Welcome to the Property Imperative weekly to 17th November 2018, our digest of the latest finance and property news with a distinctively Australian flavour.
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It has been a roller coaster ride on all fronts this week, with more market gyrations, larger predicted falls in home prices locally, and the first “unnatural act” from the Government to try and sustain the finance sector, ahead of next year’s election, expect more ahead.
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We start with the markets this week the Dow closed lower for the week, despite a rally on Friday that came despite the White House reportedly walked backed President Donald Trump’s upbeat comments on trade.
The Dow Jones Industrial Average rose 0.49% to 25,413 at the end of the week, the S&P 500 rose 0.22% to 2,736, but the Nasdaq Composite fell 0.15%.
After the falls earlier in the week, Wall Street went into rally mode Friday after Trump said he was hopeful the U.S. and China will reach a consensus on trade deal. Later the White House, however, peddled a more sombre narrative on trade in the wake of Trump’s comments, telling CNBC that a deal was not coming soon. Still, the broader averages held their gains, but that did little to avert a weekly loss following a rout in tech. The fear index, the VIX eased a little on Friday, down 9.21% to 18.14, but is still elevated, signalling uncertainty ahead.
In tech, Facebook fell 3% amid the fallout from a New York Times article detailing how the company conspired to cover up warnings that Russia had used the social media platform to disrupt the U.S. election in 2016. Apple moved higher after recent falls, up 1.11% to 193.53, while Alphabet fell 0.26% to 1,068. Intel was up 1.5% to 48.53.
Financials were mixed, with the S&P 500 Financials index up 0.06% on Friday to 443.45 but Goldman Sachs Group was down 0.8% to 202.12.
Sentiment on stocks were also lifted by easing concerns about steeper U.S. rate increases after Federal Reserve Vice Chairman Richard Clarida indicated that the U.S. central bank may stop at the neutral rate, rather than continue hiking beyond the neutral rate, which might be interpreted as an effective “rate cut,” JPMorgan said in a note to clients. The 3m bond rate slid 0.67% to 2.35, and the 10-year was 1.71% down on Friday to 3.065. Clarida does not expect a big increase in inflation this year. With that in mind, both central bankers are still confident enough in the domestic economy to proceed with a December rate hike, but there’s a good chance that it will be accompanied by a less hawkish outlook.
Energy added steel to the rally on Friday as oil prices settled flat, but slumped 6% for the week on concerns about a global glut in supplies. The WTI futures was up 0.66% to 56.83. Oil bears are back to taunting Saudi Arabia by pressuring the market again, just two days after giving a reprieve to the record sell off in crude.
In fact, West Texas Intermediate and Brent crude futures settled steady to slightly higher on Friday after rallying more than 2% earlier in the day on fears that the oil-rich kingdom and the OPEC cartel it leads could cut supplies substantially at a December 6-7 meeting. Friday’s s rebound didn’t help crude’s weekly loss of 6%, making it the sixth-straight week in the red.
Prices initially rose on an analysis from tanker-tracking firm ClipperData that showed Saudi Arabia was already loading fewer barrels on ships bound for the United States this month, continuing a trend that began in September. By sending fewer barrels to the United States, the Saudis hope to starve U.S. crude stockpiles, which have swelled by nearly 50 million barrels the past eight weeks. It’s a strategy the kingdom used last year while working alongside OPEC members, Russia and other producers to rescue oil prices from lows under $50 a barrel. But after the morning highs in New York trade, prices turned volatile before returning to positive territory just before the close. Adding pressure to the market was weekly U.S. oil rig data showing drilling activity at its highest in over three years, after an addition of two rigs this week.
In an extreme turn of events, the fire from Bitcoin Cash’s hardfork war has spread wildly across the entire crypto market, burning through virtually every cryptocurrency and leaving many investors burnt too. Bitcoin had more than $28 billion stripped from the market, as it fell beyond the support of its long-standing safety net at $5,800.
Gold was higher, up 1.9% to 1,222 on Friday, with some suggesting that the US$ bull run might be ending, as economic outperformance, rising interest rates, equity market pressure and trade policy all look suspect, and a switch to metals might make sense. But more likely it is the risks around Brexit, Theresa May could be fighting for her political survival, but the Brexit crisis she’s in has thrown gold bulls a lifeline. Initially resigned to losing the market’s $1,200 support level as the week began, fans of the yellow metal not only got to stay in their comfort zone but also saw their best weekly gain in five as hedgers rushed to the relative safely of bullion after the pounding taken by sterling from Britain’s EU-exit woes. Tory MPs may have enough votes – 48 are needed – for a letter of no confidence that would force a vote in Parliament. If the rebels within her ranks really do have the votes to force a no-confidence motion UK politics will be thrown into an even greater existential crisis.
