I’m expecting a property-friendly budget today.

The budget is shaping up to be a pretty property friendly.

On the whole, the budget is going to maintain a stimulus footing. There’s more money going into the economy through spending than there is coming out through taxes.

And it will be true that the budget bottom line that we used to care about so much is improving. The economy is going great guns, and a commodity boom is funnelling huge amounts of cash into government coffers.

But despite the projected improvement, the federal budge will remain well and truly in the red going forward.

And that’s cool. I’m ok with that.

The experience in India shows us that the global pandemic is still with us. And it’s like a fire. You can put it out in one corner of globe, but until its extinguished everywhere, you’re always at risk.

So let’s not get complacent just yet.

So we can expect the money to keep flowing, with a particular focus on infrastructure.

And we know from the information leaked already that there’s going to be a few sweeteners for the housing market.

The list, according to the AFR, looks like this:

• An extra 10,000 places will be made available under the New Home Guarantee, allowing first home buyers to buy a place with as little as a 5 per cent deposit, while the amount of money that can be released from their superannuation will be lifted to $50,000.

• More than 10,000 single parents will be allowed to buy a home with a 2 per cent deposit under a separate government-guaranteed home loan scheme targeting women.

• The government will allow the superannuation guarantee to increase to 12 per cent after flirting with stopping it.
• The maximum amount of voluntary super contributions that can be used to purchase a first home will be increased to $50,000 from $30,000.

Classic. Who doesn’t love this.

Everyone wins. For some people, it’s going to become easier to get a house. That 2% deposit thing is a real game-changer, and I think it’s a great idea to support single women on that mission.

Landing secure housing for you and your kid is a huge step towards creating better life outcomes for everybody.

And at 2%, it really makes that deposit hurdle a lot lower for a lot of people. For a property worth $700K, we’re talking about a deposit of just $14,000, rather than something like $140,000 for most people.

So that’s huge.

It does mean the tax-payers are taking on the risk of default and so on, but I’m ok with that too.

The family home always comes first, and if someone is defaulting on a mortgage you know its because things have seriously gone pear-shaped. Default is not a decision taken lightly.

And in a world where we’ve got cash for everyone, why not given single mothers a leg up too?

The thing we have to watch here is what impact this has on the entry-level of the segment.

Since these are all demand-side measures, pushing up demand can also push up prices.

And on the whole, all of these measures, on top of the huge cash-splash on infrastructure, will give property prices a lift.

It’s a very price-positive budget. I think we can say that much.

JG

The RBA doesn’t want you to be rich. They need you to be rich.

I don’t know if you’ve picked up on it, but there’s a drive to make you richer.

Are you feeling it?

Gina Reinhart is. All the rich-listers are. Their wealth has jumped a staggering 24% in the past twelve months. Gina’s has double. Doubled! According to the AFR:

Despite a global pandemic dominating global economies the top 200 richest Australians increased their collective wealth by 24 per cent in 2020 to $424 billion.

Australia now has a record 104 billionaires, including seven people in the elite “ten-digit club” with a wealth exceeding $10 billion.

Mining magnate Gina Rinehart is once again Australia's richest person, having increased her wealth two-fold in just 12 months.

Ms Rinehart topped the Australian Financial Review Rich List for 2020 with a personal wealth of $28.89 billion, a figure up 109 per cent on last year.

Partly that’s a mining story and it’s related to the mining boom. But most rich-listers aren’t from the resources sector, and their wealth is booming too.

No, it’s a cheap money story.

Money is so cheap (I say cheap. It’s practically free!) But it’s so cheap these days that those with deep pockets are making a motza.

And while the 1% always make out like bandits in a crisis, there’s a push to make ordinary Australians wealthier too.

And it’s working.

In fact, household wealth hit fresh record highs at the end of 2021, and the quarterly increase in wealth was the biggest in 11 years!

Household wealth is now up a pumping 7 percent on a year ago – despite the worst recession in decades.

That’s not bad.

Even the young’uns are feeling wealthier. At least one study of Gen Z and Millennials found that four in five are wealthier now than they were pre-Covid:

Gen Z-focused money education platform Flux surveyed 807 of its followers on social media site Instagram in February, finding the crisis has had a positive effect on the personal finances of many young Australians, notwithstanding the broader economic downturn.

The vast majority of respondents (82 per cent) to the poll indicated that they were in a better financial position now than before the pandemic hit early last year.

Government stimulus, financial returns from investment markets and an ability to save income amid the state-imposed lockdowns were among the key reasons identified.

Ahh. Investing Gainz. I know that one.

So Australians, despite the Covid recession, are feeling a lot wealthier.

