Houses and recessions

Tracey Watts from the Third Wave Group yesterday alerted me to a research paper by Gavin Putland from the Land Values Research Group that examines the relationship between recessions and property prices in 41 countries worldwide. It offers the following key findings:

  1. A downturn in the property market, especially in turnover (sales) of properties, is a leading indicator of recession, with a lead time of up to 9 quarters for turnover, or up to 8 quarters for values. Of all the countries in which a conspicuous fall in turnover was documented, there was no case in which the onset of recession preceded the fall in turnover…
  2. In the property market, a fall in turnover is a leading indicator of a fall in prices, and the lead time is usually one to two quarters. In no case is there persuasive evidence of the fall in prices coming first…
  3. Recessions are mostly home-grown… in most countries the recession was preceded by a downturn in the domestic property market.

Since Putland only examines the house price falls and recessions associated with the Global Financial Crisis, his sample is not large and varied enough to draw definitive conclusions. Each of the busts in his sample transpired within the context of a global credit crunch so, in my view, for two reasons the evidence is not conclusive enough to state that that most recessions are home grown. First, using only one business cycle, where financial conditions were identical across all nations is an overly homogeneous sample. Two, the denouncement of that cycle was a GLOBAL credit crunch.

Nonetheless, Putland’s findings are interesting and do throw light on the trajectory of Australian growth, its risks and interest rates. Today I’m going to revisit the trajectory of transaction volumes and home prices in Australia to gauge the depth of trouble that is brewing on the home front.

Below are charts showing changes in house prices and transaction volumes. My data sources for this exercise are as follows:

For each mainland capital city and nationally, two charts are presented: one showing quarterly changes in house prices and transaction volumes since 2002 (derived from ABS data); and one showing annual changes since 1992, whereby house trasnsactions have been derived from both Australian Property Monitors (APM) and the ABS and weighted by population.







As you can see, the data shows a strong correlation between changes in house transactions (sales) and changes in house prices, with the quarterly ABS data confirming that the number of house sales lead prices.

Unfortunately, the ABS house transfers data lags the house price series by 6 months, rendering it useless as a predictive indicator for both house prices and the economy.

However, RP Data does provide sales data periodically, and the picture is not pretty – the level of home sales nationally is at its lowest level since 1996 and around 16% below the five year average (see below chart).

Moreover, RP Data shows a ballooning of listings nationally:

Given Putland’s finding that turnover (sales) of properties is a leading indicator of recession, and the fact that home sales have contracted sharply across the nation, what evidence is there that a home grown recession is coming to Australia?

Certainly, consumer confidence has been sliding all year:

And, given the growing correlation between house prices and consumer confidence, that doesn’t seem likely to change:

Even though interest rates haven’t budged since November 2010, retail sales growth has stalled and there are now growing signs of a turn in the labour market with recent reports by the ABS, Roy Morgan and Melbourne Institute all suggesting growing weakness in both hiring and wages growth.

Yesterday’s profit result by Westpac might provide a glimpse into our future. Australia’s second largest home lender announced a round of job redundancies as part of efforts to reduce costs in the face of a slowing economy and subdued borrowing by households. Also, with austerity hitting many Australian service sectors, Australia’s governments are also likely to be adversely impacted by lower stamp duties, company and personal income taxes, which could lead to redundancies and/or lower employment growth within the public service as well.

As MB has also documented at length, Australia has a large growth offset in its mining investment boom so broader conditions are very different to those outlined by Putland’s research. Equally, however, Putland’s contention that falling house prices are a leading indicator of recession appears about to undergo another test.

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Unconventional Economist
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  1. This is interesting data and from a local Melbourne view in my suburb I went to auctions over the last few weeks and the houses were passed in with one getting no bids. I’m also seeing price reduction on the failed auction boards.

  2. Further proof that prices wont bounce back in spring.

    People holding off selling now when their loan is already under water is a terrible financial decision in the hope that property prices will take off in the short term.

    What people don’t understand is, it’s the 5% of people who enter the property market that dictate property prices not the other 95% of people who are already in the market paying a mortgage. As people don’t enter the property market, prices fall and people with large loans go under water. Investors realise capital gains are nonexistent in this market and sell to cut their losses. Panic sets in and people try to sell quickly and then a domino effect sets in and prices go off the cliff.

  3. watching mainstream economists trying to work out why the economy here is so weak and were “shocked” by the rise in unemployment last week is highly amusing.

    As goes the property market, goes the economy. the property bubble has burst and here comes the recession. Since they never saw a bubble in the first place and have been telling us “Australia is different” its no wonder thay cant connect the very obvious dots here.

