2014 – Wow – what a year we have had here in the lucky country! A fairy tale grand final victory, for South Sydney, worthy of a Russell Crowe Hollywood blockbuster; the ongoing political soap opera within the Palmer Not-So-United Party and the crowning glory, hosting the G20 summit to discuss and achieve – well really very little.
So beyond the hum-drum entertainment, what is really happening within the economy?
It is increasingly obvious that Australia is in a two-speed economy with the gap between those speeds wider than ever. That comfortable warm womb of job security is no more, as the job market gets tighter.
Unemployment currently sits at a 12 year high – almost 7% – higher still amongst the younger age groups and this is really beginning to bite. Yet simultaneously there are more 457 Visas in play than ever before. Over 111,500 of these skills visa holders are now in the market.
While many are criticising the scheme, higher unemployment is not a direct result of this, given that many Australians would chose not to apply for some of these roles. Dare we say it, when did the “lucky country” become a “welfare state”?
Never-the-less, rising unemployment is a phenomena that will become an increasing albatross around the neck of younger generations, perhaps aggravated further by the fact that “Generation PlayStation” has always, until now, had things fairly easy in life compared to previous generations.
And to rub ever more expensive salt into the wounds
Inflation has also remained stubbornly high, currently sitting at 2.8%. Many lower income households are now really beginning to struggle with rising costs, from all angles. In spite of a currency move, and substantial fall in energy prices, filling up the family wagon continues to remain inexplicably high, with Petrol prices at around $1.45 a litre.
The reason we say inexplicably is that crude oil prices are currently around $76/barrel – this time last year around $100 – yet no real fall at the bowser. Good job we have the ACCC making sure all is fair and well for the Aussie consumer!
Interest rates have remained unchanged in the past 15 months, and at 2.5% continue to provide plenty of weight to the property market. Borrowing costs are low right now – and will at some point need to move back up.
More than any single element, this has been driving property prices higher, as cheap money and inflation tends to force investors into “real assets” and by that we mean property and shares. These tend to fare better during periods of inflation.
While the strength and bounce back from the post GFC lows has been impressive and is without question one of the major factors underpinning the wealth effect and confidence in the economy, it is also a major risk.
Is there a property bubble?
No, not really, maybe, and yes are all valid responses depending on where you are talking about!
The Banks have maintained “prudent lending” and therefore aren’t responsible for anything bad that can happen from here. Prudent lending, by the way, may be no more than an 80% LVR. In the major cities, things have run hard but there is the whole supply and demand argument. However, that is not true everywhere and extreme caution should be exercised in some areas. Take a 3 bed 2 bathroom 1 car home in Port Headland – currently on the market for $1.2m so $960k loan against the property.
However, is $.12m the right number for this “stunner?”
Let’s say that iron ore continues to decline, which is certainly a possibility. The rental market dries up in this town, and the above comes back in at a valuation of say, $800k. Still a pretty reasonable number for this beautifully presented place.
That $960k loan is now a 120% Loan to Value Ratio – not to mention $160k negative equity for the investor. Of course, the attraction of this kind of investment is the current low borrowing cost and the ability to negatively gear and be tax efficient.
Repayments of around $5500 a month – nice and easy while on a decent mining contract, but with iron ore prices dropping, will the investor be on that kind of contract with a need to lose $5500 a month to offset tax. How many months can you support this, without the income?
Now – interest rates – they could and will likely go up. When they do, affordability goes out of the window, debt servicing goes into stress mode, defaults rise and prices will fall.
We see this as being the single biggest risk in the Australian economy – a rate rise/property slow down. Reason being that this will hit very hard consumer and investor confidence, hammer the property market back into shape, prompt a sharp rise in defaults and bad debt within the banks – irrespective of their prudent lending.
The knock on effects, will be within the job market, with further pressures on the labour market, particularly as a rise in interest rates will add some support to the Australian dollar, potentially taking it back to the early to mid 90’s vs. the US. Not good for manufacturing, but great for online shopping!
One of the key variables in our outlook is Australia’s biggest export – Iron ore. With current pricing just touching sub $70/tonne – almost unthinkable when last year we saw $158!! However, with the slowdown in China and increased new supply coming to market, this has been a hard landing – which we might note is not done yet – for the mining sector.
The knock on effects of this in the two speed economy – slower sector, lower pay, less jobs and all the spin offs from that, will begin to come home to roost. As such, we expect to see a modestly positive year from the market, in terms of directional moves.
However, within that, these sorts of conditions may well provide great opportunities for income producing strategies such as covered calls – enabling investors to not need to rely on directional moves to generate gains. Further to that, a range of 5500 to 5800 would be in line with our expectations.
The key take away message here is a simple one – we expect volatility and volatility creates opportunity. Buy and hold is not likely to work under these conditions so a more dynamic approach will likely better serve your goals and objectives, assuming of course, those goals are to make money!!
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