It’s time for a review of the Aussie economic landscape. You probably know I won’t be talking about the recent CPI number or unemployment data, or even GDP numbers (you can talk to your stockbroker or financial planner about them). Those things matter, but what matters more is understanding where we’re at within the bigger picture.
To start, a quick recap of the last 12 or so years…
In 2006 the Aussie economy is chugging away quite solidly. The tech wreck at the turn of the century is a distant memory and the economy is growing at around 3%. The mining sector is doing very well thanks to high demand from China – iron ore, copper and coal have about tripled in price since the turn of the century. Investment in mining was growing as companies sought to take advantage of the rising prices.
And then came along 2008: “The GFC.” To frame it simplistically from an economics perspective – America’s private sector debt accumulation cycle peaked, their economy hit the skids, defaults on the accumulated burden of debt skyrocketed and, because the USA had exported a lot of the debt, the defaults were felt globally. Economic weakness in Europe exposed the major flaws in the Euro system and, combined with a popping of their own credit bubbles in some countries, resulted in the whole Euro project coming close to collapse.
For China, it wasn’t good for business. They had this economic development model basically comprised of two things:
Create economic activity and employment via building things (infrastructure), and;
Suppressing their currency, making exports highly competitive and putting their massive labour force to work by being the world’s factory.
The GFC resulted in a global collapse in demand for “stuff.” China saw its exports start to fall dramatically. Facing the prospect of widespread factory closures and rising unemployment. China needed to do something, so to cushion the impact, it hit the accelerator on its other growth engine – “building stuff”.
This was a boon for Australia. Resources demand and prices went ballistic. The iron ore price went from around US$36 a tonne in 2007 to $60 in 2008, on its way to a top of around US$180 in 2011. Investment in new projects ramped up as everyone wanted to take advantage of the boom. Australians were mostly left scratching their heads – “what’s this GFC I hear foreigners talk about?” We were one of the only developed countries to avoid a recession.
But it wasn’t all about China saving us from the global recession. One quite remarkable aspect of the most recent resources boom is that despite the staggering amount of resources exports (both in volume and value), Australia still managed to run a constant trade deficit! That’s right – despite our booming exports, our imports were also booming.
The current account has averaged a deficit of 4.3% of GDP since 2000.
This global trade (i.e. “we’ll send you dirt, you process it into goods and send it back”) certainly isn’t bad and certainly has been a benefit to Australia – economic activity and employment is boosted. But when we’re importing more than we’re exporting, this isn’t any road to national prosperity – at least from a “GDP” perspective. Remember how GDP is calculated:
GDP = C + I + G + net exports Where: C = consumption I = investment G = government
Therefore, a trade deficit subtracts from GDP
“Funding” the trade deficit:
There’s not a lot of “hard science” in economics – despite what a lot of economists want us to believe, much of economics is theories that can’t be proven – or disproven – in the real world. In the area of “balance of payments,” we have some “hard science.”
The Current Account is basically a record of transactions with the rest of the world – net trade, net earnings on international investments and net transfer payments (e.g. foreign aid). It makes up half of the “balance of payments” – the other being the Capital Account. The Capital Account represents the net change in physical or financial assets.
The “hard science” – the sum of the current and capital account must be zero – it’s an accounting identity.
When a nation runs a current account deficit, it must by definition have an equal and offsetting capital account surplus. In the simplest sense – it must see an outflow of “capital.” Something essentially needs to “fund” this outflow or capital just disappears out of the economy.
The USA is in the same situation and it’s probably better understood how they “fund” their deficit. To use a bit of economics jargon: US investment exceeds US savings and the US runs a trade deficit that is by definition equal to the gap between investment and savings. It also runs a capital account surplus equal to the gap because that’s the amount of net foreign capital inflows needed to make up the shortfall in the current account.
Total US savings consists of the sum of household savings, business savings and government savings. As we well know, the US has been running a meaningful government budget deficit. The accumulating government debt in a simple sense “funds” the trade deficit by “funding” the capital outflows caused by the trade deficit.
