Welcome to the Property Imperative Weekly to 18th August 2018, our digest of the latest finance and property news with a distinctively Australian flavour. Another week, yet more data, so let’s dive straight in.
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RBA Governor Phillip Lowe appeared before the House of Representatives Standing Committee on Economics in Canberra. He was quite upbeat about the state of the Australian economy, suggesting that wages growth may pick up down the track as unemployment drifts lower. He also said, given that not so long ago, there was concern in the community about rapidly rising housing prices and debt and declining housing affordability and that these earlier trends were not sustainable and were posing a medium-term risk to our economy. So a pull-back is a welcome development and can put the market on a more sustainable footing. In other words, he is embracing home price falls. And he also said that the Royal Commission has shone a light on the issues across the financial sector.
He said the inquiry had highlighted a lack of trust, a failure of risk management, and just plain bad customer outcomes. The banks need to get back to honesty, integrity and accountability.
And at the end of the latest two week’s hearings in Melbourne, the Royal Commission shone a light on poor practice across the superannuation sector, with some companies taking fees for no service, diverting funds from member accounts to pay commissions, and other poor practices, some perhaps were illegal. For example, CBA defied a request from APRA to accelerate the transfer of 60,000 members to MySuper in order to placate the bank’s aligned advisers. NAB failed to provide ASIC with up-to-date information about its ‘fees for no service’ compensation program as the regulator was compiling an industry-wide report on the topic.
The regulators were also caught in the headlights, highlighting the contention and ambiguity between the roles of APRA and ASIC. For example, APRA was waiting for ASIC.
APRA is not so much a tough cop, as a poodle. And ASIC warned that up to $1 billion of restitution was likely to be paid out due to fees for no service.
In other words, the sector bloated their profits for year thanks to their poor practice, at the expense of members. This will have a significant impact ahead (and the market has yet to factor this in to their pricing, in our opinion).
Then the Commissioner pushed ASIC on the question of whether their approach of enforceable undertakings was the best method and whether ASIC had considered legal proceedings in the past five years.
Finally, on the Royal Commission, in my discussion with Robert Barwick from the CEC, posted on Friday, he explained that the Senate voted to extend the scope and timing of the Commission, so we will see where that goes. You can watch the whole show where we discussed the latest on breaking up the banks.
And on that front, there was an interesting The Conversation article this week, by Elizabeth Sheedy Associate Professor – Financial Risk Management, Macquarie University. She looked at the question of whether bigger banks were better. We might assume that economies of scale – reduced costs per unit as output increases – also apply to risk management. The larger the organisation, the more likely it has invested in high-quality, robust risk-management systems and staff. If this holds, then a large bank should manage risk more efficiently than a smaller one.
The possibility of unexpected operational losses should then be reduced. Larger financial institutions might also attract greater regulatory scrutiny, which might help to improve risk-management practices and reduce losses. But the reverse seems to be true, based on the analysis of American banks from 2001-2016. For every 1% increase in size (as measured by total assets) there is a 1.2% increase in operational losses. In other words, banks experience diseconomies of scale. And this is particularly driven by the category of Clients, Products and Business Practices. In this category losses accelerate even faster with the size of the bank.
This could be the result of increased complexity in large financial institutions, making risk management more difficult rather than less. As firms grow in size and complexity, it apparently becomes increasingly challenging for senior executives and directors to provide adequate oversight.
This would support the argument that some financial institutions are simply “too big to manage” as well as “too big to fail”. If bigger financial institutions produce worse outcomes for customers, there is an argument for breaking up larger institutions or intensifying regulatory scrutiny.
Is the same thing happening in Australia as in the United States? The case studies presented by the royal commission suggest it could be, but it’s difficult for researchers to know exactly. Australian banks are not required to publicly disclose comprehensive data on operational losses. APRA may have access to such information, but any analysis the regulator may have done of it is not in the public domain.
Another reason to chop the banks into smaller more manageable and transparent pieces.