But none of this is an accident.

This is exactly what the RBA wants to happen.

It’s something called ‘The Wealth Effect’.

When Aussies feel wealthier, they go out and spend more, and that’s good for the economy.

It’s a virtuous circle. The wealthier we are, the more we spend and consume, and the wealthier we all become. That’s the wealth effect.

And the easiest way to help Aussies feel wealthier is for house prices to go up.

(Over half the gain in wealth in the last quarter of last year was due to rising house prices.)

So the RBA is very happy to see house prices rise. A couple of years ago, the RBA published research that found that a 1 per cent increase in the value of housing wealth will lead to a 0.16 per cent increase in the long-run level of consumption.

So that’s a pretty decent bang for your buck.

And this is also why house prices and share prices tend to move together.

When house prices rise, they spend more, which boosts revenue and profits, which in turn boosts share prices.

This is the wealth effect in action.

And so this is why the RBA is more than happy to run the economy very hot over the next few years.

And they’re happy to see house prices soar too, because they know a lot of that is going to feed back into the economy and boost growth.

The wealth effect is in full effect.

So I wouldn’t be on the other side of this bet – of this push to make Aussies richer. There’s a saying in America: “Don’t fight the Fed.”

My advice?

Don’t rumble with the RBA.

JG

Bonds and stocks don’t dance together anymore. It’s a strange new economy.

So I think I’m looking pretty good right now.

Last week, on Wednesday, I said that the US equity market was looking a little bubbly.

By the end of the week, markets had heard the message, and the US market was hammered. Tech stocks were hit hard. Australia followed dutifully behind.

I’m so clever.

But it’s easy to say in hindsight.

And the truth is that markets can look ‘bubbly’ or at least stretched, for ages before something comes along and gives them a nudge.

But last week, something did come along and give markets a nudge.

And that thing was rising bond yields.

Now someone asked me why rising bond yields would cause stock prices to fall.

That’s a very, very good question.

In fact, that’s a question everyone wants to know right now:

But this is the thing. I don’t think anyone really knows the answer.

In the old days, back when I started investing, my mentor would get out of his horse and buggy and say, stocks and bonds always go in opposite directions.

When stocks go up, bonds go down. When stocks go down, bonds go up.

And it was such a reliable thing that people developed portfolio allocations based on it. Beginning investors were advised to follow Rick Ferri’s Two-Fund portfolio mix: 60% stocks, 40% bonds.

The idea is that bonds would help protect your portfolio in a stock market rout.

Bonds gave you protection.

And they did. It was true for generations. Stocks and bonds would move in opposite directions.

Remember, equities carry risk. Bonds, since they’re backed by the government, carry almost no risk.

And the idea was that in a risk-on environment, people would sell bonds and buy stocks. And in a risk-off environment, they’d sell stocks and buy bonds.

That transfer of demand would cause prices to move in opposite directions.

And that’s what seemed to happen.

Until the QE era kicked in.

After that, there seems to be almost no correlation at all. If anything, stocks and bond prices tend to move together.

(Oh, I’m talking about prices there. In the news you’re hearing everyone talk about ‘rising bond yields’. As a property investor I’m sure you know that if a price falls, and the return remains the same, the yield goes up. So when you hear “rising bond yields” you know we’re also talking about falling bond prices.)

So yeah, last week we saw falling bond prices (and rising yields) AND falling stock prices.

So much for the 60:40 mix.

(You were 100% down on Friday.)

Anyway, back to the puzzle at hand. Bond yields went up, and shares were sold off.

There’s two parts there. What happened to bond yields? And then what happened to shares?

So first, let’s look at why bond yields went up?

The key factor seems to be rising expectations of inflation.

As I’ve noted before, sentiment around the US economy and the Australian economy is pretty bullish right now. That’s on the back of super-cheap interest rates and massive fiscal spending.

I mean, check out the chart on the US money supply. Totally nuts:

But now, there’s so much money gushing into the system, that people are starting to worry about inflation.

The rate of return on bonds – the yield – has inflation cooked into it. So when inflation, or inflation expectations rise, yields go up.

And so the increase in yields reflects a growing belief that our economies are starting to run a little too hot.

They’re a little too awesome.

Now, that sounds like a good thing for stocks right?

Companies love a hot economy. That’s good for sales right?

But no, stocks got sold off.

And why was that?

Well, to understand that, we have to get to the mystery at the heart of the modern economy. We have to get to the thing that everything hinges on right now.

More on that tomorrow.

“The earlier part of the move was driven by rising inflation expectations because one of the components for bond yields is compensation for inflation,” he said. “More recently, the increase in bond yields has continued and it has come about by an increase in real yields.”

