all of the major currencies Friday with the exception of the Canadian dollar because as it turns out, the U.S. government shutdown has been good for the dollar and stocks. The US Dollar index was up 0.31% to 96.36. So, the continued US Government partial shutdown has not had much impact, so far.
On the main US indices, outside of the decline on the first day of 2019 trade, there has not been a down day for the Dow or S&P 500. The Dow ended up 1.38% to 24,706, the S&P 100 was up 1.17% to 1,182 and the S&P 500 rose 1.32% to 2,671. The Volatility Index, the VIX was down 1.44% to 17.80 and mirrors the fall we saw locally.
But don’t mistake that the government shutdown is not actually positive for U.S. assets. Instead, it is the delay of U.S. government releases that gives the market relief. No news is good news. The short list of data that has been released was not entirely negative, but there’s no doubt that the trend of growth is lower. While manufacturing activity improved in the Philadelphia region, activity eased to its lowest level since May 2017 in the NY area. Producer prices dropped less than expected but declined for the first time in 4 months. Consumer confidence also hit a 2-year low according to the University of Michigan, which is concerning because sentiment has a direct impact on spending. Major reports such as retail sales and the trade balance have been delayed due to the shutdown and while government shutdowns don’t tend to inflict lasting damage on the economy, it’s never gone on for this long. Now in its fourth week, the shutdown could take more than 0.5% off growth as 800,000 government workers who are not getting paid reduce spending and investment.
But the stalemate could end soon as the Trump Administration grows anxious. Tens of thousands of workers are being called back to work and are promised that they will be paid for at least one pay period. Unfortunately, the White House has shown no signs of relenting with Trump hitting back at Pelosi’s call to delay or cancel his state of the Union address by cancelling her trip to visit troops in Afghanistan. It’s not clear how much longer President Trump will put the economy and the country in limbo through his attempt to strong-arm the Democrats in providing funds to build a border wall. If the stalemate ends and the government reopens, the US dollar will rally but if it continues, other major currencies react to local data.
The results from some of the major financials came through this week, and it seems that overall the financials have benefitted from the volatility over the past quarter. The S&P 500 Financials was up 1.73% to 431.73. There were solid results, from most of the bank bellwethers — even if some results were not quite what investors had hoped.
For instance, JPMorgan missed EPS estimates for the first time in 15 quarters. Wells Fargo’s Fed-mandated cap on growth was extended beyond management’s expectations and Morgan Stanley’s wealth management division was strangely sluggish in the period.
Nevertheless, these companies—and peers such as Bank of America, Citigroup, and Goldman Sachs — cooled fears that Q4 volatility would be devastating to banks and proved that the business is still relatively healthy heading into a New Year. In fact Citigroup was up 1.04% to 63.12 and Goldman Sachs was up 1.73% to 202.54.
The NASDAQ also did well, up 1.03% on Friday to 7,157. Netflix reported earnings this week, posting mixed results on Thursday. The video streaming company added more global paid members than analysts expected, but it missed revenue estimates and guided for negative free cash flow to continue throughout 2019.
Apple was up 0.62% to 156.82, Google’s Alphabet was up 0.74% to 1,107.30, Amazon was up 0.18% to 1,696.20, Facebook rose 1.17% to 150.04 and Intel was up 1.49T to 49.12.
The suspicion is now the FED will take a breather on future rate rises, as growth slows, but the US 10-Year bond rate rose 1.49% to 2.79 and the 3 Month fell slightly, down 0.37% to 2.40. The yield curve inversion is yet to occur.
One of the burning questions is the rate of growth ahead. Fitch Ratings latest report says the outlook for global growth has been dented by a series of recent weak data releases, but not dismantled. The broad contours of the agency’s forecasts for 2019 – with above-trend growth in the US and policy easing preventing growth dipping below 6% in China – still looks intact. The eurozone outlook has weakened more significantly but some recovery in growth in 1H19 still looks likely after a very disappointing 4Q18.
A string of weak data releases has raised market concerns about the risk of a sharp downturn in global growth in 2019. Most dramatically, business sentiment in the manufacturing sector has seen a widespread deterioration across multiple geographies. The (unweighted) average manufacturing Purchasing Managers’ Index (PMI) for 20 economies suggests that the upturn in the global manufacturing cycle seen from 3Q16 petered out in 2H18, consistent with the slowdown also seen in world trade through 2018.