The economic news this week centred on the employment numbers, with the trend unemployment rate falling marginally from 5.38% to 5.36%: in the month of July 2018, according to the Australian Bureau of Statistics (ABS). This continues the gradual decrease in the trend unemployment rate from late 2014 and is the lowest it has been since 2012. Trend employment increased by around 27,000 persons in July 2018 with full-time employment increasing by over 18,000 persons. The trend participation rate remained steady at 65.5 per cent in July 2018, after the June figure was revised down. Over the past year, trend employment increased by around 300,000 persons or 2.4 per cent, which was above the average year-on-year growth over the past 20 years (2.0 per cent). The trend monthly hours worked increased by 0.2 per cent in July 2018 and by 1.9 per cent over the past year. For most states and territories, year-on-year growth in trend employment was above their 20-year average, except for Queensland, Western Australia and Tasmania. Over the past year, the states and territories with the strongest annual growth in trend employment were Northern Territory (3.5 per cent), New South Wales (3.2 per cent) and Victoria (2.5 per cent).
My read on all this is that after strong trends in the first half of the year, the labour market does appear to be softening with falling trend hours worked, falling trend jobs growth and falling trend full-time jobs growth. Frankly, it appears there is significant slack in the labour market which means wages growth will likely remain constrained.
On this, the ABS reported that seasonally adjusted Wage Price Index (WPI) rose 0.6 per cent in June quarter 2018 and 2.1 per cent through the year, with seasonally adjusted, private sector wages rose 2.0 per cent and public sector wages grew 2.4 per cent through the year to June quarter 2018. The trend data tracks a similar path, with public sector wages growth consistently stronger than the private sector.
In original terms, through the year wage growth to the June quarter 2018 ranged from 1.3 per cent for the Mining industry to 2.7 per cent for the Health care and social assistance industry.
Western Australia and the Northern Territory both recorded the lowest through the year wage growth of 1.3 and 1.4 per cent respectively while Victoria and Tasmania recorded the highest of 2.3 per cent. New South Wales was 2.1 per cent.
This wages pressure also came through in our post on Household Financial Confidence, which we released this week. The latest edition of the DFA Household Financial Confidence Index to end July 2018 remains in below average territory, coming in at 89.6, compared with 89.7 last month. We had expected a bounce this month, in fact the rate of decline did slow, thanks to small pay rises for some in the new financial year, and refinancing of some mortgage loans to the “special” rates on offer currently. However, the index at this level is associated with households keeping their discretionary spending firmly under control. And the property grind is still impacting severely.
Looking at the results by our property segmentation, owner occupied households overall remain around the neutral reading, while property investor confidence continues to fall, into territory normally associated with those who are renting or living with family. This signals significant risks in the property investment sector ahead.
There was a small rise in those reporting an income improvement, thanks to changes which kicked in from July. 2.3% said their income has improved, up 1.5% from last month, while 43.7% stayed the same, and there was a drop of 2.2% of those reporting a fall in income, to 50.5%. However, households continue to see the costs of living rising, with 82.3% reporting higher costs, up 1%, 13% reporting no change, and 2.5% falling. The usual suspects included power bills, child care costs, the price of fuel, plus health care costs and the latest rounds of council rate demands. The reported CPI appears to continue to under report the real experience of many households. Many continue to dip into savings to pay the bills.
So finally, putting this all together, the proportion of households who reported their net worth was higher than a year ago continues to slide as property price falls continue to hit home, and as savings are raided to maintain lifestyle. 42% said their net worth had improved, down 3.75% from last month. 25.6% said their net worth had fallen, up 2.5% and 28% reported no real change. You can watch our separate show on our analysis “Household Financial Confidence Grinds Lower Again”.
The latest S&P Ratings SPIN index showed another rise in mortgage delinquencies in their monthly series to June 2018. The overall score remained at 1.38, but of note in particular is the rise in more than 90 day defaults, which is consistent with other data we see, up from 0.67 to 0.70 from May. And in the AFR Chris Joye argued that this measure may understate the true arrears profile, because of the way the securitised pool is managed. His own estimates were higher, with a consistent set or rises though this year, again underscoring the pressure on households.
Turning to the markets, the ASX 200 ended the week at 6,339, up 0.17% and is visiting territory not see since before the GFC – perhaps an ominous warning. CBA, the largest owner occupied mortgage lender ended the week at 74.29 on Friday, up 0.23%, and NAB rose 0.17% to 28.85, despite the prospect of criminal proceedings relating to fee for no service. The Aussie closed at 0.7317 to the US Dollar, up a bit from its lows, but the trend is still lower over the year. We will be importing inflation at these levels.
