Australian Property Speculation Continues to Grow

Following some pretty lacklustre action in overseas markets on Friday, Aussie stocks are set for an average day today. There will be a few gains here and a few more losses there. As I write, the market is down around 0.6%

The only thing of note happening in the market lately is a return of the bear for iron ore stocks. After rallying strongly from mid-January through to the end of February — for no particular reason — iron ore stocks are again under pressure.

For the first few weeks of March, it’s been down, down, down. After approaching $66 a share two weeks ago, Rio Tinto [ASX:RIO] is now around $57.50. That’s a fall of over 12%. BHP Billiton [ASX:BHP] is back under $30 (down around the same amount as Rio) while the more marginal Fortescue [ASX:FMG] is off by about 20%.

That means they could be due for a short term rally, with China the catalyst. The Financial Times reports today that:

China is prepared to take action to stimulate the economy and boost market confidence, Premier Li Keqiang said on Sunday.

Mr Li gave his assurance in Beijing’s Great Hall of the People while warning that China would struggle to meet its annual growth target of “around 7 per cent” this year.

The knee jerk reaction of iron ore stocks is to rally on any whiff of China stimulus. However, the rallies have always given way to further falls, so this ‘buying the stimulus’ trade doesn’t seem like a smart one. And judging by the market’s response today, the standard reaction is not in play.

The trend for iron ore is down, so stand aside and wait for things to turn. It could be a while though, so don’t hold your breath…

Meanwhile, the big four banks continue to trade near their recent highs, which is a bullish sign. It’s telling you that low interest rates will keep investors interested in the banks because of their yields, and also bolster bank earnings as the demand for debt continues to increase.

But how much more can debt levels increase? Household debt is already at record levels in Australia. David Uren writes in today’s Australian:

HOUSEHOLD debt is higher in Australia than anywhere else in the

advanced world, exposing the economy to risks in the event of another financial crisis.

Household debt is equal to 130 per cent of GDP, according to analysis by Barclays chief economist Kieran Davies, compared with an average across the advanced world of 78 per cent.

Not only is household debt higher here than elsewhere, it is also higher now than at any time in Australia’s history. The level of bank lending as a share of GDP can be traced back to the 1850s and the level now is more than double the share of the previous peak, during the 1890s land boom.

If you want to know what happened after the 1890s land boom, I suggest you read a little book called ‘The Land Boomers’. It’s currently propping up my laptop in the home office, and is a constant reminder that major land booms end in busts…and these busts have devastating effect.

In fact, the 19th century boom and bust produced a depression in Australia that was much worse than the global depression of the 1930s. Capital from London fuelled the boom…and then pricked the bubble as it realised what was happening and exited the country.

Here we are now, 125 years later and still reliant on foreign capital to fuel our booms. The property market is going crazy (in Sydney and Melbourne at least), which requires banks to increase their offshore borrowing to supply the loans.

As Uren writes:

The level of household debt in Australia is inflated by the much greater popularity of real estate as an investment than in other countries, fostered by the ready availability of negative gearing tax concessions and favourable capital gains tax treatment.

That’s right, record low interest rates and hugely favourable tax treatment encourages property speculation. Everyone in the industry saw this coming except APRA, the financial regulator.

Now they are belatedly trying to halt the speculation, as punters get ready for another rate cut…possibly as early as next month.

In December, APRA wrote to the banks and warned them about excessive lending growth. Needless to say, the letter went straight in the bin, and the banks continued to make hay while the APRA sun shone.

The reports today that small bank, ME Bank, grew investor loans at a rate of 35% in the year to January. But because investor loans represent only a small portion of the total loan book, the bank has ‘no intention’ of slowing its growth.

Gee, APRA really has some authority, doesn’t it?

There is a perverse side effect to this retarded form of economic growth. That is, Australia continues to sell off productive assets to fund this insane property speculation.

Last week, Philippines food company Monde Nissan purchased family owned Menora foods for $55 million. That follows its recent purchase of Nudie Juices for around $80 million and over $100 million for dip maker Black Swan.

Then there’s the recent Singaporean purchase of Goodman Fielder for $500 million. That means all the profits from these enterprises now head offshore.

This is what happens when you run a constant current account deficit. It means Australia consumes more than it produces. And when that happens, you have to borrow or sell off assets to make up the difference.

In Australia’s case, we do both. We borrow to speculate on property and sell-off productive assets to help fill the gap brought about by excess consumption.

There’s nothing wrong with this at the individual level. Incentives drive this individual decision making (like low interest rates). But at the aggregate level, it’s disastrous.

Australia is on course for a slow motion train wreck. You can see it coming from miles away but you just don’t know when it will happen. Looking at the strength of bank share prices, it’s not about to take place anytime soon.

So it’s all good! For the time being.

While APRA looks the other way, the RBA cuts rates and ‘smokin’ Joe Hockey fans the flames with insane policy ideas, the bubble will continue to inflate. But it will only make the eventual bust that much more devastating.

Greg Canavan,
for Markets and Money

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


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