Australian Equities

When Australia's cup runneth over

31/03/2010

Martin Conlon

Martin Conlon

Head of Australian Equities

Are Australians on too much of a good thing?

The challenges facing the domestic economy are becoming far removed from those of the majority of our northern hemisphere counterparts. Interest rates well above almost all of the other developed nations are seeing Australia
suck in capital from foreign investors desperate for return in a world not offering much. An overdose of Chinese stimulus has ensured commodities remain flavour of the month and the $A remains a solid barometer of our relative
good health. Together with an unemployment rate that has barely budged from its lows, and an extremely buoyant outlook for investment in the mining and energy sector, things look pretty good…unless you’re Glenn Stevens.

The key intermediary gainfully employing this wall of foreign capital is the banking sector. Of greatest concern at present, is the fact that almost all of it is being applied in the housing sector, with the corporate sector almost stagnant. Having been pillaged at the hands of major banks in the recent past, their reluctance to embrace the newfound friendliness of their local institutional banker is unsurprising (we can’t all have the fortitude of Monty Python’s Black Knight). In any case, with the financial floodgates open, and corporates still cautious, indomitable Australian homebuyers are again happily filling the breach, using foreign borrowings to prop up our house prices, urged on by commentators adamant that it’s a supply-demand imbalance that’s driving prices. Well as far as I’m concerned, that is one load of utter tripe. With population growth of 1.5%, that’s about 300,000 people a year that need somewhere to live, and probably accounts for demand of 100,000 homes or so. Depending on how you cut the assumptions, the dominant one being the assumption on the trend in how many people live in each household, you
can come up with a rationale for housing being in short supply, perhaps 20,000 homes. Although I disagree with extrapolating a perpetual decline in the number of people per household, my biggest problem is the use of this apparent housing shortage as the reason for the prices of the other 7 million homes needing to perpetually rise in price. Supposedly, all we need to do is free up some more land and the problem will be fixed. Rubbish! Why is it
that these incremental buyers (presumably first home buyers and immigrants), force up prices in Vaucluse, Toorak and Peppermint Grove at rates faster than Sydney’s outer west? I look forward to picking up a cheap harbourside
home as the exodus from Mosman and Vaucluse instigated by land release in the outer west begins to decimate prices! If the credit taps were turned off for housing, I am very comfortable predicting that house prices would stop
rising, regardless of an apparent shortage!

Unfortunately, it is an integral part of the psyche of Australians to believe that house prices will rise in perpetuity. This psyche also permeates bank behaviour, where a history of strong volume growth and profitability, negligible bad debts and minimal capital requirements against housing, ensures diffidence is not an attribute featuring strongly amongst home lenders. Why worry about the ability to repay a loan, when you can’t lose on the asset anyway. It is the extreme reticence to learn lessons from offshore experience and the continuing unproductive use of capital which remains our main cause of concern in what is otherwise a bright picture. It is also the reason that we would urge caution in the longer term on businesses which depend on this constant price appreciation to support profits.

The relative calm in equity markets which prevailed over the quarter should not, in our view, induce undue complacency. The fact that volatility has dissipated is again likely to be a misleading sign as to what is happening to underlying risk. Although the luxury of strong employment and booming commodity prices makes life in Australia a relative paradise at present, valuations do not offer the same margin of safety as was the case this time last year. We would suggest the time to ‘bet the house’ on commodities is well passed and as the rewards for taking risk diminish, we will continue to act accordingly, by reducing, rather than increasing our exposure to risk. As is always the case in markets, we’re sure we’ll get another chance to increase our risk appetite in the future when it makes more sense.

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