Not that a change in leadership there would make much difference. U.K. Prime May on Friday reshuffled her minister team and took personal charge of the divorce talks with the European Union. The moves came at the end of an extraordinary week in which seven members of her government resigned and a push to force her from power gained momentum.
The pound gained 0.4% against the U.S. dollar on Friday, rebounding a bit from Thursday’s plunge. But sterling still suffered a loss for the week and volatility soared to a two-year high. The British Pound Dollar was up 0.48% on Friday to 1.2835, while the Euro USD rose 0.76% to 1.1414. The US Dollar index fell 0.51% to 96.43. Deutsche Bank, was down 0.06% to 8.59, not helped by recent Eurozone bank stress test results.
All 3 of the commodity currencies traded higher on Friday with the Australian hitting a 2-month high and the New Zealand dollar hitting a 4-month high. AUD and NZD ripped higher on the hope that President Trump will forgo another round of tariffs on China. Ever since the mid-term elections, his tone toward China has been softening. The Aussie ended up 0.76% to 73.32, helped by strong jobs numbers in October and bullish noises from both the treasurer and the RBA.
In the local market, the ASX 100 fell 0.17% to 4,711, reflecting similar weakness in US stocks. The ASX Financials was also down, 0.09% to 5,635.60 in bearish territory. Regional Bendigo bank was up 0.99% to 10.20, while Suncorp fell 0.15% to 13.54 and the Bank of Queensland was higher up 0.82% to 9.78. Macquarie who generates more than half of its business offshore, rose 0.16% to 119.00 whilst the majors were softer, with NAB down 0.46% to 23.77, Westpac down 0.28% to 25.27, then went ex. Dividend this week, ANZ was down 0.12% on Friday to 25.36 while CBA was up a tad to 68.90. Lenders Mortgage Insurer Genworth tracked lower down 0.91% to 2.18, not least because they are exposed to the housing sector and the investment markets, both of which look weaker. AMP continues in weak territory, although up 1.98% to 2.58. The Australian VIX index eased back, down 3.33% to 16.80, still will in the nervous zone. The Aussie Bitcoin dropped 2.76% to 7,492 and the Aussie Gold slid 0.06% to 1,666.43.
The property news continues south, with the latest CoreLogic average clearance rate down again last week, with only 42.7 per cent of homes successful at auction. And that excludes the large number of unreported results, so the true numbers in even worse. There were 1,541 auctions held across the combined capital cities, having decreased from the 2,928 auctions held over the week prior when a higher 47 per cent cleared. Both volumes and clearance rates continue to track lower each week when compared to the same period last year (2,046 auctions, 61.5 per cent).
In Melbourne, final results saw the clearance rate fall last week, with 45.7 per cent of the 266 auctions successful, down from the 48.6 per cent across a significantly higher 1,709 auctions over the week prior. Across Sydney, the final auction clearance rate came in at 42.6 per cent across a slightly higher volume of auctions week-on-week, with 813 held, up from 798 the previous week when 45.3 per cent cleared. Sydney’s final clearance rate last week was not only the lowest seen this year, but the lowest the city has seen since December 2008.
The only capital city to see more than 50 per cent of auctions successful last week was Adelaide (50.8 per cent), however this was lower than the prior week’s 57.6 per cent. Brisbane saw the lowest clearance rate, with only 30 per cent of homes selling.
Geelong recorded the highest clearance rate of all the non-capital city regions, with 57.1 per cent of auctions reporting as successful, while the Sunshine Coast region had the highest volume of auctions (55).
CoreLogic are expecting more auctions today, so we will see if this eventuate.
I discussed the latest household data at a UBS forum on Monday, other members of the Panel were included Tim Lawless from CoreLogic and Christopher Joye Coolabah Capital as well as Jon Mott Head of Banks at UBS and George Tharenou their Chief economist. You can watch my segment of the discussion “Some Thoughts About The Housing Market” via a scratch recording I made. Frankly demand for property continues to weaken, as supply rises, and sales volumes fall. First time buyers and investors are becoming more cautious. Jon Mott has been negative on the sector for some time and his new note proposes a worst case scenario in which Aussie house prices crash 30%, the RBA cuts rate to zero and launches quantitative easing, and banks are crushed by cascading bad debts, cut dividends and class actions. Smartly he has developed a range of different scenarios (scenarios will sound familiar to anyone following DFA, as we have been doing this for years, it’s the best way to communicate the intrinsic uncertainty in the system.
He thinks that his scenario 3 – housing correction is most likely, with a 10% drop in prices, and that the banks will be challenged in this environment. But if prices fall further, the banks get hit with class actions, and bad debts they will have to cut dividends.
