Share Market – Page 3

Iron Queen high on her own supply

April 28, 2015 by Jon Giaan

Iron prices have come back to ground, and give us a text book example of why boom and busts are such a regular feature of modern economic life.

The great iron reckoning is upon us.

And isn’t everyone freaking out about it. Woo boy.

You’ve got to feel sorry for WA Premier Colin Barnett (as much as you can feel sorry for any politician). He’s gone from riding the wave of endless revenues, to suddenly staring into a debt-pit deeper than one of BHPs mines.

And it’s all coming down on his head. There’s no passing the buck here. He was happy to have his signature all over the spending promises in the good times. Now he has to scrap those promises or put his signature on a seemingly endless line of credit.

If only he could have seen it coming some how.

But no, the whole iron ore community was taken completely off-guard.

Gina Rinehart was talking it up to shareholders and the mining industry last week:

“None of us predicted it would be as bad as this. Nobody was predicting – even the most conservative ones – the ore price crash.”

C’mon. Really?

In a commodity market prone to booms and busts – all the time – no one thought that prices might come back to earth?

And the correction hasn’t even been that dramatic. Prices are still above long run averages and well above where they were when the whole mining boom took flight.

So we’re not even talking about a ‘crash’ in prices. Really, we’re talking about a ‘normalisation’.

That’s a big difference.

And the claim that nobody saw it coming..? There’s a lot of commodity bears out there. It would not have been difficult to find a dissenting view. Punch in ‘iron ore price crash’ into Google and you would have found a bunch of colourful opinions.

So is what she’s really saying is that no one on the inside of the industry saw it coming.

But again, that just seems difficult to believe.

Gina is a smart cookie, and she’s proved her mettle more than once in the business world.

(Gina has also become one of the most controversial figures of the century so far. Rigthly so. But if you’re looking for a space to critique her figure or fashion sense – without applying the same lens to Sam Walsh’s taste in suits or Clive Palmers stately paunch – take it elsewhere. It’s getting old.)

But for all Gina’s smarts, is she really asking us to believe that the iron price normalisation came totally out of the blue?

The dynamics behind the price normalisation aren’t complex.

In fact, it’s as basic as you get can it. It’s economics 101.

It’s supply and demand, pure and simple.

On the supply side, the industry just went a bit bananas. They poured billions into additional supply on the belief that the golden days of Chinese steel mills paying whatever it takes would roll on forever – no matter what collective supply response was brought into play.

But now that that supply is coming on line, there’s so much of it that Chinese steel mills can shop around.

‘I’m not paying $180 a tonne! I can get it for a third of that price on ebay.’

Over-supply is creating a fall in prices.

But even then it’s not really an ‘over’-supply, as such. This is just the market doing what it does.

If demand is stronger than expected (the sudden realisation of China’s appetite in 2007), prices go up. Higher prices bring more supply to the market. More supply puts downward pressure on prices. Prices normalise.

And this is exactly what’s happened. It’s vanilla market functioning.

And so really, no one in the mining industry thought that this was a possibility?

And that’s before you take into consideration the fact that almost all of your demand is coming out of single state-run economy. A sudden shift in demand must always have been a possibility.

But while I don’t really buy that no one saw it coming, I think it’s certainly true that no one was talking about it.

Because there was no incentive to. BHP, RIO and the boys were pumping the ‘endless Chinese demand’ story because it played well to their shareholders. Share prices increased.

Executive bonuses soared.

“Possible price normalisation” was just a story they didn’t want to hear.

And BHPs and Rio’s projections of demand (which were obviously from a biased source) quickly became accepted as fact. Analysts wove it into their narratives about valuations.

Governments built into their models of projected revenues.

And investment banks and fund managers fell over them selves to get a piece of the action.

They were all getting high on their own supply.

And voices of reason were marginalised or ridiculed.

And the self-congratulatory euphoria has given us this. A $10 billion dollar mine bringing massive supply into an already saturated market where the super-sized profits have long since disappeared.

Gina’s Roy Hill will probably make money in the long run. But it will be nothing like the returns shareholders were promised.

If I was a shareholder I’d be pissed. But as Gina (and all of them) are saying, don’t blame me. It’s a shock to all of us.

Who would have imagined that the dynamics of supply and demand would have normalised prices?

Who could have thought?

This is why we have economic cycles in every asset class. People get excited. They start getting high on their own supply. But eventually, reality catches up with them.

And this is what creates timing opportunities. It’s why there’s money to be made being fearful when others are greedy, and greedy when others are fearful.

But you’ve got to keep your wits about you.

The American flip-flop is here

March 10, 2015 by Jon Giaan

The American flip-flop is here, our economic model is broken. Where are you going to hide your money?

Take a look at this chart here. This is what the ruins of the modern economic model looks like.

This compares the unemployment rate – a generally broad measure of how the Australian economy is tracking, with the ASX – the value of the share-market. Theoretically that should also be a pretty good indicator of how the economy’s doing.

But right now, the two are going in different directions. Unemployment is creeping up, leaving nervous beads of sweat of Joe Hockey’s forehead. But the ASX is close to posting record highs.

It’s a bit odd, isn’t it? So what do we believe?

a) A count of the number of people actually making things; or
b) A semi-fictional measure of company value that’s known for wild and erratic fluctuations.

(Answers at the end of the book.)

Something funny’s going on. I smell like a fish.

But hang on, haven’t we seen this before?

Well, yes, we have.

This is the ol’ American flip-flop – the bad news is good news inversion.

Take this chart here. This compares the American S&P 500 with “US Macro” – an index of positive or negative surprises in US data releases.

Same story there. Overall there’s a brighter tone to the US economy, but there have still been a number of downside surprises.

Has it stopped the share market? Oh no! It’s the running of the bulls in Wall Street right now.

