Welcome to the Property Imperative weekly to 20th October 2018, our digest of the latest finance and property news with a distinctively Australian flavour.
Watch the video, listen to the podcast or read the transcript.
As you approach a Black hole, gravity increases exponentially, to the point where it is impossible to escape. Recently we have started to see signs that as credit is rationed, prices and sentiment are falling, and I suspect we have now reached the event horizon, where the only way is down. And this will suck in households, banks, the construction sector and the broader economy. It is becoming increasingly hard to chart an escape route now, and very soon we will be dragged in. Let’s look at the latest data.
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Last week CoreLogic said they were tracking 1,725 auctions across the combined capital cities, which is slightly lower than the previous week. But the final results are shocking. They reported a large 3.7% decline in the national auction clearance rate to 47.0%, with Sydney’s auction clearance rate diving 6.9% to just 45.1%. The weighted average clearance rate came in below 50 per cent for the 3rd consecutive week with 47 per cent of capital city homes selling. One year ago, 67.1 per cent of capital city homes cleared at auction. Melbourne’s final auction clearance rate showed further softening last week, returning a 50.4 success rate, surpassing the previous week as the lowest recorded since December 2012 (50.6 per cent). Clearance rates across the city are now down around 20 per cent on last year, when over the same week a higher 1,223 homes were taken to auction and 73.2 per cent cleared. In Sydney, the final clearance rate fell last week, with 45.1 per cent of the 647 homes taken to auction selling, down from the 46.1 per cent over the week prior when 611 auctions were held. One year ago, a higher 928 Sydney homes were taken to auction with 63.3 per cent successful. There is also an increasingly large number of unreported auctions, meaning the real success rate is even lower. I had the chance to watch half a dozen auction south of Sydney, and none, not one, was sold. A real “on the ground measure” of how much trouble the housing market is in.
As we discussed on our live stream event on Tuesday – You Can Watch the Replay On YouTube -there are a bunch of reasons why the property market’s fall is different this time around. It all centres on availability of credit. It is worth repeating the underlying drivers.
Tighter Lending Standards with a focus on income AND expenses, not HEM. Mortgage Borrowing Power dropped up to 40% Foreign Buyers dropped 35%, and significant hike in extra fees and taxes. SMSF borrowing restricted. Interest Only Borrowing Restricted ($120 billion for reset each year). Investors less likely to transact, as capital growth reverses. Tighter returns on rentals (half under water in cash flow terms). Higher interbank funding costs. Rising mortgage costs and rates. Plus, risk from Class Actions and the Royal Commission. I could go on…. None of this suggests a mild fall.
This is why we have updated our scenarios modelling showing potential greater falls in value ahead and we introduced a more severe Scenario 5, which I discussed with Economist John Adams in Our Video “Scenario 5 – Hell On Earth”. Arguably there is also a Scenario 6, which involves hyperinflation, but I have not found a way to model this in our Core Market Model, as yet. Prices are we think on their way down!
CoreLogics’s weekly price indices also reinforce the falls. Since the start of the year Melbourne is sliding more than Sydney, further evidence that the Victorian property market is in trouble. But reflect on this, the Perth market as dropped on average 13.6% since its peak. I discussed the dynamics of the Western markets with Tony Locantro from Alto Capital, and you can watch this video “Despatches From The Investment Managers Front Line”.
And another data point, is the falling number of homes selling. Research by CoreLogic analyst Jade Harling shows that the number of properties selling within a given year account for a very small portion of the overall market with the trend even lower over recent years; over the 12 months to July 2018, 4.6 per cent of national dwellings transacted, down from 5.3 per cent a year ago. The more pronounced decline in turnover rates over the year to July is hardly a surprise given current market conditions, with dwelling values softening each month now for the past 12 months; coupled with the lowest levels of new stock being added to the market seen since 2012 over the past 6 months, as confidence wanes and homes take longer to sell. However, the long-term trend can be attributable to a variety of factors and will differ between each of the regions.
