Pete Wargent blogspot

Co-founder & CEO of AllenWargent property buyer's agents, offices in Brisbane (Riverside) & Sydney (Martin Place), and CEO of WargentAdvisory (providing subscription analysis, reports & services to institutional clients).

5 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.

"Unfortunately so much commentary is self-serving or sensationalist. Pete Wargent shines through with his clear, sober & dispassionate analysis of the housing market, which is so valuable. Pete drills into the facts & unlocks the details that others gloss over in their rush to get a headline. On housing Pete is a must read, must follow - he is one of the finest property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.

"Pete is one of Australia's brightest financial minds - a must-follow for articulate, accurate & in-depth analysis." - David Scutt, Business Insider, leading Australian market analyst.

"I've been investing for over 40 years & read nearly every investment book ever written yet I still learned new concepts in his books. Pete Wargent is one of Australia's finest young financial commentators." - Michael Yardney, Australia's leading property expert, Amazon #1 best-selling author.

"The most knowledgeable person on Aussie real estate markets - Pete's work is great, loads of good data and charts, the most comprehensive analyst I follow in Australia. If you follow Australia, follow Pete Wargent" - Jonathan Tepper, Variant Perception, Global Macroeconomic Research, and author of the New York Times bestsellers 'End Game' and 'Code Red'.

"The level of detail in Pete's work is superlative across all of Australia's housing markets" - Grant Williams, co-founder RealVision - where world class experts share their thoughts on economics & finance - & author of Things That Make You Go Hmmm...one of the world's most popular & widely-read financial publications.

"Wargent is a bald-faced realty foghorn" - David Llewellyn-Smith, MacroBusiness.

Friday, 31 October 2014

Financial Aggregates show Housing Credit continues to rise

Total credit rises by 5.4 percent

The Reserve Bank of Australia has released its Financial Aggregates data for the month of September 2014, which revealed some interesting trends as total credit growth picked up to 5.4 percent over the past year.

Business credit growth, which has largely been lacklustre, showed a nice uptick in the month of September to be 3.8 percent higher over the past year.

However, business credit remains 1.5 percent below its previous peak which was hit way back in November 2008.

Unsurprisingly perhaps, given the currently easy monetary policy settings, housing credit growth continues to lead the way back with a 6.8 percent year-on-year growth.


As we will look at in more detail below, the RBA will particularly interested in the pace of investor housing credit growth, a point which it recently again flagged in its October Board Minutes.

Inflationary pressures easing

This is particularly so since there appears to be very little chance of interest rates being hiked any time soon,

The Australian Bureau of Statistics released its Producer Price Index data today which came in at just +0.2 percent for the quarter and only +1.2 percent for the past year, which is the slowest pace we have seen since the June 2013 quarter.

Inflationary pressures are seemingly receding, and since the central bank has an inflation target and full employment remit, imminent rate hikes look to be unlikely.

Cash rate futures markets remain ambivalent about the next move in interest rates, with the implied yield curve suggesting a long period of "no change" ahead, perhaps for even for the next 18 months.

Housing Credit expanding further

The RBA's Financial Aggregates showed owner occupier credit increasing by a seasonally adjusted $4.2 billion in the month of September 2014, with the equivalent increase in investor credit coming in at a $4 billion (which, of course is equivalently significantly higher credit growth for investment lending when considered on a percentage basis).


This result pushes the growth in investor credit up to 9.5 percent for the past year, far ahead of the 5 percent pace of growth in owner occupier credit aggregates.

While these are much slower rates of credit growth than we have seen in previous housing market cycles, we are of course coming from a higher base (in any case it is what is happening at the margin that really counts in housing markets), and further, these figures do not capture the potentially significant flow of funds from offshore.


The monthly numbers tend to jag around a little, but if we smooth the figures on a rolling annual basis we can see that investor credit growth is comfortably outpacing owner occupier credit growth.

At the current rate of progress investor credit growth will soon have reverted to a double digit pace, especially given that there are no interest rate hikes visible on the immediate horizon to pull things up.


Outperforming housing markets

With both owner occupier credit and investor credit picking up, in order to identify the housing sub-markets which are due to record capital growth, analysts should follow the flow of funds (for owner occupier credit, that means to Brisbane, and for investor credit, this means into inner- and middle-ring Sydney suburbs).

Today's data takes the investor share of outstanding credit a notch higher to 34 percent, which is now the highest percentage share we have ever seen in Australia.

Over the very long term we might expect to see this share of outstanding credit increasing towards 40 percent given the ever more prevalent Australian penchant towards (centric) capital city lifestyles, although this trend will take many years to play out in full.


Macro-prudential measures?

The above charts will give the RBA a little more food for thought as to whether it needs to work with APRA on implementing measures to restrict, ration, direct or control the flow of credit.

Call me an old sceptic, but the Minutes wording from the RBA's October Board Meeting (which note that dwelling investment picking up "as expected", and credit growth remaining "moderate overall") in conjunction with other rhetoric, have suggested to me that there will be few serious measures taken, other than to simply step up the monitoring of the quality of interest only lending.

The RBA wanted all along to see an increase in housing market activity and dwelling investment, and while the share of credit flowing to 'investors' may be higher than the Board might have wanted to see, it would seem contradictory to then step in and slow the market given the previous rhetoric of the Board's own members. 

The central bank does not have a mandate to intervene in the allocation or direction of credit, and whether first-time buyers and others decide to buy housing as an investment or a home is outside the scope of the RBA's own mandate or duties (except to the extent that this impacts future price stability or economic prosperity/welfare).

In any case, there are two crucial releases lying right ahead on November 10 (ABS Housing Finance) and November 12 (ABS Lending Finance - which will show the extent to which investors are still focusing on Sydney) respectively, which between them will shed a great deal more light on how credit is being allocated across the housing market at the state level (new housing, construction lending, owner-occupiers, major renovations and investor credit etc.). 

Thus in turn these monthly releases will ultimately determine the answers as they relate to macro-prudential measures.

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As noted previously, commencing from Monday we have an absolutely rip-snorting ten days ahead for domestic economic data. 

You can find an overview or rundown of the key releases from Scutt Partners here.

Gold decline continues

Precious metals decline

The US economy is threatening to reach escape velocity and gold markets aren't happy. The gold spot price is down once again by another 2.1 percent to US$1172/oz.