There’s only one thing to blame for the flip flop – liquidity.

Through the Quantitative Easing era, the US Fed’s response was to leave the money taps on full-bore. Effectively printing money and throwing it around.

No one really knows exactly what QE did. Maybe it saved the economy. Maybe it didn’t.

But one thing for sure is that it gave share prices a boost.

Why? Because the Feds gave money to the banks. The banks gave money to companies. Companies bought back their own shares and gave their executives a bonus.

And that, seems to be about it.

In theory, companies should have invested the money – built a new factory, employed some more workers, refurbish the staff kitchen. That, theoretically, should have given output a boost.

But it didn’t work out that way. Companies didn’t expand production. They paid down debt, and bought back their own shares – driving up their share prices in the process.

And so the harder the Fed leant on the printing press– the higher share prices went.

And so if the economy posted some bad news – say a worse than expected unemployment rate – the markets knew that the Fed would likely send them some more money – and so share prices spiked.

Bad news was good news.

But if there was a positive surprise, markets worried that the Fed might take the punch bowl away – and share prices dropped.

Good news was bad news.

This is the American flip flop.

And economists don’t get it.

Because companies aren’t doing what they’re supposed to do. In the economists models, firms borrow to invest in productive capacity, not buy back their own shares.

(The government’s strategy seems to be to keep throwing money at them until they start behaving like the models say they should.)

IBM is a case in point. After WWII, IBM was an innovation powerhouse – it was behind such marvels as the credit card, the floppy disk, and the ATM. But things got tough in the nineties, and went on to shed 180,000 workers in the next ten years.

But did shareholders suffer? Oh no. IBM managed to find billions of dollars to pay shareholders – much of it funded by debt. It was a trend that started in the 90s, and went into over drive in the QE era.

Between 2003 and 2012, IBM spent more on shareholder rewards — $130 billion — than it earned in revenue. In 2012 alone, IBM issued $34 billion in debt. Its rewards to shareholders that year: $38 billion.

Like much of corporate America, IBM borrowed money to boost it’s own share prices. Why?

It may have something to do with business in the 21st Century. There is massive productive capacity, and business niches are much harder to defend than they once were. There’s a lot more churn in the S&P 500 than there used to be.

So maybe firms just don’t see as much value in investing in new capacity or new ideas.

It may also be that CEOs are just greedy bastards. Most have much of their pay in stock, so if the share price goes up, they benefit directly.

A totally misplaced incentive.

But whatever the case, until corporate America starts spending again, the US economy will struggle to get into its higher gears.

But should we be concerned that the flip-flop seems to have landed on our shores? That’s what the first chart shows. People think the RBA is going to cut rates and keep cutting rates, pumping liquidity into the system…

You beauty. Share prices spike.

This isn’t a good thing.

This is a break down in the basic economic model – the model that’s driven growth over the past 50 years. It’s also the tombstone on top of monetary policy as we know it.

So what do we do about it?

Well, as I’ve said before, if the government is pumping up asset prices – if money printing is about to cause a massive spike in asset inflation – the thing you want to do is obviously own assets.

Now you might get into the share market, but it’s probably going to be a much wilder ride.

I’ll be sticking with property. Liquidity from all over the globe is making its way into the Australian property market right now, and its only just getting started.

The RBA is about to throw trillions more at the Australian economy.

And my bet is it will be years (and long after a major boom in property prices) before they realise that their model is broken.

Are you ready for an interest rate surprise?

February 3, 2015 by Jon

Is the RBA about to drop a bombshell on us? A quick look at the back-story data shows us they’ve got every reason to cut if they want to…

I’ve been saying for a while that I expect one or two rate cuts this year, but there’s every chance we could see one this afternoon.

Really? It’s be a bit of a radical move, but Glenn’s not afraid of getting radical. And he’s got all the justification he needs.

First up, there’s inflation. Inflation is trending lower, and on the core measure (taking out volatile items), it’s just a fraction above the lower bound of the RBA’s target band of 2-3%.

They’ve got a country mile of head room. But this measure excludes petrol prices, which have dropped recently and driven inflation a lot lower. That won’t show up in the core measure straight away, but petrol is one of the fundamental building blocks of the economy. Lower prices, mean sooner or later, the price of most things will start to fall.

So that’s the inflation situation. We’ve only just got our head above the lower-bound, but there’s a heap of downward momentum coming our way. There’s enough of a story in this one chart alone to justify a rate cut tomorrow if they want to.

But what about the economy? How are we doing? Normally you only see rate cuts when the economy’s not going so great.

In my view though, the economy is holding up ok – well, even.

To start with petrol prices have given every thing a whip along. This has a big impact on the entire economy, because suddenly the cost of shipping stuff all over the place just got a whole lot cheaper. The physical side (less so for the services sector – real estate, finance etc….) of the economy just got a big shot in the arm.

But it has a huge and direct impact on consumers. The average weekly petrol bill has fallen to levels not seen since the aftermath of the GFC.

Household budgets just got a lot more wiggle room. We should see a bounce in consumer spending before too long.

How long?

Probably about 3 months if past form is anything to go by. This chart here tracks consumer sentiment and petrol prices (fast-forwarded by 3 months, and inverted.)

There’s a pretty tight relationship, and that makes sense because petrol makes up a considerable part of household budgets.

So we should see a boost in retail spending soon enough. But retail spending is already holding up well.

Towards the end of last year retail sales growth bounced up above averages of the past four years – where they were growing at just 2.7% a year, to around 6% pa. This is the kind of growth we saw in the boom years of the 2000s.

At the same time, record-low interest rates have reduced household debt servicing burdens.