We can see evidence of this in China’s mountain of US treasury holdings. Simplistically, China sends the USA more “stuff” than the USA sends China (i.e. a US trade deficit). The USA sends money as payment (i.e. capital account surplus). The Chinese then have a mountain of US$ and, largely as a means of managing the exchange rate, they return it via investments in US treasuries. (And this arrangement is incredibly unlikely to change much so long as China runs a trade surplus with the USA – despite what Chinese officials may say about “reviewing their treasury holdings”.)
Returning to the “savings” identity mentioned above (Total savings consists of the sum of household savings, business savings and government savings), the meaningful increase in the US government debt (dissaving) allowed for the private sector to save. Since the financial crisis we’ve seen their household debt decrease from around 100% of GDP back to below 80%.
This sort of de-levering will always have a profound effect on the economy. No wonder their economy has been barely crawling along. And without the increase in government debt, well, their economy would have been much, much worse.
What happened in Australian during this time? This:
Whilst the household sector of the US (and many other countries) de-leveraged after the GFC, Australia didn’t. The little Aussie battler continued to leverage up!
Note that the flat-lining in the last 12 months or so doesn’t mean debt has decreased. Remember, this is debt to GDP – GDP has increased and thus debt has to have increased by at least the rate of GDP to remain constant. This is important to understand – for debt to GDP to continue increasing, the rate of increase in debt will need to be greater than the rate of increase in GDP.
So, although Australian government debt has increased since the GFC, the continued buildup of household debt is the more significant event. The increase in debt fuels an increase in demand and, together with the mining boom, this has been the saviour of the Australian economy since the GFC.
Instead of a significant increase in foreign ownership of Australian government debt in order to “fund” our current account deficit (the USA experience), what we’ve seen more is an increase in private debt in the international markets, principally in the form of an increase in offshore borrowings by our banks in order to stem the capital outflows resulting from the current account deficit.
The Leader Board:
Here we have the household debt to GDP ratios across major developed countries:
It’s important to note that there’s one key difference between Australia and Switzerland, Denmark and the Netherlands – aside from being the only country not in Europe, Australia is the only one that runs a current account deficit! The others all run quite substantial surpluses – Switzerland’s has averaged around 10% of GDP since 2000!
So Australia now holds the honour of having the world’s highest level of household debt for a large developed nation that runs a trade deficit! We’ve held this honour since 2010 when we overtook the former leader, Ireland.
Another honour Australia now holds is being the world record holder for the longest period without a recession (as measured by the traditional 2 consecutive quarters of negative GDP) at 27 years!
Summary:
Performance throughout the GFC period was something to be especially proud of. However, it’s important to understand that the drivers behind growth have been a spectacular mining boom which has largely run its course – especially in terms of the “investment” aspect of the boom (i.e. the development of new mines), and an increase in household debt to record (and unsustainable) levels.
Where to from here?
To many schools of economic thought, the credit cycle is the economic cycle. There’s a huge amount of historical precedents to support this. Increasing debt increases demand: if you want a new car, the cheapest way of financing it is to take money from your mortgage offset account. Buying the car provides income to the dealer who pays his salesperson, who then goes to the pub to celebrate a successful week – that’s the economy and the role expanding credit plays. The opposite is also true – if debt isn’t increasing, or worse, falling, demand also falls.
There’s also a multitude of precedents that demonstrate that there’s a limit to the amount of private debt a country can handle. At some point you hit a saturation point where debt starts to outstrip interest servicing capacity and the nation collectively can’t increase debt anymore.
The higher debt levels get relative to GDP, the more the economy becomes reliant on credit growth to stoke demand. As noted earlier, you need to see credit continue to rise at a faster rate than GDP or you suffer a fall in demand and the higher the debt, the higher the increase in debt (simplistically, 5% of a big number is a big number!).
Are we there yet? We don’t know. What we do know is we’re well within that zone where nations in the past have hit the ceiling and gone through a period of de-levering. Look at the USA pre-GFC – it didn’t even manage to crack 100% household debt/GDP.