  4. “A downturn in the property market, especially in turnover (sales) of properties, is a leading indicator of recession, with a lead time of up to 9 quarters for turnover, or up to 8 quarters for values.”

    How long the downturn and how deep? Interest rates during that time?

    In 2008 the downturn was there, but it did not result in a recession in Australia. This time it looks like it is going to be more prolonged.

    • We only avoided recession in 2008 in terms of GDP, and GDP is an almost totally useless measure. In the space of 12 months, the govt went from a surplus to deficit spending that was around 4% of GDP. Hardly a surprise that this was enough to prevent consecutive quarters of negative GDP.

      Meanwhile unemployment was up sharply, and tax revenue down sharply. Indeed, 3 years on, and tax revenue has still not recovered to 2008 levels.

      • our real GDP per capita was down as well,
        GDP was nominaly up just because we had huge population boom in 2008,

      • Our focus on GDP is a big mistake IMO, distilling all economic activity to a single number means that at the macro level economists and policy makers will often (usually?) completely miss what is going on. It also means you have an “avoid negative GDP at all costs” outlook when, from time to time, economic contraction is required to cleanse poor investment decisions and reallocate capital.

        If you take on debt and stimulate otherwise unprofitable activities, GDP may rise but have you actually helped or hurt the economy?

      • Wonderful! I thought I was the only person who knows that GDP is a totally useless and meaningless statistic. Paying people to install pink batts and building school halls that nobody uses is not a sign of national prosperity! The fact that these idiotic schemes are paid for by taxpayers money only makes it all the more scurrilous and inane.

        • What about if the installation in schools was libraries, computer labs, gymansiums, basketball courts, canteens instead of halls?

  5. If interest rates fall as many are predicting then all bets are off. The banks will lend to anyone again to ensure their bonuses and dividends.

    • Perhaps, but the banks are not stupid. Their goal is to make money. If property falls anything like it has overseas then lenders are going to be very tetchy about loaning money when the underlying asset is constantly declining month on month.

      A lot of punters seem to think the property bubble popping will all be over in a month or two. In the US the decline has been 4 years now and still hasn’t hit the bottom.

      I can see some much great LVR requirements, say 40% down and we lend you the money.

      Which is probably not a bad thing anyway, although I suspect there is going to be a lot of pain to come for many folks.

    • jousting sticks

      How much money will they have to lend though?

      Will they still be supplied with huge amounts of internationally sourced wholesale funding if Australia isn’t providing a nice high rate of return?

      I’d appreciate any insight that experts in the field might be able to provide…

      • wholesale funding is being partially mitigated by increased savings rates, so the pressures arent as great as they were 12-18 months ago.

        Term funding markets are pretty dry at the moment for longer term issues. I think the banks are pretty aware of possible difficulties (and our economic situation wont matter too much, a global downturn or french bank imploding will screw the term funding market regardless of what happens in our economy).

        Expect the RBA to extend emergency funding facilities if SHTF.

    • It depends on how much of the banks funding comes from offshore borrowing and their maturity (when/how much do they need to roll over within the next 3-6 months).
      If RBA interest rates fall, that does not necessarily mean banks will be able to borrow at a lower rate from the offshore credit market. Either they will have to crimp their NIM (bring down their profit margin) or sit tight.

    • One thing I agree with Chris Joye is that we shouldn’t turn too bearish

      Just a quick look of RBA household balance sheet:

      liability, largely mortgage, 150% disposable income
      housing asset, 450% disposable income.

      On aggregate, household has considerable buffer to weather downturn.

      Of course, the risk is always on marginal borrowers or recent new borrowers, who has leveraged too much.

      • u seem to forget that when deleveraging starts to happen that 450% starts coming down! . Look at the graph in 2008 , that is not hard cash.

        • yeap, since prices change at the margin it will be a relatively small number of people entering the market who will crash the value of RE assets of the rest.

      • Based on the RBA chart:

        Since 1993(?) our net wealth has increased by roughly 1/3 from 450% of household disposable income to 600%. Our debt has increased by roughly 3 times from 50% to 150%.

        Or alternatively our net wealth has increased by 150% of disposable income by us borrowing 120% of disposable income.

        What could possibly go wrong with that house of cards? Even in the best case of no crash, how can anyone think that this increase in wealth and borrowing can continue?

        • I agree the “good” time driven by cheap money and borrowing is behind us, which is why RBA call for productivity to improve standing of living.

          No doubt, improve productivity is more hard than cheap borrowing.

          We will have to get used to it, but we are not doomed.

  6. Westpac not the only Big 4 player looking at shedding staff. Friend at ANZ looking at redundancy ATM.

    Perhaps they’ll put this analysis up against CJs over at BS! Or these days, should that be the MB guys giving CJ a shot over here?