Household debt as a percent of disposable income remains at record highs, but all that matters is whether households can afford those levels of debt. And one of the big reasons why they’ve been able to afford them up until now is because of falling interest rates.

Interest payments as a percent of disposable income have already been falling. Further rate cuts will drive them even lower.

This creates even more room in household budgets, and should also help give consumer spending a boost.

(This also, by the way, is a big boost for house price growth.)

At the same time, the production side of the economy is also doing pretty well – in part helped along by a lower Australian dollar.

The transition away from the mining boom has been one of the dominant themes over the past year or so. Would it be a gentle transition, or collapse and carnage?

Well now it seems that the gentle transition scenario is looking most likely. This chart here shows capex (capital expenditure = investment) in the mining and the non-mining sectors.

The downturn in mining investment is evident, but there is a clear upswing in the non-mining sector coming into play as well. And if we get more action on the consumer front, that should encourage even more investment.

It’s definitely not crash and carnage.

At the same time, our key export markets are going great guns. The US recovery is more solid every day, and China is also keeping it together.

A lot has been made of falling growth rates in China, but it’s mostly a statistical artefact. Big percentage growth rates are easier off a lower base. Even though growth rates are slowing, they’re still adding over a trillion USD to the economy every year.

That’s still big demand, and big demand for Australian commodities and exports.

So this is the picture that the RBA will be looking at. Inflation is stalling, but the economy is holding up well.

So what’s going to be the deciding factor?

The exchange rate. It comes back to that.

The RBA will be very happy with the recent falls against the USD, but you just can’t keep a good currency down – especially when other countries are tyring to drive their currencies down as well.

And Europe and Japan are throwing trillions at driving their currencies lower.

And if you look at what’s happened with the Aussie dollar, there’s been some good falls against the USD, but less so against many of the other major currencies. It’s even appreciated against the Canadian dollar and British Pound over the past month or so.

The RBA knows that in this environment, when everyone’s leaning hard on their currencies, you can’t just sit on the sidelines. You need to get in the game.

If they don’t move, and move soon, all the good work that’s happened could be undone.

So lower rates are coming. The only question is when…

Today?

A toothless tiger gets its teeth

December 2, 2014 by Jon

Foreign buyers are still a hot-button topic. The government inquiry plans to finally give the FIRB the teeth it needs. This should take the heat out of the issue, but won’t make all that much difference to a price-driven market.

The foreign property dollar story just keeps on giving.

Last week the AFR was running with the story that Malaysian developer UEM Sunrise has sold out a new high-rise residential tower in central Melbourne after just two weeks.

Three-quarters of the apartments were bought by foreigners.

92 storeys, 941 residential apartments and 210 serviced units – all sold, in just two weeks. Mostly to buyers in China and south-east Asia.

“Raymond Cheah, director of UEM Sunrise’s Australian subsidiary, said the sell-out was “breathtaking”, as the project launch had originally been slated for January next year.

“In UEM Sunrise’s 49 years of history in property development, the intensity and excitement of Aurora Melbourne Central is unmatched,” he said.

Mr Cheah said the project’s offshore buyers were attracted both by Melbourne’s reputation as the world’s most liveable city and its relatively low prices by international standards.

60 percent of buyers were investors…”

This issue is quickly approaching boiling point.

More and more people are trying to paint it us a foreigners vs local first home-buyers, us vs them type issue.

More and more people are running with the convenient argument that it’s the Chinese who are making homes unaffordable for our poor kids (never mind sloppy land-release strategies and loopy taxes).

And they’ve been able to make hay with these arguments because no one quite knows what’s going on. There’s a general feeling that a lot of Chinese buyers are rorting the system – particularly with non-residents buying existing properties, which is against the rules (new properties are fine).

And so into the mix comes some pretty handy work by the government, and the FIRB inquiry led by Kelly O’Dwyer.

Now, if you’ve been following my blogs you’ll know I’m not shy about sinking the boot into the pollies, but I’ll also tip my hat when it’s due, and the parliamentary inquiry into foreign property investment has pretty much nailed it.

(Though at the same time, it was bleedingly obvious, and they could have just read a couple of my blogs and saved themselves a whole bunch of time and money. But that’s the times we live in. The government gets the bleeding obvious right and it’s cause for celebration.)

Basically where O’Dwyer and the committee come out is that the basic framework around the foreign purchase of property is about right, it just needs to be enforced. And it seems that the FIRB just hasn’t had the resources, or the inclination, to do much about it in recent times.

As O’Dwyer says, “…these rules are not being properly enforced. We’ve had no court prosecutions since 2006 and not one divestment order issued by the Foreign Investment Review Board since 2007… I think that FIRB has definitely been asleep at the wheel.

We have been very critical in our report about the internal processes at FIRB for audit compliance and enforcement activity. But we have also, equally, said that FIRB does need to be beefed up and that penalties need to be stiffer and there needs to be more transparency…”

And so that’s the recommendation that’s on the table. Give the FIRB more money so that it can do its job. And the proposal for a small fee to be attached to the screening of foreign purchases to fund the FIRB’s work is essentially a good one I think.

There’s a couple of other key changes that should give the system more teeth and more integrity.

The committee recommends a civil penalty regime for breaches of the rules. They also recommend that fines be calculated as a percent of the property value, so they can still act as a deterrent to richer buyers.

One of the more novel proposals is that penalties should also apply to third parties who knowingly assist a foreign investor to break the rules. It’s not clear how’d you police that, but it should send a slight chill through real estate agents and developers targeting Asian buyers.

They also recommend that any capital gains made on the sale of an illegal property should be forfeited to the government, to stop investors seeing fines as just a ‘cost of business’.

None of this is rocket science and all the proposals are thoroughly sensible. And O’Dwyer deserves credit in wrangling those parliamentary cats to such a good outcome.