Based on the findings, it’s likely that housing affordability has delivered a large impact on the broader downward trend in turnover rates and where the likes of Sydney and Melbourne would have weighed heavily given the high growth seen across these larger markets relative to only mild growth in household incomes. Fifteen years ago the dwelling price to income ratio as a national figure showed that dwelling prices were 5.1 times as high as the gross household income, while recent data shows this has increased to 6.8. In Sydney and Melbourne, where affordability has been a challenge for prospective buyers for some time, the price to income ratio sits at 9.1 and 8.1 respectively. In turn, what can be seen as housing has become less affordable across some capital city markets, regional areas have benefitted from the flow-on effect for being the more affordable option.
In addition, the high transactional cost to both purchase and sell property has likely added a further barrier to housing market participation. From the sell side there are marketing costs, agent fees and commission, legal costs and potentially some costs associated with getting the property ready to present to market. From the buy side, stamp duty costs as percentage of the purchase price are a major barrier to entry, especially in the more expensive markets as well as the costs associated with building and pest inspections and conveyancing. More recently, they conclude, credit rationing has provided an additional dampening effect on housing activity.
The headline employment figure of 5% released by the ABS this week may seem to be good news, although the more dependable trend remained at 5.2%, but this was mainly thanks to more people not seeking employment. Damien Boey at Credit Suisse said that results were mixed, and they do not move the needle for the RBA.
He said that the September labour market report was mixed. Headline employment came in below expectations, rising by only 5.6K in September. However, the composition of jobs growth was actually quite favourable, with full-time employment rising strongly by 20.3K over the month. Part-time employment fell by 14.7K. Aggregate hours worked rose by 0.4% in September. But partly because of unfavourable comparables, year-ended growth slowed to 1.9% from 2.1%. By state, hours worked fell by 0.7% in NSW, but rose solidly in all other regions. The biggest surprise from the release was the sharp fall in the unemployment rate to 5% from 5.3%. The unemployment rate is now at its lowest level since June 2011. The decline in the unemployment rate was not so much due to job creation, but rather, a sharp fall in the labour force participation rate to 65.4% from 65.7%.
He went on to say that RBA Deputy Governor Debelle argued that labour market conditions are strong – but notwithstanding the Bank’s expectation for continued solid job creation, it is quite likely that the unemployment rate can fall further before wage inflation comes back in earnest. The September labour market data fits into this story. Job creation has continued at a solid pace, but it is hard to read too much into the apparent erosion of labour market slack, because: first unemployment rates have reached very low levels in developed economies, but yet there is not compelling evidence that wage inflation is breaking out. The international experience suggests that it may take a while for inflation to pick up, even after full employment is reached. And second there are technical factors at work supressing the official unemployment rate.
For what it is worth, Boey says their proprietary measure of slack in the economy, based on NAB survey capacity utilization, and male full-time equivalent employment as a share of the “active” labour force suggests that not much has changed over the past few months. The output gap is more or less at the same level as it was in 2Q. Moreover, they note that the state of the labour market may not be the dominant consideration in RBA policy setting at the moment. In Q&A time, Debelle suggested that Bank officials are paying very close attention to what is happening in the housing market.
More are calling lower home prices ahead. The latest was AMP’s Chief Economist Shame Oliver has revised up the expected falls. Only in August had he said he expected price falls in Sydney and Melbourne to max out at 15% from peak to trough. He has upped this to 20% thanks to tighter credit conditions, supply rises and a negative feedback loop from falling prices”. Plus, auction clearances in recent weeks have been running around levels roughly consistent with a 7-8% price decline. We discussed this scenario in our post “Does Negative Equity Loom?” We estimated that based on his data, close to 600,000 households will fall into negative equity. And Macquarie suggests that home owners with negative equity might claim the banks broke their responsible lending obligations, and could be up for as much as $6 billion in legal costs and remediation. We think that could be a conservative estimate. Later we disclose which post code has the
Others are calling for RBA action to reduce rates. The Kouk is one of the latest, suggesting in a recent piece that the RBA could cut the official cash rate to 0.5 per cent and on the back of that, the unemployment rate drops to 4.75 per cent on a sustained basis, underlying inflation hits the mid-point of the 2 to 3 per cent target range and annual wages growth lifts to 3.25 per cent. This is what a range of credible economic models suggest would happen with such a simple and transparent monetary policy move from the RBA. And what’s more, it is free to implement! It would be, on all measures, a good economic outcome. So why is the RBA not going to do it? What kind of monetarist poltergeist has possessed them it is now a bad idea to try and hit their inflation target, put tens of thousands more Australians into work, and stoke a much-needed rise in wages growth? Why is the RBA the only central bank on the world seemingly obsessed with peripheral issues when the inflation target has been missed so comprehensively for so long? He suggests Protests about ”house prices” and “household debt” cloud the debate. He says these refrains highlight the other critical error of the RBA – its reluctance to embrace macroprudential policies to address these specific issues when they were needed several years ago. Those problems, to the extent house prices and household debt are problems, could be easily addressed with policies other than interest rates.
