Keep an eye on the bank pressure point
There is an old saying in the stock market business that life in the market is never as good as it looks during a boom, and it is never as bad as it looks in a slump. That philosophy has made people a lot of money.
And, right now, we are looking at a fascinating example of that basic principle in our banks and I think in the Downer EDI takeover bid for Spotless. In addition, it is going to apply to the Trump presidency. But let’s start with the banks.
What a fantastic money making exercise they are now engaged in. The bank regulator APRA is telling the banks they must not increase their investor loans by more than 10 per cent a year. But the demand for investor loans is rising in excess of 10 per cent a year.
So the banks can increase their interest rates on investor loans – claiming it is a funding cost increase, which has little validity – and not lose market share. All the banks are in the same boat, so it is simply an open ticket to lift their margins.
And the Reserve Bank is very happy about this because, if interest rates go up in the investor sector, it doesn’t put pressure on the official rate which affects the currency. Everyone is happy for the moment.
Banks under the microscope
But under the surface there is danger. First, there is the combined view of the Reserve Bank, ASIC and APRA that there is reason for great concern about the level of dwelling prices in Sydney and, to a lesser extent, Melbourne. It is rare for the three bodies to be so united, but currently they are all in the business of trying to convince would-be dwelling buyers that the prices are too high.
But if they are successful and prices come down, it will affect the solvency of many bank housing loans. Frankly, it will take a lot more than verbal warnings to bring house prices down. More dangerous for banks is the fact that in the Parliament amongst the Labor Party and the Senate cross-benches there is rising anger about the banks. Bank management has blundered from scandal to scandal, and it is not a good look.
Elements in the ALP want to split the banks up. And it is just possible that that idea will gain momentum. If there is an enquiry – or even the quarterly appearances of bank CEOs to the parliamentary committee – there will be much anger when the banks report higher margins as a result of the investor loan rate increases. It will probably all blow over, but it is a dangerous game for banks.
Rates and house prices
At the moment the Trump rollercoaster has been halted by problems with Obamacare. The expectation is that the rollercoaster will get back on the rails, so once again US interest rates will rise. That's probably right, but there are market fears that the turmoil in Washington will stunt growth and delay interest rate rises.
In Australia we are vulnerable to global rate rises because our household sector is borrowed to the hilt.
Any increases in Australian interest rates above 1 per cent will affect house prices and bank bad debts. None of the above is a signal that right now you should sell all your bank shares, but Australians have a much higher percentage of bank shares than any other nation and that high percentage is prevalent amongst retail investors and self-managed super funds. The older generation desperate for income to pay their pensions have found yield in bank stocks irresistible and concentrated their investments there.
And that concentration was multiplied by the rising bank stocks and the difficult time our miners experienced.
The graph below shows just how big our bank exposure is, and if you include non-bank financials it completely dominates the Australian investment scene. That means if something goes wrong in the banking sector, and there is plenty of scope for that to happen as you can see, then Australian savings are going to be savaged.
As many of you know, some time ago I lightened my bank exposure and I was far too early because bank shares have performed extremely well.
But I would urge Eureka Report readers to have another look at this, because we have a lot of eggs in the bank basket. I fully realise the income problem created by any reduction in the reliance on bank shares.
Downer’s challenge with Spotless
And now we come to Downer EDI and Spotless. The sums are good, but Spotless is a very difficult company to manage. Over the decades it is a company that has done well for periods and then gets into all sorts of bother, only to be rescued. Whether Downer has the management ability to make the Spotless acquisition a success is a major question mark.
Wesfarmers developed skills in managing different businesses, but the principle of having a fluctuating business of mining and offsetting it with the totally different business of providing services is a strategy that carries considerable risk. Downer may or may not get Spotless, but if it does Downer shareholders need to assess very carefully that their management has the skills to run a very difficult business.
Trump’s agenda hits a stumbling block
The Trump saga rolls on. The Americans got themselves set for higher US rates, a high American dollar, higher share prices etc. But the legislation requiring the lower taxes and other assorted measures requires first the abolition of Obamacare. This is not easy to do because the Republicans came to office in the very states that are among the major beneficiaries of Obamacare.
Many US voters didn’t know what Donald Trump was talking about when he promised to abolish Obamacare. They didn’t know medical benefits by that name. But they are starting to understand, and that is starting to make a lot of Republicans very nervous.
Trump the dealmaker will likely find a way around the problem, but that will likely delay his tax agenda and that makes the market very nervous. This week we saw a rush to buy US bonds because clearly some in the market fear that the growth outcome will be less than expected, so interest rate rises will be less than expected.