Real yields are the component of the bond yield that is left after investors receive compensation for inflation, and are a good proxy for underlying economic growth expectations.

“If people think that economic growth is going to improve, then real returns – economic growth after inflation – are likely to improve across the entire economy because it’s easier to generate positive returns when the global economy is growing,” Mr Hamlyn said.

Relative yields. – 1.55 T vs 1.51 in equities. Higher yield with zero risk.

Corporate interest burden increases

Discounting

Higher bond yields a negative for gold, since gold doesn’t generate yields.

Discounting

Bond yields, in a way, represent the opportunity cost of investing in equities. For example, if the 10-year bond is yielding 7% per annum then the equity markets will be attractive only if it can earn well above 7%. As bond yields go up the opportunity cost of investing in equities goes up and therefore equities become less attractive.

The yield on bonds is normally used as the risk-free rate when calculating cost of capital. When bond yields go up then the cost of capital goes up. That means that future cash flows get discounted at a higher rate. This compresses the valuations of these stocks.

On the forward rates front, the fed funds futures market is now pricing in more or less a full hike in 2022 as well as two in 2023, and we think the 2022 expectation will be viewed by the Fed as excessive and potentially starting to become problematic.”

Treasury drawdown = liquidity coming

US Broad money up $3tn y/y

JG

Mortgage holidays are hiding a lot of pain. But if that pain makes it way on to the banks’ books, they’re in real trouble.

In less than 100 days, the Australian economy will topple over a cliff.

Australia is doing better than most nations right now (tell that to the one in five workers who lost work!), but the mountain of stimulus and support we’ve put in place is all due to end in September.

We’re talking about JobKeeper and the JobSeeker supplement, but we’re also talking about mortgage deferrals.

Remember that banks have been offering borrowers a ‘holiday’ from their repayments.

According to the Australian Banking Association, 772,600 loans have been deferred across Australia, including 480,700 mortgages.

That’s one in 14 mortgage holders – about 7% of the market. Substantial.

And while mortgages account for a bit more than half of the number of loans, they account for about three quarters of the value of loans deferred. $234.1 billion total loans have been deferred, of which $173.5 billion are mortgages:

So… so far, so good. A substantial number of loans have been deferred, but we’re not talking about the collapse of the mortgage market.

But the key thing here is how this shows up on the banks’ books.

Remember that when the deferrals were announced, some people wondered why the banks weren’t going further.

Because the loans aren’t simply being paused. Anything you miss has to be made up, in the time that remains. That pushes your minimum monthly repayments up somewhat.

And when they were asked why they were deferring rather than pausing the loans, the banks said that if they ‘paused’ the loans, they would be technically “impaired”.

An impaired loan is a loan that has gone bad, with a higher risk that it will not be repaid.

That has serious implications for the banks. APRA – the banking regulator – has rules about how much capital you hold against your loan book, and it depends on loan quality.

So, to make some numbers up, if you have $100 of high-quality loans, you might have to hold $10 in cash.

But if you have $100 of impaired loans, you might need to hold $20 or $30 in cash.

That is, if the banks pause the loans, the loans get treated as ‘impaired’ and that means the banks have got to come up with extra money to hold against those loans. 

How much of a problem is that?

Well, economics grey-beard Alan Kohler does some back of the envelope calculations.

If the deferred loans were treated as impaired this year rather than deferred, and the big four’s share of them was the same as their 80 per cent share of total loans and advances – probably a safe assumption – impaired loan expense would be 16.6 per cent of their loans and advances and would more or less wipe out their capital…

After six months, the support program runs out in September, at which point, it is assumed, $224 billion in loans, plus whatever is deferred between now and then, would instantly become 90 to 180 days in arrears…

September is rushing towards the banks. How many of the 744,904 people and businesses, and counting, will be able to resume repayments? How long can loan deferrals go for? What proportion of the loans must be classified as impaired at September 30? What provisions must be struck for future impairments? How much capital would need to be raised to cover these sums? If it’s a 12-figure amount (that is, more than $100 billion), who will supply it?…

But if the government’s various income support packages end in September and October, as planned, the bank support will have to begin, or else the pandemic crisis will turn into a financial crisis like no other.

Yup. If October comes, JobKeeper ends and all these loans move from deferred to impaired (not even assuming more people end up in default), the banks get “wiped out”.

And it seems to leave the government with the choice of either nationalising the job market, or nationalising the banking sector.

Both options are ugly.

This is going to take some fancy footwork to get out of this one.

… and we’ve got 100 days and counting.

JG.