In the US markets, the Dow Jones Industrial ended the week at 25,669, up 0.43% on Friday. The Fear Index – the VIX also calmed down, falling 6% to 12.64 after some market nerves were calmed.
The earnings calendar began to lighten up this week, but there were still enough major reports to move the market, especially in the retail sector. The broader market tends to perform well if retail is humming along, as consumer spending accounts for as much as 70% of U.S. economic growth. Walmart reported quarterly earnings that topped consensus and raised its full-year earnings guidance and ended at 97.85. Home Depot lifted its full-year guidance for both revenue and same-store sales. But Macy’s shares struggled on margin concerns. In tech, Cisco Systems beat on both the top and bottom lines and the company forecast better-than-expected numbers for its fiscal first quarter and ended up 1.57% to 45.87. The NASDAQ ended at 7,816, up 0.13%.
Talks of trade rapprochement between the U.S. and China helped ease the nagging tariff tensions in stocks. China said it will hold a fresh round of trade talks with the U.S. in Washington later this month, offering a glimmer of hope for progress in resolving a conflict that has set world markets on edge. A Chinese delegation led by their Vice Minister of Commerce will meet with U.S. representatives led by Under Secretary of Treasury for International Affairs, the Ministry of Commerce said in a statement on its website. The upcoming meeting, which is lower-level compared with four previous rounds of talks, comes at the invitation of the U.S., according to the statement.
The Turkish lira took currency traders on another wild ride this week, keeping bank stocks, especially in Europe, on the back foot. The struggling currency sank to an all-time low of 7.2393 on Monday amid growing concern over a deepening diplomatic rift with the United States over Ankara’s detention of Andrew Brunson, an American pastor detained in 2016. It found its footing on Tuesday, after the country’s central bank pledged to provide liquidity in response to the meltdown. Then on Friday, Turkey remained in the spotlight as U.S. Treasury Secretary Steven Munchin’s announced that the U.S. is prepared to slap Turkey with more sanctions if its President Erdogan refuses the quick release of Brunson.
The Turkish lira has lost almost 50% of its value this year, largely over worries about Erdogan’s growing influence over the economy, his repeated calls for lower interest rates in the face of high inflation and worsening ties with the U.S. It ended at 6.0175, up 3.15%.
Wall Street dealt with mixed economic data over the week. On Friday, the University of Michigan reported a drop in its preliminary measure of August consumer sentiment, which surprised the market. The measure of 95.3 was down from July. Economists were looking for a rise to 98.1. But July retail sales, and core retail sales, which exclude autos, came in above expectations. Housing data was mixed. Housing starts for July rose less than economists anticipated. But building permits, an indicator of future demand, were stronger than forecasts for the month. And the Philadelphia Fed index fell sharply to the lowest reading since November 2016. The Philadelphia Federal Reserve said its manufacturing index fell by 14 points to 11.9 from 25.7 in July. The consensus forecast had been for a reading of 21.9.
Gold prices were on track for their biggest weekly loss since April 2017, as worries about demand from China and contagion from Turkey’s currency crisis. And copper fell into bear-market territory during the week, but then recovered a little to 2.66. Gold was also hit by strength in the dollar, as a stronger greenback makes gold more expensive for holders of foreign currency, but again rose a little on Friday to 1,191, still well down across the year, as the US Dollar takes centre stage in terms of a risk hedge.
In China, data showed fixed-asset investment rose less than anticipated, as did factory output.
Copper prices sank on indications of China weakness and were hit by easing supply concerns. BHP Billiton and the union at the world’s biggest mine in Chile agreed to put a new wage offer to a vote by workers, potentially saving the industry from a strike that threatened to disrupt supply at a time of shrinking stockpiles.
And looking at Bitcoin, there was a small rise, up 3.69% on Friday to 6,607, but the bears are still stalking the halls.
The 10-Year Bond yield was down this week to 2.864, but the gap between the short and long term rates is still tighter, suggesting that a US recession may be on the cards later. We discussed this in our post “What Does A Yield Curve Inversion Really Signal?”
