A quick note on yesterday’s invitation to the “Australia in the Red” summit, to be held in Melbourne on Friday, July 31st from 7pm to 11pm at the State Library of Victoria. We’re still accepting requests to be put on the list to buy tickets. We can’t guarantee you a ticket (only available on a first come, first serve basis). But according to our web wizards, there are still a few spots open. We also received more than a few requests to host a similar event in Sydney. We’re on the case!
And now back to the financial markets….
Go you little Aussie mortgage bubble! The value of new mortgages grew in May by 2.2%, according to the Australian Bureau of Statistics. For the month, investors boosted their demand for new mortgages at a faster clip than people who intend to live in the house (owner occupiers). That doesn’t sound like a bubble at all does it?
Two other items of note in yesterday’s housing numbers. The First Home Buyer’s consolidated their position as the most important group propping up Australian house prices. First home buyers increased their percentage of total owner-occupied mortgage demand from 28.6% in April to 29.5% in May. Nearly a third of all demand for new mortgages is coming from new buyers sucked in by the grant. Hmmn.
One final note. The average loan size for the first home buyer was $281,000. That was actually a $3,400 fall from the month before. But it’s still $14,400 higher-or about 5%–than what the average loan size of all the other borrowers in May ($266,900). Max out your borrowing at the low point of the interest rate cycle. Hmmn.
Moody’s economist Matt Robinson told a reporter that, “The policy stimulus from the Federal Government and the central bank has helped boost the housing market, offsetting the deterioration in the labour market conditions that would otherwise subdue the willingness of people to purchase houses…This is a ‘prime example” of monetary and fiscal policy working.”
That statement seems like a ‘prime example’ of getting the analysis absolutely wrong. We’ll explain why in a moment. But first, a word about abductions.
What the heck is going on in Shanghai? Chinese police have detained Rio Tinto iron ore executive Stern Hu on suspicion of “espionage and stealing state secrets,” according to Bloomberg. Hu hasn’t been charged with a crime yet. Three other Rio workers who are also Chinese nationals are being held.
Incidentally, the Age’s Matthew Murphy is reporting that Chinese steelmakers have agreed to a 33% cut in iron ore fine prices and 44% for lumps. “The deal would break a tense nine months of negotiations between the Australians and the Chinese, which had allowed the June 30 deadline to pass while refusing to budge on their demand for a price cut of up to 45 per cent,” Murphy says.
Let’s recap. In late March, Treasurer Wayne Swan knocked back China Minmetals’ bid for 100% of Oz Minerals based on the proximity of Oz’s Prominent Hill gold and copper mine to the Woomera weapons testing range in South Australia. Then in early June, Rio Tinto abandoned its offer to sell an 18% equity stake to Chinalco and instead raised the money from shareholders and a joint venture with BHP Billiton. And finally, the Aussie ore producers refused to give Chinese steel makers a larger discount this year than customers in Korea and Japan got.
So perhaps there’s some hardball going on now? There are more than just business interests at stake in the relationship between Australia and China. There is national interest too. Interesting times, eh?
Let’s quickly get back to that nonsense from the Moody’s economist about policy stimulus ‘working’ by supporting the housing market. It could be a simple case of diagnostic failure. He said the policies are, “offsetting the deterioration in the labour market conditions that would otherwise subdue the willingness of people to purchase houses.” But is this true? And if so, is it something to celebrate?
First off, throwing money at people to buy a house when they are at risk of losing their job doesn’t seem like a good policy at all. It seems reckless. It also seems like the height of stupidity. But the larger issue is whether you can correct a problem if you don’t really understand its causes.
The correct answer would be, “no.” The policy responses inspired by John Maynard Keynes call for the government to run a deficit and spend money that households and businesses will not. But this response assumes that aggregate demand (household and business spending) has fallen for no good reason at all and that all the government has to do is restore confidence (by stimulating the appearance of health) and everything will be fine.