But how much difference will it actually make?

My guess is, not much.

The real problem here is that no one had any faith in the system, and that opened the way for doubt and hearsay, and at its worst, racist name-calling.

Giving the system teeth and actually enforcing the rules should help take some of the heat out of this issue. This is a good thing. I think most foreign buyers are playing by the rules.

And getting our house in order now means we can avoid some knee-jerk, populist freeze nf foreign buying somewhere down the road, which I think is where we were heading.

But I don’t think this is going to deter most foreign buyers. Remember in China, Australians aren’t allowed to own property at all. So enforcing Australia’s regime, which is still generous by comparison, is not going to send some message that we’re anti-foreign buying.

And I just don’t think illegal buyers were having that big an impact on the market.

But of course, it’s been difficult to know. Hopefully giving the FIRB more power should also help shed some light on what is actually happening.

And just a final note on the topic, MacroBusiness have put this chart together of Australian house prices in Chinese Yuan:

What it shows is that price gains over the past couple of years have been off-set by a falling Australian dollar (relative to the Chinese Yuan).

From a Chinese perspective, Australian property is still 15% below it’s peak…

Bargain?

ISIS terror pumps property prices

November 12, 2014 by Jon

Could terrorism be good for property prices? The world has subtly changed in the last 6 months, leaving us with a safe-haven vacuum. Is property about to step into the breach?

The tectonic plates of global finance are shifting.

And now everything is topsy-turvey. All the relationships we thought were iron-laws have turned on their heads. It’s an era that seems completely unpredictable.

And the dawn of the post-post-GFC era (I’m sure some witty journalist will come up with a name for it sometime… the Po-Po era?) seemed to catch everyone by surprise.

For example, imagine it’s 1994. Imagine I told you that an unpredictable and passionate fundamentalist Islamic army had emerged in the Middle East, and was cutting a violent swathe through Iraq and Syria.

Imagine that I also told you that at the same time, Russia was fighting a not-so-cold war with one of its neighbours, again in an important energy region. Europe is pissed and introducing sanctions, driving Russia further into bed with China, threatening to completely recast the balance of global power.

What would you expect to happen?

Well if it was 1994 you could bet the house on it. War in the Middle East would automatically feed through into a spike in oil prices. Major political dramas, like we’re seeing unfold now, would spark a rush to safe haven assets like gold. Gold prices would rise.

Over the last 30 or 40 years, gold and oil prices have effectively been a barometer of global peace and stability. Wars, terrorist attacks, even stern words on the political stage were enough to put a spike into oil and gold prices.

You could pretty much set your watch by it.

But not anymore. These are interesting times and the Po-Po era is uncharted waters.

Let’s start with oil prices.

From 2011 til recently, oil has traded in a very narrow range around US$110 a barrel. But then around June this year, around the time the ISIS offensive really took off, prices totally collapsed.

They’ve now fallen below $90 a barrel, for the first time since the end of 2010.

So ISIS is running one of the most media-savvy terror campaigns in history, the world’s seventh-largest oil producer is effectively under siege, and oil prices tanked?!?

You can count on one hand the number of analysts who saw that coming.

It’s pretty much the same story for gold.

Gold’s bull run (one of the most remarkable in any market) came to an end towards the end of 2011. It’s come off quite a way since then, but through most of this year, it looked like Gold had found a floor somewhere around $1300 / oz.

But take a look at the 12-month chart.

In July, gold prices started diving. That’s about the time ‘somebody’ shot down an international passenger plane and everyone started stressing about the Ukrainian crisis.

Gold prices firmed a little in October, but coming into November, prices went into free-fall again.

And yields? Oh wait, that’s right. Gold doesn’t have yields. There no income associated with owning it. It’s only an “asset” in the sense that you can speculate with it.

(ooh. Cheap shot, Jon.)

So what’s going on? Our barometers of peace and stability and pointing to perfectly sunny conditions. But almost exactly the opposite is true.

Has the world gone crazy?

Now it is true that there are some unusual fundamental factors at play in both the oil and gold story.

In terms of oil, it seems that ISIS is just forcing oil through unusual channels. Kurdistan in the north of Iraq normally has to sell oil through Baghdad. But they’re using the conflict to justify selling directly to Turkey – at a bit of a discount.

ISIS are also keen to sell oil from captured territories in order to fund their campaign (do you have any idea how expensive facebook advertising is?). They have no interest in turning the oil taps off.

All that means is that the oil is still flowing, some of it at a discount.

The oil price falls.

The main story in gold of course is the end of Quantitative Easing in the US, which wound up a few weeks ago.

QE was a massive money printing experiment, essentially. Pretty much everyone, following text-book logic, thought that all the money printing (peaking at $85bn a month!) would trash the American dollar.

Gold was the place to store value.

It was a seductive logic, but it just didn’t play out that way. The QE Zeppelin took off (against analysts expectations) flew in the air for a long time (against analysts expectations) and then landed again safely (again, against analysts expectations).

Suddenly, everyone who owns gold isn’t sure what they’re hedging against anymore. They’ve got all this money tied up in an asset that doesn’t generate any income, and whose ‘fair price’ is completely impossible to determine.

Gold is still 3x what it was worth in 2002. Is that reasonable? Who knows?

But whatever’s going on, Oil and Gold are just not the dependable safe-havens they used to be. They’re no longer your go-to guys in times of crisis. This is the new reality in the Po-Po era, and everyone knows it.

But that creates a safe-haven vacuum. Frightened money has to flow somewhere.

So, I’m going to offer the thesis that developed country real estate is the new safe-have of choice.

Since it’s real, and in limited supply (which is what gold has going for it) it’s a natural hedge against inflation.

A stable democracy like Australia also offers a hedge against political instability elsewhere.