Remember, an economy is made up of all the individual inhabitants going about their lives. You may think “…well I have heaps of capacity to take on more debt…and so do a lot of people I know.” That may be true, but you need to think more broadly – there’s now a lot of evidence that Australia is at the limit of its debt servicing capacity. After 60 years of relentless credit growth (aside from a small dip in the early ‘90’s during Keating’s “recession we had to have”), we are nearing that point where private debt can’t increase much more.
It’s important to understand that you don’t need a “catalyst” to trigger a downturn caused by a reduction in the acceleration in credit growth. The “reduction in acceleration in growth” is the catalyst. A term popularised in the GFC to describe that sort of event is a “Minsky Moment” – named after mid-20th century economist Hyman Minsky who spent much of his career researching credit cycles. In essence, a prolonged period of stability eventually leads to instability.
Part of the reason for this is because there are pro-cyclical drivers at play. A simple example is bank lending standards. In the midst of a credit boom, it’s easy to get credit. Part of the reason for the boom is that the economy is doing well and banks, run by humans, are feeling optimistic and willing to lend. As credit levels peak, the economic outlook starts to look less rosy. Those same humans that lent money now start to worry about the amount of money that they’ve lent and become more averse to lending more. This tightening of credit conditions will of course have a negative impact. There’s an increasing amount of evidence that this is occurring right now.
What can go right/wrong?
Australia has become reliant on increasing household debt to feed demand and fuel economic growth. Credit growth looks set to hit its natural limits and, all else being equal, the ramifications of this will be a meaningful fall in demand and contraction in the economy.
What could offset this and deliver a “soft landing”?
We’d need to see the baton for economic activity passed to another sector.
A meaningful improvement in the current account (trade) deficit would help. If the trade deficit could be shifted to a meaningful surplus, the inflows would increase demand and cushion the economy from a private sector deleveraging.
What we’re taking about here is a big uptick in exports. Another mining boom anyone? A big uptick in exports from our manufacturing sector (okay stop laughing – we all know anufacturing has been all but wiped out).
An inevitable side-effect of an economic downturn will be a fall in the Australian Dollar, especially if the growth trajectory of the rest of the world remains relatively stable thus interest rate differentials collapse (i.e. Aussie interest rates fall whilst rest of world rise). In time, a meaningful currency depreciation will aid manufacturers (but unfortunately make my overseas holidays more expensive).
Still on exports, if demand for exports was to decline (say from a slowing China economy) at a time when Aussie households were looking to de-lever, that would not be a good combination. In fact, it could be a significant headwind.
Another “soft landing” option could be a dramatic increase in the government deficit. Just like the USA experience of recent years, a dramatic decline in the government sector savings (i.e. increase in deficit) would stoke demand and help allow the household sector to increase its savings (i.e. reduce debt).
Invariably, an economic downturn leads to higher government deficits – the term often used is “automatic stabilisers.” In a downturn, tax revenues will decline and welfare payments increase. This increased deficit helps stabilise the economy.
A big increase in government spending would also help. For example, from a deficit-fuelled infrastructure package. Our governments have been obsessed about deficits and debt, fearing we will end up like Greece, and I’m sceptical about any pre-emptive increases in the currently modest government deficit
Property:
In a credit-driven downturn, it will be those sectors that are most reliant on credit that will feel the pinch the most. On that note, I can’t resist a few comments around our beloved residential property sector.
Did you know that there’s around 350 construction cranes active across Sydney? According to the USA-based commentator who recently quoted that figure, that is more than all the cranes in the 12 largest US cities combined!
Make no mistake, property construction is booming in Australia as it has been the key benefactor of the increase in household debt. The money is feeding the incomes (and thus “demand”) for a huge number of people; from the builders, to architects, and engineers to the worker getting paid $50/hr to hold the “stop/slow” sign while the truck unloads. This construction, in turn, is fuelled by credit. If credit stops expanding, the booming property sector has a real problem on its hands.
You will hear numerous arguments for support: “demand, lack of supply, low interest rates, immigration, low unemployment.” There are all sorts of variables that will influence property prices, especially in different areas. But the most important of them all at the moment is credit growth. When credit growth stops, property price appreciation stops, unless credit growth is replaced by something else such as wage growth. If credit growth turns meaningfully negative, prices will most likely fall – possibly by a lot.
