Quarterly Review July 2018

17/07/2018
Posted in Wealth
17/07/2018 Level One

Share Market Update

The Australian share market has finished the 2018 financial year with a capital gain of 8.26% (before dividends), or up 13.8% including dividends.

The strong performance can be attributed to earnings upgrades from the resources sector and a strong performance from the high-growth market darlings including CSL, Macquarie & Aristocrat.

CSL, which has broken the $200 share price level in the last few days, has been one of the biggest anchors of the market’s performance. BHP Billiton is the single biggest contributor to the index’s advance, followed by CSL and Macquarie Group.

Telstra, Commonwealth Bank and AMP were the largest detractors. Telstra has dropped 39% of its value over the last twelve months and the banking index is down 7%.

Bank stocks have found support this quarter but have not recovered this year’s losses. The Royal Commission has fuelled the view that banks will tighten the availability of credit in the economy, which removes a source of support for house prices.

The Australian share market is now sitting around 6,200 points and is at 10 years highs. However, we are still sitting below pre GFC highs from November 2007 of 6,873.20.

Australian Share Market Movement

 

Economic Update

June marked 21 months of the cash rate being kept on hold by the Reserve Bank of Australia (RBA). The Board continues to keep their existing stance on monetary policy until their measures see “further progress in reducing unemployment and having inflation return to target”. Interestingly, the Board removed it is “more likely that the next move in the cash rate would be up, rather than down” from its June minutes, which caused economists to question the RBA’s intentions.

On the other hand, the lenders have continued to increase their mortgage rates despite the RBA. We have also seen term deposit rates move upward over recent times also.

The primary reason for both the RBA being on hold and the banks upping their rates is housing. The household debt-to-income ratio has soared to a record high of 190% in the first quarter of 2018. This high level of debt makes the RBA nervous, particularly when wage growth has been sluggish and interest rates are at historic lows.

ASIC APRA and the Royal Commission has been putting pressure on lenders to tighten lending criteria. The slowdown in demand had started to occur in early 2018 after house prices peaked in late 2017 but the Royal Commission, which commenced in March, has seemingly exacerbated the slowing of the housing market.

Home loans are the key leading indicator being watched for signs of a ‘credit crunch’. Loan growth is forecast to fall by around 20% with the banks continuing to tighten lending. House prices are expected to continue to decline, with the actual percentage being anyone’s guess.

All of these factors will likely see the RBA on hold until mid-2019 or into 2020.

Recent GDP numbers indicated that the economy was doing better than average, consistent with very strong levels of business sentiment. This is partly reflected in the strong global economy. There is strong demand for commodities, including iron ore, coal and gas. Tourism is very strong and overseas students attending Australian universities (and schools) are on the rise. Infrastructure spending is booming, most notably on the East Coast. Population growth is still relatively strong. Firms are again spending more on Capex.

More good news is that high business confidence has led to stronger jobs growth over the past 12 to 24 months. This has reduced consumer fears of unemployment. The RBA noted that job vacancy levels are high, and other indicators point to ongoing strong employment growth. Overall, consumers acknowledge that the economic outlook is improving. Despite this, households indicate that the state of their personal finances is only ‘OK’, a reflection of the very modest growth in their disposable incomes over recent years.

The outcome of this is that people are using more of their incomes for cost of living, they are saving less, and if there is spare cash, it is being used to pay down debt, rather than used for retail spending. Therefore, wage growth in a stronger labour market is a key element of continued economic stimulus. The RBA is confident this will occur but will take some time yet.

The Aussie dollar is expected to lower again to around US$0.72 to US$0.73 by the end of the calendar year. This will also improve economic conditions domestically, in the face of increased risks globally.

 

Property Market Update 2017-18 Financial Year In Review

In this update we delve into how national housing markets have performed in terms of value growth in the 2017-18 financial year and how it stacks up against previous years.