Live 24 hours gold chart [Kitco Inc.]

The silver price isn't any happier, tanking by nearly a further 2.4 percent to only US$15.94/oz.

Live 24 hours silver chart [ Kitco Inc. ]

Although there is a tendency to think of gold as important to investors but not so much to the country, a glance at the Reserve Bank of Australia's commodity index weights shows gold to be the fourth most important commodity to the Aussie economy with a weighting of 8.4 percent. 

Commodity index still declining

As such the collapse in the gold price from above $1900 is just another needle for the Reserve Bank which saw its index of commodity prices fall by another 2.4 percent in September, or 1.4 percent in Australian dollar terms.

Over the past year the index is down some 16 percent even in Australian dollar terms.

Graph: RBA Index of Commodity Prices

As for investors, the retreat in the gold price will obviously be of interest to investors in and net buyers of the physical commodity.

It's also a bearish signal for producers such as Newcrest Mining, with the share price back below $10 and now likely to be threatening to break lower again.


It's been a heck of a ride over the past decade for Newcrest with its share price collapsing from well above $40 in 2011 to a 12 month low of below $7.

The gold producer has an "all-in sustaining cost" of A$976 per ounce, implying that although group production volumes of gold and copper have remained high, results will be way down across the board on their 2011 levels on most of the key measures for such a gold producer.

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*for a producer such as Newcrest these would be:

-earnings before income and tax (EBIT)
-cash flows from operations
-free cash flows
-underlying profit (as distinct from statutory profit)

UK house prices +0.5% m/m (+9.0% y/y)

UK house prices continue in October...but momentum fading

The UK housing market continued to rise in October, up by 0.5 percent in the month and up by 9 percent over the past year.

However, momentum definitely appears to be fading as mortgage approvals decline. 


Positive indicators

On the plus side employment is rising and many of the economic indicators look strong enough.

Furthermore, mortgages are just so darned cheap. 

The average 2 year fixed rate in Britain for those with a 25 percent deposit is now an absurdly cheap 2.46 percent.

A massive 95 percent of lending to first time buyers in the UK is now on fixed rates.

We also recently saw the introduction of an unprecedented 0.99 percent fixed rate mortgage from HSBC. 

Despite this, around 60 percent of outstanding mortgages are on variable rates, but most borrowers are well placed to cope with likely hikes in 2015.

The Bank of England has admitted that interest rates will peak at lower levels in the cycle ahead as lower interest are the "new normal" (quote). 

London leads

This has largely been a London (and Home Counties) recovery, with not very much to write home about in the regions located away from London. London prices are 21 percent higher than one year ago.

However price action and transaction levels in most of the regions has remained very slow compared to the heady pre-crisis days when spiralling household debt pushed prices higher almost everywhere.

The good times of easy gains for most regional towns are probably in the past, I'd suggest.


Interestingly, Northern Ireland index has rebounded to 346.5 (index: 1993 = 100) after having collapsed by more than 50 percent from an impressively ridiculous bubble peak of 659.4.

People like to talk about bubbles in Australia, but in truth Australian dwelling prices over the past 10 years have been far from spectacular, increasingly only moderately ahead of incomes in most cases. 

US economy grows at 3.5%

US turns upbeat

The US economy grew at a 3.5 percent pace in the September quarter (Q3), following on from a big rebound in the June quarter (Q2) when the economy grew at a 4.6 percent pace.

David Scutt of Scutt Partners summarises the overnight news in his excellent daily update here.

US stocks rebounded strongly with the S&P 500 adding 0.6 percent and the Dow Jones (DJIA) index rebounding by more than 220 points all the way back up to 17,195 after the recent wobbles of the index.

There have been no shortage of bubble analysts warning of a massive correction in recent months, particularly now that quantitative easing (QE) is to be withdrawn by the Federal Reserve.


Timing stock markets is difficult

Of course, stock markets are liquid and as such are always and everywhere prone to sharp corrections, and with the market at or around all-time highs, there is no question that downside risks almost by definition must outweigh the likely upside in the short to medium term.

Calling bubbles is one thing, but timing them is quite another, as Shiller found with the US housing market - a correction did happen, but not for some years after the "bubble" call was made in 2003, as we looked at here.

Indeed US stocks have been described as a bubble since 2013.


& 2012...

...& 2011...


The Dow Jones average is up by more than 70 percent since July 2011 (returns have been higher still when dividends are thrown in) and the index has run up massively from its nadir of around 6600 in early March 2009, which gives you an idea of the potential size of a correction when it comes.

This is why I tend to favour an averaging approach and diversified products.. 

Reading markets appears easy in the rear view mirror when reading the chart from right to left and everyone is an expert after the event. 

Reading the chart in real time from left to right is not nearly so easy.

QE ends

It interests me how dramatically views differ on the stimulus known as quantitative easing or "QE".

Some people, including my missus in fact, are vehemently against the idea on a matter of sheer principle, and suggest that it will all end badly when the stimulus is withdrawn.

Indeed, with both of us being from a CA background, we have heated arguments about this kind of thing (thinking about it, perhaps that's why the dinner party invites dried up?).

I guess the "against" argument is that a problem in part caused by (private) debt should be solved by austerity as penance rather than by more debt. 

"For" QE

Hailing from a part of the world - Sheffield in South Yorkshire - where the sad decline of the steel industry and then later the coal industry devastated a workforce, a city and indeed an entire county (the population has declined over the last few decades), I believe wholeheartedly that faltering economies should be stabilised by government expenditure.

An economy which slips into a prolonged recession with high unemployment may fall into a depression and perhaps never come back out again as a negative spiral takes hold.

Jobs should come first

Indeed, probably to the detriment of holding a balanced viewpoint, I believe that jobs should come first always, and governments should move heaven and earth to bring elevated unemployment rates down, at almost any short term cost.

As I said, we are all a product of our environment, experiences, and our upbringing.

The US has seen millions dropping out of the workforce, but at least the unemployment rate has fallen from double digit levels to 5.9 percent, which I personally would argue makes QE a success, as the labour force data continues to steadily improve (would it really have one so without stimulus?). 

Of course, this has inflated balance sheets and debt ultimately needs to be repaid or at least curtailed, but what chance would there be anyway of balancing the books when there is huge slack in the workforce and tax receipts are way down?