SQM’s Louis Christopher also issued their latest Boom-to-Bust report, and guess what, he also used scenarios. SQM’s base case forecast is for dwelling prices to fall between -6% to -3%, which is a continuation of the current falls of 4.5% over the past 12 months. Sydney and Melbourne will drive the falls. Other cities will record mixed results with Hobart expected to have a third year of strong price rises of 5% to 9%. The base case forecasts assume no changes in interest rates, a Labor win at the next Federal Election with Negative Gearing repeal and CGT changes coming into effect 1 July 2020. If SQM Research is correct on the Sydney and Melbourne forecasts, it will mean by the end of 2019, the peak to trough declines will be at least in the order of 12% to 17% for these two cities. SQM Research believes that, presuming the RBA does not intervene in the market, 2020 could also record price declines due in part to the repeal of Negative Gearing which is a firmly stated Labor party objective. As such there is a risk that the total peak to trough declines could be in the order of 20% to 30% for our two largest capital cities. The range is dependent on: When, if and how the RBA responds to the downturn; How the economy responds to the downturn; Will the banks be required to lift rates out of cycle; Will negative gearing and capital gains tax concessions be repealed as per the Labor Party’s policy. Christopher said, “If the RBA does not respond and/or the bank lift interest rates again in 2019, it is possible the peak to trough falls in Sydney and Melbourne could be even more than this negative range. But we do take the view that the downturn in Sydney and Melbourne will be a significant negative for the overall economy, and so the central bank will eventually respond at some point and cut interest rates.”
Gareth Aird the senior economist at CBA discussed the drivers of dwelling prices, and identified four leading indicators that capture the momentum in the property market well. They are: (i) the flow of credit (i.e. housing finance); (ii) auction clearance rates; (iii) foreign residential demand; and (iv) the house price expectations index from the WBC/MI Consumer Sentiment survey. Presently all of these indicators are pointing to dwelling prices continuing to deflate over the near term (up to six months).
Indeed, credit and prices are strongly correlated, as we have discussed before. From a dwelling price perspective, the flow of credit matters more than changes in the stock. The annual change in housing finance has a close leading relationship with the annual change in dwelling prices by around six months. New lending is driven by the supply and demand for credit. The latest housing finance data indicates that the flow of housing credit continues to fall. And the pace of the decline has accelerated (chart 3). Credit to investors has been trending down for the past 1½ years. But it’s the shift downwards in lending to owner-occupiers that is behind the recent acceleration in the decline of credit.
Generally, auction clearance rates are a leading indicator of prices. Auction clearance rates tend to lead prices on average by two months. Auctions are more popular in Sydney and Melbourne as a means of selling a property. As such, the link between auction clearance rates and property prices is very much a Sydney and Melbourne story. As a rough rule of thumb, the annual change in dwelling prices tends to be negative when the auction clearance rate is below 55%.
Over the past two years, foreign investment in Australian property has waned. This is primarily due to a lift in state government stamp duties levied to foreign investors as well as tighter capital controls out of China. There is a decent relationship between the annual change in property prices against the share of sales going to foreign investors. Generally foreign purchases have led prices on average by around four months, although that lead time has shrunk more recently.
And finally on consumer sentiment, Aird says it has proved a very useful near term indicator of the annual change in dwelling prices. There is of course a self-fulfilling aspect at work. If households expect prices to weaken then demand for credit will fall and prices will correct lower. The reverse is also true when households expect price growth to accelerate. The WBC/MI house price expectations index is pointing to dwelling prices continuing to deflate over the near term.
The RBA’s Deputy Governor Guy Debelle summarised the Bank’s assessment of the various measures put in place to address the risks around housing lending. He argued risks are under control, though external shocks could still hit household balance sheets. Loose lending is not seen as a risk…. Hmmmm! Whilst the regulatory measures have significantly reduced the riskiness of new housing lending, we have masses of loans written under weaker regulation, which are still exposed.
He also again illustrated the fall in investor borrowing, the shift away from interest only loans, and a significant decrease in the maximum loan sizes now on offer – on average down 20%, though we think for some households the fall is significantly larger. He also showed some households were now paying higher rates, thanks to larger spreads over the P&I loan benchmark.
The trend unemployment moved a little lower according to the data from the ABS, from 5.2 per cent to 5.1 per cent in the month of October 2018. This is the lowest unemployment rate since early 2012 and the 25th consecutive monthly increase in employed full-time persons with an average increase of 20,300 employed per month. The trend underutilisation rate decreased 0.1 percentage points to 13.4 per cent and the trend participation rate remained steady at 65.6 per cent in October 2018.