Shane Oliver, AMP Capital
Investment markets and key developments over the past week
- The US share market finally saw a daily decline greater than 1 per cent for the first time since last October and this dragged other share markets down to greater or lesser degrees over the last week, although Eurozone and Chinese shares managed gains. Worries about whether President Trump will be able to pass his pro-business agenda of tax cuts, deregulation and infrastructure spending were the main driver but high levels of short term investor optimism has left the market vulnerable. The risk off tone in markets saw government bond yields decline, credit spreads widen and commodities excepting gold weaken. The $US also fell, but this didn’t stop a decline in the $A.
- Will Trump’s pro-business agenda pass Congress? Can the Republicans get their act together? A common concern seems to be that if Trump and the Republicans can’t pass their Affordable Care Act (or Obamacare) replacement, what hope have they got for the bigger measures around tax cuts, etc? This reasoning is too simplistic. Obamacare had three key elements: Federal spending on healthcare subsidies; tax hikes to pay for them; and regulations imposed on health insurers. The Republican House leadership have reasoned that if they reverse the spending increase and tax hikes then their Obamacare reform could pass through the Senate as part of the budget reconciliation process which just requires 51 votes (out of 100 Senators) which they have rather than the normal 60 votes (which they don’t have) if they push for removal of regulations as well. The sticking point is that the Freedom Caucus (a group of conservative tea party sympathetic republicans in the House) want to remove the regulations too. So there is now a risk that any reform bill that passes the House may not have the votes needed to pass the Senate. But a failure of the Obamacare reform to pass does not mean that Trump’s pro-business reforms will be stalled. The Freedom Caucus, the broader Republican Party and Trump all want lower taxes and less regulation and would prioritise this as they want to “starve the beast” of government as they see it. The GOP also realise that given the risks around Trump’s presidency (investigations around links to Russia, risk of eventual impeachment) and the risk they lose the Senate in next year’s mid-terms mean that they only have a small window to get through the reforms they want. So they are not going to let repealing Obamacare get in the way of their small government agenda. So the bottom line is that Trump’s pro-business agenda remains on track.
- The tragic events in London perpetrated by another deranged nutcase provide another reminder of the ongoing terrorist threat. But as has been the case with recent terrorist attacks the impact on investment markets was minor as investors have become accustomed to them (much as occurred a generation or so ago with the IRA and other terror attacks in Europe) and their economic impact remains insignificant.
- In Australia, signs continue to point to an imminent fresh round of macro prudential controls to slow lending to property investors and further tighten home lending standards. The minutes from the RBA’s last Board meeting clearly indicate that it has become more concerned about a “build-up of risks associated with the housing market” and there is reportedly a special regulatory working group – composed of the RBA, APRA and ASIC – looking at the issue. Likely measures include a cut in the cap on annual growth in the stock of investor lending to 5-7 per cent from 10 per cent now (it’s been running at 8.5 per cent lately) and tougher interest rate tests for borrowers. The last round of macro prudential measures combined with significant negative media publicity at the time worked very well in late 2015/early 2016 in slowing the Sydney and Melbourne property markets and would have kept working if they were tightened again around six months ago when it became clear that the initial impact was wearing off. Sure macro pru is second best to rate hikes to slow property prices, but in the absence of more fundamental solutions it’s the best option at a time when its way too early to hike rates given the state of the overall economy and property markets outside of Sydney and Melbourne.
Major global economic events and implications
- US data was mixed with weak existing home sales and home prices but a large gain in new home sales. Jobless claims rose but remain historically very low.
- Eurozone consumer confidence rose and is about as high as it ever gets.
Australian economic events and implications
- In Australia, official ABS home price data confirmed that the housing market has hotted up again after a soft patch in late 2015-16. Private data points to a further acceleration in the first few months of this year. Sydney and Melbourne remain the main culprits though with prices still trending down in Perth and Darwin and only seeing moderate growth in other cities. Meanwhile, September quarter data showed an uptick in population growth to a solid 1.5 per cent year on year or 349,000 people highlighting a key source of underlying property demand.
What to watch over the next week?
- In the US, expect consumer confidence to have remained high and continued growth in home prices (both Tuesday), a bounce back in pending home sales (Wednesday), modest growth in personal spending and core consumption deflator inflation remaining around 1.7 per cent for the 12 months to February (Friday).
- Eurozone economic confidence indicators (Thursday) are expected to remain solid and core inflation is likely to have remained unchanged at 0.9 per cent year on year in March.
- Japanese data for February to be released Friday is likely to show continued strength in the labour market, strong industrial production but weak household spending and core inflation remaining only just above zero.
- China’s manufacturing conditions index for March (Friday) is expected to slip back to 51.5 but retain most of its recent gains.
- In Australia, expect credit growth (Friday) to remain moderate but the focus will likely be on a further acceleration in lending to property investors. Data on new home sales and job vacancies will also be released.