Like the US, the UK also engaged in stimulus and has also seen its unemployment rate tumble, while total employment in Britain has soared to a record high of more than 30.75 million. although an unspecified number of new employees are known to be on zero-hour contracts and real wages growth has been dire.

The UK economy is growing at a 3 percent pace too, as I looked at last week, among the fastest growing of the developed economies. 

Of course, Britain has massive challenges to face including deficits, falling real wages, sliding inflation (CPI) and more, but less slack in the workforce can surely only help to face down each of these problems.



Of course, it is impossible to know the counter-factual and what might have been had Britain and the US not indulged in bond-buying programs, but a glance across the English Channel to the continent might provide us with a clue.

The Eurozone is threatening to slip in a devastating deflationary funk and youth unemployment rates in some Med countries are at astronomically high levels. 

Austerity is one thing, but what have those youths done to deserve such a total lack of opportunity (I would argue)?

Anyway, a debate for another day, perhaps!

Gold dives below $1200

One thing that is certain is that the gold market didn't like it with the price plunging below US$1200/oz, which is a collapse of 37 percent from the 2011 peak of above $1900/oz. 


We shouldn't cherry-pick numbers too much, though, since over the past decade gold has performed strongly as a hedge. 

Thursday, 30 October 2014

Inflation-adjusted house prices since 2008

Inflation-adjusted house prices

Plenty of other interesting things to look at this week with the winding down of QE in the US as the labour market strengthens, with considerations for how that might affect share markets.

One further point of Australian property market interest first, though.

A key theme of this blog has been that, particularly after our experiences in London, we felt that after Australian household debt hit a plateau (essentially when the financial crisis put an end to most of the debt binge party) the best performing cities would be the largest cities.

And specifically, we picked out Sydney. We have focused in particular on the areas where investors dominate, which is the inner ring suburbs, within an easy 10-15 minute train commute of the city.

Not that it has been a fashionable viewpoint over all these years, with the experts recommending almost anywhere but Sydney in many cases (h/t Chris Gray of Empire of Empire, who was one property expert who actually did get it right).

Six year itch

Goodness has it really been six years since the prophets were guaranteeing us all that there would be "an epic property crash" across Australia?

Gosh, it really has. Where does the time go?

As good a time as any for a market update, then.

Interestingly we are now seeing some property markets tanking in mining towns, but on the other hand prices are rising in many of the capital cities.

RP Data's Cameron Kusher tackled the answers here.

You can argue the toss over whether "real" increases in dwelling prices should be adjusted back for inflation (CPI), household disposable incomes or median wages growth, but since wages are only growing at around the pace of inflation at the present time, the results wouldn't be a whole lot different.

Nominal and real house price growth by capital city

As we expected Sydney, and to a lesser extent Melbourne are miles out in front, with Sydney having recorded capital growth of 51.2 percent, although by investing in quality stock, particularly ijn the inner west, you could easily have done better than the averages.

Due to the compounding effect on growth assets, that represents solid compounding capital growth of around 7.2 percent per annum since December 2008.


Not all capital city housing markets have performed very well, though.

Kusher notes that when adjusted for inflation, real prices have declined in Brisbane, Adelaide, Perth and Hobart.

"Sydney and Melbourne have been the strongest capital cities for value growth over the past year and consistently over recent years.  

In nominal terms, values have increased by 14.3% and 8.1% respectively over the past year.  

As the above chart shows, when you adjust the growth in values for the effects of inflation, the level of growth is lower.  

Note that real home values have still increased in each capital city except for Canberra over the past year.  Although, outside of Sydney, Melbourne and Darwin the rate of growth has been 4.0% or less in all cities.”

As we have already highlighted, real home value falls are much more frequent than falls in nominal terms.  

This is also the case across the individual capital city markets.  

As you can note from the above chart, outside of Sydney and Melbourne, real increases in home values over the past two years have been minor.

Combined capital city home values began to recover from the financial crisis at the beginning of 2009 after reaching a low point in December 2008.  

Since that time, nominal home values have increased by 34.0% across the combined capitals, largely driven by increases of 51.2% in Sydney and 44.9% in Melbourne.  

Notably, Brisbane (6.0%), Adelaide (10.9%), Perth (14.5%) and Hobart (-1.6%) have all recorded nominal gains of less than 15% since December 2008.

In real terms, between December 2008 and September 2014, combined capital city home values have increased by a much lower 16.5%.  

Across the individual capital cities, real changes in home values between December 2008 and September 2014 have been recorded at: 31.6% in Sydney, 26.1% in Melbourne, -8.0% in Brisbane, -3.7% in Adelaide, -0.6% in Perth, -14.7% in Hobart, 11.0% in Canberra and 5.1% in Darwin.

The next time you hear someone talk of the booming national housing market remember these statistics.  

Yes combined capital city home values are rising and this is due to the influence of the Sydney and Melbourne housing markets where values are rising.  

Real home values in Brisbane, Adelaide, Perth and Hobart are still lower than they were before the financial crisis and have seen no real growth in more than six years.”


Very good points from Kusher as usual.

Sydney property has beaten inflation by 31.6 percent. Not too shabby, and we can expect to see more of the same in FY15 for the harbour city, with solidly rising prices in Brisbane over the next three years too.

For various reasons that we have covered here previously, we would expect to see a rather more sedate 2015 for Melbourne, Perth, Adelaide, Canberra and Darwin.

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Are you interested in investing in property? Contact us by email: 

brisbane@allenwargent.com 
sydney@allenwargent.com

Migration from NSW declines to lowest level on record

Demographic shift

A huge shift in net interstate migration has taken place since the financial crisis, a major demographic trend which is a game-changer for this property market cycle, particularly in Sydney. Let's take a look in four short parts.

Part 1 - Mining states slowing...but Sydney booming

Drilling into the most recent round of demographic data from the Australian Bureau of Statistics confirmed an interesting fact: net interstate migration from New South Wales has declined to its lowest level on record at just 1036 in the March 2014 quarter.

Typically there has been a very significant population flow away from NSW, especially expensive Greater Sydney, which is comfortably more than replaced by immigrants from overseas and natural population increase. But as the mining construction boom fades so too does the tide of interstate population shift away from Sydney.

