Bulls were baited with a third ASX 200 breakout above resistance at 6000, only to see the index retreat yet again. Declining Money Flow warns of commitment from sellers. Breach of support at 5920 would confirm a correction already signaled by Money Flow (21-day) crossing to below zero.
The ASX 300 Retailing Index is weak, anticipating a poor Christmas.
But Food & Staples Retailing is strengthening.
ASX 200 direction, however, is largely determined by Banks and Miners.
The bear-trend on iron ore is weak, with the bulk commodity continuing its test of resistance at 70. Respect would warn of another decline, while breakout above 80 would signal a primary up-trend.
The ASX 300 Metals & Mining Index, however, shows signs of selling pressure, with Money Flow (21-day) declining to zero. Breach of support at 3300 would warn of a correction.
Banks continue to disappoint, with the ASX 300 Banks index headed for a test of short-term support at 8250. Twiggs Trend Index peaks below zero indicate continued selling pressure. Breach of 8250 is likely and would warn of a test of primary support between 8000 and 8100.
The greenback continues its bear market rally, assisted by the new tax bill and the December Fed rate hike. Breakout above resistance at 95 would signal a primary up-trend, a strong bear signal for gold, but the Dollar still has to overcome concerns over North Korea.
Gold found short-term support at $1240/ounce and recovery above the descending trendline would indicate that the down-trend is weakening. Breach of primary support at $1200 is unlikely but would be a strong bear signal, warn of a primary down-trend.
The All Ords Gold Index is also correcting. Breach of primary support at 4300 would warn of a primary down-trend.
But I expect this to be cushioned by further weakness on the Aussie Dollar.
Helped in part by a declining yield differential between Australian and US government bonds.
GDP growth has lifted in 2017 and the labour market has tightened.
Our base case has these trends continuing over the next two years, but there are a number of downside risks.
The ability of monetary policy to support the economy in the event of a negative shock is more limited than in the past thereby exacerbating the potential impact that any negative shock may bring.
On some important metrics it’s been a reasonably good for year the Australian economy. The labour market has tightened courtesy of very strong employment growth and real GDP growth has lifted. At the same time, nominal GDP growth has been buoyant due to firmer commodity prices when compared to a year earlier. Wages growth, however, remains soft and real wages are barely in positive territory.
The house view is that the improvement in the labour market continues over the next two years and the unemployment rate should continue to grind lower. But there are plenty of risks that would change the outlook if they were to materialise.
This note discusses some of the key global and domestic risks to the Australian economy. It begins with an outline of CBA’s base case for the economy over the next two years before delving into some of the potential risks. This is not an exhaustive list, but rather it covers a few areas that the author considers to be the most acute risks to our central scenario. They are: (i) the capacity to respond to a negative shock with monetary policy (and to a lessor extent fiscal policy), (ii) a solid fall in commodity prices; (iii) a sharp correction in dwelling prices; (iv) a policy “mistake”; and (v) a fall in net migration via a policy change.
CBA’s central scenario
CBA’s base case for the economy over the next two years is a benign one. It is broadly similar to the RBA’s forecast profile for the economy which is also not dissimilar to the consensus view.
On the key components, we see output growth continuing to lift to a pace of around 3%pa in 2018 (chart 1). We put potential growth at 2¾% (population plus productivity growth) which means our forecast profile has a gradual decline in the unemployment rate as spare capacity recedes (chart 2). In 2018, most of the key components of the economy are expected to contribute to growth, with dwelling investment the exception.
The capacity of wages growth to slow further from here is also limited in the event of a commodity price shock. That is because wages growth is already at record lows and wages growth is sticky downwards. A fall in wages growth was able to cushion the most recent terms-of-trade shock (late-2011 to early 2016) because growth in wages slowed in line with the weakness in commodity prices. This helped to support the labour market and keep the unemployment rate from rising as much as it otherwise might have. But this time, a fall in wages growth will not be able to absorb the shock to the same extent given wages growth is already so low.
A sharp correction in dwelling prices
The single biggest risk to the domestic outlook looks to be a sharp correction in dwelling prices. In our view, this carries a greater risk to the real economy than it does to financial stability given the banking system is well capitalised.
