Welcome to the Property Imperative weekly to the second of March 2019 – our digest of the latest finance and property news with a distinctively Australian flavour.
We live in a weird world where the financial markets seem disconnected from the real economy, for example locally home prices data continue to fall, and future company earnings are under pressure, yet the market has shrugged this off. But we need to understand this breakdown, and why when a crash comes it will be more severe.
So, lets start with the latest data from CoreLogic. On a national basis, the CoreLogic Home Value Index dropped 6.3% year-over-year and 6.8% from its peak in October 2017. It’s now back where it had been in September 2016. That said, CoreLogic’s report points out that, despite the decline, the index remains 18% higher than it had been five years ago, “highlighting that most home owners remain in a strong equity position.” Only recent buyers are underwater. But that, on our estimates is more than 10% of property owners and growing. And of course, if households are forced to sell, then they will not command top dollar, and have to pay the transaction costs too. Plus, February being a short month, is one week less in terms of falls.
Across the metro area of Sydney, prices of all types of homes combined, according to CoreLogic’s Home Value Index, fell 1.0% in February from January or 10.4% from a year ago, and nearly 13% from its peak in July 2017. Just over the past four months, the index has dropped 5.5%. Plus, the volume of closed sales recorded in Sydney in February plunged 20.6% from the already weak sales in February last year, according to CoreLogic’s report. Units, generally the lower end of the market, is where first-time buyers are thought to have a chance, and they were considered the saving grace in this market. But prices continue to drop, and the industry’s hope that first time buyers would bail out this market is now fading. On average, House prices dropped 1.1% in February and 11.5% year-over-year. Unit prices dropped 0.8% in February and 8.8% year-over-year.
In the Melbourne metro, the second largest market in Australia, prices of all types of homes fell 1% for the month and 9.1% year-over-year, according to the CoreLogic Home Value Index. The index is now down nearly 10% from the peak in November 2017. Over just the past four months, the index for Melbourne dropped 5.0%. House prices in Melbourne dropped 1.2% for the month and 11.5% year-over-year. Condo prices dropped 0.6% for the months and 3.7% year-over year. CoreLogic estimates that closed sales in Melbourne plunged 22.1% in February from the already weak sales a year ago.
Of the bottom 10 sub-regions of Australia’s capital cities seven were in the Sydney metro and three were in Melbourne.
The metros of Sydney and Melbourne, due to their enormous size and high prices, dominate the national home values, but weakness is now spreading to other capital cities, with only Hobart and Canberra still showing year-over-year gains.
Westpac released their latest Housing Pulse. One chart tells the story – national housing turnover fell to the lowest level since 1987 in the final three months of 2018, while total listings have also increased significantly.
And CoreLogic also showed that vendor discounting is rising. Across the combined capital cities – the median vendor discount is recorded at -6.3% which is the most significant discount since January 2009. In January 2018, discount levels were much less significant at -4.7% which highlights just how quickly housing market conditions have deteriorated in 12 months with discounting levels mirroring those seen during the financial crisis.
Across the regional markets – the deterioration in selling conditions has not been as substantial as it has been across the capital cities. Discounting levels are currently recorded at -5.2% compared to -4.5% a year ago. The worsening in discounting reflects the fact that dwelling values have begun falling in regional markets over recent months.
In Sydney properties in Sydney are seeing more substantial discounts now than they were during the financial crisis. The median vendor discount is currently -7.5% which has weakened from -4.8% a year ago. The last time it was larger than it is currently was all the way back in February 2006. The rate of deterioration of selling conditions in Sydney has been rapid.
Melbourne – vendor discounting has become more significant over the past year as dwelling values have fallen rapidly. A year ago, vendor discounting was -3.6%, having fallen to -7.0% currently which is its weakest level on record. Like Sydney, this highlights just how weak housing market conditions are and how few buyers there are.
And CoreLogic also released its final auction results, which reported a 4.7% decline in the final national auction clearance rate to 49.4% – below last week’s 51.2%. Sydney’s auction clearance rate fell by 8.4% to 50.2% whereas Melbourne’s fell 2.5% to 50.6%. Final auction clearances were still 14.9% (Sydney) and 20.0% (Melbourne) below the same weekend last year when dwelling values were also falling. Moreover, auction volumes were also down 36% and 30% respectively in both Sydney and Melbourne.
I discussed the reliability of the auction clearance rates with property insider Edwin Almeida. See our post “Edwin Almeida – What Are The Numbers Really Telling Us?Do not believe the hype, there is nothing here to show the market is bouncing back. Plus the indices are averages, and there are wide variations on the ground, with falls of up to 40% already evidenced in some areas.
And by the way, I get a lot of requests for more local, and regional data so I hope to start a series on this, when I can – but remember from a macroeconomic perspective the concentration of property in Melbourne and Sydney means they will drive the broader economic outcomes.
