Welcome to the Property Imperative weekly to the fifteenth of December 2018, our digest of the latest finance and property news with a distinctively Australian flavour.
Financial markets have remained weak through December, and its prompting the question, is this more than just volatility – are we seeing falls turn into something more significant – is this the start of the rout? So today we look at the latest data and try and assess where we stand.
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Today we start with the markets, which continue in a state of heightened volatility and uncertainty. The US volatility index went up again on Friday by 4.75% to 21.63 which continues the trends seen since October. A range of concerns from slowing global growth, trade tensions and a partial yield curve inversion all played into the mix.
This despite upbeat data from the Commerce Department at the end of the week, which showed that U.S. consumer spending gathered momentum in November as households bought furniture, electronics and a range of other goods, which could further allay fears of a significant slowdown in the American economy even as the outlook overseas continued to darken. Plus, worries over the US economy’s health were eased on Thursday after government data showed the number of Americans seeking unemployment benefits fell back to a near 49-year low last week. And in a separate report on Friday, the Fed said industrial production rebounded 0.6percent last month after falling 0.2 percent in October.
US Retail sales excluding automobiles, gasoline, building materials and food services surged 0.9 percent last month after an upwardly revised 0.7percent increase in October. These so-called core retail sales, which correspond most closely with the consumer spending component of gross domestic product, were previously reported to have gained 0.3 percent in October.Economists had forecast core retail sales rising 0.4 percent last month. November’s increase in core retail sales and upward revisions to October’s data suggested a brisk pace of consumer spending in the fourth quarter. Consumer spending,which accounts for more than two-thirds of the U.S. economy, increased at a 3.6percent annualized rate in the July-September quarter.
But this upbeat data from the Commerce Department bolstered expectations that the Federal Reserve will raise interest rates for a fourth time this year at its Dec. 18-19 policy meeting, despite moderating inflation and tighter financial market conditions. The U.S. central bank has hiked rates three times this year.
In the wake of the strong core retail sales numbers, economists bumped up estimates for fourth-quarter gross domestic product growth to as high as a3.0 percent rate from around a 2.4 percent pace. The economy grew at a 3.5percent pace in the July-September period. Spending is being boosted by a tightening labour market, which is starting to spur faster wage growth, lower taxes and moderate inflation. It remains strong despite the sharp stock market losses.
It also stood in stark contrast to reports from China showing a dramatic fall-off in retail sales in the world’s second-largest economy and from Europe where a key measure of business activity expanded at its slowest rate in four years. China said it will temporarily reduce tariffs on imports of American-made cars when the Chinese Finance Ministry said in a statement that it will cut tariffs on car imports from the United States to 15% from 40% for three months starting Jan. 1. The Chinese Yuan US Dollar was down 0.37% to 0.1448.
Yet, a sharp sell-off on Wall Street and partial inversion of the U.S.Treasury yield curve had stoked fears of a recession. A poll released on Thursday showed economists now see the risk of recession in the next two years at 40 percent, up from 35percent last month.
The Dow closed lower for the second-straight week on Friday, as fears over slowing global growth triggered a steep selloff across stocks on Wall Street. The Dow Jones Industrial Average fell 2.02%, to end at 24,101, and is down 1.2% for the week. The S&P 500 dropped 1.91% to end at 2,600, while the Nasdaq Composite lost 2.26%, ending at 6,911. Apple, weighed on tech as analysts continued to warn about weaker iPhone sales, sending its share price more than 3% lower to 165.48. Intel was down 0.89% to 47,86 and Google(Alphabet) was down 2.03% to 1,052. Amazon was down 4.01% to 1,591.91. The S&P 100 was also down 2.09% to 1,153.59.
Ahead of the Federal Reserve meeting next week, investors continued to abandon bank stocks, pressuring financials, which have fallen about 10% so far this month. The S&P 500 Financials was down 1.01% on Friday to end at400.78, with Citigroup down, and Goldman Sachs lower, down 1.79% to 172.77.
The dollar hit a 19-month peak against a basket of currencies, up 0.42%to 97.47. The US Ten Year Bond was down 0.61% to 2.893, while the 3-month rate was down 0.13%.