Well, my view is that the debt bomb is the most critical issue to manage, and cutting rates will do very little, other than removing options from the RBA later. So I think they will stick for some time to come. The Kouk does not seem to read the debt bomb the same way. Pity he won’t debate it with me!
But the stakes are getting higher. For example, recent comments from the Lafferty 500 (a comparative study of 500 banks globally) put three of the four major Australian banks in in the sub-standard category, and CBA came out a little better with an average score. Lafferty’s conclusion was that all of [the four majors] preferred to talk about some other version of their results, rather than the statutory figures they report in the audited financials. And “none meet our target of 10 per cent equity to assets or 4 per cent cash to assets”
Among the other damning conclusions that Lafferty drew were that the strategy statements of all four majors “are fluff and fail to set out credible actions”. He said failure to explain clearly to their shareholders what they were doing had led to the ratings of zero for “culture” and zero for “digital dependency”. This analysis fed into a list of 19 separate metrics. Westpac: only scored four out of 19 metrics, with 15 no-scores, ANZ: six positive scores out of the 19 metrics, with 13 no-scores, NAB: six out of 19 metrics, with six no-scores and CBA: positive scores on 10 out of the 19 metrics, with nine no-scores.
This all underscores the repair job the banks need on them – including in our view structural and regulatory changes, as I discussed with Robbie Barwick this week in our Video “What Does Glass-Steagall Really Mean?”.
Yet we know that The Reserve Bank of Australia and Treasury have privately cautioned the Morrison government that any regulatory response to the financial services Royal Commission must be careful to avoid putting the brakes on lending to home buyers and business.
And others again are calling for a dial-back of the recent tightening. This week Robert Gottliebsen wrote “ It’s true that Australia needed a correction in the housing market and the banks, which were key drivers of the boom, needed to return to proper lending practices. …Bank analyst Brett Le Mesurier from Shaw and Partners says the confessions of the banks will cost the industry an incredible $7.4 billion. If the payouts are anything like that figure the Big Four banks will be badly damaged and their credit rating will be dumped. To that you can add housing bad debts. The underlying problem is all the above groups are busily doing what they believe is right but the end result is that our banking system is being drained of capital, the executives are scared and the end result is a severe credit squeeze that looks like intensifying. He concludes … unless all the above regulators (including the royal commission) start stepping back and looking at the combined effect of what they are doing we will see the building industry (plus other areas of employment) badly damaged and that damage will last for years.
But the point is we are now normalising lending standards to more logical and sustainable levels. You do not solve a credit and property boom by allowing it to continue for ever. We had better get used to the new situation, and yes Bank profitability will be impacted long term. And yes, construction will take a hit. Time for the RBA to take a new stance. Less credit, and tighter standards is the New Normal!
So to the markets. Locally, the banks recovered a little towards the end of the week, with CBA ending up 1.04% to 67.90, ANZ up 0.62% to 26.04, Westpac up 0.6% to 26.85 while NAB fell 0.27% to end at 25.67, perhaps because of the profit warning issued this week that additional costs of $314 million after tax would be taken in connection with its customer remediation programme. This will reduce 2H18 cash earnings by an estimated $261 million and earnings from discontinued operations by an estimated $53 million. All the CEO’s of the major banks have now admitted to Parliament they did wrong, and should not have resisted the Banking Royal Commission. But talk is cheap, we need to see real change.
The smaller banks also did a little better, with the Bank of Queensland up 0.85% to 10.65 and Bendigo was up 0.68% to 10.34, though, Suncorp fell 0.42% to 14.07.
