Is the Coalition prepared to die defending the housing bubble?

I don’t always agree with David Llewellyn-Smith but love his pithy style. Here he takes the Turnbull government to task over their housing and immigration policies.

Cross-posted with kind permission from Macrobusiness:

….Because that’s what it looks like.

We all know that the Coalition hearts the housing bubble. Everything it does spells undying infatuation:

  • protecting property tax rorts;
  • focusing only on supply-side reform and even then doing pretty much nothing;
  • shelving any and all policy reform that might disrupt its smooth and burgeoning progeny, plus
  • running a staggeringly huge immigration program despite widespread economic damage.

It’s the last point that I want to focus on today because that’s the one where Coalition bubble-love rubber hits the road for its electoral prospects.

Since the WA election, Coalition polling has been devastated. A little bounce in Newspoll has been wiped out by landslides against the government in Ipsos and Essential polls. Moreover, the carnage has been just as apparent in the Coalition’s primary vote which has hemorrhaged voters to One Nation. The latter has been unaffected by the WA election despite doing less well than expected.

The major change in politics since the state result has been a commitment by One Nation to never ally with the Coalition again. The fringe party has realised that such pragmatism is lethal to its prospects.

This simple truth seems yet to have filtered through to the federal Coalition. As One Nation takes a material portion of its vote, and that vote refuses point blank to ally with it, there is ZERO chance of the Coalition winning a federal election ever again, and probably not at the state level either. While One Nation exists in this form, the Coalition has effectively ceased to exist as a political force.

One might have thought that the prospect of NEVER WINNING ANOTHER ELECTION might be enough to trigger some soul-searching in the party. And it has done a little. Do-nothing Malcolm has switched from toying with random ideas to deploying random ideas but it’s still all at the margins and is meaningless:

  • 18c reform won’t move the needle;
  • contradictory coal and hydro investment won’t move the needle;
  • a retrograde company tax cut won’t move the needle;
  • a supply-side housing affordability Budget won’t move the needle.

All together they might nudge it a little but it won’t be enough. Nothing like it.

Indeed, I’ll go so far as to say that the Coalition could do the following immensely popular policies and it would still get clubbed from office:

  • abolish negative gearing;
  • install gas reservation;
  • offer tax cuts.

The problem is that these are all cyclical fixes for what is a structural shift to One Nation driven by one very simple truth: Australians are done with high immigration.

That’s Pauline Hanson’s primary appeal. She makes little sense on other issues and is bat shit crazy on many. But her one great power, the one that vibrates deep in the bowels of every Australian that is marginalised by house prices, falling wages, can’t get a job, is fearful of Islam or just a bigot, or is just plain pissed off at the direction of the country, is the deep and legitimate truth that running a mass immigration program during a period of high unemployment is treasonous economics.

Thus there is only one policy shift that can change the Coalition’s fate and it is as plain as the nose on Pauline Hanson’s face: cut immigration and cut it hard.

Cutting immigration back to 70k per year or less would completely shift every electoral parameter as the Coalition:

  • finally had a housing affordability policy to put up against Labor’s negative gearing reforms;
  • finally had an environmental policy to put up against the immigration-hypocritical Greens;
  • could gut One Nation overnight and go to work on wiping it out by exposing the loons as weakening polls divide them.

This one policy shift would put the Coalition instantly in the running for the next election even if it were Do-nothing Malcolm that did it.

So, why does the Coalition suffer from such suicidal bubble-love that it can’t or won’t grab this lifeline?

  • many Coalition MPs are personally leveraged to the bubble so they’ve their own financial interests in mind;
  • as yesterday’s revelations about the MPs that prevented negative gearing reform showed, they are political hacks with terrible policy judgement;
  • they are bereft of the intellectual depth and corporate memory to contemplate alternative economic models. Cutting immigration to 70k would take pressure off eastern capital house prices enabling further rate cuts and a lower currency;
  • the Howard and Costello myths make this even worse,
  • and, the Coalition is closely wedded to the business interests in banking, retail and construction that benefit from high immigration even as the net result is negative for the wider economy.

I’ll add one more factor which appears increasingly important. Career politicians don’t care for their own political party or its nominal values as they used to. The dominant ideology of unglued self-interest comes with the wonderful fringe benefit of not having to take responsibility for anything. Contemporary Coalition MPs see party membership as a gravy train to private sector riches in board positions, lobbying roles and other forms of ‘control fraud’ in the very sectors that thrive on the bubble. So, for them, arbitraging the fate of the party for personal gain is all just a part of being a good liberal.