One thing I recall reading about during the GFC is how much negative equity is a killer. It has a dramatic psychological impact on people and thus their willingness to “participate” in the economy. Further, it locks people in to their present circumstance. e.g. they have difficulty relocating for a new job.
But as much as anything, what a decent fall in property prices will likely do is batter confidence which feeds into demand. Even for many not truly “impacted,” it becomes a matter of “I might just wait a while before upgrading the car,” or “there’s really nothing wrong with the kitchen – renovations can wait,” or “I might just hit pause on that townhouse development and see where the market is headed.”
Remember, the economy is the cumulative outcome of 24 million people going about their lives; you might not “feel” some of this, but the collective outcome of millions of people pulling back on spending is profound.
In conclusion, there’s presently strong evidence that Australia’s credit cycle is peaking. This has the scope to cause an economic downturn regardless of what unfolds elsewhere around the world. Like any good investors, we are ready and willing to change our minds if the data warrants it. And we’re certainly optimistic about the future; in the sense that we are optimistic about successfully applying our analysis towards investments that won’t just preserve capital if a downturn ensues but capitalise on opportunities to profit
This document contains information which is the copyright of Aviator Capital Pty Ltd (AFSL 432803) or relevant third party. Any views expressed in this transmission are those of the individual, except where the individual specifically states them to be the views of Aviator Capital Pty Ltd. Except as required by law, Aviator Capital Pty Ltd does not represent, warrant and/or guarantee that the integrity of this document has been maintained nor is free of errors, interception or interference. You should not copy, disclose or distribute this document without the authority of Aviator Capital Pty Ltd. Aviator Capital Pty Ltd does not accept any liability for any investment decisions made on the basis of this information. This information is intended to provide general information only, without taking into account any particular person’s objectives, financial situation, taxation or needs. It does not constitute financial advice and should not be taken as such. Aviator Capital Pty Ltd urges you to obtain professional advice before proceeding with any financial investment.
Register your interest in this Fund
Lorem ipsum dolor sit amet, consectetur adipiscing elit. Ut elit tellus, luctus nec ullamcorper mattis, pulvinar dapibus leo.
Australian Economic Update – February 2018
It’s time for a review of the Aussie economic landscape. You probably know I won’t be talking about the recent CPI number or unemployment data, or even GDP numbers (you can talk to your stockbroker or financial planner about them). Those things matter, but what matters more is understanding where we’re at within the bigger picture.
To start, a quick recap of the last 12 or so years…
In 2006 the Aussie economy is chugging away quite solidly. The tech wreck at the turn of the century is a distant memory and the economy is growing at around 3%. The mining sector is doing very well thanks to high demand from China – iron ore, copper and coal have about tripled in price since the turn of the century. Investment in mining was growing as companies sought to take advantage of the rising prices.
And then came along 2008: “The GFC.” To frame it simplistically from an economics perspective – America’s private sector debt accumulation cycle peaked, their economy hit the skids, defaults on the accumulated burden of debt skyrocketed and, because the USA had exported a lot of the debt, the defaults were felt globally. Economic weakness in Europe exposed the major flaws in the Euro system and, combined with a popping of their own credit bubbles in some countries, resulted in the whole Euro project coming close to collapse.
For China, it wasn’t good for business. They had this economic development model basically comprised of two things:
The GFC resulted in a global collapse in demand for “stuff.” China saw its exports start to fall dramatically. Facing the prospect of widespread factory closures and rising unemployment. China needed to do something, so to cushion the impact, it hit the accelerator on its other growth engine – “building stuff”.
This was a boon for Australia. Resources demand and prices went ballistic. The iron ore price went from around US$36 a tonne in 2007 to $60 in 2008, on its way to a top of around US$180 in 2011. Investment in new projects ramped up as everyone wanted to take advantage of the boom. Australians were mostly left scratching their heads – “what’s this GFC I hear foreigners talk about?” We were one of the only developed countries to avoid a recession.
But it wasn’t all about China saving us from the global recession. One quite remarkable aspect of the most recent resources boom is that despite the staggering amount of resources exports (both in volume and value), Australia still managed to run a constant trade deficit!