They see a slowdown in China, which is significant because China’s share of world GDP has continued to grow rapidly in recent years and its domestic economic cycle now has much more pronounced effects on the rest of the world than in the past. The current slowdown in China is substantial – particularly when measured in terms of nominal GDP growth, which peaked at nearly 12% y/y in early 2017 and likely fell below 9% y/y in 4Q18. Moreover, the latest slowdown has been reflected in consumer spending to a greater extent than in the past, including in car sales, which recorded a 4.3% decline last year. China accounts for around a third of global car sales and it seems likely that global auto sales – a key component of world manufacturing – declined last year for the first time since 2009. They are still forecasting a 6.1% growth rate for 2019 because policy in China has been eased further with the recent cut in banks’ required reserve ratios and the authorities’ commitment to tax cuts and supporting infrastructure spending has become more vocal in recent weeks. This also includes the assumed US tariffs on USD200 billion of Chinese imports will rise to 25% in early 2019, a shock that may be avoided if trade talks make further progress. The Yuan US Dollar ended down just a little on Friday to 0.1475.
There is a more material threat to our 2019 eurozone growth forecasts. Eurozone PMI’s have seen the largest falls in recent months and this has been corroborated by weak ‘hard’ industrial production data in the large member states. The Fitch forecast that 4Q18 GDP would rebound to 0.5% is not supported by the incoming data – instead this now points to another quarter of very subdued growth similar to the 0.2% expansion seen in 3Q18.
After surviving a no-confidence vote Prime Minister May is now required to present a backup plan to The UK Parliament by Monday. Sterling’s reaction to further Brexit uncertainty has been remarkable. Instead of falling, it hit 1.30, and settled on Friday at 1.289, up 0.07%. As the market ruled out a victory days before the Brexit vote, the recovery in GBP reflects expectations for the extension of Article 50 and the diminished possibility of a no-deal Brexit.
In terms of options ahead, May has no choice but to ask the EU for more time, which is why by Monday, Article 50 should be extended. It then goes to vote by EU member states who are widely expected to approve the request. However, it won’t be an open-ended extension. The European Parliament’s Brexit coordinator suggested that he’s open to an extension to May and not beyond that because he doesn’t want Brexit opinions to spill over to European parliamentary elections. But an extension can’t be the only element of Plan B. May will need to decide what course to take in the coming months – either a Norway style model or a permanent customs union or relent to a second referendum – all of which should be positive for GBP. However, after winning her no confidence vote, May made it clear that leaving with no deal cannot be ruled out. Although unlikely, if she does not ask for an extension, it could pave the way for a no-deal Brexit. GBP will crash, even if Parliament responds by taking control of Brexit negotiations. After that, Parliament is scheduled to debate and vote on Plan-B a week later on January 29.
The possibility of a no-deal Brexit adds further downside risks. The weaker activity outlook reinforces our expectation that the ECB will likely modify its forward guidance on interest rates soon and possibly consider other accommodative moves related to bank financing.
Shrugging all this off, the FTSE 100 rose 1.95% to 6,968 on Friday, the FTSE Financials Index was also up by 1.67% to 651.93 and the Euro USD was down 0.21% to 1.1371. Deutsche Bank rose 2.4% to 7.954.
Crude Oil WTI has recovered, up 3.19% to 53.73, as demand increased, partly by a reduction is US sale oil production, and Opec steps to limit supply. Gold slid as the other markets rose, down 0.86% to 1,281.15, Silver also fell, down 1.15% to 15.36 and in contrast Copper was up 1.19% to 2.71. Finally, Bitcoin fell another 0,74% on Friday to 3.674. Bitcoin is currently caught in a trading range between $3,550 and $4,200, and the markets are seeing decreasing volatility despite this week’s choppy trading, with BTC’s volatility dropping to its lowest levels since mid-November, from a peak of 140 on November 28th to today’s value of 60. Other coins are following a somewhat similar path, with analysts warning that Bitcoin could well test the $3,000 level in the next few weeks.