There is a commonly held belief in Australia that the main trigger for a fall in dwelling prices is a rise in unemployment. This seems logical because rising unemployment would generally be associated with a lift in mortgage delinquencies which would put downward pressure on prices. But the data suggests that employment is more likely to lag changes in dwelling prices rather than lead (chart 12). The obvious question to then ask is why? We attribute the answer, in part, to the wealth effect and the recent track record of monetary policy in smoothing out the business cycle.
In periods when employment growth is slowing, the RBA is generally easing policy. When this is occurring, as long as the RBA can fend off a recession, falling interest rates tend to push up dwelling prices via cheaper credit which in turn encourages spending and supports employment growth. Of course, it’s a different story if employment growth falls too fast and unemployment rises sharply. But so far, at the national level, this hasn’t happened since the recession of the early 90s.
The risk of a material correction in dwelling prices looks higher now than it has been for a long time given: (i) the incredible lift in dwelling prices over the past five years; (ii) mortgage rates are probably unlikely to go lower and indeed can’t go much lower; (iii) household debt to income is at a record high; and (iv) dwelling supply is in the process of lifting quite significantly in some jurisdictions.
A soft correction in dwelling prices would probably have no material negative impact on the labour market. But there is a risk that a hard correction in prices (a fall of 20% or more) would lead the economy into a downturn via the wealth effect (i.e. the notion that changes in demand are influenced by changes in the value of assets). Since income to one person comes via the spending of another, there is a risk that falling home prices leads households to put the brakes on spending which ultimately drags consumption and employment growth lower.
A policy “mistake”
We consider a policy mistake by the central bank to be a risk to the economy given how much debt the household sector is carrying. Specifically, if the RBA hikes too early it could derail the improvement in the labour market that has been underway over the past two years. The record level of debt being carried by the household sector means that interest payments as a share of income will rise quickly if/when rates move higher (chart 13).
The construction sector in Australia, for example, is proportionately bigger than the construction sector in most other advanced economies because strong growth in people means that more needs to be built – dwellings, roads, schools, hospitals, ports etc. Finally, at the margin, a strong population growth rate at a time when there is labour market slack is likely to be putting downward pressure on wages as workers from offshore add competition to domestic labour.
At present, both major sides of politics (i.e. the Liberal-National Coalition and the Labor party) support maintaining a high permanent migrant intake every year. But there is a risk that one of the major parties opts for a different policy stance. The example here is to be found in New Zealand where there has been a change in immigration policy following the recent election outcome that means migration should drop substantially over the next few years. As a result, a change in immigration policy cannot and should not be ruled out in Australia.
A material reduction in net migration to Australia would increase the risk of a fall in dwelling prices as well as weigh on total output growth (not GDP per capita) and negatively impact the construction sector. But it would also likely put upward pressure on wages growth by reducing the pool of workers in many occupations. In that context, it’s not so much a downside risk, but rather one that would see a shift in the economic outlook that would have both winners and losers. From a policy perspective it’s about assessing whether there is a net societal benefit. But that’s a question for another day.
The ASX 200 index is running up against resistance at 6000. Reversal below support at 5920 would signal a correction. As would Twiggs Money Flow (21-day) crossing to below zero.
Iron ore is testing resistance at 70. Respect would warn of another (primary) decline. Breakout above 80 would signal a primary up-trend but that is unlikely if China continues to crack down on bank lending.
The ASX 300 Metals & Mining Index is testing support at 3300. Decline of the Trend Index below zero warns of medium-term selling pressure. Breach of 3300 would warn of a correction.
The ASX 300 Banks index found short-term support at 8300. Recovery above 8500 would be a bullish sign but respect is more likely and would warn of a test of primary support between 8000 and 8100.
The ASX 300 Metals & Mining Index retraced to test support at 3300. Breach is still unlikely but would warn of a correction.
Iron ore strengthened to test the declining trendline but respect of resistance at 70 would warn of a continued down-trend. Breakout above 80 would signal reversal to a primary up-trend but that is unlikely if China continues to rein in bank and shadow bank lending.
The ASX 300 Banks index broke support at 8500 and is expected to test primary support between 8000 and 8100. The sector faces headwinds from slowing development and falling prices, especially in high-density apartments. Recent Trend Index peaks at/below zero warn of long-term selling pressure.
Banks are the biggest sector in the broad ASX 200 index which retreated below resistance at 6000. Failure of short-term support at 5920 would signal a correction. The ASX 200 exhibits a tentative up-trend but bearish divergence on the Trend Index warns of long-term selling pressure.