And on top of that, it pays an income – in a world where decent returns are increasingly difficult to find.

This is a transition that’s in progress, but the amount of foreign interest in Australian property tells you it’s happening.

And if property becomes the new safe-haven of choice, that means that the next time ISIS launches a media offensive, or some other mad government announces they’re going to start dropping money from helicopters, we should see a spike in house prices.

Terrorism could be good for property prices.

This is the strange, strange world we live in.

Why the Chinese can’t get enough of Aussie property

August 7, 2014 by Jon

Chinese investment in Australia is only partly about life-style. The economics of investing in Australia is a much bigger motivation, particularly as the Chinese property market looks less and less inspiring.

Why do you think the Chinese love Aussie property so much?

We’ve all heard about what kind of impact Chinese buying is having. The latest I’ve heard is that they could account for one in ten new homes this year.

Ask you’re average Aussie and they’ll say it’s a no brainer. Australia is an awesome country. The weather’s sweet and we’re living the good life. Why wouldn’t you live here?

That might be true, but somehow I doubt it. The top investment destination for the Chinese is America. We’re second, Canada’s third, and the UK’s fourth.

If the leaderboard includes Canada and the UK, you can be sure they’re not investing for the sunshine.

Dig into a bit further and you’ll see that emigration intentions feature prominently in their motivations. A property is seen as a solid stepping stone to one day living here.

Educational opportunities for the kids also rate highly. Australia has some of the best universities in the world. It seems many Chinese are buying properties for their kids to live in while they’re at University.

But again, I don’t think this can be the full story. Owning property isn’t that big a leg-up towards permanent residency. And the kids could always rent.

So eclipsing and encompassing all these factors is the economics of investing in Australia. The Chinese know that property is always a solid investment, and Australia is still one of the best property markets around.

The Chinese have a long connection with property, and many of the wealthier Chinese, who are the ones looking to invest in Australia, have made their fortunes, in part, through property.

But now they’re casting their property net further afield.

And why’s that? Partly it’s just a basic diversification strategy. But the wealthy and switched-on Chinese know that opportunities at home are drying up.

Because the realty is that the Chinese property market is looking pretty grim right now.

On all accounts the market seems to be slowing sharply, and house prices have actually started falling – for the first time in 2 years. More than half of China’s 70 biggest cities had price falls last month.

Housing credit is also slowing and housing sales have fallen 15% over the past year. Unlike Australia, it seems their market is clearly moving into a down-phase.

As a result Goldman Sachs are predicting prices to fall 10-15% in most cities, and Chinese property will remain stuck in the wilderness for at least two years.

And the key factor driving the slowdown seems to be what the Financial Times calls a “chronic oversupply”. In Beijing, inventories of unsold homes have risen from 7 to 12 months supply in the past year.

And it’s worse out in the Tier 2 cities, where the overhang has risen to about 15 months, and worse still in Tier 3 and 4 cities, where it is a massive 24 months.

Because following the GFC, the Chinese loosened the monetary policy tap, cut interest rates, and encouraged a massive ramp up in Construction.

In 2007, China built around 6 million homes. By the end of last year, that had risen to over 10 million – an increase of 66%!

Now we’re often told about China’s rapid urbanisation experiment, with peasants coming off the farms and into the cities, and this is what creates the need for all these new homes.

But the truth of it is that the pace of urbanisation has peaked. And each year, the increase in the urban population gets smaller and smaller. In the 2000s, over 200 million Chinese made the cities their home. In the 2030s, it will be just 50 million. In the 2040s, China’s cities will have stopped growing altogether.

Indeed, according to the UN population projections, China’s population is actually expected to peak sometime around 2030, and start falling pretty rapidly after that.

And so it’s hard to shake the feeling that there’s a massive over-supply of housing, which will keep downward pressure on prices for years to come.

And the scary thing is that several years of falling prices could actually be the best case scenario.

The St. Louis Fed in the US compared the Chinese market right now, with the US market leading up to the bust there in 2007.

It’s a scary comparison.

In the 5 years leading up to 2007 in the US, and in the last 5 years in China, house prices in both markets increased about 50%. But it’s not prices that are the worry.

It’s the construction figures that are truly staggering. Housing under construction increased about 30% in the US, but it’s increased about 130% in China. That’s that massive construction boom we’re talking about.

But all that supply’s not being taken up. Vacant housing increased about 20% in the US. In China, vacant housing has increased close to 250%!

That’s starting to look like a massive over-supply, and it’s an over-supply that depresses prices, or worse still, could potentially trigger a collapse.

And so this is why the smart money in China is starting to cast their eyes further afield. They see the writing on the wall for the Chinese property market. The best-case scenario is that prices will remain sluggish and doughy over the foreseeable future…

… but with every chance it could end up being a whole lot uglier than that!

And so that’s where Australia comes in – a mature property market entering a boom phase, in a sophisticated and stable economy. AND, as I’ve written about many times, the Australian market this is still defined by a chronic undersupply and shortage of housing.

Savvy Chinese investors would be all over this.

Australia is an awesome country to be sure, but it’s not all about lifestyle.

It’s the economics that’s driving investment in Australia. And as China slows, you can bet on a whole lot more interest in Australia.

What do the banks know that we don't?

July 29, 2014 by Jon

The big-banks have started slashing their fixed-rate mortgages, so what do they know that we don’t? I reckon they’ve seen how the chips lie, and know that a interest rate cuts are pretty much a sure-bet from here.

CBA sparked a bit of a rate-cutting and media frenzy last week when it announced that it was cutting the rates on its fixed home mortgages to below 5%.

And the majors have all since followed suit.

What’s going on? Are we entering some golden age of competition between the banks as some people have suggested? Or do the banks know something that we don’t?