And so to the local property market. With auction clearance rates and mortgage lending in the doldrums, it is of no surprise to see the latest CoreLogic data showing that the combined effect of low rental yields and declining dwelling values has resulted in a rapid reduction in overall returns from housing over the past year. Their Total Returns Index is similar to the ASX200 Accumulation Index in that it measures overall housing market returns. To do this it measures annual value changes along with annualised gross rental yields to provide the total picture on typical housing returns. Over recent years, value growth has been much stronger that rental returns so the majority of the returns have been achieved via capital gains rather than rental income. With dwelling values now falling and gross rental yields close to historic lows, the total returns from residential housing are not looking so attractive and a greater share of returns are coming from the yield component.
With national dwelling values having fallen by -1.6% over the 12 months to July 2018, total annual returns have fallen to just 1.9% which is the lowest they’ve been since June 2012. The fall in total returns has been substantial given that a year earlier total returns were recorded at 14.2%.
Across the combined capital cities, total returns over the 12 months to July 2018 were recorded at 0.8% which was the lowest they’ve been since May 2012. Total returns across the combined regional markets were recorded at 6.6% over the past year which was the lowest they’ve been since June 2013. As the chart shows, total returns are falling across the combined capital cities and the combined regional markets with capital city returns falling much faster. A year ago, annual total returns were recorded at 14.8% across the combined capital cities and 12.0% across the combined regional markets.
Over the past 12 months, total returns in Sydney have fallen by -2.5%. The -2.5% fall in returns over the year is the weakest result since February 2009 and is a substantial slowdown in annual returns from July 2017 when they had increased by 19.0%. With dwelling values falling -5.4% in Sydney over the past year it highlights that value changes largely dictate total returns in Sydney. In regional NSW total returns increased by 6.7% over the past year which was the smallest annual increase since February 2013. Annual returns in regional NSW have slowed from 17.1% a year ago.
So to the Housing Industry Association which continues to discuss a simply demand supply equation for property prices, when in fact our analysis suggests it is credit supply which is the real lever of price growth. As credit is tightening, and supply of property is booming, which ever lever you look at, it suggests prices will continue to fall, and further than many are predicting….
They said this week that “Housing affordability is about ‘supply and demand’ and for most of this century there have been constraints on new home building that have limited supply and forced up prices. Since 2014, Australia has built an unprecedented volume of new homes and we are starting to see affordability indicators improve. The fall in house prices in Sydney and Melbourne is one indicator that affordability is improving, but the stalling of rental price inflation in the June quarter this year is the most important indicator as it tells us that the pent-up demand for new housing in Sydney and Melbourne is beginning to be met with a record volume of new housing. The fall in house prices will dampen demand for new housing over the next 12 months. Add to this, the proliferation of punitive taxes on investors in the housing market, disincentives to overseas buyers and tighter oversight of mortgage lending for home purchases and the environment for residential building is facing significant challenges.
For these reasons we expect that the housing market will cool over the next couple of years, but the down-cycle that has emerged, in certain segments of the market and locations, will be moderate.
Well, we agree the market is falling, but the tighter credit will drive prices lower still. Indeed, the effects are being being felt in the previously booming Hobart market, according to CoreLogic. Over the three years to July 2018, Hobart dwelling values have increased by 32.4% which is a significantly greater increase in values than Melbourne (the city with the second largest increase in values over the same period) in which values increased by 18.7%. The latest quarterly data shows that values increased by 1.1% over the three months to July 2018, the slowest rate of quarterly growth since July 2016. Furthermore, although dwelling values are 11.5% higher over the past 12 months, which makes Hobart the region with the nation’s strongest value growth, it was the slowest annual rate of growth for the city since February 2017. The trends in the data are certainly pointing to some weakness starting to appear in the Hobart market. In addition, belatedly, dwelling approvals are now starting to trend much higher indicating that supply is starting to increase which should also have an impact on the rate of value growth in the city.
Which takes us nicely to our upcoming live stream event on Tuesday. Mark your diary, the next DFA live stream event will be on Tuesday 21st August at eight PM Sydney. We will be updating our four scenarios looking at the prospect for home prices and the broader economy over the next three years. It’s is already scheduled on the channel if you want to set a reminder and I hope to see you there in the live chat. But also feel free to send questions in beforehand if that’s easier.
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