That’s right – despite our booming exports, our imports were also booming.
The current account has averaged a deficit of 4.3% of GDP since 2000.
This global trade (i.e. “we’ll send you dirt, you process it into goods and send it back”) certainly isn’t bad and certainly has been a benefit to Australia – economic activity and employment is boosted. But when we’re importing more than we’re exporting, this isn’t any road to national prosperity – at least from a “GDP” perspective. Remember how GDP is calculated:
GDP = C + I + G + net exports
Where:
C = consumption
I = investment
G = government
Therefore, a trade deficit subtracts from GDP
“Funding” the trade deficit:
There’s not a lot of “hard science” in economics – despite what a lot of economists want us to believe, much of economics is theories that can’t be proven – or disproven – in the real world. In the area of “balance of payments,” we have some “hard science.”
The Current Account is basically a record of transactions with the rest of the world – net trade, net earnings on international investments and net transfer payments (e.g. foreign aid). It makes up half of the “balance of payments” – the other being the Capital Account. The Capital Account represents the net change in physical or financial assets.
The “hard science” – the sum of the current and capital account must be zero – it’s an accounting identity.
When a nation runs a current account deficit, it must by definition have an equal and offsetting capital account surplus. In the simplest sense – it must see an outflow of “capital.” Something essentially needs to “fund” this outflow or capital just disappears out of the economy.
The USA is in the same situation and it’s probably better understood how they “fund” their deficit. To use a bit of economics jargon:
US investment exceeds US savings and the US runs a trade deficit that is by definition equal to the gap between investment and savings. It also runs a capital account surplus equal to the gap because that’s the amount of net foreign capital inflows needed to make up the shortfall in the current account.
Total US savings consists of the sum of household savings, business savings and government savings. As we well know, the US has been running a meaningful government budget deficit. The accumulating government debt in a simple sense “funds” the trade deficit by “funding” the capital outflows caused by the trade deficit.
We can see evidence of this in China’s mountain of US treasury holdings. Simplistically, China sends the USA more “stuff” than the USA sends China (i.e. a US trade deficit). The USA sends money as payment (i.e. capital account surplus). The Chinese then have a mountain of US$ and, largely as a means of managing the exchange rate, they return it via investments in US treasuries. (And this arrangement is incredibly unlikely to change much so long as China runs a trade surplus with the USA – despite what Chinese officials may say about “reviewing their treasury holdings”.)
Returning to the “savings” identity mentioned above (Total savings consists of the sum of household savings, business savings and government savings), the meaningful increase in the US government debt (dissaving) allowed for the private sector to save. Since the financial crisis we’ve seen their household debt decrease from around 100% of GDP back to below 80%.
This sort of de-levering will always have a profound effect on the economy. No wonder their economy has been barely crawling along. And without the increase in government debt, well, their economy would have been much, much worse.
What happened in Australian during this time? This:
Whilst the household sector of the US (and many other countries) de-leveraged after the GFC, Australia didn’t. The little Aussie battler continued to leverage up!
Note that the flat-lining in the last 12 months or so doesn’t mean debt has decreased. Remember, this is debt to GDP – GDP has increased and thus debt has to have increased by at least the rate of GDP to remain constant. This is important to understand – for debt to GDP to continue increasing, the rate of increase in debt will need to be greater than the rate of increase in GDP.
So, although Australian government debt has increased since the GFC, the continued buildup of household debt is the more significant event. The increase in debt fuels an increase in demand and, together with the mining boom, this has been the saviour of the Australian economy since the GFC.
Instead of a significant increase in foreign ownership of Australian government debt in order
to “fund” our current account deficit (the USA experience), what we’ve seen more is an increase in private debt in the international markets, principally in the form of an increase in offshore borrowings by our banks in order to stem the capital outflows resulting from the current account deficit.
The Leader Board:
Here we have the household debt to GDP ratios across major developed countries:
It’s important to note that there’s one key difference between Australia and Switzerland, Denmark and the Netherlands – aside from being the only country not in Europe, Australia is the only one that runs a current account deficit! The others all run quite substantial surpluses – Switzerland’s has averaged around 10% of GDP since 2000!