The ASX 200 faces resistance at the key 6000 level. Money Flow is forming troughs above zero, indicating buying pressure. Recovery above 6000 would signal another advance. Failure of support at 5900 is less likely but would warn of a strong correction.
Iron ore prices are strengthening and likely to test the descending trendline at 70. Breakout above 80 would signal reversal to a primary up-trend but that still seems a long way off.
Miners responded with another rally, the ASX 300 Metals & Mining Index respecting support at 3300.
So why the hesitancy? Banks are the largest sector in the ASX 200, with Financials representing 37.2% of the broad index. The ASX 300 Banks index is retreating and expected to test the band of support between 8000 and 8100. Trend Index peaks below zero warn of long-term selling pressure.
The outlook for banks is not that rosy. Household debt is growing faster than disposable incomes, placing finances in an increasingly precarious position. Interest payments are still manageable at 8% of disposable income but that could change if interest rates rise.
The housing cycle appears to have peaked, with growth now falling. A function of tighter controls by APRA over investor lending and a Chinese crackdown on capital outflows.
Building approvals for detached houses remain steady but approvals for higher-density housing are falling.
A boom in construction of high-density housing has provided a strong tailwind to the economy over recent years, illustrated by the sharp spike in total residential construction compared to new houses in the chart below.
But the downturn in apartment prices and falling building approvals is likely to turn that tailwind into a headwind as apartment construction falls. This would affect not only the construction sector but the entire economy.
Political uncertainty over the continuation of favorable tax treatment for housing investors could also impact on new housing investment and strengthen the headwinds facing the economy.
South Korea’s Seoul Composite Index continues in a strong up-trend despite the nuclear threat from its northern neighbor. The latest retracement appears mild and likely to test the rising trendline around 2450.
Japan’s Nikkei 225 Index also retraced but the long tail on this week’s candle indicates solid support at 22000.
Hong Kong’s Hang Seng continues in a strong bull trend, with the Trend Index respecting the zero line.
China’s Shanghai Composite Index is consolidating above support at 3340. Bearish divergence on the Trend Index warns of selling pressure but this appears to be secondary in nature, warning of no more than a correction.
India’s NSE Nifty Index is also in a bull trend, with the Trend Index respecting zero. Respect of the rising trendline is likely and would signal a fresh advance.
Target 10000 + ( 10000 – 9000 ) = 11000
Moving to Europe, Dow Jones Euro Stoxx 600 shows a stronger correction, with bearish divergence on the Trend Index warning of selling pressure.
The UK’s Footsie displays a stronger bearish divergence and the index is likely to test primary support at 7200.
The S&P 500 displays a strong bull trend but penetration of the rising trendline is likely to lead to a correction to 2500.
Australia is headed for a period of political uncertainty, while tighter Chinese monetary policy and a crackdown on capital outflows will slow the local real estate boom. Employment is strong but low wage growth suggests under-employment.
Reliance on mining and real estate as the backbone of the economy is bound to disappoint. What the economy needs is a vibrant manufacturing and tech sector but this is shrinking rather than growing, with investment in machinery and equipment falling from 8% to almost 4% of GDP over the last decade.
Stocks are rising but we need to temper our enthusiasm with a hint of caution. The ASX 200 is testing medium-term support at 5900. The tall shadow on Friday’s candle indicates continued selling pressure. Breach of 5900 would warn of a strong correction to test primary support at 5650, while respect (indicated by recovery above 6000) would confirm an advance to 6250 (5950 + 300).
I remain wary of the banks because of their low capital base and high mortgage exposure. Reversal below the medium-term trendline warns of a correction to test the band of primary support between 8000 and 8100. Recovery above 8800 is less likely.
Miners are more bullish despite the low iron ore price. The ASX 300 Metals & Mining index is testing medium-term support at 3300. Respect is likely and would signal another advance.
The ASX 200 closed above its 2015 high of 6000, confirming an earlier breakout by the All Ords. The immediate target for an advance is 6250 (5950 + 300) but the long-term target is the 2007 high of 6800.
I remain wary of the banks, with the ASX 300 Banks index facing resistance at 8800. Reversal below the medium-term trendline at 8600 would warn of another test of primary support (8000). Recovery above 8800 is as likely. I remain concerned over their low capital base and high mortgage exposure.
Miners are more bullish despite the falling iron ore price. The ASX 300 Metals & Mining index reached its target of 3500 but is now retracing to test the new support level. Respect would signal another advance.