Now, according to Fitch Ratings, the risk of an imminent U.S. recession remains low despite the recent flattening of the U.S. yield curve. They say The underlying recession signals traditionally embodied by a yield curve inversion,namely high policy interest rates relative to long-term expectations of policy rates, and falling bank profitability and credit availability, are absent.Yield-curve flattening does nevertheless emphasize that the U.S. economic cycle is in a late stage of expansion. The yield curve has been a good lead indicator of U.S. recessions. Each of the past nine recessions were preceded by a yield curve inversion when 10-year yields fell below one-year yields. The recent narrowing of the 10-year minus one-year spread to its lowest level since summer2007 has prompted a debate about potential economic implications. The yield curve has not yet inverted except at some shorter tenors. We forecast the U.S.10-year yield to end this year at 3.1% from 2.85% today and predict a year-end Fed Funds rate of 2.5%. We also see both the Fed Funds rate and 10-year yields rising broadly in tandem through 2019. Even if the yield curve inverts, there are reasons to discount this as a ‘red flag.’ The historical time lags between inversion and recessions have been highly variable, from six months to up to two years. The correlation between the yield curve and GDP growth has been far from perfect. While each recession has been preceded by an inversion, not every inversion has been followed by a recession. The relationship through themid-1990s was very poor. Since early 2010 there has been a steady flattening while U.S. growth has remained broadly stable. Solid consumer income, private investment momentum and an aggressively expansionary fiscal stance should all support strong U.S. GDP growth in the next 12 months. Nevertheless, the flattening yield curve is consistent with the U.S. economy being at a late stage in the cycle, with an unusually long expansion to date and growth currently well above Fitch’s estimate of U.S. supply-side growth potential of1.9% Fitch expects U.S. growth to tail off quite sharply in 2020 to 2.0% (from2.9% in 2018) as macro policy support is removed and supply side constraints start to bind.
Finally, Oil was down 2.68% sitting at 51.17. Gold futures fell 0.43% to 1,242.05. Bitcoin continues to languish, down a further 3.47% on Friday to 3,231.4.
Brexit uncertainty raged on after Prime Minister May survived a vote of no-confidence in the week, but then made little progress in negations in Brussels suggesting that the final decision will come down to the wire. The FTSE 100 was down 0.47% to 6,845.17. The uncertainty continued to drive UK financials lower, with the FT Finance index down 0.51% to 617.71. The British Pound US Dollar was down 0.39% to 1.2587. The Euro US Dollar was down 0.49% to1.1305. Deutsche Bank, the bellwether Germany bank was up 0.11% to 7.744, still in red alert territory.
Locally, the market had another bad week, with the local fear index up3.37% on Friday to 16.908, mirroring the US VIX. The ASX 100 fell 1.05% to end at 4,612.40. Banks had another bad week, and not helped by the Reserve Bank of New Zealand’s Friday release of its plans to lift capital requirements higher,ahead. The ASX Financial Index was down 1.63% on Friday to end at 5,493.29. Westpac was down 2.20% to 24.88, ANZ was down 2.71% to 24.80, NAB was down 1.7% to23.69 and CBA was down Bendigo Bank was down 0.48% to 10.33, Bank of Queensland was down 0.31% to 9.56, while Suncorp rose 0.08% to 13.02. Macquarie Group was down 0.72% to 113.18, Genworth the Lenders Mortgage Insurer was down 3.75% to2.31, while AMP rose 1.75% from its lows, to end at 2.330. Aggregator Mortgage Choice put out a profit downgrade warning, saying mortgage settlements will be10% lower than last year and ended at 1.11.
The Aussie ended at 71.72 against the US Dollar, down 0.75% on the day,and continues its weak trend, having fought a little higher in the week. The Gold Aussie Cross was up 0.41% to 1,725.87. The Bitcoin Aussie Cross was 9.89%lower on Friday to 4,180.9.
So really no good news from the markets, and no reason to think recent falls will reverse. And its worth noting that bank funding costs, as represented by the Bank Bill Swap Rate are on the move, and higher, again – so bank margins will be under more pressure.
Household financial confidence slide again, using our household surveys to end November 2018. The overall index fell again, down to 87.8, well below the neutral setting, and close to the record low we measured in 2015. Property owning household segments continue to react to the changed environment, as prices weaken, and mortgage availability tightens. Around half of all mortgage applications are being rejected due to the tighter conditions. Property investors are now very concerned about their financial status, and owner occupied households confidence continues to drift lower. That said, those not owning property – who are renting or living with family or fields are still even less confident so it is still true that property ownership bolsters financial confidence. We discussed the details in our post Household Financial Confidence On The Blink- Again!
