- Recently released Australian statistics paint a gloomy picture of the economy.
- There are several very real threats facing the Australian economy.
- Do Australian equities trade at a level that takes into account these threats.
The latest statistics illustrating the state of the Australian economy are not pretty. The most recent indication that the Australian market is on shaky ground is derived from the New Motor Vehicle Sales data (m/m) that came out today. It showed that the sale of new cars and trucks declined by 1.6%, the third decline in four months. This in itself would be nothing to worry about, but it is considered a leading indication of consumer confidence - consumers are most likely to purchase expensive items if they feel safe in their financial position or if they are confident they will be able to pay off the loan in the coming years. Cars and trucks are an oft-traded expensive goods that can be relied upon for information about where Australians are in the economic cycle. The property market would also give us a good idea of the economic situation, but the Australian property boom that has been fuelled by foreign investment for years has so warped housing prices, that it's a valid argument to state that it trades in a bubble that will shortly burst. The Reserve Bank of Australia has stated on numerous occasions that the property market is a cause for concern and this is the primary reason why they have not lowered the interest rate order to boost an economy tormented by plummeting commodity prices. Remember it was the resources boom that most likely saved Australia from the GFC that afflicted all major economies in 2008/09. With this boom over and Chinese growth and global economic activity slowing, what will save Australia now from any external risk? Could it be hit twice as hard seeing as the country is way past due for a true recession, not experienced since 1990/01 and are the RBA's hands tied in softening the blow due to a potential property bubble, the bursting of which could be far more catastrophic?
The ASX200 is currently trading at levels that were considered fair to overly priced in April this year. It extended those gains 4% to 5680 but has since retreated. At that time the Australian bureau of statistics was publishing healthy economic data, but here is a sample of the most important recent results:
11/11/14 - NAB business confidence. Previous 5. Actual 4
10/11/14 - Home Loans. Previous -0.9%. Forecast -0.3%. Actual -0.7%
10/11/14 - Employment Change. Previous -23.7k. Forecast 20.3k. Actual 24.1k
04/11/14 - Trade Balance. Previous -1.01B. Forecast -1.78B. Actual -2.2%
04/11/1 - Retail Sales m/m. Previous 0.1%. Forecast 0.3%. Actual 1.2%
03/11/14 - Building Approvals m/m. Previous 3.4%. Forecast -0.9%. Actual -11.0%
30/10/14 - Import prices q/q. Previous -3%. Forecast 0.3%. Actual -0.8%
These figures have come out in the backdrop of rising unemployment to 6.2% (this rate was last published in Jan 2002), declining immigration and plummeting Iron Ore price, Australia's main export. Equity market investors must be asking themselves if we have recently hit the top and if it is possible to add more value to stocks with these negative statistics in mind. Perhaps a good reason for the propped up index price is due to America's economic recovery. US stocks have surged ahead following years of QE and Australia has no doubt piggy-backed (to some degree) upon the stimulus wave as well. Historically, Australian stocks looked to US equity markets for guidance but we are witnessing a clear divergence in the direction of the two economies and the fair value of Australian market prices do not equal those of its American counterparts. Yet despite its poorer fundamentals, as American stock prices continue to rise with conviction, they continue to pull Australian stocks up along with them. It's only a matter of time before that bond breaks, and once it does, it may stay broken for years to come as is the case with the Nikkei.
It should be stated that even though the US economy's recovery is moving along satisfactorily, a stock market correction is predicted as a real possibility within the next six months as stimulus comes to a close, and an increase in interest rates is factored into the market which is necessary to take some steam out of the hot and overly-valued financial system. Many argue that after years of America's corporate addiction to cheap money (the benefit of which has not filtered down to households) an asset bubble has developed which itself poses a new catastrophic danger. In other words, there are large problems facing the US economy as well. Owing to the high US/Australian equity market correlation, it may be that the upcoming correction will hit Australian equities far harder than those on US exchanges.
One of Australia's largest sources of income is derived from the mining and energy sectors. Coal and particularly crude oil have fallen heavily and although Australia's not a huge producer of oil, its lack of demand driving down the price is indicative of the state of China's manufacturing machine which is starting to decelerate. The construction sector in China is also in trouble with the housing bubble considered a risk to the Australian economy. Glen Stevens of the RBA stated recently in a policy report that "concerns about asset quality in China have been heightened by softening conditions in the residential property market. While China has been able to manage a small number of defaults in trust funds and corporate bonds, a more widespread series of private-sector defaults - potentially associated with a sharp correction in property prices - could be more damaging."
To a large degree, Australia depends on a strong building industry in China for advantageous prices of construction materials (NYSEARCA:TAO). As the amount construction drops off, the prices of the materials that the mining industry in Australia produces falls as well. Lower mining prices and activity means increased unemployment and less taxable income. Additionally, as defaults increase in China, Chinese property investors are forced to sell up foreign asset investments such as those in Australia to pay off debts incurred by rapidly falling Chinese property prices. As thousands of cashed up Chinese property investors have had almost unfettered access to the Australian market for years, their sell-up brings us to the risk of an Australian property bubble popping in the near future.
Australia has the third largest housing price to income ratio in the world. Australian properties have never been so out of reach to households looking to own a home, particularly those looking to buy their first. If they take the plunge, Australians are forced to take out loans that are ever increasingly harder to pay off, they become more sensitive to interest rate rises, but more importantly, due to cashed up foreign investors who are willing to pay the higher prices to diversify and hedge their wealth, the domestic mortgages acquired do not accurately reflect the true price of the property bought. For a home owner, this is not too much of a cause for concern as a 30 year mortgage will paid off at any time during the economic cycle, but for those who purchase an investment property, they will get far less than what they paid should the foreign investors flee the market to pay off their own local debts. Property funds in particular will be in all sorts of trouble, some of which are listed on the ASX 200. Adding to this problem, with domestic interest rates rising following an historically long run of very low rates, as Australians become increasingly unable to make their repayments, they will be forced to sell at huge losses potentially leading to bank repossessions which may in turn lead to large bank losses if it is widespread. This is a gloomy but real scenario that will most certainly lead to a protracted recession.
The ASX200 (BEAR, EWA) is currently only 5% from the last high, but does that truly reflect the true state of the economy and do the fundamentals support the current price level? For the last six years, the Australian economy has been firing all cylinders, but the current data tells us that this is currently not the case. To compound concerns, there are clear and present dangers facing the Australian economy that have clearly not been factored into prices. The Australian equity market may dodge one bullet, but it can't dodge all of them.