Australia seems headed for a period of political instability, while tighter Chinese monetary policy and a crackdown on capital outflows could also impact on the Australian economy. There is a lot that could go wrong but the market is taking this in its stride. Just temper your optimism with a measure of caution.
The ASX 300 Metals & Mining index is more bullish, breaking resistance at its three-year high of 3300 to signal another primary advance. I remain cautious because of iron ore weakness and rising Chinese interest rates but retracement that respects the new support level would confirm the advance.
The Australian Dollar is falling, iron ore is weak and banks face headwinds but the overall outlook remains (surprisingly) bullish.
Leith van Onselen questions whether the RBA should target a flat growth rate of say 5% for nominal GDP rather than inflation:
I am not convinced that the RBA and RBNZ should necessarily set interest rates around nominal GDP. As shown in the below charts, setting interest rates in this manner would likely see the cash rate rise significantly from current levels which, given anaemic wages growth and high underemployment in both nations, would seem unwise:
Let’s look at the graph of GDP growth a bit closer. If we target 5% GDP growth:
From 2001 to 2007 rates were too low. That would have softened the sharp fall in 2008
Rates in 2008 were too high
Rates were not too low in 2009 to 2010 because of the growth undershoot in 2008
Rates were too high 2011 to 2016
Again, rates are not too low in 2017 because GDP has undershot its growth target for the last 6 years
I believe that targeting nominal GDP would help to stabilize growth with higher rates in the boom to prevent the need for lower rates in an ensuing bust.
Where I do agree with Leith is that banks need to re-focus from financing largely speculative (housing) assets to financing productive investment. In fact, not just the banks but the entire economy.
The CoreLogic home value index held flat in Oct taking annual growth to 7%yr, an abrupt slowdown from the 11.4%yr peak in May.
Policy measures continue to have a material impact. Although official rates remain near historic lows, regulators introduced a new round of ‘macro prudential’ tightening measures in late March. Meanwhile a range of other changes have also seen a progressive tightening of conditions facing foreign buyers.
….Sydney continues to record the sharpest turnaround in conditions, annual price growth slowing to 7.7%yr in Oct, essentially halving since Jul. Melbourne continues to see a much milder turn with price growth still tracking at 11%yr.
….The houses vs units breakdown shows a more pronounced slowdown for houses with annual price growth slowing to 7.2%yr from 12.4% in May. Our monthly seasonally adjusted estimates suggest prices have been declining at about a 2% annualised pace over the last 3mths. ….Notably, the detail suggests the pace of unit price declines in Brisbane and Perth is moderating while price growth in Melbourne units has shown essentially no slowing to date.
The slowdown is likely to carry through to year end. However, the next few months will be a critical gauge of whether markets are starting to stabilise. To date, the timeliest market measures – buyer sentiment, auction clearance rates and prices – are showing few signs of levelling out. However, some of the pressure from macro-prudential measures may ease off a little.
China’s crackdown on capital flight seems to be having an impact on housing prices in Australia. Whether this is sufficient to cause a collapse of the property bubble is doubtful unless there is a general decline in prices, causing mortgage lenders to tighten credit standards.
The banking sector remains my major concern. With CET1 leverage ratios between 4 and 5 percent, the sector could act as an accelerant rather than a buffer (Murray Inquiry) in an economic downturn.
A note on Leverage Ratios:
I use Tier 1 Common Equity (CET1) to calculate leverage rather than the more commonly used Common Equity which includes certain classes of bank hybrids — convertible to common equity in the event of a crisis — as part of capital. Inclusion of hybrids as capital is misleading as conversion of a single hybrid would be likely to panic the entire financial system (rather like a money market fund “breaking the buck”). In the recent banking crisis in Italy, regulators chose not to exercise the conversion option for fear of financial contagion. Instead the Italian government was called on to bail out the distressed banks. Same could happen here.
A global investment bank has called the end of Australia’s world record housing boom, saying the golden years are “officially” over after home prices fell in Sydney for the second month in a row.”
There is now a persistent and sharp slowdown unfolding”, ending 55 years of unprecedented growth that has seen home values soar by more than 6500 per cent, UBS economists wrote in a note to clients on Thursday.
….recent weakness in auction clearance rates and anaemic price growth over the past five months suggested “the cooling may be happening a bit more quickly than even we expected”, economists George Tharenou and Carlos Cacho wrote in their note, downgrading their growth forecast for 2017 to just 5 per cent.