The mining states which have benefited most from net interstate migration historically are now no longer doing so - predominantly the maroon line of Queensland (and how!), the gold line of Western Australia (we use state cricket colours, see?) and the red of South Australia (Redbacks? Ah, you have the hang of it now), in that order.


Instead an expected rebound in services and construction jobs in Sydney and to a lesser extent 
Melbourne is seeing a massive boom in the population of those two cities.

Charted below is the annualised rate of population growth by state, which shows New South Wales (+115,000) now threatening to spiral off the top of the chart, with Victoria (+109,000) not too far behind.


It never pays to get too aroused by one quarter of data - particularly from ABS releases at the present time! - but the population change in the March 2014 quarter showed NSW recording an extraordinary increase of 35,285, potentially implying an unheard of annualised pace of well over 140,000.

In the event, we will not see the state's annual population growth figure scaling such dizzying heights due to the now slowing pace of net overseas migration, with fewer Kiwis and Poms in particular choosing to take the path Down Under at this stage in the cycle. Indeed, most immigrants to Australia now hail from Asia as analysed here previously.

Nevertheless, despite the slowing pace of net overseas migration, by the time the June 2014 data rolls around we will probably see New South Wales annual population growth approachin~120,000, which is a huge figure.


Part 2 - Dwelling supply: too hot, too cold...or just right?

There is some some conflicting and some zany market commentary when it comes to the adequacy of dwelling supply in Australia, often involving a preconceived notion ("massive overbuilding" or "chronic undersupply") and the producing of data to support the position.

Sometimes we see analysis of building  completions in Australia compared to the existing population, which is an interesting point of comparison, but a clear confusion of stock versus flow.

Much more unusually we see offbeat comparisons of Australian construction versus that seen in certain US states which previously had a cahuna oversupply and now aren't constructing much (relevance?), or on particularly obscure days, comparisons with Japanese construction. 

The slightly boring answer is that there is no chronic undersupply of dwellings in Australia and nor is there massive overbuilding in aggregate, although it is possible to highlights regions and suburbs which represent examples of each.

Property markets are complex and imperfect beasts. If you can analyse and understand data flows it becomes possible to identify specific areas where undersupply will begin to bite, and thus you can comfortably outperform market capital growth averages over time by buying investment property with an element of scarcity value in these locations. 

The data to analyse

A better starting point is to scrutinise Australian building approvals, dwelling commencements and completions data against the changes in demand in Australia, drawing inferences based upon average household sizes (a little over ~2.5 depending on your preferred source) for the regions analysed.

There have been warnings about a potential oversupply of dwellings in Sydney, for example. Travelling around certain parts of town I can see why you might reach that conclusion, but from a macro perspective, you'd be wrong. 

There is something of an oversupply of units looming in a few pockets - in the CBD and inner city, around the airport and inner south, and in a few of the new Urban Activation Precincts (UAPs) around transport hubs, where there will now be fewer height restriction on the building of apartment tower blocks.

Largely bought by offshore investors, these off-the-plan apartments will generally be poor performers and are likely to suffer from falling rents, vacancies, and possibly both.

(As an aside it's often highlighted how most property investor loans written are for established dwellings, but since there are now 9,366,800 dwellings and counting in Australia, and since a high proportion of the new stock is sold offshore, the percentage of domestic investment in established stock will continue to rise. 

Moreover, established properties usually represent better value than most expensive new units and therefore a majority of domestic investors will rationally steer clear of the newly constructed stock in the absence of incentives to do otherwise. In short, we probably do need foreign investors to create supply).

Sure, there are some areas where there are more new flats than willing renters. But ask anyone in the market and they'll tell you that in the lifestyle suburban areas where most people actually want to live, precisely the opposite problem exists - there is a dearth of quality stock and the decent stuff is selling in a matter of days.

Part 3 - New stock has come online

Think back to the annualised population growth figures discussed previously for New South Wales, which are tracking at about ~115,000 over the year to March 2014. In the 12 months to June 2014, the state saw the completion of 19,134 houses...


...and only 17,510 completions for unit and apartments.


That's a grand total of 36,644 completions. Given that the state population in the year to March 2014 increased by 114,509, I don't think we need to panic about massive overbuilding just yet.

Completions have not even been high enough to match the demand from the state population growth let alone address previously inherent supply imbalances in Sydney...and that's before we even begin to account for brownfield site demolitions and stock obsolescence.

In fact, if you drill in more closely to the population and demographics data you will find that population growth in New South Wales regional centres has been far below the national averages in all but a tiny handful of localities. Meanwhile Greater Sydney is set to record population growth somewhere in the vicinity of 90,000 in this calendar year.

Part 4 - Decent approvals & supply in the pipeline

In terms of forthcoming supply, it is true that there is more to come in the pipeline. In the 12 months to June 2014, New South Wales commenced 20,000 houses and 25,000 units. And Greater Sydney apartment approvals are now tracking at a little over 26,000 on a rolling annual basis.

That's a decent enough supply response to rising prices, assuming all approvals make it to completion, which they won't.

However the level of monthly apartment approvals peaked way back in March 2014 and is now rolling over. The major developers, who are nobody's dummies, are aiming to have their Greater Sydney new apartment stock completed and sold by December 2015.


Oversupply theory? Doesn't pass the "Sniff Test"

With the exception of the aforementioned locations, there is no city-wide oversupply of dwellings in Sydney, and nor is there going to be any time soon. 

Inner Melbourne and inner Brisbane are two other areas we can talk about with an apartment oversupply. And, for example, some coal mining towns and regions are likely to experience oversupply too, albeit as result of a collapse in demand rather than over-building.

As a Chartered Accountant and sometime auditor, too many years ago now I was trained at accounting college to consider that when people make sweeping yet unsubstantiated claims such as "there is an obscene amount of construction going on in Sydney" then that claim should be weighed up against or made to pass a common sense or "sniff test".

Even if you choose to dismiss vacancy rates as an unreliable indicator, which in Sydney are hovering way below the notional equilibrium position of 3 percent at just 1.7 percent, the best "sniff test" for oversupply to my mind is to look for signs of negative rental growth. 

Today apartment rental growth is tracking somewhere between at 3 percent and 5.3 percent in Sydney, depending on your data provider of choice.

