Quarterly Review April 2018

20/04/2018
Posted in Wealth
20/04/2018 Level One

Share Market Update

The ASX200 has started 2018 with a negative quarter declining from 6,065.30 at 31 December 2017 to 5,759.40 at 31 March 2018, which represents a drop of 305.9 points or -5.04%.

This is the worst performance for a quarter since the GFC. Investors have only suffered two worse March quarters over the past 25 years – a 15% plunge in 2008 and a 6.3% loss in 1994.

This effectively neutralised the previous strong October to December 2017 quarter returns which saw the market jump 5.06% and push through the 6,000 point barrier for the first time in almost 10 years.

The heavyweight big four lenders have dragged on the overall market as the stocks wilt under the pressure of a royal commission into the sector. Losses for the quarter stretched to -8.8% for Westpac, while NAB was the best performer but still fell -3.8%.

Telstra has also been a major drag on the ASX in 2018. The big telco has slumped by more than 10% the first three months of the year amid worries its prized dividend is unsustainable.

We have been through a peculiar time in recent years when interest rates have been unbelievably low, deflation has been a key risk, rising inflation was sought after, wage rises were scarce and most stock markets have rocketed along, thanks to central banks throwing money at our economic problems.

Now central banks are going to try to avoid an economic and stock market slump by managing inflation. They need to do this because all their past stimulous activities are working well enough to not only create jobs but now wage rises are starting to happen in the US; hence the threat of inflation has started to spook financial markets. If the inflation levels spike too quickly, then the Fed will have to raise interest rates quickly and that could hurt the positive outlook for US economic growth. This is what spooked the market and caused share markets to fall in early February.

Other overseas developments didn’t help the market either. Threats of a trade war initiated by US President Donald Trump and continued unrest in Syria also depressed share markets around the world.

While this may all look like doom and gloom there are a lot of positives that will drive the market. Market corrections are normal and they can often be more than 10% per cent – and so far, we are only down 6% in Australia from the January high – but deep bear markets (downturns) are normally associated with a recession in the Australia or US, and at the moment there’s no sign of that.

The Australian share market underwent reporting season in February and March which was overall positive with a broad improvement in corporate profits, with around three quarters of companies reporting an increase in earnings versus a year ago. That was the strongest performance since before the GFC.

Solid earnings growth in Australia and abroad will help share markets resume their upwards trend. 2018 will be a year of volatility, but overall should be positive for stocks.

Economic Update

The first quarter of the new year saw the Reserve Bank of Australia (RBA) again keep rates on hold, signalling that the “accommodative monetary policy is still necessary to support our economy”. The Board continues to flag that it will likely be some time before we see an acceleration of wage growth – real wages rose a modest 0.2% in the December quarter – and subdued household spending is still the biggest hurdle.

The US Fed however has continued to increase its rates and indicated that four rate rises could be expected in 2018, rather than the previously stated three, which would see their cash rate overtake ours for the first time since the 1990’s.

Our GDP is expected to continue to be sluggish, with a forecast growth of 2.5% this year and next. At face value, the December quarter GDP numbers were a bit disappointing. Not only did they come in under consensus forecast, but they were lower than the September quarter figures. The annual growth rate of around 2.5% is no better than the average rate recorded over the past 10 years. All of this looks disappointing, particularly given the very low level of interest rates and the economic momentum that appeared to be developing. With non-mining business investment growth firming but consumer spending expected to moderate given softer labour market conditions, the outlook is mixed. Residential construction activity is also expected to continue to decline.

There is optimism in the world economy however and overall the ‘synchronised growth’ phase we are currently in has gained momentum. Tax cuts and additional spending from the US Government has led to an increase in forecast US GDP growth this year, and the latest data suggests the same positive outlook for Europe and Asia. The ‘Trump factor’ and his proposed tariffs on aluminium and steel imports (25% and 10% respectively) continue to present risks to the world economy and cause market shocks, which we experienced in February when the Dow Jones fell 10% on the back of concerns that interest rates would increase earlier than expected. We note that the Dow has since recovered 6% to date.

The RBA also noted that the December quarter numbers were impacted by temporary weakness in exports. More generally, the GDP numbers appear inconsistent with other evidence. Business sentiment is back to the levels last seen at the peak of the pre-GFC good days. Growth in the number of hours worked is more consistent with an economy shifting into top gear. And the (modest) decline in the unemployment rate over the past year points to an economy doing a bit better than average.

So, on balance the economy looks to be doing better but that is still not good enough. The underutilisation rate (the unemployment rate plus those working part-time looking for a full-time job) is still too high indicating that the economy has not run strong enough for long enough. Even taking into account the noise in the data, the economic growth rate in Australia in 2017 was only about mid-table when compared to global peers. Australia has had very strong population growth, boosting the size of the labour force and increasing the demand for houses and infrastructure. But economic growth has only been a little bit faster than population growth. This has resulted in growth of GDP per person being only a bit higher than the pace during the recessions of the 1980s and 1990s.