So to events locally. There is of course little property market news at the moment, though the latest on the Opal tower is set to put more pressure on new built and off-the plan sales of units across the country. I discussed this with property insider Edwin Almeida in our post “The Opal Tower and Beyond”. We think there is a case for a Royal Commission in the construction sector, as other buildings have defects, and the self-certification processes may be compromised. As the Conversation put it “badly built apartment blocks are far from unusual. Right now across Australia’s cities many buildings have significant leaks, cracks and fire safety failings… developers owe buyers few legal obligations once the apartments are sold, which limits their risk if they get things wrong. There are also significant market pressures, particularly in boom times, to build quickly and cheaply. And there are gaps in how the construction process is overseen, meaning errors go unnoticed…
Corelogic’s latest data shows a weekly fall in all markets, with Sydney down another 0.37%, Melbourne 0.44%. Brisbane down 0.11%, Adelaide down 0.09%, Perth down 0.42% and the 5 Cities down 0.35%. Melbourne continues to fall faster than Sydney. As a result more households are slipping into negative equity.
I also discussed the latest finance data from the ABS which showed a further fall in credit growth for home lending, on both the owner occupied and investment lending side. That said the total loan stocks are still growing, all be it more slowly, and we are still seeing around 40% of loans being rejected compared with 8% last year, thanks to tighter underwriting standards. We explored the impact of this in our post “A Sharp Intake of Breath As Property Lending Declines Again”.
Fitch Ratings is suggesting that Australian Property Prices could fall further in 2019, For Australia, they expect a national peak-to-trough home price drop of 12% in Australia with Sydney and Melbourne posting larger declines in 2019. They warned that high household debt makes the wider economies more vulnerable to shocks in the financial sector and borrowers more exposed to downturns. They forecast loans in arrears over 90 days to increase slightly to 70bp by 2020, and Housing credit growth is projected to ease further in 2019 to 3.5% from 5.1% yoy growth in October 2018. This is due to tightened macro-prudential limits and a more conservative interpretation of regulatory guidelines for mortgage servicing in light of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. Fitch believes the commission’s final recommendations, due in February, may further reduce credit availability.
We can expect the debate about Labor’s plans for negative gearing reform to hot up now in the run up to an election later in the year. As the Australian reported, Mr Shorten says the government is trying to hide that the economy is not working in the interests of everyday Australians. “The current government is pulling a sort of pea and thimble trick, where they want you to look over here at Labor’s future policies so as to take your attention from the fact that under the current government this economy is not working properly,” he told reporters in Brisbane on Thursday. Labor wants to retain negative gearing only for newly-built homes – with the policy grandfathered so the changes won’t apply to existing investors – and make changes to capital gains tax. The coalition says the move would be “bad policy” that would reduce the value of people’s homes and raise rental costs. But Mr Shorten says it’s simply a “fairness measure”. “I haven’t heard anyone explain to me how it is fair that a property investor can get their taxpayers to subsidise that person for their seventh house, but a first home buyer, well, they get no help at all,” he said. Doubling down on fairness makes sense, and it will be harder to the incumbents to rubbish that – bear in mind tax payers are subsidising property investors. We also think the potential impact on home prices will be limited.
The HIA reported that “HIA New Home Sales continued the declining trend that we saw throughout most of 2018, with detached house sales falling by 6.7 per cent in the final month of 2018 so that sales during the final quarter of 2018 were 14.9 per cent lower than last year. The HIA said that while declining home prices in Sydney and Melbourne have made home buyers in these markets far more cautious, the ongoing challenges accessing finance that face many would-be home buyers across the rest of the country continue weigh on new home sales. New home sales declined steadily throughout 2018. The declines ultimately ended up with sales in December dropping to their lowest level since late-2012. There is still a large amount of residential building work under way due to residential developments that proceeded with large numbers of off-the-plan sales during 2016, 2017 and early 2018. These off-the-plan sales have been flowing through the build process and many are now in the construction phase. This high level of building activity is masking a deterioration looming on the horizon. We already know housing starts are down, as shown by HIA data. And the AFR reported that BIS Oxford Economics, estimates that residential building construction activity peaked in the second half of 2018 and is expected to decline 1 per cent this financial year, followed by a 14 per cent fall in 2019-2020. This includes a 19 per cent downturn in NSW and a 17 per cent downturn in Victoria, over the same period. This mirrors the falls in credit as the data from the ABS showed.