Over the past ten years the growth in median rental for detached houses in Sydney has been 80 percent, and for attached dwellings the equivalent growth in median rental is 77 percent.

'Nuff said.

Wednesday, 29 October 2014

October close

October wrapping up

From November 3 we have an absolute rip-snorter of a fortnight (well, more like ten days) of domestic news coming our way, which will be very interesting to analyse.

In particular, by November 11 it should become clear whether the Reserve Bank and APRA will be inclined to step up any unconventional macro-prudential measures relating to the allocation of housing credit (seems unlikely) or rather will allow the property market to work through the cycle itself while maintaining a watchful eye on the quality of investor lending (more likely).

This week, by contrast, will be a much quieter one for domestic news.

In the US a range of commentators congratulated themselves on calling the bursting of the stock "bubble" (this has been happening for well over three years now) only to watch in bemusement as markets rebounded to within a fraction of their all-time highs.

Trying to second guess stock market movements while QE is taking place is clearly no easy matter.

In Australia, share market valuations are fairly middling, and certainly less than stretched.

Trailing P/E Ratios graph

  Forward P/E Ratios graph

October home values

In the absence of much other exciting news, let's take a sneak peak at what RP Data is set to report for the month of October from its much-maligned Home Value Index.

It has taken a while to get a handle on the machinations of the index, but the consistently recurring lulls at the mid-point of each calendar year do suggest something of a lag however much the media likes to report weekly movements as being 'real time'.

Of course, the daily index has also given commentators almost limitless scope to champion their favoured markets through the cherry picking of data ("this month's best performer!" is a favourite).

Anyway, based on what we have seen reported from other sources of data, including mortgage finance, we should probably expect to see Sydney surging upwards this quarter and moderate gains elsewhere.

Below is what RP Data's index shows for about the past 15 months (note the mid-year dips), which includes significant increases for the month in Sydney and Melbourne, and notably a 3.8 percent gain for Sydney over the last quarter.

Sydney home values are up by around 13 percent over the past year according to RP Data's hedonic home value measures.


The other capital cities each recorded gains over the past quarter, although Adelaide reversed last month's gains with a 1 percent decline in the month of October (cf. "this month's worst performer!").


Naturally these city-wide figures mask wide variations in the performance of different property types and across individual municipalities, but nevertheless summarised below is what we might expect RP Data to report by city for the month and quarter to the end of October based upon the daily index data.


Overall, if we strip out Sydney the rebound in most housing markets rebound has only been fairly moderate, while most indicators for Melbourne seem to suggest that the Victorian capital city market is likely to roll over some time soon, especially given the elevated volume of stock on the market and the proliferation of sellers.

Outside Sydney investor credit, there is little for the regulators to get too excited about.

There will be continued discussion about the levels of household debt hitting new highs, of course, but sooner or later I expect two other things will also become increasingly apparent:

(i) just how far average borrowers are ahead of repayment schedules given ongoing easy monetary policy settings; and

(ii) how a significant level of 'household debt' relates to the refinancing of buffers.

Household Wealth and Liabilities graph

SQM warns on regional towns

SQM warns on regional towns

SQM Research are always worth a follow for independent property market news - subscribe to their free newsletter here. This week, SQM warns on regional towns.


In this week's newsletter, SQM looks at town with a resources focus.

The challenges variously facing Gladstone, Bowen, Emerald and Moranbah have been well documented elsewhere, implying that the potential for fast returns can sometimes also come with equivalent downside risks when the tide reverses or when sentiment is low.

The reasons for a reversal can vary - a property boom can result in a new supply of dwellings taking pressure off rents, the transition from the construction phase of a major project to to the less labour-intensive production phase can reduce demand for property, or a flood of commodity supply can see commodity prices tank making projects unviable at certain stages of the commodities cycle (as is happening right now with coal prices).

The areas covered off in this week's SQM newsletter read like a list of 2012's hotspots: Muswellbrook, Orange, Olympic Dam, Port Hedland...

On Port Hedland, SQM reports asking prices as down by 40 percent from their peak and house rents having collapsed in half.


It is painful to observe as someone with a background in mining myself, but it appears to me that the
coal industry in Australia is heading for quite a bust, since the key commodity prices of coking coal and thermal are simply much too low to support our relatively high cash costs of production (see link for more on this).

Related to that point, here is SQM on Muswellbrook, which has recently been further adversely impacted by the rejection of the Drayton mine expansion:


SQM reports house rents in Muswellbrook as having been "pulverised" by 31.9 percent in the last three years. 3 bedders have fared little better, falling by 25.4 percent.


Investors may be able to stomach falling rents but it is vacancies which can really hurt landlords. Vacancy rates in Muswellbrook spiralled to 14 percent but have now come back into orbit at a still very high 9.2 percent per SQM. 


By way of contrast, suburbs within Sydney's inner west have sustained vacancy rates as low as 0.6 to 0.8 percent, which is essentially as close to zero as you will ever see. 

Chasing superficially higher yields may appear to be a safer approach to investing (in any asset class), but it is not necessarily so, although lower entry prices can no doubt at times seem appealing.

And here is SQM on Orange where previously sharply declining rents may now be stabilising:


The message from SQM seems to be clear. Investing in property in resources towns, in particular those with an iron ore or coal focus, is likely to be risky. Subscribe for more of their thoughts here.

Personally I look mainly towards capital cities which are due to experience strong long term population growth. 

New properties in capital cities are constructed for the growing population at today's labour and materials costs, and thus over the long term well located capital city property tends to act as an effective inflation hedge. 

Due to high transaction costs property as an asset class generally doesn't lend itself so well to short term speculation.

Confidence

Confidence rises

It's not really very fashionable to report positive news these days.

Rather it's often deemed much more 'credible' to report only gloomy news or viewpoints, regardless of whether or not they are warranted.

Reuters reports today that US consumer confidence has jumped to its highest level since October 2007.

I haven't bothered to look, but no doubt there will be the usual range of opinion pieces explaining to us why we should ignore confidence at a 7 year high.

No change there.

It's considerably more popular to put a negative spin on such measures and instead explain why QE has been such a terrible injustice and an awful failure, but without knowing the counter-factual (i.e. how bad things might have been) such arguments are nigh on impossible to prove or dis-prove, and as such often tend to reflect the bias of the commentator.