But wages growth remains sluggish with the seasonally adjusted Wage Price Index (WPI) up 0.6 per cent in September quarter 2018 and 2.3 per cent through the year. The more reliable trend was 0.5% in the September quarter. Private sector wages grew by 0.55% over the quarter, whereas public sector wages grew by 0.61%. So Public Sector wages are growing more strongly, whilst the private sector continues to struggle. The weak wages growth will dent the budget projections and household budgets. Western Australia recorded the lowest through the year wage growth of 1.8 per cent while Tasmania recorded the highest of 2.6 per cent.
So no surprise that our household financial confidence index was lower in October The index measures households overall comfort level with their finances across a number of key dimensions. Recent home price trends, lower returns on deposits and share market gyrations have combined to take the index lower, despite strong employment trends. The wealth effect is now working in reverse, with a potential impact on future consumption. The index returned a result of 88.1, down from 88.4 last month. This continues the decline since late 2016, and is now approaching the lowest ratings from 2015. The convergence across the states continue as home price falls in NSW and VIC take a toll, with the southern state showing a significant slide. WA and QLD appear to be tracking quite closely. Across the age bands, younger households are under the most pressure (thanks to large mortgages, or renting) while those aged 50-60 years remain the most confident, thanks to lower net borrowing, and more savings and investments. For those aged 40-50 recent falls in property prices swamp any benefit from stock market performance. Those holding property for owner occupation remain the most positive, despite falls in paper values of their homes, but property investors are now registering significant concerns, thanks to flat or falling net income from rentals, falling capital values and concerns about the future of negative gearing and capital gains tax relief. More property investors signalled an intention to seek to sell property, as the switch from interest only to principal and interest loans continues. More than 41% of mortgage applications were rejected, compared with 5% last year, as more rigorous underwriting standards bare down. In fact those renting are in many cases more confident than property investors, significant turnaround. The great property investor decade in passing. You can watch our show “Household Financial Confidence Is In The Gutter”.
The use of the Household Expenditure Measure HEM may well be back in play, following the latest from the Westpac ASIC case. Given that at some banks HEM is still being used for around half of applications, and the Royal Commission commented specifically in the use of HEM, perhaps the law needs to be changed. The core of the argument is whether the loans were unsuitable, and that it seems would depend of the ultimate progress of the loan subsequently. In other words, it cannot be proved to be unsuitable until it falls over. ASIC would need to prove the loan was unsuitable! Actually we think the law says lenders have to verify expenses, and in other cases, for example in pay day lending specific inquiries are required as part of the assessment. But it’s as clear as mud at the moment! When is unsuitable lending to be demonstrated? This will have a significant impact on any potential class actions. And of course next week the Royal Commission start they next round, with senior bank executives and regulators on the stand. This should at very least be entertaining, and will perhaps get to the heart of the cultural issues in banking and finance. In this regard you should watch our recent show with John Dahlsen, business man and ex. ANZ Director, who has some important things to say about what has driven the poor outcomes from the sector and what needs to change. It’s a long piece, but highly relevant – “Thinking About Banking From The Inside”.
But for now, banks want more data on expenses, and the latest was ANZ who outlined new tighter rules from 20th November, where mortgage applicants will need to provide much more evidence, and history on income and expenditure. Any income from bonuses will be ignored and income shaded to 80% and evidence of continuous employment is needed. As well as more granularity and evidence on expenditure, they also will want more detail on potential changes to personal circumstances.
And finally, this week we saw the first “unnatural act” from the Government to support the banking sector, in an attempt to alleviate the home price falls and lending freeze ahead of the election next year. The proposed $2 billion funding pool is small beer in the estimated $300 billion SME lending sector. There is precedent a decade ago when the government’s $15 billion co-investment with the private sector into the residential mortgage-backed securities market during the GFC. So the federal government announced a new, $2 billion Australian Business Securitisation Fund to help provide additional funding to small business lenders. But this is lipstick on a pig in my view, and does not get to the heart of the matter at all. But I expect more such measures in the run up to the next election.
And if you want to understand what is ahead, then watch my recent interview with Harry Dent, as we discuss the limitations of central banks, and how QE has really created a monster which is still running rampant. And we are also extending our reach into the New Zealand market with the help of Joe Wilkes, see our latest Ireland V New Zealand – A Passion For Rugby & Property.
But to sum up the state of play, the Bears are indeed in town, and we should prepare ourselves for more falls ahead. Our scenarios continue to play out as expected.
Finally, a quick reminder, our next live Q&A session is now scheduled for November 20th at 8 pm Sydney time. You can schedule a reminder by using the YouTube Link and join in the live discussion, or send in questions beforehand. If previous sessions are any guide, it should be a lively event!