    Lovely work.

  7. Please correct me if required!

    With ‘fractional reserve banking’ an economy can be stimulated up to 9 Dollars for every 1 dollar injected ?


    And the reverse is also true?

    I guess that tighter borrowing conditions for banks may send shock waves through industries dependent upon discressionary consumption at the lower and middle income levels anyway

  8. Great post and responses guys!

    I’m afraid, I’m seeing this issue through glasses which have been smeared with vaseline!

    I’d love to get some bullet points on just how the rubber hits the road here! Can anyone please assist?

    This is my take on it.

    Firstly, watch the financiers for they will lend to us and create exuberance that finally leads to greed.

    Remember the worst loans are made in the best of times!

    We’ve been there and all the evidence points to the fact that we are now heading down to the bottom of the credit cycle where “fear” reigns supreme.

    What do the financiers do when falling property prices occur?

    Over-react as usual and so they yank the money supply. Risk averseness rises, and along with it, interest rates, credit restrictions & covenant requirements.

    Businesses become starved of capital. Borrowers are unable to roll over their debts, households slam shut the “spending wallet” all of which leads towards defaults & bankruptcies.

    This process contributes to and reinforces the economic contraction.

    Yes, I see a recession in the offing here…but equally I know that at the bottom of the cycle, where fear is extreme, is the ideal time for a contrarian to be buying into quality businesses.

    So, I’m sitting on a growing cash hoard just waiting.

    Yep, as I see it, is this just another repeat of the same old movie…
    Prosperity brings expanded lending, which leads to a unwise lending, which produces large losses, which makes lenders stop lending, which ends prosperity, and on and on.

    Please tell me honestly, am I a simplistic old boofhead or am I reading this somewhat correctly? I’d love to get thoughts here.

    • I don’t think we are anywhere near the “fear reigns supreme” yet.

      A colleague today reckons Australians did not realise what a bad situation they were in going into 2008/9 and that is half the reason we ‘got through it so well’.

      I actually agree with the sentiment that most people did not realise how close they could have come to oblivion. And fear (at the household level) did not reign supreme. Some businesses much different, obviously.

  9. email received today from Michael Yardney:
    Hi Stephen,

    Today I’d like to share a really powerful insight about investing that most people don’t get.

    I’ve written this article especially for the NSW readers of my newsletter so if you’ve got any interest at all in property or developing financial freedom through real estate, this is for you.

    I’m writing it because over the last week I’ve had lots of our clients with properties in Sydney ask me what’s going on in property and how much further will property values fall. I guess this is because the latest figures came out recently showing a flat property market around Australia and that Sydney’s recent property boom has flat lined.

    So I thought I’d give you my take on it and I’m sure not everyone will agree with me.

    That’s O.K. because I love sparking debate and getting people thinking about what I’m saying.

    The problem is, most people just take the information that the media spoon feeds them as truth, and they miss out on opportunities because they don’t really understand what’s going on.

    Today, I wanted to give you one of the most important insights that I ever gained as an investor, because it opened up a whole new world of opportunity for me.

    We already know that currently there’s a lot of debate about whether the real estate market has “hit the bottom”. Is property just too unaffordable? Are prices going down more? Is the worst behind us? Are they going back up?

    This kind of debate sells lots of newspapers, but the reality is that sophisticated investors don’t care whether the market has bottomed out yet. IT DOESN’T MATTER!

    Here’s why…the moment you leave your success or failure up to what direction the market goes, you’re in TROUBLE.

    Buying any kind of asset because you’re trying to “time the market” and hoping it goes up puts you in serious jeopardy. You have no control over your returns, and you’re making one of the most common mistakes I see investors make – and that’s speculating rather than investing.

    Timing the market is what unsuccessful investors do.

    Here’s What Smart Investors Do
To Create Long-Term Wealth:

    First, they become educated in a specific asset or investment strategy. They read, they learn, and they understand. They don’t just throw money into an investment on a “hot tip” or because everyone else is doing it.

    By the way if you’d really like to learn the property investment strategy that has worked for me for close to 40 years please join me at my upcoming 1 day training in Sydney

  10. Yardney is an idiot. A mono asset spruiker who preys on the dumb and unsophisticated.

    No AFSL required

    Investors do their best to price the value of an asset based on owner earnings/free cashflows. Speculators do their best to try to time the trading of an asset.

    • You could run a course. Use PowerPoint.

      Two bullet points:

      * Investors do their best to price the value of an asset based on owner earnings/free cashflows.

      * Speculators do their best to try to time the trading of an asset.