Anyway, it is what it is...

Aussie confidence above average

Moving back Down Under I surely can't be alone in thinking the weekly consumer confidence polls in Australia represent a monumental overkill, and are arguably of little use.

Heck, even once a month would be pushing it! 

Nevertheless it is interesting to note from the ANZ-Roy Morgan consumer confidence rating is up by 2.7 percent to 141.6 points, which is above its long run average as the "sticker shock" from budget cuts recedes into the rear-view mirror.


Of course, one might argue that consumers are unwise or even foolish to be so upbeat, but confidence remains above its long run average level.

And that, by the way, is an average level of confidence which has seen Australia steer free of recession (generally, by a fair margin) for more than 20 years, whilst through nearly all that time sustaining decent wages growth and asset price growth. 

Glitch in the matrix

While on the subject of ANZ, a point of moderate amusement arose as the bank released an announcement to the Securities Exchange last week promising to assist market participants in their understanding of the forthcoming full year results by uploading an Excel template showing the expected presentation thereof.

ANZ certainly more than achieved that goal, since in a tremendously embarrassing mix-up the bank uploaded the version of the template disclosing the (unaudited) full-year results to their website. 

ANZ hurriedly requested a trading halt after the cock-up was realised (one can only imagine the panic) but we can expect that a full year cash profit of just under $7.1 billion (+11 percent) will be reported on Friday when the results proper are released to the market.

As a seasoned veteran of ASX continuous disclosure breaches and balls-ups myself, I can offer the ANZ finance team two thoughts in which they may find a small amount of solace - firstly, while the error might seem like a disaster now, in a few weeks almost everyone will have forgotten about it. 

And secondly, looking on the bright side, at least the prematurely reported results were positive!

Leaking negative news such as an unexpected capital raising, a profit warning or even just missing an earnings expectation tends to go down less well with shareholders.

Chin up!

Tuesday, 28 October 2014

MYOB Pulse: 5 Big Ideas that made a difference to my business

Read my latest MYOB Pulse piece here.


Aren't LICs much too expensive?

High earnings ratios

A question I am asked fairly often is: "Aren't Listed Investment Companies (LICs) far too expensive?".

The answer is "not really" and the reasoning is a little technical, but easily enough explained.

LICs have often been trading at Price/Earnings (P/E) ratios of as high as 25 or above in Australia.

Now, sure, you wouldn't be able to make much of a case for investing in capital-intensive resources companies such as BHP Billiton or Rio Tinto if they were trading at such a high PE.

Indeed, even a PE of above 15 for the major banks, when considered in conjunction with price-to-book values, would be arguably too expensive to represent value, as considered here previously.

What actually are LICs?

But when you stop to consider what LICs actually are, being companies which invest in a wide range of other companies and trusts, then the answer becomes clearer.

For example, here is the FY2013 Income Statement for Argo (ARG) courtesy of the company's Annual Report:


The profit and loss account comprises revenues which are predominantly dividends harvested from other entities which have been invested in, premium income on exchange traded options written, interest income and some relatively small net gains on trading investments.

Administration costs are comparatively very, very low (a management expense ratio or MER of only 0.15 percent, meaning 0.15 percent of average assets, predominantly for director remuneration, office rent and share registry costs) allowing the company to record a net profit after tax of $175 million from income of only $191 million, equating to earnings per share (EPS) of 27.7 cents.

In 2014 profits surged by a further 12 percent to $196 million.

Most of the profits are distributed to shareholders, with fully franked dividends a priority. 

Argo has been consistently distributing around 26 cents per share to shareholders in recent years, which increased again to 28 cents in 2014.

It is fair to expect that LICs will trade at a small premium in order to reflect the reliability of their performance.

Argo has been returning capital growth and dividend income to shareholders consistently since 1946, and also has a proven track record of beating the All Ords returns with only a low management cost.

I like companies with such a track record of success over 60 or 70 years - it shows that their patient, value investment philosophy works because the thriving company has outlasted the working lifespan of individual portfolio managers!


A better way to value LICs?

Investors in LICs should try to look at things another way, that being to focus on the consistently growing dividend income. 

Here are ARG's interim and full dividends paid since 1986.


For 2014, ARG pays a total annual dividend of 28 cents per share.

I would suggest that a fair value in the current low interest rate environment could be somewhere around 25 times that dividend figure ($0.28 x 25 = $7.00), thereby equating to a yield of 4 percent.

Clearly if risk free returns elsewhere were higher than they are presently, one might take a different view on that.


The current share price of $7.85 may arguably be a little expensive, therefore, but it's nowhere near as overpriced as implied by the apparently 'high' P/E ratio, for the reasons explained previously.

Remember that an LIC benefits from the growth and dividend income of the ventures it invests in.

Unlike, say, a mining company, there after no hefty capital outlays and the business model is self-sustaining (indeed, some LICs should as Argo weight themselves towards an industrials allocation, companies which generally themselves are more sustainable and less capital intensive than the resources stocks equivalents).

With a net tangible asset backing of $7.46 per share in FY14 Argo has over the past year just about "priced for perfection" with only a small price premium, representing the comfort which some investors are taking in such well diversified products.

A couple of things to watch out your when choosing an LIC to invest in are:

(1) gearing - whether the company is using leverage to invest, and if so, how much?; and

(2) liquidity - how easily can you buy and sell parcels of shares given the volumes traded?).

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Disclaimer: I don't recommend individual stocks. Always consult a licensed professional before making investment decisions.

Sirtex Medical - Another Home Run

Shares race

A few months of water under the bridge since I took part in the Sun Herald share investing competition back in May/June.

Of course, it's not really an investing competition at all. It's actually a very short home-run hitting competition, with excellent potential to make one appear remarkably foolish. 

If your life depended upon you winning the competition you would pick simply ten "penny dreadfuls" or micro cap stocks in the hope that one or two of them double in price in order that you could thus take home the spoils.

Naturally such an approach introduces an equivalent risk of a couple of your share picks halving in value.

Since few of us want to risk looking a complete dingbat through being annihilated by the selections of a dartboard and an astrologer respectively, entrants tend to play it a little safer by taking some kind of middle ground.