Balderdash! The problem isn’t that demand has fallen unreasonably. It’s that credit rose too much. The economy needs to walk itself back to more production (creating value) and less credit-financed consumption. Recessions aren’t caused by too little spending. They’re caused by spending gone wrong in a credit boom (mis-allocated capital).
In his latest Gloom, Boom, and Doom Report Dr. Marc Faber says, “This is where I have the greatest problem with US economic policy makers [ed note. We’d add Australian policy makers to the mix]. I don’t think they have ever recognised that the excessive, credit-driven expansion of the US economy was unsustainable in the long run and that, sooner or later, the current crisis was inevitable. But not only that!”
“Now that we all know that the monetary policies implemented after the Nasdaq bubble burst in 2000 led to the current crisis, US economic policy makers are attempting to restore economic growth through essentially the same policies; the difference, this time, being that gigantic fiscal deficits are also being created.”
To be fair, not ALL Aussie policy makers are making the same mistakes. As we reported yesterday, Glenn Stevens seems to know that in a balance sheet recession, the way back to recovery is to patiently rebuild the balance sheet on a foundation of solid assets and reduced debt. That’s the course he encouraged businesses to take.
It’s Australia’s government that has us worried, and it’s both parties frankly. The worse the recession gets (it IS a recession and it will probably get worse, we reckon) the more tempted (and forced) the government of the day will be to borrow more and more and run the deficit higher and higher. This won’t be good for confidence in Aussie assets.
Speaking of which, Faber also had something to say about the on-going feud between inflation and deflation. “Asset markets,” he wrote “are buffeted by recurring waves of inflationary and deflationary expectations and I’m afraid we might now run again into a bout of deflationary fears. But unlike the deflationists, I don’t expect new interest rate lows in this cycle.”
“The interesting part about all this is how the various asset classes relate to each other. Equities and commodities seem to move up at the same time (driven by rising inflationary expectations and growth expectations), while bonds and the US dollar move down (the pattern since March 2009). But, when deflationary expectations increase, the US dollar and bonds strengthen while commodities and stocks decline (the patter of 2008).”
If Faber right and the deflationistas have the upper psychological hand, bond prices and the U.S. dollar go up and stocks and commodities will go down. For Australia, you’d probably see a weaker Aussie dollar versus the greenback and lower stock prices too. Meanwhile, the government will try to restore growth by running large fiscal deficits which may stabilise the economy a bit, but a lower level of output (as businesses stay on the sidelines with investment spending).
So how much lower could stocks go? Faber thinks it will be a few years before stocks make new lows (below the 2003 levels, we assume). He says stocks were oversold in March but overbought in June. Stocks are now priced for an economic recovery that looks increasingly illusory.
Two other things from the good Doctor. He expects to see rebounding corporate profits as businesses begin to reap the earnings benefits of cost-cutting and deleveraging. They will be coming off a low base anyway. So he may be right to consider the dismal upcoming profit season as a contrarian nadir.
The other interesting observation is that there is still a large cash position in the market. In fact, according to The Bank Credit Analyst, cash as a percentage of the Wilshire 5000 (the broadest index of U.S. stocks) is at its highest level ever. It’s a veritable mountain of cash.
If we’ve done our maths correctly and the Wilshire has a total market capitalisation of nearly US$9 trillion, that means there’s about $8 trillion in cash, money market funds, and savings waiting to hit the road. Where will it go?
It doesn’t look like investors are buying the “green shoots” line being peddled by Ben Bernanke. That means the cash may not be going anywhere. Or-again using the Faber thesis-it could go into U.S. bonds. Faber also says that on a price-to-book basis emerging market stocks look a lot more attractive than U.S. stocks.
We reckon U.S. investors are still scorched from the last two years and would be reluctant to get back into the market with authority via emerging market stocks. That alone might make emerging market stocks good value for money. It doesn’t really tell us where all the cash might go, though, does it? We can think of a few places and will have more to say about it tomorrow. Until then!
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