Shane Oliver is head of investment strategy and chief economist at AMP Capital.
Craig James, CommSec
Quiet week ahead in Australia
- As was the case in the past week, there are no ‘top shelf’ indicators due for release in Australia in the coming week.
- The week kicks off on Tuesday when Roy Morgan and ANZ release the weekly consumer confidence reading. Aussies consumers have become a bit more downbeat of late with the latest confidence reading the lowest in eleven months. No doubt the discussion about risks in the housing market have spooked some. The question is whether the significant amount of home building underway at present gives way to localised oversupply, driving down home prices.
- Certainly home prices have lifted significantly in places like Sydney and Melbourne. And more homes (especially apartments) are being built. But interestingly the latest data suggests that existing home buyers aren’t selling up, and that is another factor intensifying demand for the number of properties on the market.
- In the December quarter, property settlements in Sydney were the lowest for any December quarter in the past 11 years. And while Generation Y are getting their own places in other cities and states, in Sydney the number of people per household remains relatively stable and higher than other cities.
- On Tuesday there is speech from Reserve Bank Deputy Governor Guy Debelle to be delivered to the FX Week Australia conference. Investors will watch for any new warnings about the state of play in the housing industry.
- On Thursday, there are three items of note. First, the Bureau of Statistics releases the Finance & Wealth publication. Second, the ABS issues data on job vacancies. And third, the Housing Industry Association releases data on new home sales.
- The Finance & Wealth publication includes a raft of indicators such as the share of bonds or equities held by foreign investors; the average wealth level of Aussie families; and cash holdings by consumers, businesses and fund managers. The data should show that wealth is at record highs but it will interesting to see how much debt has risen in comparison.
- The job vacancies data is a key forward-looking gauge on the job market, like job advertisements. The difference being that vacancies data is only released quarterly while job ads is issued monthly. In broad terms, vacancies and ads are both at, or near, 5-year highs, pointing to positive prospects for employment.
- The home sales data is important in getting a sense of the supply component of the supply-demand equation. While home sales eased 2.2 per cent in January, the number of sales remains comfortably above both 5-year and 10-year averages.
- And on Friday the Reserve Bank releases the private sector credit data – effectively measuring the changes of outstanding lending. The data has proved a little volatile in the past few months, surging 0.7 per cent in December before inching 0.2 per cent higher in January. On average, credit has been growing around 0.4-0.5 per cent a month and similar growth is tipped for the February data.
Quiet times continue in US and China
- In the US there are healthy offerings of new economic data, but the indicators are more ‘second tier’ rather than top shelf. But there will be at least 10 more speeches by Federal Reserve presidents and officials to digest. In China the purchasing manager surveys will be issued on Friday.
- The week kicks off on Monday in the US with the release of the Dallas Federal Reserve manufacturing business index.
- On Tuesday, there are a number of indicators to watch. Advance readings on international trade and inventories, both for February, are scheduled. The influential Richmond Federal Reserve survey is also released. And the usual weekly data on chain store sales is also issued.
- But of more interest on Tuesday will be the March consumer confidence results together with the Case Shiller survey of home prices for January. Consumer confidence lifted to 15-year highs In February so there may be some retracement in March. And home prices may have lifted 0.8 per cent in January after a 0.9 per cent gain in November.
- On Wednesday in the US, the pending home index is released alongside the usual weekly data on housing finance. And on Thursday in the US the usual weekly data on jobless claims is released alongside the final estimate of economic growth (GDP) for the December quarter. The US economy is growing near a 2 per cent annual pace.
- On Friday in the US, data on personal incomes and spending is issued with the Chicago purchasing managers’ index. Economists think incomes rose 0.4 per cent with spending up 0.2 per cent. The spotlight will also shine on the Federal Reserve inflation measure – the core personal consumption deflator. Annual price growth is 1.7 per cent. Any easing in the inflation estimate and the Fed can take time in lifting rates, weighing on the greenback.
- Also on Friday in China the National Bureau of Statistics releases the “official” purchasing manager surveys covering the manufacturing and services sectors.
- Total returns on Australian shares – dividends and share prices – have been consistently hitting record highs since mid-February. The All Ordinaries Accumulation index may be up just 3 per cent over 2017 but it is up by a more meaningful 16 per cent over the past year. In fact annual growth of sharemarket returns has been holding above 15 per cent for most of 2017.
- In terms of share prices, the Aussie sharemarket has under-performed in 2017, lifting around 2 per cent and is in 51st spot of 73 bourses. The US Dow has lifted around 6 per cent and is in 26th spot. Hong Kong and India have lifted around 10 per cent in 2017 and near the top of the ranking list.
Craig James is chief economist at CommSec.
Readings & Viewings
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