Macquarie was up 0.51% to 116.87, still well off its recent highs, and AMP was up 2.21% to 3.24. The Financial Index overall was up 0.43% to 5,810, while the ASX 100 fell 0.04% to 4,885, after another volatile week. This was reflected in the local VIX or Fear Index, which was up 1.29% to 16.45 on Friday. And the Aussie ended up 0.27% to 71.18, still in the lower end of its recent trading ranges. The Aussie Bitcoin was down 0.35% to 8,840.
So to the US markets, which also had a volatile week. US stocks experienced their worst selloff since last week on Thursday, as they ricocheted back and forth on the US-China trade spat, compounded by a Fed bent on tightening rates along with an added bonus in the form of the Italian debt crises. And as if investors didn’t already have enough to worry about, earnings shortcomings from industrial companies and Bank of America’s move to downgrade the housing sector brought already fraught nerves to a breaking point.
But on Friday, The S&P 500 closed just below the flatline at 2,768 as upbeat earnings from corporates helped ease investor jitters about global growth. The US VIX index was down a little, – 0.85% to 19.89, on Friday but is still elevated. The S&P 100 was up 0.26% to 1,236 on Friday, while the Dow was up 0.26% to 25,444. But the NASDAQ was down 0.48% to 7,449, with some of the big technology stocks being sold off.
The 3 month US bond rate was flat at 2.309, but the 10-Year bond continues in higher territory following the release of the Fed minutes this week, which underscored higher US rates ahead as they continue their normalisation strategy. Expect more hikes ahead. US mortgage rates continue higher.
Oil was lower across the week, ending up a tad on Friday to 69.37, Gold was flat at 1,230, having move up during the week, in reaction to the increasing market risks.
Bitcoin ended down 1.3% on Friday to 6,539, and continues in the doldrums, But there may be signs of that changing. Certainly the volume of the Bitcoin futures trading at the CME Group has increased by 41% in the third quarter and the community may be expecting an increase of the negative dynamics before the next expiration of futures. But this was smaller than crypto-community initially thought. And a number of factors indicate the preparation for a second wave of “Wall Street invasion” on the cryptocurrency market.
The world’s largest holding company Fidelity Investments, with $7.3 trillion of assets under management, announced the launch of custodian crypto services within a separate company Fidelity Digital Asset Services. Goldman and other investment banks have similar plans. The intentions of such giants are difficult to overestimate.
In conjunction with the race of the largest crypto exchanges to obtain regulatory approval through the introduction of tools such as “Know Your Transaction” to track user transactions, it can be assumed that in the near future crypto assets can attract substantially bigger institutional liquidity compared to the “grey” retail investments in 2017. However, the strategy of large capital is unknown to anyone and usually everything happens against the expectations of the masses, therefore, we should be cautious.
The spread between borrowing costs for 10 years in Italy and Germany widened to the most since 2013 on Thursday as Italian yields rose 14 basis points. The move came after the EU delivered a letter to Italian officials that draw a line in the sand on the budget. It said the budget had a ‘significant deviation’ from the rules and was ‘unprecedented’, calling it serious non-compliance. They said planned spending next year increased 2.7% while the max allowed under EU rules is 0.1%. The ball now is in Rome’s court as it an explanation is expected from Brussels. But first, Italy’s 2 coalition parties have to resolve an internal spat with regards to tax sweeteners to the wealthy initiated by the Northern League.
The risks are high no matter which side backs down. If the EU chooses to dig in and wins the battle, it may further alienate and inspire voters outside the mainstream and lead to significant anti-EU sentiment at a sensitive time. If Italy’s government wins, which is what most expect, then it will further undermine EU rules. Next Friday ratings agencies are also scheduled for an update on Italy. That will be a major risk event. Conte touched on it Thursday saying he thinks a downgrade can be avoided. The market increasingly thinks it’s inevitable, with the risk of two-notch downgrade to junk.
And finally in case you were asking, the post code across Australia with the expected highest proportion of households in negative equity, according to our latest analysis is Victorian post 3030, which includes Derrimut, Point Cook and Werribee. This happens to be one the post codes with some of the highest levels of mortgage stress. Stress and Negative Equity are related. But did you also know there is a clause in the mortgage contract which essentially allows a bank to make a margin call in the event of negative equity. You may consider this a futures contract on housing – but at very least it’s another issue to consider – at some point, some households may be asked to make a capital reduction. Now, that would be an very inconvenient request!