Call me a sceptic, but when the big four banks control 85% of the mortgage market, I’m not holding my breath for ‘rigorous and healthy’ competition. I think the best we can hope for is some sort of muted oligopoly – and that kinda seems to be what we’ve got – punctuated by shameless bouts of collusion and rent seeking.

The sceptic in me also thinks that this might also be more about media and PR than any fundamental change in bank business. CBA saw the writing on the wall, and so seized the first-mover advantage. It now gets the kudos of being the ‘market leader’ every time the media reports it.

And when you break it down, 70 basis points sounds like a lot – close to three regular rate cuts – but it’s not actually all that amazing. CBA’s sub 5% rate only applies if you bundle in your other banking with them, and there’s an annual fee of a couple of hundred dollars as well…

And for whatever reason, Aussies just don’t seem to dig fixed-rate mortgages. In NZ and Britain, they account for almost half the market. Here’s it’s like one in 5, tops. 18% of CBA’s book is fixed rate. ANZ is like 11%

But even then, I’ve seen some estimates say that 5-year fixed rates are an even smaller percentage again – something like 1% of their books.

So a cut to 3 and 5-year fixed rates is going to have a minimal impact on their business (and from a marketing perspective, is probably money well spent!)

The other point is that the banks can afford it. Their wholesale cost of funds has been falling for over a year now. There’s this cute notion that someone in your neighbourhood puts money in the bank, and then the bank lends it out to you, and that’s how banking works.

Maybe back in the stone-age. Now, banks borrow money on international money markets and lend it to you (though deposits also have a role to play).

And the price banks pay to borrow from these international money markets has been falling.

Like this chart here shows that the 3 year swap rate, has fallen from 3.3% towards the end of last year, down to around 2.8% now. That’s a full half a percent.

In fact, some analysts are saying that banks are currently enjoying the cheapest capital on offer since before the GFC.

(You might have noticed that the banks haven’t passed these discounts on to you…. How’s that competition working out for you?)

And so a few basis points here and there, tied in with some backhanded packages and fee hikes is no skin off anyone’s nose.

What is interesting though is what this means about the banks’ longer-term view of interest rates.

That is, the banks certainly don’t see rates rising any time soon. In fact, they’re probably going lower still.

Even the most bullish commentators aren’t expecting rate hikes until the middle of next year at the earliest. But even they’re in the minority. Most people are expecting more cuts.

And markets seemed to have priced in at least one, maybe two rate cuts over the next year.

And it’s not because the Australian economy is looking wonky – though there are some questions about how the transition away from the mining boom is going to go.

No, it’s all about the global outlook, and what’s happening with interest rates around the world. The US, Europe and Japan all have their interest rates tied to zero. Policy is getting a little tighter in the US, as they unwind quantitative easing, but they’re still a long way from raising rates.

And that means there’s still a yawning interest rate differential between us and the rest of the world. If we hike rates and the gap gets bigger, then Aussies assets are paying more of a return, people will want Aussie dollars to buy Aussie assets…

… and extra demand will push the Aussie even higher.

And we know what a thorn in the side the high Aussie has been.

In fact, with markets having already priced in one or two interest rate cuts, they’ve got the RBA over a barrel. The current exchange rate – already a hefty 94 cents – factors in the expectation of more rate cuts to come.

So if the RBA doesn’t deliver the promised rate cuts, the exchange rate suddenly looks cheap, and it’s not a much of a leap from here over the parity mark.

So the RBA would be testing the markets patience if they held those rate cuts back for too long. But if they raised rates?

Forget it. The markets would quickly punish us, and we could be looking at a crippling exchange rate of $1.10 or $1.20. That’d would be a pain in the arse.

The banks know that the market’s got Glenn pinned down. And so betting on further rate cuts – which is what their adjustment to the fixed-rate is – seems like a pretty safe bet to me.

Say what you like about banks, but they’re no fools with their money.

Are your investments about to evaporate into EZ money air?

July 15, 2014 by Jon

EZ money is sloshing around the globe like never before, but it’s making the stock market look a little shaky to me. Property stands like a beacon of reality in this ‘unreal’ world.

The world is awash with easy money. From the US to Japan and across to Europe, governments are just pumping markets full of cash. But just how easy is this EZ money? And how do we get ourselves a piece?

Well, let’s take a look at some of Uncle Jon’s fun facts from the world of high finance.

For starters, in 2013, US$477 billion worth of high-yield bonds were sold – effectively pumping that much cash into the global economy. That was a new world record, but we’re on track to smash that record this year – we’ve already sold US$340 billion in the first six months alone.

If we keep up that pace, we’re losing at something like US$700 billion by Christmas.

And how big is that? Well, it’s something like the entire economy of Switzerland! It’s a whole other top 20 global economy, just pulled out of thin air, turned into cash, and pumped into the system.

It’s big.

And if you’re adding the equivalent of Switzerland to the global system every year, it’s going to have a big impact. And it’s going to have a big impact when you take it away.

And at the same time (and actually because of it), central banks are practically paying people to take money off them. Official interest rates are just a whisker above zero in Japan (have been for twenty years!) the US and Europe.

Those banks not on the EZ money main line can still enjoy the cheapest borrowing conditions the world has ever seen. And banks are sending it our way, with the cheapest borrowing rates on record.

We talk about the lowest official interest rates in 50 years here in Australia. In Holland, interest rates are also at the lowest levels in recorded history – and recorded history there goes back 500 years!

2MG Funds manager Mike Mangan, put it in perspective:

Meteorologists (and insurers) speak of the 1 in a 100 year flood. But what is happening in western economies (and Japan) is not even close to a 1 in a 100 year event. It has not happened in centuries and I would argue human civilisation hasn’t experienced the sort of monetary conditions we now bear witness to, since the Bronze Age.