So Australia now holds the honour of having the world’s highest level of household debt for a large developed nation that runs a trade deficit! We’ve held this honour since 2010 when we overtook the former leader, Ireland.
Another honour Australia now holds is being the world record holder for the longest period without a recession (as measured by the traditional 2 consecutive quarters of negative GDP) at 27 years!
Summary:
Performance throughout the GFC period was something to be especially proud of. However, it’s important to understand that the drivers behind growth have been a spectacular mining boom which has largely run its course – especially in terms of the “investment” aspect of the boom (i.e. the development of new mines), and an increase in household debt to record (and unsustainable) levels.
Where to from here?
To many schools of economic thought, the credit cycle is the economic cycle. There’s a huge amount of historical precedents to support this. Increasing debt increases demand: if you want a new car, the cheapest way of financing it is to take money from your mortgage offset account. Buying the car provides income to the dealer who pays his salesperson, who then goes to the pub to celebrate a successful week – that’s the economy and the role expanding credit plays. The opposite is also true – if debt isn’t increasing, or worse, falling, demand also falls.
There’s also a multitude of precedents that demonstrate that there’s a limit to the amount of private debt a country can handle. At some point you hit a saturation point where debt starts to outstrip interest servicing capacity and the nation collectively can’t increase debt anymore.
The higher debt levels get relative to GDP, the more the economy becomes reliant on credit growth to stoke demand. As noted earlier, you need to see credit continue to rise at a faster rate than GDP or you suffer a fall in demand and the higher the debt, the higher the increase in debt (simplistically, 5% of a big number is a big number!).
Are we there yet? We don’t know. What we do know is we’re well within that zone where nations in the past have hit the ceiling and gone through a period of de-levering. Look at the USA pre-GFC – it didn’t even manage to crack 100% household debt/GDP.
Remember, an economy is made up of all the individual inhabitants going about their lives.
You may think “…well I have heaps of capacity to take on more debt…and so do a lot of people I know.” That may be true, but you need to think more broadly – there’s now a lot of evidence that Australia is at the limit of its debt servicing capacity. After 60 years of relentless credit growth (aside from a small dip in the early ‘90’s during Keating’s “recession we had to have”), we are nearing that point where private debt can’t increase much more.
It’s important to understand that you don’t need a “catalyst” to trigger a downturn caused by a reduction in the acceleration in credit growth. The “reduction in acceleration in growth” is the catalyst. A term popularised in the GFC to describe that sort of event is a “Minsky Moment” – named after mid-20th century economist Hyman Minsky who spent much of his career researching credit cycles. In essence, a prolonged period of stability eventually leads to instability.
Part of the reason for this is because there are pro-cyclical drivers at play. A simple example is bank lending standards. In the midst of a credit boom, it’s easy to get credit. Part of the reason for the boom is that the economy is doing well and banks, run by humans, are feeling optimistic and willing to lend. As credit levels peak, the economic outlook starts to look less rosy. Those same humans that lent money now start to worry about the amount of money that they’ve lent and become more averse to lending more. This tightening of credit conditions will of course have a negative impact. There’s an increasing amount of evidence that this is occurring right now.
What can go right/wrong?
Australia has become reliant on increasing household debt to feed demand and fuel economic growth. Credit growth looks set to hit its natural limits and, all else being equal, the ramifications of this will be a meaningful fall in demand and contraction in the economy.
What could offset this and deliver a “soft landing”?
We’d need to see the baton for economic activity passed to another sector.
A meaningful improvement in the current account (trade) deficit would help. If the trade deficit could be shifted to a meaningful surplus, the inflows would increase demand and cushion the economy from a private sector deleveraging.
What we’re taking about here is a big uptick in exports. Another mining boom anyone? A big uptick in exports from our manufacturing sector (okay stop laughing – we all know anufacturing has been all but wiped out).
An inevitable side-effect of an economic downturn will be a fall in the Australian Dollar, especially if the growth trajectory of the rest of the world remains relatively stable thus interest rate differentials collapse (i.e. Aussie interest rates fall whilst rest of world rise). In time, a meaningful currency depreciation will aid manufacturers (but unfortunately make my overseas holidays more expensive).