Backing self-interest used to work in political forecasting but does this rabble even have that in them?

More evidence of a bull market, except in Australia

One of my favorite indicators of financial market stress is Corporate bond spreads. The premium charged on the lowest level of investment-grade corporate bonds, over the equivalent 10-year Treasury yield, is a great measure of the level of financial market stress.

Moodys 10-year BAA minus Treasury yields

Levels below 2 percent — not seen since 2004 – 2007 and 1994 – 1998 before that — are indicative of a raging bull market. The current level of 2.24 percent is slightly higher, reflecting some caution, but way below elevated levels around 3 percent.

The Financial Stress Index from St Louis Fed measures the degree of stress in financial markets. Constructed from 18 weekly data series: seven interest rate series, six yield spreads and five other indicators. The average value of the index is designed to be zero (representing normal market conditions); values below zero suggest low financial stress, while values above zero suggest high market stress.

St Louis Financial Stress Index

Current levels, below -1, also indicate unusually low levels of financial market stress.

Leading Index

The Leading Index from the Philadelphia Fed has declined slightly in recent years but remains healthy, at above 1 percent.

Philadelphia Fed Leading Index

Currency in Circulation

Most recessions are preceded by growth in currency in circulation falling below 5 percent, warning that the economy is contracting.

Currency in Circulation

Current levels, above 5 percent, reflect healthy financial markets.

Australia

On the other side of the Pacific, currency growth is shrinking, below 5 percent for the first time in 7 years. A sustained fall would warn that the economy is contracting.

Australia: Money Supply

Further rate cuts, to stimulate the economy, are unlikely. The ratio of Household Debt to Disposable Income is climbing and the RBA would be reluctant to add more fuel to the bonfire.

Australia: Household Debt

There is no immediate pressure on the RBA to raise interest rates, but when the time comes the impact on the housing market could be devastating.

ASX stalls at 5800

Banks have run into resistance, with the ASX 300 Banks Index retreating below 9000. The recent false break (above 9000) is a mildly bearish sign but the long-tail on this week’s candle is mildly bullish. Follow-through above 9100 remains more likely and would signal an advance to 9500*.

ASX 300 Banks

* Target medium-term: 9000 + ( 9000 – 8500 ) = 9500

This is not a criticism of the policy, but recent rate hikes on investor mortgages become a self-fulfilling prophecy. Concerns about the housing market lead banks to hike rates. Higher rates discourage new borrowing, leading to a contraction in demand. Which in turn leads to lower house prices.

Miners continue their downward path. The ASX 300 Metals & Mining Index has broken its long-term rising trendline, while Declining Twiggs Money Flow peaks below zero warn of strong selling pressure.

ASX 200

With its two biggest sectors meeting resistance, the ASX 200 is stuck at 5800. But rising troughs on Twiggs Money Flow (above zero) signal buying pressure. Breakout above 5800 is likely and would signal a test of 6000*. Reversal below 5600 is unlikely but would warn of a correction.

ASX 200

* Target medium-term: 5800 + ( 5800 – 5600 ) = 6000

ASX 200 bullish

The ASX 200 is testing resistance at 5800 after a weak retracement. Rising Twiggs Money Flow troughs above zero signal strong buying pressure. Breakout above 5800 is highly likely and would signal a test of 6000*.

ASX 200

* Target medium-term: 5800 + ( 5800 – 5600 ) = 6000

Confidence in housing falls to lowest level in 40 years

From Eryk Bagshaw & Peter Martin at SMH:

Confidence in the housing market has collapsed, with the number of Australians describing property as the wisest place to put their savings falling to its lowest level in more than 40 years.

The Melbourne Institute of Applied Economic and Social Research has been asking about the wisest place to store savings since it began its consumer confidence survey in 1974. Real estate has been one of the most popular answers, often eclipsing bank deposits and paying down debt as the wisest place for savings.

Australian Housing Confidence

Westpac’s Bill Evans: “There is no doubt nervousness about the sustainability of prices.”

Lack of confidence is a vulnerability rather than sign of an imminent collapse. It may also reflect consumer nervousness about record low interest rates (lowest in more than 40 years) and the impact on affordability, and house prices, when rates eventually rise.

Source: Confidence in housing collapses to lowest level in 40 years: survey

Australia: Don’t expect a repeat of the last boom

Gerard Minack, courtesy of Macrobusiness, explains why the recent rise in commodity prices will not result in a repeat of the last boom.

There are two main ways the last commodity boom boosted domestic activity. Neither seems likely to be repeated now. The first is that the mining sector lifted its investment spending as commodity prices increased (Exhibit 5). Now, however, mining investment is likely to continue to fall (although most of the declines have been seen).