Not quite a Minsky moment but something to watch closely if you hold bank stocks.
A Minsky moment is a sudden major collapse of asset values which is part of the credit cycle or business cycle. Such moments occur because long periods of prosperity and increasing value of investments lead to increasing speculation using borrowed money.
The spiraling debt incurred in financing speculative investments leads to cash flow problems for investors. The cash generated by their assets is no longer sufficient to pay off the debt they took on to acquire them.
Losses on such speculative assets prompt lenders to call in their loans. This is likely to lead to a collapse of asset values.
Meanwhile, the over-indebted investors are forced to sell even their less-speculative positions to make good on their loans. However, at this point no counterparty can be found to bid at the high asking prices previously quoted.
This starts a major sell-off, leading to a sudden and precipitous collapse in market-clearing asset prices, a sharp drop in market liquidity, and a severe demand for cash.
The Aussie Dollar broke support against the US Dollar at 77 cents, warning of a decline to test long-term support between 71.50 and 72.00.
Iron ore continues to test new resistance at $62/tonne. Respect would warn of a test of primary support at $53. Declining Twiggs Trend Index indicates selling pressure.
The ASX 300 Metals & Mining index fared better, testing resistance at its three-year high of 3300. But the index is likely to follow iron ore lower. Breach of support at 3100 would warn of a decline to 2700.
The ASX 300 Banks index retreated from resistance at 8800. Respect warns of another test of primary support at 8000.
If banks and miners are both headed in the same direction, the index is sure to follow.
The ASX 200 continues to test resistance at 5900. Follow-through above 5920 would be a strong bull signal, indicating an advance to 6000. Reversal below 5880 would suggest retracement to test the new support level at 5800 (top of the narrow ‘line’ formed over the last four months). Twiggs Money Flow reversal below zero would be a bearish sign.
Despite the falling Dollar and iron ore, the present outlook continues to favor the bull side.
The ASX 300 Metals & Mining index breached its new support level at 3300, warning of a bull trap. Penetration of the rising trendline would test primary support at 3100.
The divergence between iron ore and miners was bound to end and a correction of the Metals & Mining index is now likely. Iron ore below support at $62 warns of a test of primary support at $53. Declining Twiggs Trend Index signals selling pressure.
The ASX 200 encountered resistance at 5900. Retracement is likely to test the new support level at 5800 (top of the narrow ‘line’ formed over the last four months). Twiggs Money Flow reversal below zero would be a bearish sign.
The ASX 300 Banks index are testing resistance at 8800. Respect of resistance would warn of another test of primary support at 8000.
If banks and miners both turn bearish, the index is likely to follow.
Bill Evans at Westpac sums up their outlook for the Australian economy:
….Constraints on growth next year are likely to centre on a lack lustre consumer who struggles under the weight of weak wages growth; high energy prices and excessive leverage. Conditions in housing markets, particularly in the eastern states, are likely to soften while the residential construction boom will turn down.
We are also less euphoric about growth prospects for our major trading partners than seems to be the current consensus. We expect China’s growth rate to slow from 6.7% to 6.2% as the authorities step up policies to slow its long running credit boom.
Yet the ASX 200 broke out of its line formed over the last 4 months, signaling a primary advance.
Miners are advancing, with the ASX 300 Metals & Mining Index breaking resistance at 3300.
The ASX 300 Banks Index is headed for a test of 8800. Upward breakout would complete a bullish outlook for the ASX 200.
Banks rallied, with the ASX 300 Banks index breaking 8500 to signal another test of resistance at 8800. Breakout above 8800 would signal resumption of the primary up-trend but expect retracement to first test the new support level. I will remain wary of banks until the support level is respected.
The bank rally helped to lift the ASX 200 above resistance at 5800 — from the narrow ‘line’ formed over the last four months. Breakout signals another primary advance but again wait for retracement to respect the new support level. Respect would confirm a test of the 2015 high at 6000. Twiggs Money Flow peaks below zero still warn of long-term selling pressure. Reversal below 5800 would mean all bets are off.
On a more bearish note, iron ore is heading for a test of primary support at $53. Declining Twiggs Trend Index signals selling pressure. Breach of primary support would spell trouble for the miners.
The ASX 300 Metals & Mining index rally continues but another test of 3100 is likely. Breach of 3100 would most likely drag the ASX 200 (and banks) lower.