Picks

In my case, I picked half a dozen relatively boring cyclicals (listed property trusts or "REITs", mainly) which have all fared solidly enough.

For my "home run" picks I went for four small- and mid-cap stocks in industries which I felt should have decent prospects - the month of May being the time of the budget, I plumped for the infrastructure and healthcare sectors - and strong "technicals", since in such a short competition you have to go for something with momentum behind it, and ideally with some blue sky potential.

80/20 rule

If you're familiar with Pareto's Law or the 80/20 Principle you might expect that 80 percent of my gains in a ten stock portfolio would be gleaned from only 20 percent of my ten picks i.e. two of them.

And so it has been.

Sirtex Medical ($SRX) which I picked largely based upon a quite beautiful technical breakout combined with blue sky potential (and more specifically, thanks to a nailed on trading tip from share trading legend Assad Tannous of Asenna Wealth - bang tidy, cheers buddy!) has proven to be one such home run.

After a blistering set of full year results with sales revenue +34 percent and NPAT up by more than +30 percent, SRX today is a very expensive growth stock. 

With a market cap of nearly $1.3 billion the expanding company is trading at close to 50 times earnings, with a very handy 50 percent return from the entry price inclusive of the full-year dividend.


Transfield Services ($TSE) has also recorded a stunning turnaround on last year's trading losses and snared a couple of major contracts leading to a $1 billion takeover offer from Spanish suitor Ferrovial. 

As a result of the $1.95 per share takeover offer, my selection has also seen a return of well over 60 percent on this trade since May.


The portfolio of ten stocks which I picked is up by 11 percent, which isn't a bad effort for 6 months, being a return of well over 20 percent on annualised basis.

It could have been a lot better, to be sure, but I also had a couple of pretty ordinary picks including Downer EDI ($DOW) which, true to form, continues to disappoint shareholder and market expectations alike, almost like clockwork...for year after year.

Come to think of it, I don't know why I even picked DOW at all. A combination of vague familiarity (being a former audit client of mine, from many years ago) and a mistaken belief that all infrastructure companies with the potential to win government contracts might benefit equally from the budget, I think.

Whereas in the event Downer lost a major $360 million BHP Billiton coal contract which was cancelled in the month of June.

I should have known much better, in truth, since I've been warning of coal mining industry doldrums on this very blog throughout the year myself, in particular questioning property expert recommendations to buy in coal mining regions, which seems unnecessarily risky.

Trading approaches

The approach to share trading described above is probably closest to that described in William O'Neill's classic book How to Make Money in Stocks.

That is, through rigorous ratio analysis to identify small- to mid-cap companies with strong financials, great medium term earnings growth potential and promising technicals, in order to hit some massive home runs.

To be enduringly successful using such an approach, traders need to snap the losing trades off quickly and relentlessly, perhaps using stops to cut off loss making trades of 6 or 7 percent, while letting the big winners run.

Pretty simple in theory, but much harder to pull off when you are reading the charts from left to right rather than looking back at what has gone before. There are apparently a million experts in reading the charts from right to left.

Harder than it looks!

Of course, if life were that easy we would all be heroes and the market would be totally cornered by trading programs and algorithms, and there would be few profits to be made from trading at all.

Instead what most beginner traders do is snatch at profits in order to "lock them in" and let the losing trades run and run in the vain hope that they might "come back" to somewhere close to a notional break even point.

Moreover, during each share market cycle the market tends to be chock full of amateur traders who think they are pretty smart when the market is going up, but have little or no protection on the downside and no workable strategy for when the market reverses.

In each dramatic market correction or secular bear market they get wiped out and the cycle rinses and repeats.

In my experience most expert traders who succeed over the long term, including the proven successful traders such as Assad himself, have only become so through learning their lessons in the markets the tough way, by losing some trades in the bear markets in their early days and resolving to learn from the mistakes.

They generally know how to deal with bear markets better the second time around, and the third time around they are making decent money on the way down as well as on the way up.

Only those with a clearly defined strategy and the iron clad discipline to learn money management skills will continue to make profits in both "good" markets and in "bad". Most will be flushed out and give up well before they reach that stage.

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Disclaimer - these are not share trading tips and I don't recommend individual stocks. Always consult a licensed professional before making financial decisions.

Monday, 27 October 2014

4 Major Housing Market Trends Until 2020

4 Major Housing Market Trends for this Decade

At times it is possible to become so engrossed in analysing weekly data series concerning the Australian economy and housing markets that we neglect to recap on the bigger trends unfolding over the years ahead. Here are four of them...

Trend #1 – Rebalancing: The “Great Rotation” is well underway

The Reserve Bank’s best laid plans to rebalance the Australian economy away from mining construction and towards a residential construction boom have been vigorously denigrated at almost every step along the way.

Variously it has been argued that credit growth was too low, land prices too high and that a sharp property market correction was assured.

And yet while the transition has by no means been perfectly engineered, dwelling prices have recovered fairly robustly in most cities, supply has begun to follow accordingly, and 2015 is shaping up to be a prodigious year for dwelling construction.

Building activity has already scaled levels not seen for two decades, while dwelling approvals are all but brushing ~200,000 on a rolling annual basis, reflecting a substantial volume of supply in the pipeline as the market responds.


From an economic perspective this is a welcome result, especially since previous research has proven residential construction to unfurl a strong multiplier effect.

Of course, there are always weak links in the economic data.

Major renovation activity is moribund, which has continued to shave irritating fractions from housing investment’s quarterly contribution to GDP growth.

The dearth of renovation activity is no doubt partly a result of the structural shift towards apartment dwelling, and to some degree it reflects the expensive nature of detached housing stock in the capital cities.

There is also a generational factor at play, with younger family buyers having used first home owner grants to buy new properties or in some cases being priced out of the detached housing sector entirely.

In the UK Homebase announced this week that it would close a quarter of its 323 stores as Brits also fall out of love with renovating and DIY.

Paradoxically, while Australian television viewers are bombarded by an artillery of cookery and renovation shows, official ABS data continues to show retail turnover for takeaway and café meals booming to unprecedented levels and renovation activity in most states dying a slow death.

We seem to enjoy watching others rustle up fancy meals and renovating houses; actually doing the stuff ourselves, not so much.

If capital growth in earlier property market cycles was once in part illusory, driven by improvements to the existing stock of dwellings, this is not so much the case today.