Maybe it’s a big call to make. It’s hard to know exactly what the monetary policy settings of inter-glacial Mesopotamia were, but I reckon he’s probably right.

We’re right now still in the middle of the most interesting financial experiment in human history.

And that experiment is this – advanced economies are trying to starve off the wolves of deflation and economic collapse by throwing their printing presses into over-drive and, put simply, throwing money at the problem.

EZ money flying everywhere.

And with all this money flying around you’re probably wondering, how do I get in the way of some of it?

Well, unless you’re a bank, it’s probably not as easy as you’d like. Banks are first in line in the easy money gravy train. Government’s lend the banks money. Banks lend it to us (when they get around to it… if they want to…)

But the question that’s got the pointy-heads up all night is what kind of distortions does having all this cash just sloshing around the system create?

The big worry used to be inflation and hyper-inflation. Traditionally, when government’s let their printing presses run, the currency collapses and inflation careers out of control. The price of bread doubling every few days, even the same day – kinda thing.

But we haven’t seen that so far – because the printing presses are blowing money into a deflationary gale, and with recoveries only now looking like they’re gaining any traction, deflation seems to still remain a bigger threat than inflation or hyper-inflation every has been.

And how long can it go on? Well, Japan’s been at it for 20 years…

The other thing pointy-heads worry about is how it messes with the normal rewards and payoffs of economic activity.

For example, in the US, there are more mergers and acquisitions underway right now than there were at the previous peak in the heady pre-GFC days of 2007.

Why is that? Well when government’s and banks are practically giving money away, it makes sense for companies to borrow it and spend it on something… But what, though? If the economy is still struggling for life (and consumers aren’t spending) there’s no point investing in extra capacity and extra production. Who will buy it?

No. Far better to borrow to buy an existing company and gobble up their profits. And so the big fish are on a buying binge, and mergers and acquisitions are at record levels.

And all this buying activity bids up the prices of successful companies, and share prices rise. Indeed, one thing we know for sure is that EZ money has created a surge in the American stock market – here too probably, but not so extremely.

It all makes me a bit nervous, and makes me think the global share market is a bit frothy. If its success is built on a Switzerland of cash, and that Switzerland was created out of nothing, how ‘real’ and stable is it?

And could it all come crashing down?

No, that’s why my money’s still with bricks and mortar. Property is a step removed from this crazy global experiment (and actually stands to benefit from safe-haven flows if the whole show comes undone.)

If you’re watching the mega-rich and global elites, it’s where the smart money is. Always has been. Probably always will.

Where is the SMSF rocket taking us?

June 10, 2014 by Jon

Data shows that SMSF demand for property is booming. The RBA is worried it might make the cycle worse, but I argue that SMSFs will actually make the market more predictable… and safer.

I’ve been arguing for some time there are two massive factors that make this property cycle different to any one that’s come before.

That’s the surge in Chinese buying and the weight of SMSF buying waiting in the wings.

And it’s these two factors that make it such an interesting market right now. We’ve got these two super-factors overlayed over the top of a long-due cyclical recovery.

And it’s these factors – both weighing very heavily on the demand side – that means we could see incredible price growth in this cycle.

About a year ago, I did some rough back-of-the-envelope calculations, and showed that we could see SMSFs adding $160-$350 billion worth of demand to the market. At current prices, that’s several years worth of supply.

If it all came at once, it’d be a massive price shock to the market. You think property in Sydney is expensive now. Just wait.

Some people thought I was over-playing my hand. But the news from the front is that SMSfs are on the move.

A recent report in the Sydney Morning Herald said that “there has been a five fold increase in borrowing to fund a $40 billion splurge on property.”

In the four years to the end of the 2012/13 financial year, SMSF investment in residential property has increased from $37 billion to $88 billion. In terms of portfolio share, residential property is up 80%!

SMSFs are piling in. And keep in mind that though this the latest data we’ve got, it’s pretty old news now. It only up to June 2013, just one month past the bottom of the cycle.

Since then, the property boom has found its legs. There’s a good chance that our SMSFs positions are actually much larger than this.

So we’re probably already a third of the way towards the lower bound in my calculations.

But the SMH is also reporting that SMSFs are leveraging themselves into property, which is what opens up the upside potential in my estimates.

Apparently, limited recourse lending arrangements have increased 460%!

So SMSFs have pulled out all stops and are really ramping it up.

As I’ve said, the impact on the market could be massive!

So massive in fact that’s it’s got the RBA looking a little tetchy.

In their submission to the current Financial System Inquiry (haven’t heard of it? I know right? Facebook has been unusually quiet about it) the RBA lets us know that they’ve got their eye on it.

In their words: “Property investment by SMSFs is a new source of demand that could potentially exacerbate the property cycle.”

But they shouldn’t be so nervous.

While they see the writing on the wall in terms of the massive injection of demand that’s coming our way, I think it’s wrong to think that it’s just going to feed into cyclical dynamics.

What they’re saying is that the swings in the cycle could become more pronounced. The boom will be bigger, but the consolidation phase could be steeper… and more painful.

I don’t think that’s actually the case. What I think we’ll actually see is a level shift in prices as new demand is absorbed by the system, followed by a more stable and dependable cycle after that.

Why more stable? Well, think about the kind of thing that could rock the property market from here. What might pull the rug out from under property and cause a sudden correction?

Almost the only conceivable cause that I can see is some kind of major international economic shock. Maybe the US government defaults on its debt. Maybe another European economy craps its pants.

This could hurt Australia. And if people start losing their jobs, mortgages become more difficult to service, and we could see a fall in demand feed through into a fall in prices.

This is pretty much what happened with the US property bust. A few banks went belly up, people started defaulting on their homes (which brought an excess supply to the market), and prices fell sharply.