We expect prices to continue to fall, and as Wolf Street highlighted, there is a bitter irony to all this. For example, In February 2017, just months before the market in Sydney peaked, Anthony Roberts, New South Wales Minister for Planning and Housing, was promoting the launch of a 690-unit apartment development at Olympic Park, heaping praise on the developer for having reserved 60 units for first-time buyers. Roberts was hyping new incentives for first-time buyers, including a reduction of the down-payment to 5%, to lure them into the Sydney housing market. He said “This is about fairness, and this is about enabling people to get into the Sydney housing market. Once you are in the Sydney housing market, you’re pretty well set then for the rest of your life.”
This is now, at least a open question thanks to home prices in free fall, and of course more questions about the quality of construction, as typified by the Opal Building, and now a tranche of other questionable towers across the country.
Now, let me remind you again of what the RBA said in their recent minutes, as they maintained the cash rate at a low of 1.5% in their February meeting. From a longer-run perspective, members assessed that, following such large increases in housing prices, the effect of the recent price falls on overall economic activity was expected to be relatively small. From a financial stability perspective, tighter lending standards, an improving labor market and low interest rates were all likely to support households’ capacity to service their debt. Few households were in negative equity positions despite the falls in housing prices, implying that banks’ losses would be limited even if household financial stress were to become more widespread. I do not regard 450,000 households as Few!
Compare that with the recent IMF stress tests, when they said “the financial sector faces continued vulnerabilities from high household debt, still-stretched real estate valuations, and banks’ ongoing dependence on funding from global markets.” The assessment “recommended further steps to bolster financial supervision as well as to reinforce financial crisis management. We think that is an absolute requirement.
The latest data from the RBA and APRA showed that the credit impulse slowed again in January. The RBA lending aggregates shows that annual owner home lending now stands at 6.2%, investment lending at 1% and overall credit growth is 4.4%. There was a considerable drop off in personal credit, and a rise in business lending. But despite all the funnies in the numbers, lending from the non-bank credit sector is booming. Owner occupied non-bank lending is growing at an annualised rate of 17.2% and lending for investment housing is 4%. Both well above the bank sector. This is unsurprising, given the different funding arrangements, and restrictions between the banks and non-banks. Of course, both have responsible lending obligations, but evidence suggests non-banks are more willing to lend, at a price. APRA sort of has responsibility for the non-bank sector, but do not seem to be doing much to stem the tide.
Non-banks will fund their mortgage lending either from private investors, companies or hedge funds, rather than from deposits. They may also securitise their loan books (sell them off via the bond market). So, they are not under the controls which are applied to banks in terms of the capital they need to hold. This gives them greater flexibility.
But rightly tighter lending (the banks were too loose before) and falling home prices are going to hit the economy. For example, UBS said this week that February’s auction bounce has given “false hope” to those seeking a housing recovery, and forecasted that price falls will double to 14%, with negative spill over effects for the broader economy.
Much has been made of the ‘bounce’ in auctions in Feb-19. However, it’s clearly a false sign of hope. The rise in auction clearance rates this year is 1) seasonal, & 2) based on a spike in under-reporting of failed auctions, with the ‘preliminary’ result massively revised down 5%-10%pts to the ‘final’. Indeed, while the national clearance rate rose to 48.6% in Feb-19, this remains very weak around prior cycle lows (after the late-2018 trend was a record low in the low 40’s). Furthermore, demand is weak as the number of auctions held in Feb dropped by ~30% y/y, & sales at auction collapsed by 50% y/y…
The UBS credit tightening thesis is still playing out, with accelerating weakness in home prices, sales, approvals, loans, & credit growth. The peak-to-trough decline in home prices is still ‘only’ 7%. Looking ahead, while the Royal Commission didn’t change any laws, with APRA & ASIC reinforcing ‘sound lending practices’, we expect price falls to double to 14%, making a negative household wealth effect on consumption likely. We remain non-consensus expecting GDP to clearly slow to a below trend 2.3% y/y in 2019, seeing unemployment rise, & the RBA cut in Nov-19, with risk of earlier easing.
And UBS has downgraded its Q4 GDP outlook following the “disastrous” 3.1% decline in construction activity. UBS now expect a GDP print of just 0.3% with risks tilted to the downside.
We suspect a per capita recession is a certainty, given per capita growth was negative in Q3. However, the risk of an aggregate recession is clearly on the rise too.