The most astonishing news this week came from the Council of Financial Regulators. In their first ever release of minutes from their quarterly meeting, they belled the cat, arguing that the banks were now being too strict in their lending standards, and should lend more. In effect this means the shadowy power, when the Treasury, ACCC, ASIC, APRA, ATO and the RBA – chaired by the RBA – is endorsing the predatory mortgage lending which has become a feature of the Australian market – and implicitly condoning the poor practice exposed by the Royal Commission and the ACCC.
Let’s be really clear. Debt it too high. People have been lent too much,which is why the debt ratio is so high, and this has created the biggest risk to our economic future. Now the banks are running scared, having being remained what the law says about responsible lending and have adopted more rational lending policies. Better late than never. Yet even now, mortgage credit is still growing at more than 5%, and clearly the RBA wants more. This is being funded by yet more offshore funding. Over the year to September 2018,Australian banks’ offshore borrowings rose by $62 billion (+6.8%), with Bonds(+$44 billion) and Loans (+$14 billion) driving the rise. In fact, this lending has been behind the property price rises. But this creates its own risks. All of this is so far from what the RBA is there for – to control inflation, driven employment and safeguard our prospects – it’s not funny.
And they then also said that if needed they would cut the cash rate and print money (in answer to a specific question). Frankly, we need a Royal Commission into the RBA. It has truly lost the plot, and we should add in ASIC and APRA too. Personally, the only team in town who are truly looking after our interests is the ACCC. Their report on mortgage pricing, which is discussed in our post “The Great Mortgage Rip Off”makes the point that loyalty is not rewarded, mortgage discounts are deliberately obtuse, and it is possible to save loads by shopping around, but that processes is hard to do.
The APRA data for the quarter, which we discussed in our post Home Price Falls Accelerate – And Will Bank Capital Be Impacted? shows that investment lending and interest only lending is down, but that more loans are being written outside normal underwriting criteria. We also argue that as home prices slide there are implications for bank capital – and of course underwriting standards need to adjust to potential falls, with higher loan to value loans less available.
And the RBA also this week endorsed Australian equities, making the point that when interest rates go down, share prices tend to increase, and this increases the wealth of households who hold those equities. In addition, over the long run,equities have been worth much more to investors than other investment options:they have returned about 5 percentage points more than long-term bonds on average each year. Yet the equity market is more volatile than many other markets, so contains more risks. The ASX is bank-heavy and the financial sector more broadly makes up about a third of the exchange by market capitalisation. And finally, on a price-to-earnings ratio basis, Australian equities are not showing signs of heightened valuations. Perhaps they should have added that until recently about half of all dividends came from the finance sector, though that may change in the next few years given the slowing lending market, and the focus on wealth management efficiency and fairness. And they should have shown the distribution of large (international) investors versus smaller local “Mum and Dad” investors who are at structural disadvantage in the equities market.
The Reserve Bank in New Zealand is also encouraging more household debt,to stoke the economy, as I discussed with our New Zealand Property Expert Joe Wilkes this week – See “Flipping And Flopping In New Zealand”. But they also shook the market this week with a discussion paper in which they consult on proposals to lift the capital held by banks in New Zealand. The expected effect on banks’ capital is an increase of between 20 and 60 percent. This represents about 70 percent of the banking sector’s expected profits over the five-year transition period. They expect only a minor impact on borrowing rates for customers. You can read the details in our post RBNZ To Lift Bank Capital Requirements.
CoreLogic data released this week also shows a fall in prices. Values in Sydney are on average now down 10% from their peak, 15% in Perth and 6% in Melbourne. Expect more falls ahead. But as we say, the markets are quite different, as their data at the SA3 level shows. Some have done well this year,with annual rises of more than 16% in some areas of Tasmania, around 8% in the Woden Valley in the ACT, and 4.9% in Queensland’s Central Highlights.
But the same is true in the falling markets, with areas in Queensland down more than 15% this year, and some areas in NSW not far behind, for example Pennant Hills. And many areas of New South Wales down more than 10%, including Liverpool, Parramatta and Hunters Hill, as well as in Victoria – for example Bayside and Manningham. And we see the falls continuing in many areas if WA and QLD. 28 of the top falls were in NSW.