Still on exports, if demand for exports was to decline (say from a slowing China economy) at a time when Aussie households were looking to de-lever, that would not be a good combination. In fact, it could be a significant headwind.
Another “soft landing” option could be a dramatic increase in the government deficit. Just like the USA experience of recent years, a dramatic decline in the government sector savings (i.e. increase in deficit) would stoke demand and help allow the household sector to increase its savings (i.e. reduce debt).
Invariably, an economic downturn leads to higher government deficits – the term often used is “automatic stabilisers.” In a downturn, tax revenues will decline and welfare payments increase. This increased deficit helps stabilise the economy.
A big increase in government spending would also help. For example, from a deficit-fuelled infrastructure package. Our governments have been obsessed about deficits and debt, fearing we will end up like Greece, and I’m sceptical about any pre-emptive increases in the currently modest government deficit
Property:
In a credit-driven downturn, it will be those sectors that are most reliant on credit that will feel the pinch the most. On that note, I can’t resist a few comments around our beloved residential property sector.
Did you know that there’s around 350 construction cranes active across Sydney? According to the USA-based commentator who recently quoted that figure, that is more than all the cranes in the 12 largest US cities combined!
Make no mistake, property construction is booming in Australia as it has been the key benefactor of the increase in household debt. The money is feeding the incomes (and thus “demand”) for a huge number of people; from the builders, to architects, and engineers to the worker getting paid $50/hr to hold the “stop/slow” sign while the truck unloads. This construction, in turn, is fuelled by credit. If credit stops expanding, the booming property sector has a real problem on its hands.
You will hear numerous arguments for support: “demand, lack of supply, low interest rates, immigration, low unemployment.” There are all sorts of variables that will influence property prices, especially in different areas. But the most important of them all at the moment is credit growth. When credit growth stops, property price appreciation stops, unless credit growth is replaced by something else such as wage growth. If credit growth turns meaningfully negative, prices will most likely fall – possibly by a lot.
One thing I recall reading about during the GFC is how much negative equity is a killer. It has a dramatic psychological impact on people and thus their willingness to “participate” in the economy. Further, it locks people in to their present circumstance. e.g. they have difficulty relocating for a new job.
But as much as anything, what a decent fall in property prices will likely do is batter confidence which feeds into demand. Even for many not truly “impacted,” it becomes a matter of “I might just wait a while before upgrading the car,” or “there’s really nothing wrong with the kitchen – renovations can wait,” or “I might just hit pause on that townhouse development and see where the market is headed.”
Remember, the economy is the cumulative outcome of 24 million people going about their lives; you might not “feel” some of this, but the collective outcome of millions of people pulling back on spending is profound.
In conclusion, there’s presently strong evidence that Australia’s credit cycle is peaking. This has the scope to cause an economic downturn regardless of what unfolds elsewhere around the world. Like any good investors, we are ready and willing to change our minds if the data warrants it. And we’re certainly optimistic about the future; in the sense that we are optimistic about successfully applying our analysis towards investments that won’t just preserve capital if a downturn ensues but capitalise on opportunities to profit
This document contains information which is the copyright of Aviator Capital Pty Ltd (AFSL 432803) or relevant third party. Any views expressed in this transmission are those of the individual, except where the individual specifically states them to be the views of Aviator Capital Pty Ltd. Except as required by law, Aviator Capital Pty Ltd does not represent, warrant and/or guarantee that the integrity of this document has been maintained nor is free of errors, interception or interference. You should not copy, disclose or distribute this document without the authority of Aviator Capital Pty Ltd. Aviator Capital Pty Ltd does not accept any liability for any investment decisions made on the basis of this information. This information is intended to provide general information only, without taking into account any particular person’s objectives, financial situation, taxation or needs. It does not constitute financial advice and should not be taken as such. Aviator Capital Pty Ltd urges you to obtain professional advice before proceeding with any financial investment.
Register your interest in this Fund
Lorem ipsum dolor sit amet, consectetur adipiscing elit. Ut elit tellus, luctus nec ullamcorper mattis, pulvinar dapibus leo.