And as the ABC reported, There’s a clear warning we should be alert, if not alarmed, about the state of the economy, and the risk that many jobs could be lost in coming month. The roll call of big names with falling profits is a long one. Coles, Qantas, AMP, Caltex, Commonwealth Bank, Transurban, Telstra, Domain, Scentre Group, Flight Centre, REA and Fortescue are just a few. “It’s pretty clear the Australian economy is moderating,” Perpetual’s Head of Investment Strategy Matt Sherwood said. “The key question is, how much further does it have to go?” According to AMP Capital, the number of companies reporting a fall in earnings has jumped by more than three-quarters to 41 per cent. “Those parts of the share market most exposed to the Australian economy, particularly housing and retailing, that’s where the weakness is,’ AMP Capital chief economist Shane Oliver said. “With around 1.1 million Australians employed in the construction industry, and others whose employment relates to residential construction, we can see that potentially there’s going to be a drop-off in hiring and potentially an increase in unemployment to come,” Ms Creagh said. And that doesn’t auger well for the unemployment rate. More than a quarter of the people employed in the construction industry received their jobs after the start of the building boom in 2012. If employment in the sector returned to pre-boom levels, around 240,000 jobs could be lost, sending the unemployment rate soaring to more than 7 per cent.
If that were to happen, then mortgage stress and defaults would rise, and home prices would drop further. We highlighted last week that delinquencies are rising, based on data from the banks and the S&P Spin index.
So Westpac has downgraded its outlook with housing-related weakness now expected to exert a more significant spill over drag on the wider economy. In turn, they now expect the RBA to lower the Cash Rate with two 25bp cuts in Aug and Nov.
So to the markets.
Across to the US, The S&P 500 and Dow snapped three-day losing streaks on Friday as optimism about the prospects for a U.S.-China trade agreement overshadowed downbeat U.S. and Chinese manufacturing data.
Despite the rally, the Dow finished down slightly — 0.02% — for the week, after nine-straight weeks of gains. The S&P 500 was up 0.4%, its fifth gain in a row and above 2,800 for the first time since November 2018. The Nasdaq added 0.9% on the week and has seen gains for nine-straight weeks.
As Wall Street got a new month underway, traders were reminded of headwinds that could hinder the path to swashbuckling gains. One of the biggest: The U.S. economy continued to show signs of a slowdown. Consumer spending, which accounts for more than two-thirds of U.S. economic activity, fell 0.5% in December. ISM manufacturing data for February missed expectations of 55.5.
The fall in personal spending was the largest since 2009, and which serves to give more credence to the abysmal retail sales figure released a couple weeks ago. The downbeat data arrived after China’s economy showed a fall in factory activity for the third month in a row. However, the pace of the slowdown had moderated, raising hopes a bottom was forming. Sentiment on Wall Street was boosted by signs that U.S. and Chinese negotiators are closer to reaching a trade agreement.
“We made so much progress last week when the Chinese were here,” National Economic Council Director Larry Kudlow told Fox Business Friday. “The agreements made last week represent tremendous progress on IP theft, on forced technology transfer, on ownership, on cyber interference and, maybe most importantly, on enforcement.”
Beyond trade, the markets were powered by a rise in energy stocks despite a fall in oil prices on signs of weakness in China’s economy.
Bitcoin fell 2.89% this week but is up about 11 percent in February.
So to that question I posed earlier. How come the markets are so buoyant in the face of the weakening economic data both here and overseas?
In the eurozone the weakness is evident and more pronounced than even the most pessimistic expected. Both industrial production, consumer confidence and indicators such as the trade surplus have deteriorated sharply. Despite the bad data, the Italian recession and the fact that the European Commission has had to revise down by more than 30% its own estimates from a month ago, Europe will likely grow in 2019.
China continues to slow down under the weight of its indebted and inefficient model, but it also grows. The United States showed poor retail sales data, but both employment and gross capital formation show that the economy continues to expand. The emerging countries have worsened their prospects, but have navigated the monetary imbalances that deactivated the mirage of synchronized growth in 2018.
Yet markets are strongly up from that December dip. Why? The answer is Central Bank intervention.
U.S., China, the euro zone and Japan shows their aggregate money supply peaked at $73.1 trillion in April, before dipping to $69.8 trillion in mid-November and then rebounding to as much as $72.6 trillion at the end of January.
Since the end of December stock markets have rebounded strongly because the data, although poor, is not as bad as feared, and mainly because the Federal Reserve changed its tone on the number of rate hikes, the ECB announced that it would be much more accommodative and the Central Bank of China introduced the largest injection of liquidity in five years.
It’s this growth of the global supply of money by central banks looking to first combat the financial crisis and then keep their economies from falling into recession has been a key reason for the stellar performance in riskier assets. That growth is evident in the more than doubling of the money-supply index from $35.3 trillion in late 2008, just a few months before global stocks embarked on a rally that would see the MSCI more than double itself by early 2018 before last year’s rough patch.
In other words, the global markets are reacting the cash sloshing around in the financial system looking for a home, but its all artificial. Expect more ahead, as the central banks try to manage the massive debt burden which underpins the expansion, and lower rates later. But as a result, the crash when it comes will be deeper and more significant.
And the truth is central bankers are stacking the deck to support the financial system, despite the spill over effects on many individuals and households. Equality has been banished in favour of expediency. As you know, I do not expect this to end well… but the rate of money supply growth may mean its later and more extreme. And Australia appears to be leading the way down now. We will see.