The second way the mining boom filtered through to domestic activity was via fiscal policy. The boom provided a windfall for governments. For the Federal Government the windfall was several percent of GDP….Almost all the revenue windfall was used to fund a discretionary loosening of fiscal policy….. With the budget now in deficit I expect the Federal Government to trouser the latest windfall. (Yes, there will be political pressure on a behind-in-the-polls-government to spend more, but the countervailing political fear is that to spend the windfall now would lead to a politically damaging downgrade to Australia’s sovereign rating.)

The unforeseen consequence of this government profligacy was a spectacular rise in the Aussie Dollar and subsequent decimation of the manufacturing sector.

Source: Minack Special Report: Forget rate hikes – MacroBusiness

Australia’s economic growth is slowing.

Employment and Participation rates are falling.

Australia Employment & Participation Rates

Wage rate growth is slowing.

Australia Wage Rates

Slowing wage rate growth and inflation confirm that the economy is faltering.

Australia Underlying Inflation

The RBA, with one eye on the housing bubble, has indicated its reluctance to cut rates further. Increased infrastructure spending by Federal and State governments seems the only viable alternative.

With the motor industry winding down and apartment construction headed for a cliff, this is becoming increasingly urgent.

Can Australia dodge the great deleveraging? | MacroBusiness

Interesting chart from UBS (via Macrobusiness). Movement between 2002 and 2016 for a number of Developed and Emerging Market (DM and EM) countries in the ratio of bank credit to GDP and bank debt to credit.

The good guys are in the top left corner and the bad guys bottom right.

Australia and China are testing record levels of bank credit to GDP, tracing a similar path to Spain. We all know how that ended.

Source: Can Australia dodge the great deleveraging? – MacroBusiness

ASX 200 slows as resources fall

The Australian Resources sector has been on a tear over the last 12 months, something I was slow to pick up on. China’s PBOC stepped in to boost a slowing economy, sending property prices surging. But now the central bank is tightening monetary policy and housing price growth is slowing.

China House Prices

The ASX 300 Metals & Mining Index is losing momentum, falling below its long-term trendline. Declining Twiggs Money Flow, with peaks near zero, warns of selling pressure.

ASX 300 Metals & Mining

The fall has slowed advance of the ASX 200. Resistance at 5800 is proving stubborn. Breach of support at 5600 would complete a double top reversal, warning of a primary down-trend. But declining Twiggs Money Flow indicates no more than medium-term selling pressure at present, recovery above 5800 is more likely and would signal a test of 6000*.

ASX 200

* Target medium-term: 5800 + ( 5800 – 5600 ) = 6000

Australia is on a different path

Motor vehicle sales are strong, according to the Federal Chamber of Automotive Industries:

Motor vehicle sales across Australia got off to a solid start in January, with the month’s sales nudging ahead of the same period last year and showing a rise in activity among private purchasers.

Total sales for January, including passenger cars, SUVs, light and heavy commercial vehicles totalled 84,910 for the month, 0.6 percent up on the same month in 2016.

Within the segments, light commercials fell 3.9 per cent, passenger car sales declined slightly (down 0.8 per cent), while SUVs continued their consistent growth pattern with a gain of 3.2 per cent….

But retail sales growth is slowing.

Australia Retail

While housing is slowing after a surge in high-density units over the last five years.

Australia Housing

Resources exports have been performing well but a slow-down in Chinese housing sales could act as a hand-brake on future growth.

ASX 200 retreats

The ASX 200 broke down below its recent consolidation, signaling another test of support at 5600. There is no indication on Twiggs Money Flow of unusual selling pressure and at present I expect support to hold.

ASX 200

* Target medium-term: 5800 + ( 5800 – 5600 ) = 6000

Australia & Canada in 4 charts

RBA governor Phil Lowe recently made a speech comparing the experiences of Australia and Canada over the last decade. Both have undergone a resources and housing boom. Four charts highlight the differences and similarities between the two countries.

Australia’s spike in mining investment during the resources boom did serious damage to non-mining investment while Canada’s smaller boom had no impact.

Australia & Canada: Mining v. Non-Mining Investment

Immigration fueled a spike in population growth in Australia, adding pressure on infrastructure and housing.

Australia & Canada: Population Growth

Both countries are experiencing a housing bubble, fueled by low interest rates and lately by export of China’s property bubble, with capital fleeing China and driving up house prices in the two countries.

Australia & Canada: Housing

Record levels of household debt make the situation more precarious and vulnerable to a correction.

