The consensus on MacroBusiness is that housing currently has more downside risk than upside potential, that the banks’s earning growth is increasingly limited and that the consumer has switched off. Being a bear by temperament myself, I can but agree. But we bears are often wrong and it is worth at least considering the opposite case. That has been put in a note by Morningstar, which argues that things are not so gloomy. It says that “scaremongers” — for which read most of the bloggers on MacroBusiness — continue to “push investment risks” such as “steeply higher interest rates, collapsing house prices, a sharp economic slowdown in China stopping the commodities boom, equity markets not recovering pre-GFC highs, carbon taxes increasing everyday living expenses, higher oil/petrol prices, natural disasters increasing insurance costs, higher household utility costs and higher food costs”. Sounds awfully familiar.
Morningstar, however, sees things very differently:
We do not see current trends heralding long-term structural change, particularly with the outlook for low unemployment, wages growth and a very reasonable economy over the next few years. Increased savings and low credit growth are logical short-term reactions following an economic shock. But in Australia the GFC was not an extreme event as events go, so we expect a resumption in spending as economic conditions pick up following a period of balance sheet adjustment.
The national household savings rate hit 10% for the December quarter 2010 after 20 long years closer to zero. Consumers are now more cautious, debt is repaid more quickly, growth in credit card transactions and balances is declining, and discretionary retail sales are suffering. Baby boomers are moving closer to retirement and there is an increasing trend towards boosting savings outside volatile equity markets. A flood of money moved into government guaranteed bank deposits and credit growth may not return to pre-crisis levels. Of course the increase in local deposits is very good for the banks as it reduces reliance on more expensive offshore wholesale funding.
Credit growth has fallen sharply since its peak in January 2008 and business activity outside of the resources sector could remain subdued for the remainder of 2011. Growth rates for housing, personal and business credit are all weaker. Household deposit growth rose significantly during the worst of the GFC as investors rushed to the safety of the big banks. Household deposit growth is still strong, but eased off over the past six months and is off the highs of 2009. The long-term increase in the proportion of the population who traditionally are savers and not spenders, particularly new Australians from Asia and the Middle East, is also boosting national savings.
Corporate deleveraging continues at pace with balance sheet repair continuing following massive capital raisings during 2009. Importantly, many corporates actually entered the GFC in reasonable financial shape, with the obvious exception of the property sector, but most were saved from becoming bank bad debts by heavily discounted capital raisings, with the take-up largely funded through superannuation flows.
A generation has spent rather than saved, and not surprisingly, market gyrations over the past three years focused attention on boosting retirement savings. For many, superannuation is not enough and the pension by itself is insufficient to sustain a comfortable post-retirement lifestyle. Investment savings continue to struggle due to the GFC- induced equity market collapse.
What to make of these parallel universes? They proceed from the same basic facts; for the most part there is little disagreement about the data. We could engage in ad hominem attacks and meanly point out that Morningstar is trying to get people to buy shares, so they are naturally biased towards optimism. But that doesn’t really tell us much. Just because they have a motive to argue a case does not mean they are wrong.
What is probably more useful is to see where the parallel universes intersect. There is agreement about a slow down in consumption, but given that saving is unusually high, perhaps that trend will dissipate (we bears tend to notice over shooting on the upside, but not over shooting on the downside). Maybe a punt on low growth, but not no growth in demand.
It is also fair to assume, from what both sides are saying, that there is a lowering of expectations from investors about returns. They expect less reward, and are less inclined towards risk (especially the increasing number who are soon to be retired). Meanwhile, corporates have low gearing, so they, too, are taking on less risk. The recent drop off in housing will also make investors more risk averse (and of course something much worse might occur, such as panic, if house prices really tank).
So a safe conclusion might be that if there is a structural shift, it is from a high risk-reward environment to a low risk-reward environment. That may be an indicator for investment strategies.
(p.s. As the perspicacious Andrew pointed out in response to my blog yesterday, I misread the Macquarie recommendation on Leighton. They were giving an underperform recommendation, not a buy. Apologies to Macquarie.)