The first chart highlights the change in dwelling values nationally across each financial year from 1997-98 to 2017-18.  In the most recent financial year, dwelling values fell by -0.8% which was the largest fall in values over a financial year since 2011-12 (-3.0%).  The fall in values over the year was a significant contrast to the 10.2% increase in values over the 2016-17 financial year.

National Market Performance

Dwelling values fell by -1.6% over the 2017-18 financial year across the combined capital cities.  This represented the largest fall since 2011-12 (-3.0%) and it was a substantial slowdown compared to the 11.1% increase in values over the 2016-17 financial year.  Last financial year was one of only four financial years over the past two decades in which capital city values have fallen.

Although combined regional market dwelling values increased by 2.2% over the 2017-18 financial year, the rate of growth was much slower than the 6.4% the previous year.  Regional dwelling value growth last year was the slowest it has been since 2012-13 when values increased by just 0.9%. Regional markets have only seen three years out of the past 20 in which values have fallen over the financial year.

Sydney dwelling values fell by -4.5% over the 2017-18 financial year which was their largest financial year fall in over 20 years.  In fact, looking at data which goes back to 1980-81 financial year, this is the weakest financial year for growth in Sydney dwelling values over that period.  The slowdown in Sydney dwelling value growth is stark when considering that a year earlier values had increased by 16.4% over the financial year.

Dwelling values were 3.2% higher over the 2017-18 financial year in regional NSW.  Like Sydney, there has been a significant slowdown in growth over the year compared to the 11.9% increase the previous year.  In fact, the 3.2% increase was the slowest financial year growth since 2012-13.

Over the 2017-18 financial year, Melbourne dwelling values increased by 1.0%. Although values rose for the sixth consecutive financial year, it was the slowest rate of growth out of any of those six years and well down on the 13.0% increase over the 2016-17 financial year.

Growth in Brisbane dwelling values has slowed over each of the past two financial years with an increase of 1.1% in 2017-18.  The change in values over the most recent financial year is the lowest since values fell by -3.6% over the 2011-12 financial year.  Although the rate of value growth slowed, values have increased over each of the past six financial years.

Adelaide dwelling values increased by 1.1% over the 2017-18 financial year, marking the 5th consecutive year in which values have increased. Although values increased over the year, it was the slowest rate of change for the city since values fell -0.4% in 2012-13.

Perth dwelling values fell by -2.1% in 2017-18 which represented a slowing of value declines from the -2.6% fall in 2016-17.  Although values have now fallen for four consecutive financial years, declines over the most recent year were the most moderate of those four years.

Hobart dwelling values increased by 12.7% over the 2017-18 financial year which was marginally lower than the 12.8% over the previous financial year.  Dwelling values in Hobart have now increased for five consecutive financial years however, the past two years have seen the strongest growth since 2003-04.

For the fifth consecutive financial year, dwelling values in Darwin have fallen, down -7.7%.  The rate of value decline over the past financial year was much greater than the -2.6% in 2016-17 however, it was slightly lower than the -8.0% decline in 2015-16.

Across most regions of the country, dwelling value growth over the 2017-2018 financial year slowed compared to the previous year.  Unlike previous downturns, the slowing of value growth was not precipitated through movements in the cash rate.  Independent increases to the cost of borrowing, particularly for investors, tighter credit conditions and a lack of real wage growth which has led to reduced affordability are some of the main drivers of the weakening housing conditions.

Looking forward to the 2018-19 financial year, the factors which contributed to the slowing growth in 2017-18 seem unlikely to be removed over the coming financial year which may result in even weaker value changes over the coming year.

 

Level One Outlook

Looking forward we at Level One keep a keen eye on offshore developments. Importantly a strong US economy coupled with strong US jobs growth should continue to see US interest rates rising going forward (they have risen seven times since December 2015).

This will place significant pressure on our domestic cost of funds which will drive our interest rates higher despite the RBA holding the cash rate on hold at 1.5%. This is already happening as local banks slowly lift rates. Make no mistake – there is more to come and this will obviously have a direct effect on property prices into the future.

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