Australia & Canada: Household Debt

Hat tip to David Llewellyn-Smith at Macrobusiness

ASX banks lead the charge

The ASX 200 followed-through above 5750 after respecting its new support level at 5600, indicating an advance to 6000*. Rising Twiggs Money Flow signals buying pressure.

ASX 200

* Target medium-term: 5800 + ( 5800 – 5600 ) = 6000

Australian banks are leading the charge, with the ASX 300 Banks Index testing 9000. A trough high above zero on Twiggs Money Flow indicates strong buying pressure. Breakout above 9000 would signal another advance.

ASX 300 Banks Index

Bank profits have declined for the last two years, but Bad and Doubtful Debt Charges are not a major cause.

RBA Chart Pack: Bank Profits and Bad Debt Expenses

The main culprit is declining return on equity as banks beefed up capital ratios and risk-weighting on residential mortgages in response to pressure from APRA.

RBA Chart Pack: Bank Return on Equity

Seven Signs Australians Are Facing Economic Armageddon

Economics advisor John Adams warns that Australia faces “economic Armageddon” because of “significant structural imbalances” not seen since the lead up to the Great Depression in the 1920s.

Here are his seven signs:

Seven Signs Australians Are Facing Economic Armageddon

Sign 1: Record Australian Household Debt

According to the Reserve Bank of Australia, Australia’s household debt as a proportion of disposable income now stands at a record high of 187%.

The two closest episodes were the 1880s and the 1920s, which both preceded the only two economic depressions ever experienced in Australian history in 1890 and 1929.

Sign 2: Record Australian Net Foreign Debt

Australia’s net foreign debt now stands at more than $1 trillion and as a proportion of Gross Domestic Product was at a record high of 63.3% in June 2016.

This makes Australians much more vulnerable to international economic developments such as higher global interest rates, international financial crises or major government or corporate bankruptcies.

Sign 3: Record Low Interest rates

Australia has its lowest official interest rates on record with the Reserve Bank of Australia’s cash rate sitting at 1.5%. The current low rate of interest is not sustainable over the medium term and will inevitably rise.

Australians, particularly in Sydney and Melbourne, who have borrowed record amounts of money are very susceptible to higher interest rates.

4: Australian Housing Bubble

The expansion of credit by the Reserve Bank of Australia has been pumped into the Australian housing market over the past 25 years. Credit, which has been directed to Housing as a proportion of Australia’s GDP, has exploded from 21.07% in June 1991 to 95.06% in June 2016.

Over the same period, credit which has been directed at the business sector or to other personal expenses has remained relatively steady as a proportion of GDP.

5: Significant Increases in Global Debt

The General Manager of the Bank for International Settlements stated on 6 February 2017:

“Total debt in the global economy, including public debt, has increased significantly since the end of 2007 … Over the past 16 years, debt of governments, households and non-financial firms has risen by 63% in the United States, the euro area, Japan, the United Kingdom, Canada and Australia, 52% in the G20 and 85% in emerging economies. Heavy debt can only leave less room for manoeuvre in responding to future challenges.”

Sign 6: Major International Asset Bubbles

There are significant asset bubbles in bonds, stocks and real estate in major economies such as the United States and China, which has been fueled by the significant increases in global debt.For example, the Shiller PE Index in the United States which measures the price of a company’s stock relative to average earnings over the past 10 years is now at 28.85. This is the third highest recorded behind the Tech Bubble in 1999 and “Black Tuesday” in 1929.

Sign 7: Global Derivatives Bubble

According to the Bank for International Settlements, the value of the over the counter derivatives market (notional amounts outstanding) stood at US$544 trillion.

Much of these derivatives contracts are concentrated on the balance sheets of leading global financial and banking institutions such as Deutsche Bank. The concentration of complex derivative contracts on bank balance sheets poses significant risks to both individual institutions and the global financial system.

Veteran Investor Warren Buffet has repeatedly warned that derivatives are “financial weapons of mass destruction” and could pose as a “potential time bomb”.

Household debt is too high. Rising foreign debt and record low interest rates are fueling a housing bubble. Global debt is too high and rising, while stocks are over-priced. Throw in the global derivatives “bubble” with some truly terrifying numbers just to scare the punters out of their wits.

Nothing new here. Nothing to see. Move along now. The global economy is in good hands…..

Or is it? Aren’t these the same hands that created the current mess we are in?

John Adams is right to warn of the dangers which could have a truly apocalyptic effect, that makes the global financial crisis seem like a mild tremor in comparison.

