We talk a lot on MacroBusiness about an Australian housing bubble. H&H, UE and DE are doing a sterling job of demonstrating Australian house prices are historically high by any meaningful measure. Plenty of people – in fact most in the mainstream media and real estate industry – disagree with them, some vehemently so.
But this won’t be another blog about house prices (no truly, it won’t). Nor is it a prediction. Rather, I want to discuss what would happen to Australian equities if the eventuality of a correction and how you might best profit from it .
Given the recent MB debate on what constitutes a crash or correction, I’ll set the scene for this article by defining it in similar terms to the US correction between 2006 and 2009 of 11% per year for 3 years.
The macroeconomic impact of a housing correction would be big. The big 4 banks (CBA, Westpac, ANZ and NAB) have large volumes of mortgages on their books – CBA and Westpac account for just over half of the Australia’s mortgages. Falling house prices would mean a drop in their capital bases (see Steve Keen’s exhaustive article here for more info) and as such a drop in the amount they can lend. Overseas credit would most likely become more expensive too as international debt markets increase their risk premiums for Australia, however the supply itself would likely reduce as institutions lowered their exposure. So whilst the RBA would drop interest rates, credit could remain expensive or be rationed as our banks find it more difficult to borrow offshore.
The resulting writedowns in bad debt and lack of mortgage lending would hurt the share prices of the Big 4 banks, which would see sharp falls in the major indices as the banks make up such a large proportion of the Australian market – 24% of the ASX200 and 20% of the entire equities market.
A combination of reduced lending and low confidence would be felt strongly in retail spending, especially on discretionary items. Even the non-discretionary parts of the economy (e.g. health, basic food stuffs) would be impacted as people tighten their belts. The savings plans of the baby boomers would take a serious hit – not only because of dropping house prices but the subsequent losses to their superannuation portfolios.
Outside of the share market, federal and state government revenue would plunge with company profits and stamp duty and land taxes take a haircut. Conversely, welfare spending would rise as unemployment grew.
However, the pain would not be evenly spread in share market. Some companies will be figuratively killed off, some will suffer badly and others will bear the brunt only to come out stronger due to reduced competition and improved cost efficiencies.
Which Companies will be In Trouble?
Obviously the banks would be in trouble as discussed above – CBA, ANZ, WBC, NAB, Suncorp, Bank of Qld, Bendigo, Rock Building Society and Wide Bay Australia would all be affected. In the case of CBA, holding 26% of the nation’s mortgages during a housing downturn will have big impacts on capital ratios. In fact at Empire Investing, we’ve already relegated the big 4 banks to non-investment grade.
Property developers and builders (those still left after the GFC) would be in big trouble as projects stop, houses and units go un-purchased, revenues dry up and asset values plummet. This will impact the likes of Centro, Fleetwood, Mirvac, Stocklands, Sunland and any Real Estate Investment Trust (REIT). Building supply companies would also see demand drop as projects dry up and people stop renovating houses that banks are foreclosing on – think Reece, James Hardie and the Bunnings side of Wesfarmers.
Most Australian consumers will reduce spending on anything that isn’t essential. Eating out, clothes and fashion, holidays, furniture, electronics, home renovations, home repairs, car services – pretty much anything not inside your food pantry or fridge. Companies like Myer, David Jones, Oroton, Pacific Brands, Harvey Norman and JB HiFi will find conditions very difficult.
On the commercial front, Seek will feel the pressure of increasing unemployment as employers stop hiring and their Australian revenues diminish, though it would get some protection from ongoing expansion in the resource-associated industries.
Aside from the sectoral damage, any company with very low return on equity (i.e. marginal businesses) and/or high debt will be at risk of going under. There may be a few rock-bottom capital raisings and share purchase plans to save the under-performers. However, the new capital will just follow the old – from the investors pocket into the hands of the creditors and administrators.
Who’s (Relatively) Immune?
In a world where house prices drop but China still hoovers up our raw materials, the resources sector will likely sail on. In fact, current operations will do even better as the AUD drops against the USD (in response to the RBA lowering rates amid the macroeconomic chaos), making commodities priced in USD more lucrative. Engineering service companies tied to mining will also be OK, including Sedgman, Leighton’s, Monadelphous and Worley Parsons.
Non-discretionary stocks should fare well (at least compared to the rest of the market). Healthcare stocks with high ROE and good products will do well – especially those with large offshore revenues that would benefit from the lower AUD. Cochlear, Celestis and CSL would fall into this category.
Basic food stuff suppliers would remain solid (even the jobless need to eat) so Woolworths should remain a safe harbour. Coca-Cola Amatil would be safe, despite moderate debt levels, offset by increasing revenue from Asia and a timeless, tasty product. These two companies also have great return on equity (ROE) and dominant market positions – bulwarks that will be required during a house crash tsunami. In our opinion Wesfarmers (owner of Coles) would take a hit owing to its Bunnings arm.
On the fast food front, Dominos should fare well because its product (pizza) is well liked and a very cheap way to feed a family. As Michelin Hat restaurants and funky cafes go out of business, Dominoes, Pizza Hut and MacDonald’s will be the beneficiaries of a new culinary frugality.
One final refuge may be those companies that profit from tough economic times. Cash Converters would see a big upswing in business as people resort to hocking possessions to pay the bills. In a similar light, FSA Group, the largest debt consolidation and personal bankruptcy firm in the country, may also see an upswing in debt arrangements as people and businesses go to the wall (although FSA’s sub-prime loan division would likely suffer). Failing that, convincing your local loan shark to list publically may also be a good play.
Well, that will be subject of tomorrow’s article. So stay tuned..
Until then, I’d like to hear your views on what a decent housing correction would do to Australian listed shares.
Disclosure: The author is a Director of a private investment company (Empire Investing Pty Ltd), which has interests in some of the businesses discussed in this article. The article is not to be taken as investment advice and the views expressed are opinions only. Readers should seek advice from someone who claims to be qualified before allocating capital in any investment.