One of the more positive indicators was the trade balance. After a disappointing end to 2017, the merchandise trade balance bounced back in January, recording a $1 billion surplus. Exports increased by 4% with both goods and services seeing an uptick. A decline in the consumption of goods however saw a 2% decline in imports. Further export growth is expected this year with new Liquid Natural Gas (LNG) capacity set to support this expansion. In contrast, growth in imports is forecast to slow in line with the relatively subdued pace of consumer demand. As a result, the trade balance is expected to remain comfortably in surplus this year and the next.

Following a year when jobs growth was near a record annual high and the unemployment rate declined, it is reasonable to be more confident about our economy. But there are too many people looking for a full-time job, the household debt ratio is too high and wages and productivity growth too low for policy makers and economists to breathe easy just yet. All things considered, we can say that it is good, but could be improved.

Key Trends that will Define the Sydney Housing Landscape in 2018

The Sydney housing market has remained a contentious subject over the past 12 months, with 2017 recording its fair share of ups and downs. Most would agree that residential property has peaked for this cycle and multiple factors are having a negative impact on pricing.

Despite the recent slide in dwelling values across the city, CoreLogic data shows property prices are still 69% higher than they were when the market reached a low point in Feb 2012 and, although interest rates remain low, affordability is still a talking point. So how will the current landscape influence government policy, developer activity and consumer behaviour in Sydney over the coming year? 

Investors

Investors are still active in the market, with the latest ABS housing finance data showing they comprise 51% of new mortgage demand; well above the long run average of 37%. This is despite tougher serviceability criteria and mortgage rate premiums.

That said, the share of investor mortgages across New South Wales has fallen from their peak of almost 65% in 2015, and we could possibly see this decline further in light of slow capital gains and low rental yields in Sydney as well as credit restraints on investment and interest only mortgages. 

First Homebuyers

On the other hand, first homebuyer activity, as a proportion of all owner occupier finance commitments, rose from 7.5% in early 2017 to almost 15% by the end of last year, indicating a rush from first time buyers to benefit from stamp duty concessions. But despite the increased activity, saving for a deposit is prohibitive for many and this cohort remains a small percentage of all buyers.

To combat this, ‘rentvesting’ – where you rent in your preferred area and buy somewhere more affordable – is likely to become more popular among younger buyers, as is staying at home for longer, or even moving interstate. This already growing trend for domestic migration out of NSW is set to continue as people consider how far their dollar will stretch outside of Sydney. 

Government

In contrast, strong overseas migration rates into Sydney are fuelling greater demand for housing. As such, we can expect housing supply to be a priority among government housing policies, including more affordable options.

Taking a long-term view, this is bound to have a greater impact on housing affordability challenges then initiatives such as stamp-duty concessions, which stimulate demand and are likely to simply drive values higher across the more affordable priced areas of the market.

It should be noted that while net overseas migration remains at very high levels, net interstate migration is seeing an increasing number of residents of New South Wales moving to other state and territories. 

Developers

Apartment construction has grown to unprecedented levels in recent years, stimulated by demand from local investors and foreign buyers. As these groups are no longer buying at the levels they were, this should influence an easing in high rise unit construction across NSW – mirroring a trend that has been emerging in Victoria and Queensland since late 2016.

Instead, we can expect to see developers shift away from high-rise construction towards medium density options, building town houses and terraces that meet the needs of families. Medium density housing stock located close to the city and along transport spines are currently under supplied and will be highly sought after. 

Lenders

While the cash rate isn’t likely to rise this year, mortgage rates could still push a little higher due to increased funding costs on capital markets. Sydney homeowners with several years of property ownership under their belt may have built substantial equity in their home and be able to withstand interest rates moving higher. More recent buyers, particularly those with thinly stretched balance sheets, could find themselves at greater risk of mortgage stress.

However, it could be feasible for lenders to slightly relax their lending policies as APRA limits around credit growth and interest only lending have been comprehensively achieved. If lenders become more willing to lend for investment purposes, ensuring they remain within the regulatory benchmarks, it could help to ease the downward trajectory of Sydney home values.

While there have certainly been some positive outcomes for several players in the Sydney housing market over the past year, enduring challenges remain – particularly around affordability and supply. In a few decades time, this may be less of an issue with technology making it easier for people to live and work outside of the city. But in the short term, tackling these challenges has to remain a priority.

At Level One we believe our economy and property market face some significant challenges going forward including increased banking regulation as a result of the royal commission, restrictions and costs on foreign property buyers, international geo-political uncertainty as well as our own federal election due in the next twelve months. These issues come on the back of the longest and strongest bull run in the property market seen in decades.

Source CoreLogic
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