Some of the risks may be overstated:

The derivatives “bubble” is probably the least of our worries as most of these positions offset each other, giving a net position a lot closer to zero.

Defensive stocks like Consumer Staples and Utilities are over-priced but there still appears to be value in growth stocks. And earnings are growing. So the stock “bubble” is not too alarming.

Global debt is too high but poses no immediate threat except to countries with USD-denominated debt — or Euro-denominated debt in the case of Greece, Italy, etc. — that cannot issue new currency to repay public debt (and inflate their way out of the problem).

But that still leaves four major risks that need to be addressed: Household debt, $1 Trillion foreign debt, record low interest rates and a housing bubble.

From Joe Hildebrand at News.com.au:

Mr Adams called on the RBA to take pre-emptive action by raising interest rates and said the government needed to rein in tax breaks like negative gearing as well as welfare payments.

This, he admitted, would result in “a mild controlled economic recession” but would stave off “uncontrolled devastating depression”.

The problem is that the Australian government appears to be dithering, with one eye on the next election. These are not issues you can “muddle through”.

If not addressed they could turn into the four horsemen of the apocalypse.

Source: Apocalyptic warning for Australian families

ASX finds support

The ASX 200 respected its new support level at 5600. Twiggs Money Flow respected the zero line, suggesting buying pressure. Follow-through above 5750 would offer a target of 6000*.

ASX 200

* Target medium-term: 5800 + ( 5800 – 5600 ) = 6000

ASX 200 correction

The ASX 200 continues to test its new support level at 5600. Twiggs Money Flow is now declining, reflecting medium-term selling pressure. Breach of support is likely and would test the lower trend channel around 5500 but the primary up-trend is unchanged.

ASX 200

* Target medium-term: 5800 + ( 5800 – 5600 ) = 6000

The ASX 300 Banks Index has undergone a sell-off in the last few weeks, weighing heavily on the broader index. Declining Twiggs Money Flow indicates medium-term selling pressure. Respect of support at 8000 would indicate that the up-trend is intact.

ASX Small Ordinaries Index

Australia at risk as USD rises

NAB are predicting that the RBA will cut rates twice in 2017.

This ties in with the Credit Suisse view: if Donald Trump succeeds in reducing the US trade deficit, it will cause a USD shortage in international markets. And, in Australia, “a USD shortage tends to exert downward pressure on rates, bond yields, the currency and even house prices.”

Macrobusiness joins the dots for us: “a rising USD this year is very bad for commodity prices and national income while being bearish for interest rates and the AUD.”

Source: CS: Australia at risk as USD rises – MacroBusiness

BIS: High household debt kills growth | Macrobusiness

From Leith van Onselen, reproduced with kind permission from Macrobusiness:

Last month I showed how Australia’s ratio of household debt to GDP had hit 123% of GDP – the third highest in the world – according to data released by the Bank for International Settlements (BIS):

ScreenHunter_16670 Dec. 13 07.13

Martin North also compiled separate data from the BIS, which showed that Australia’s household debt servicing ratio (DSR) is also the third highest in the world:

Despite record low mortgage rates, Australia’s mortgage slaves are still sacrificing a far higher share of their income to pay mortgage interest (let alone principal) than when mortgage rates peaked in 1989-90:

ScreenHunter_16672 Dec. 13 11.05

Now the BIS has released a working paper, entitled “The real effects of household debt in the short and long run”, which shows that high household debt (as measured by debt to GDP) has a significant negative long-term impact on consumption and growth. Below are the key findings:

A 1 percentage point increase in the household debt-to-GDP ratio tends to lower growth in the long run by 0.1 percentage point. Our results suggest that the negative long-run effects on consumption tend to intensify as the household debt-to-GDP ratio exceeds 60%. For GDP growth, that intensification seems to occur when the ratio exceeds 80%.

Moreover, the negative correlation between household debt and consumption actually strengthens over time, following a surge in household borrowing. What is striking is that the negative correlation coefficient nearly doubles between the first and the fifth year following the increase in household debt.

As shown in the table above, Australia’s household debt-to-GDP ratio was 123% as at June 2016 (higher now) – way above the BIS’ 80% threshold by which GDP growth is adversely impacted.

According to Martin North:

This is explained by massive amounts of borrowing for housing (both owner occupied and investment) whilst unsecured personal debt is not growing. Such high household debt, even with low interest rates sucks spending from the economy, and is a brake on growth. The swelling value of home prices, and paper wealth (as well as growing bank balance sheets) do not really provide the right foundation for long term real sustainable growth.

Another obvious extrapolation is that there could be carnage when mortgage rates eventually rise from current historical lows.