But the important thing to note here is that the key agents in the price erosion were regular working families in the suburbs, who had taken on stretch, ‘aspirational’ mortgages.

It wasn’t the investor class. SMSFs, with large, mature diversified portfolios would be much better placed to ride out the ups and downs of the market than young suburban families.

So to the extent that the balance of the market shifts more towards SMSF investors, this should make demand and the market more stable.

The other thing to remember is that the share market remains fragile – in the US more so than here. So any economic shock large enough to rock the housing market is going to hit the share market too.

Again, this is what we saw in the US.

So before house prices take a hit, shares are going to go into free-fall.

So what’s a SMSF going to do? Bail out of property and buy into a plummeting share-market?

Forget it. They’ll know that property is always a good long-run bet. They’ll just sit tight and ride it out.

So SMSF demand is likely to be the most stable demand segment in the market. And that means that the more SMSFs we have in the market, the more stable it’s going to be.

We’re not looking at a super-cycle as much as a level-shift in prices.

Good time to get on board.

Interest Rates to Rise Sharply…?

May 15, 2014 by Jon

Relax, I just wanted to get your attention… Now that I’ve got it, let’s have a grown-up discussion as to exactly what’s going to happen to interest rates in the next 12-24 months…

If you’re an investor, you need to read this… If you’re not an investor, sorry, you’re at the wrong place.

Let’s go…

Like the government, the RBA is trying to talk the economy down, but their eyes are squarely on the exchange rate. It’s a game of cat and mouse, but shows you that rate hikes are completely off the table until the AUD falls a lot further.

Through all the budget hoo-ha, which had very little of interest for property investors, the RBA has been keeping a low profile.

With the government all out to whip up a sense of budget emergency, the RBA has been careful not to go ‘off message’. It left rates unchanged for eight months in a row, but its public statements remain sombre.

In fact, surprisingly, if not suspiciously so.

Take for example the growth forecasts in the latest quarterly statement on monetary policy. At the moment, they’ve got growth slowing through the second half of 2014 and into 2015.

BUT – they had to revise UP their forecasts for the year to 2013/14 financial year. There wasn’t much they could do about this, after the stronger than expected print for GDP in the December quarter last year, and what we already know about the March quarter of this year.

So, to put it in perspective, we’ve got growth of about 0.8 percent a quarter this year, slowing to around 0.6 percent a quarter in the year after. So after ramping it up a bit this year, the economy shifts down a gear the year after.

But why?

It’s left a lot of folks scratching their heads. The outlook is surprisingly downbeat given what’s being going on in the economy lately. There’s been a clear lift in momentum in recent times. The household sector’s looking stronger, and the employment data have consistently surprised on the upside in recent months. There’s also a mini-boom emerging in housing construction, which is always welcome news.

(The impact a budget full of big cuts could have on dragging down growth is a real prospect, but doesn’t rate a mention…)

The only explanation the bank gives for cutting its outlook for 2014/15 is a 4% increase in the Aussie dollar since February. But even then, it’s starting to look like old news when you start thinking about FY14/15.

Still, the RBA has put the dollar front and centre again. It’s sending a very clear message about how sensitive the Aussie outlook is to the fortunes of the currency.

But RBA “jawboning” has also become a bit confused in recent times. The “I’ve got a gun and I’m not afraid to use it” rhetoric we saw at the end of last year is gone and all we got in this SMP was, “with resource prices expected to decline further, historical relationships suggest that the exchange rate could move lower over time.”

What a wet piece of lettuce.

So what’s going on? Is the RBA forcing their forecasts down so as not to offend Canberra, or should we really be worried about the outlook ahead? And have they stopped holding out for further falls in the dollar? And where does that leave interest rates?

I reckon what we’re seeing is a more nuanced approach to “managing expectations” in the market.

Last year, when Glenn subtly hinted that sometimes central banks do intervene to help their currencies down, and theoretically, he just might do exactly that one day, he would have been very well aware of what affect that had.

Nothing.

Markets barely battered an eyelid. There was a bit of a shock on the day, but beyond that, diddly squat. And why would the markets care? The RBA is small-fry compared to the banks of China and Japan, who are very actively manipulating their currencies.

And currency markets themselves are wild, untamed behemoths. No one has pockets deep enough to take them on in any serious way, even the RBA.

Jawboning Mark I: FAIL.

And so enter jawboning Mark II. In this version, the RBA tries to shift the consensus around what the longer-term outlook for the Australian economy is. If they can convince people that Australia is facing several years of below-trend growth, especially if the outlook for the US is improving at the same time, then that should take some pressure off the dollar.

Because the price of the currency today keys off expectations of the future. If there’s an expectation that the US assets of the future will perform better than the Aussie assets of the future, demand will swing around from Aussies to USDs, and the Aussie dollar should fall.

And with a government selling economic calamity, it’s the perfect time to do exactly that. Mime along with the words from the government’s hymn sheet, and hope that markets shift their views.

The only hiccup is the actual data itself – data that shows growth accelerating, and painting a strong picture over the medium term.

How inconvenient.

But the RBA doesn’t have a choice. Interest rates are sidelined for the moment. They’re already at record lows, and pushing them down even further risks driving property prices through the roof.

It also leaves you very little room to move in case of a genuine emergency.

But so long as the dollar remains expensive, it will weigh like an anchor on the sectors of the economy you want to get kicking. Growth will be unbalanced, with some sectors charging along, but others getting left behind.

The RBA has made it very clear it wants to see the AUD with an eight in front of it. And until the AUD goes to the lower end of US80 cents, you can forget about rate hikes.

Until it gets what it wants, talking the Aussie economy down is about all it can do. The only question is how many of us will see through the subterfuge.