Overall, though, the picture is strong for residential construction activity – for units and apartments in particular - and the aggregate new capex volumes in 2015 will not represent anything like the disaster that had been feared as the resources-driven engineering construction boom unwinds.


The above having been said, dwelling investment alone can only bridge so much of the gap.

As has been well documented previously, residential construction activity represents only a relatively small percentage of GDP and itself cannot offset the forthcoming plunge in mining capital investment.

More heavy lifting will be required from other sectors of the economy, and the net result of this is that the official cash rate will be lower for longer, with perhaps up to 18 months or more of uncommonly low interest rates ahead.

Trend #2 – Real rental growth is dead

It is often said that a “quest for yield” is dramatically altering investment decisions, wrenching savers out of cash into the risk asset classes in a search for acceptable returns above the rate of inflation.

While this may be true of the equity markets, net yields in residential property are in fact low and heading lower, and the incentives to invest in residential real estate are largely centred upon expectations of reliable future price growth as an inflation hedge.

One of the most notable trends playing out through this cycle is that levels of investor activity are set to break through unparalleled levels, with the Reserve Bank’s own financial aggregates data showing that the gradient of credit growth relating to investment housing continues to rise more steeply than that associated with owner occupiers. 

The inescapable conclusion of this is that property buyers seeking capital growth must anticipate the locations investor funds will flow to, which research has shown are very heavily concentrated in the inner- and middle-ring suburbs of the large capital cities.

As each month passes further evidence also gradually comes to light that the official data may be materially understating the role of foreign investment in the capital cities, particularly from Asia, and the real level of investor activity could be significantly higher still if offshore funds were to be captured effectively.


While these trends are doubtless pushing inner city dwelling prices higher, the corollary is that with greater volumes of supply coming online - a high proportion of which is investor owned – real rental growth is declining.

While the rate of rental inflation has held up reasonably well in supply-constrained Greater Sydney to date, where the population is also booming, the risks for most cities are to the downside (and in some smaller cities such as Canberra, nominal rents have already turned alarmingly negative).


Trend #3 – At long last…it’s time for Brisbane to shine

Sydney has become the Antipodean equivalent of London and the residential property market just keeps on keeping on.

An imperiously strong FY14 will be followed by more of the same in FY15, with SQM Research forecasting a further 8 to 12 percent growth for the harbour city.

The supply versus demand imbalance in Sydney has been well known about by those close to the market for half a decade, and dwelling price growth continues to respond accordingly.

Variously Australian cities face considerable challenges. Adelaide’s labour market and economy are lacklustre, Melbourne has a surfeit of supply and of sellers, while Perth is juggling an awkward transition from mining construction to production in concert with a decline in Australia's terms of trade.

Queensland aside, full-time employment in regional Australia has stalled completely and is actually lower now in the major states than it was way back in 2006, as I analysed here.

We have taken great care to analyse the Brisbane data for false dawns and have refrained from calling prematurely for a marked uplift in prices, but the data suggests that at long last it is time for the maroon of Queensland to have some time in the sun.


The recovery in Brisbane housing finance to date has been studious rather than explosive, but upon closer inspection of the figures we see that while most states have recorded seasonally weak mortgage finance data since June, Queensland is going from strength to strength, with owner occupier commitments increasing by another 15 percent over the past year.

It has been a significant bounce back for Queensland owner occupier finance activity and dwelling transaction levels since 2011, and more timely data from mortgage aggregators suggests that there has been further strength through to October 2014.


We called the Sydney property investor boom long ago and took action accordingly - you would have to be living under a rock not have heard about it by now.

However the ABS Lending Finance activity data that investors have not yet fully come to the party in Brisbane - at least, not domestically.

Enquiries and mortgage broker data have indicated that a steady rotation towards Queensland is taking place, with interstate investors enticed by stronger yields and considerably more attractive entry prices.


Trend #4 – Asset selection will be critical in this cycle

For all the above, buyers in Brisbane need to undertake more educated investment decisions than in cycles past, and asset selection will be critical to a successful outcome.

The coming upturn in Brisbane is not resultant from a chronic undersupply such as was the case in Sydney, with more attached housing stock (units and apartments) approved in Brisbane on a rolling annual basis than we have previously seen.


The clear implication of this is buying generic, off-the-plan city apartment stock is an almost guaranteed route to a sub-optimal investment outcome, and the ROI from such a strategy could easily be negative.

Not only do investors need to steer clear of the standout pockets of looming apartment oversupply and elevated vacancy rates, they must look to source stock which will retain a level of scarcity value through the cycle. 

For units this can mean boutique blocks, river views or district views which will not be subsequently built out.

The apartment construction boom will be effectively absorbed by population growth in due course and over time, yet Brisbane will not any time soon see a repeat of the dramatic boom in interstate migration which played out in previous cycles.

Population growth in Queensland remains very strong, but in common with other mining states, the pace of growth is presently declining.


As the mining construction boom begins to unwind net interstate migration to Queensland has slowed, and it will be natural increase combined with net overseas migration which drives Brisbane forward in the immediate future.

Informed investors will take note of the property types favoured by immigrants, leaning towards favoured modern types of investment housing (ideally, as noted, with water or district views which will not be built out)

Headwinds and challenges persist in the local economy in Brisbane, as indeed is the case in most Australian capital cities.

Previously encouraging labour force growth appears to have hit something of a plateau lately, and while strong construction employment is a welcome start, Australia needs to stimulate a broad-based recovery in the services sector and encourage household consumption.


Price growth for Brisbane and Sydney ahead

Dwelling price growth in Brisbane has been weak for more than half a decade with prices having declined from peak to trough by close to a fifth in real terms, which, with interest rates at exceptionally low levels might give an indication as to the potential quantum of a successful rebound.

After a prolonged hiatus, sentiment in Brisbane has turned a corner and improved prospects lie ahead.

BIS Shrapnel forecasts capital growth in Brisbane of 17 percent over the next three years, while the SQM Research forecast of 8 percent to 12 percent capital growth in Sydney will continue to attract investors in the harbour city.

Over the longer term Residex forecasts capital growth tracking at 5 to 6 percent per annum in Sydney and Brisbane.

We will be buying investment outstanding properties for clients in both cities in 2015.