More economists are calling for the RBA to cut the cash rate (they are still publically suggesting the next rate move will be up). For example, Capital Economics has become the fourth forecaster to call for interest rate cuts by the Reserve Bank of Australia this year, joining Market Economics, AMP Capital and Industry Super Australia. Their forecasts for GDP growth and inflation are more downbeat than the consensus and they put the Australian cash rate at 1 per cent by the middle of next year based on one cut in late 2019 and further easing in 2020. The slowing is becoming more obvious and home prices will fall further. That said rate cuts will do little to address the root causes, and will put millions of households against the wall as savings rates are cut again. I remain amazed that that voice of the saver is lost in the howls given out by the property sector. They need a stronger voice.
UBS also sees a rate cut saying “a broadening range of weaker data raises the risk of RBA rate cut. The continued fall in home loans suggests that credit tightening is still playing out, ahead of the Royal Commission final report (due Feb 1) & the next three game changers of Debt-To-Income limits, & potentially negative gearing & CGT. Our long held forecast peak-to-trough drop in loans was 20%, but our risk case of -30% seems increasingly likely; seeing housing credit growth slow towards flat by 2020, & house prices to drop by 10%+. Given this, compounded by the recently weaker data across residential and non-residential commencements, and consumer sentiment, we think the risk of a rate cut from the RBA has increased.
Damian Boey from Credit Suisse this week wrote that “The money market is suggesting that there is a 30% chance of a 25bps cut this year. However, considering that there are more than 50bps worth of out-of-cycle hikes to come, and that growth is slowing much more sharply than the Bank has forecast, this pricing is arguably not dovish enough”.
And the Australian said “In the years leading up to the second half of 2018 we went through a period where banks hosed money at people seeking a resident or investor home loans, causing them to bid up at actions. Expense levels were fudged, and no one worried too much if investors took out more than one interest-only loan. House prices went through the roof and those higher values boosted consumer spending. …too many Australian have borrowed too much money. Their incomes are not rising and in some areas of small business they were falling. But employment was high partly driven by housing construction and government jobs. Then came the banking and finance royal commission and the unprecedented credit squeeze on the banks… APRA over reacted… Australians went into their banks seeking housing, business and credit card loans and saw fear in the eyes if the ordinary branch bankers. The clamps and penalties for investors were hideous… A person who could have borrowed one hundred units at the start of the year was lucky to get 70 units — a 30 per cent reduction… And the looming Royal Commission report in March would make it worse…
Except we think the banks are now finally obeying the responsible lending laws, and APRA did not over react – the debt bomb has to be defused, and it will be painful. Prices will slide further.
And housing falls are now occurring in many markets across the world – reflecting the tight integration in financial markets globally, and the current capital rules. As Bloomberg put it this week: In Manhattan, the median condo price dipped below $1 million for the first time in three years. Hong Kong home values endured their longest losing streak since 2008, while prices in outer London neighborhoods fell for the first time since 2011. Sydney home owners are grappling with the worst real estate slump since the 1980s. Luxury residential prices are growing at the slowest rate since 2012, according to a Knight Frank index of prime properties in 43 cities… Governments became concerned the gains were unsustainable, and reacted with measures aimed at curbing the flows of international money… Similar dynamics are playing out around the world. The number of home sales in Vancouver dropped 32 percent in 2018 from the previous year, following a series of new taxes, stricter mortgage rules and rising interest rates. Median prices in Auckland registered their first annual drop since 2008 after the New Zealand government passed legislation to restrict foreign buying that it said was partly to blame for escalating housing costs. Home prices have dropped 11 percent in Sydney from their 2017 peak after government restrictions on foreign purchases and tighter credit.
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So, we see the fundamentals in the housing market weakening, spilling over more broadly into lower consumer spending, and so economic activity is set too slow. Rate cuts are on the cards, but we think they will have very little real impact, as we approach zero bounds. Against this backcloth, the recent financial market momentum is over down, and we still expect more negative news later in the year. Do not mistake a brief break in the clouds for a long hot summer, they may look the same, but the result will look very different.
