Don’t worry, be happy

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.)

Morningstar Banking Special Report

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  1. “..many New Zealanders are using credit in ways that could eventually harm them. Against this backdrop, Dun & Bradstreet’s New Zealand general manager John Scott says future interest rate rises could be “the trigger that causes distress for many households.”
    Et tu, Aussies?

  2. Well…I read the report to challenge myself. And frankly, from a macro perspective, it’s ahem…a little behind the times.

    Take this for instance: “We expect GDP growth to average 3.5% to 4% over the next few years, and based on historical trends,credit growth should at least double GDP growth. We expect housing credit growth to improve from 7% towards 10%, but still remain well below long-term trends. Business credit growth should recover to 5–7% by the end of 2012 and we expect individual investors to follow the lead of corporate Australia and increase exposure to more risky investments. The uplift in business profitability and the sharp rise in global M&A activity will boost confidence across corporate Australia.”

    First, the GFC has just started. It isn’t over. There will be NO end to the kind of shocks we saw last night around sovereign debt. Confidence will get hammered then smashed then pounded over and again. There will surely be uplegs in the equities market but the M&A happy land described here is delusional.

    Second, and even more importantly, there is NO way known that the RBA will allow mortgage credit growth of 10% per annum. Every time credit threatens to expand much above its current rate so will interest rates.

    The two reasons for this are:
    a) For those who didn’t notice, we just went through a GFC. It wrecked our banks offshore borrowing to pump housing strategy. The RBA and APRA both now know that NY and London can seize up and bankrupt our banks. After such an experience, they have sensibly concluded that it is no longer prudent to accumulate offshore debt. That measn limimited system growth for the banks. The end.

    b)We are going through a commodities boom that the RBA and Treasury have confimred ad nauseum is absorbing huge amounts of Australia’s economic capacity. They will not allow consumption to rise as well. They will stomp on it, again with higher rates.

    None of this is intrinsically bearish. In fact, it’s extraordinarily fortunate. Most importantly, however, it’s just reality.

    • Deus Forex Machina

      Another good one SoN
      Dead right H and H on all the points above…the GFC is ongoing, the RBA is not going to tolerate a consumption snap back with a mining boom and at a time of nominal full employment and crucially they want the almost $200 bln in deposits on ADI’s balance sheet above the trend that existed pre- June 2007 (thanks DataSword for this) to stay on Australian ADI’s balance sheets and thus reduce offshore funding needs (or at least balance them against the increase coming from the rise in the AUD).

    • Gotta agree with SoN on the dangers group-think bias. As I’ve said before, nothing worse than a room full of people reinforcing their own opinions. But I think MB and the commenter’s do pretty well in avoiding (thanks go out to the likes of Shadow and Sarah P.)

      On topic though, I see a lot more macroeconomic downsides at the moment compared to 5 years ago – which was admittedly a boom time. Maybe we can maintain a meta-stable state of low credit growth, low unemployment, increasing funding costs, stagnating house prices and a continued resource boom. But then I look at Euro and US debt, Chinese and global inflation, Middle East turmoil, increasing offshore funding costs and a (probable) Aussie housing bubble. Sheesh. And those are the known unknowns..

  3. Compulsory superannuation has only been in effect for 20 years, and by most account it will take 40 years to build up a sufficient ‘nest egg’. A lot of the ‘Baby Boomers’ have less than 100K in their accounts. They will not be the future source of consumption growth.

    With loan volume falling, I am afraid that Australian banks will start pushing fixed annuity backed by real estate to retirees. The bank will pay you a fixed amount per year, and when you die, the bank gets the house. Beyond the inflation risk, some contract may contain a clause where the bank can seize your house if the price of property falls by a certain percentage. It is going to be the stuff of nightmares.

  4. Stop the press!! I posted this on morning links post, but this is worth repeating.
    Gotti on house prices:
    “But if Australian banks restrict consumer housing credit in the same way as the US banks and the banks involved in the Gold and Sunshine coasts market did we will see a big fall in property asset prices, which, in turn, will lead to a rise in bank bad debts.
    In many ways the Australian banks are trapped. They must keep up consumer housing funding to avoid a fall. As long as the bankers understand their role in the game all should be well. But you can understand why some global investors get nervous. Bankers are not always that smart.”

  5. Consumers are careful, they are not spending. People are not borrowing as they used to before GFC. The banks can push loans as much as they want – it will not work if people don’t want to take on more debt.

    The RBA believes that consumer spending will pick-up sooner rather than later, they are wrong. Deleveraging will continue for a few more years – not months, GFC is far from over.

  6. I don’t know, what is referred to as ‘nominal unemployment rate’ I’d call the ‘propaganda unemployment rate’. Not out of negativity, rather and as I’ve posted here before, comes from my CentreLink and MissionAustralia acquaintances.

    People I know that run their own business (as I too), are finding it tougher, I know few people that can’t find jobs nor full time well paid jobs. Also there is a sense of less money being out there cause its’ much harder to get. Households are doing it tough too.

    There are houses in Sydney’s Eastern Suburbs that haven’t been sold for a while (others that sell in a sneeze), but in better times these houses would be gone in a blink, and for over 1.1 million.

    I don’t think this blogsite is negative nor full of bad vibrations, I actually see if someone says something not right (bull or bear), there are questions and corrections to their post.

    There is a feeling of negativity out there in the community though. I would be pleased if Australia starts the up and up from here on but, I also feel the GFC hasn’t been realised here as yet. That’s just me (and some other people I know). Things aren’t that good.

  7. I feel like singing, “Happy Days Are Here Again.” Brings back memories of when I was a young lad in the early 1930s. Honestly, I do remember Bush (I think the first one) who campaigned very successfully on the slogan, Be Happy, Don’t Worry–which was also a very catchy song.