They also reported that there were 2,631 homes taken to auction across the combined capital cities last week, returning a final auction clearance rate of 41 per cent. The weighted average has continued to decline over each of the past four weeks, surpassing the previous week as the lowest recorded since October 2011. Last year, a significantly higher 3,371 capital city homes went to auction returning a clearance rate of 59.5 per cent. Melbourne’s final auction clearance rate came in at 43.8 per cent last week. There were 1,283auctions held across the city, down from the week prior when 1,378 Melbourne homes were taken to auction and a lower 42.7 per cent cleared. In Sydney, a final auction clearance rate of 41.3 per cent was recorded across 870 auctions,down from the previous weeks 41.6 per cent when 937 auctions were held. Across the remaining auction markets, Canberra returned the highest final clearance rate of 43.7 per cent, while only 22.4 per cent of Brisbane homes sold at auction last week. Of the non-capital city auction markets, Geelong returned the highest final clearance rate of 47.3 per cent across 61 auctions. The combined capital cities are expected to see a lower volume of auctions this week with CoreLogic currently tracking 2,285 auctions, down from the 2,631 held last week and lower than the 2,890 homes taken to auction one year ago.
We can also see that vendor discounting is growing, around 8% in Sydney,6% in Brisbane and 8% in Perth. Darwin holds the record at more than 9%. And time on market continues to rise with Darwin units on the market for more than 100 days, while Sydney and Melbourne are close to 40 days now (and in some cases we know properties are withdrawn when they do not sell). And the CoreLogic transaction volumes are also down. Over the 12 months to November 2018, turnover of national housing stock was recorded at 4.6%. Over the nine years shown on the chart it was the lowest turnover of stock and was down from 5.3% the previous year. Turnover has been trending lower since it was recorded at 6.3%in mid-2015.
All this points to more falls in values ahead.
Shane Oliver from AMP, said this week “For years we have felt that the combination of surging household debt and surging house prices was Australia’s Achilles heel in that it posed the greatest domestic threat to Australian growth should it all unravel. But we also felt that in the absence of a trigger it was hard to see it causing a major problem. However, over the last year a combination of factors have come together to turn the housing cycle down and create a perfect storm for house prices in Sydney and Melbourne. These include:poor affordability; tight credit conditions; a surge in the supply of units; a collapse in foreign demand; borrowers switching from interest only to principle and interest loans; fears by investors now that changes to negative gearing and capital gains tax if there is a change of government (assuming Labor can get it through the Senate) will reduce future demand for their property investment;all of this is seeing the positive feedback loop of recent years (of rising prices > rising demand > rising prices etc) give way to a negative feedback loop (of falling prices > falling demand > falling prices etc). This could all be made worse if immigration levels are cut sharply.
Auction clearance rates have fallen to record lows – which for Sydney and Melbourne are consistent with further price falls running around 8-10% pa –and housing credit continues to slow. He concludes House prices in Sydney and Melbourne will likely have a top to bottom fall of around 20% (10% in 2019) and national average prices will likely have atop to bottom fall of around 10%. This will have an impact on growth, of around0.4% directly, plus more indirectly. He calls out a reduced demand for household equipment retail sales as dwelling completions top out and decline; a negative wealth effect on consumer spending of around 1% pa. Rising housing wealth helped drive decent growth in consumer spending in NSW and Victoria as households reduced the amount they saved as their housing wealth rose. This is now likely to go in reverse detracting around 0.6 percentage points from GDP growth and there could also be a feedback loop into further bank credit tightening if non-performing loans and defaults rise. Taken together these could detract 1-1.2 percentage points from growth over the next year. Barring a deeper property slump, a recession is unlikely.He concludes.
I hope he is right.
So we think there is more downside risk both locally and internationally, and we suspect there will more falls ahead. However, it is too soon to pick whether things will just grind lower, or whether a rout is coming.We need to keep watching the data for more severe and consistent falls which would signal the latter. This could move quickly if the skids really start rolling.
Before we sign off, a quick reminder, our final live stream event will be next Tuesday the 18thof December at 8 PM Sydney Time. During this session we will review the year,and also discuss the outlook for 2019. The event is already scheduled on YouTube, here is the link so you can add a reminder, and do come and join the livechat, where you can ask questions in real time, or send me a question beforehand. I look forward to seeing on.
