I went and saw The Big Short last night. It’s a movie based on Michael Lewis’ book of the same name, which in turn is about those who bet on the demise of the US housing market.
More on that in a moment. But first, it’s time for a little reprieve from this bear market. Overnight, European Central Bank boss Mario Draghi hinted at more monetary stimulus for Europe, which triggered a rally in stocks. From the Financial Times:
‘Mario Draghi signalled that the European Central Bank is prepared to launch a fresh round of monetary stimulus as soon as March, bolstering a recovery on US and European equities in the wake of heavy losses this year.’
This is just the excuse the market needed to rally. Stocks were oversold in the extreme, meaning the market was way out of balance. It just needed an excuse to rally. Predictably, Draghi gave it that excuse. Now let’s see where this rally takes us.
My view is that the change in sentiment over the past few weeks has been strong enough to see investors want to sell the rallies…not buy the dips as in years past. Only some unambiguous good news on the economic front will change that.
That’s my view, but what is the market saying?
Let’s have a look at the Dow Jones index:
As you can see, the recent collapse in the index brought prices back to the lows of August 2015.
What was the cause of both of these near identical plunges?
Devaluation of the Chinese yuan, reflecting weakness in the Chinese economy and a deleveraging in global financial markets.
It’s a positive that the Dow found support at this level. It provides hope that the bottom may be in. But as I mentioned, the extreme oversold nature of the market meant that a short term rally from here was likely.
The important thing now is to see how far this rally goes. Much will depend on what happens with the yuan. It’s good to hear that China has no intention of letting market forces play out in respect of their currency. From Bloomberg:
‘China’s vice president underlined the Communist leadership’s pledge to avoid pursuing a policy of devaluation of the yuan, after criticism that his nation’s policy makers haven’t been clear on their intentions with the exchange rate.
‘“The fluctuations in the currency market are a result of market forces, and the Chinese government has no intention and no policy to devalue its currency,” Li Yuanchao, who is also a member of the party’s Politburo, said in an interview with Bloomberg News Thursday after arriving at the World Economic Forum’s annual meeting in Davos, Switzerland.’
No intention to devalue its currency? Currency speculators love official denials or pledges. They’re like a red rag to a bull. China’s currency driven volatility isn’t over by a long shot.
I’ll have more to say on China in a moment, in relation to its impact on Aussie property.
But first, let’s talk about The Big Short
It’s a brilliant movie. I highly recommend it. The highlight is Christian Bale’s performance as Dr Mike Burry, the central character of the film. (Then again, Bale steals the show in just about anything he does).
Steve Carrell is also fantastic in the role of Mark Baum, based on the real life character of Steve Eisman.
What strikes you in the film is how nearly everyone is completely ignorant of the unfolding crisis. The sceptics were derided and laughed at. While things are always pretty clear in hindsight, at the time the mood was so intoxicating that very few were thinking clearly.
Mike Burry, who saw the opportunity early and actually got the banks to create the instruments he wanted to sell (and profit from) suffered the most.
I won’t give too much away. But the point is it’s a lonely place being early on a trade. Being early is the same thing as being wrong. Only conviction can get you through it.
Watching The Big Short will no doubt give Aussie audiences confidence in housing. After all, banks here aren’t slicing and dicing mortgages and selling them on to unwary investors. And they’re not giving loans to people with no income and no jobs.
But it would be a mistake to be so complacent. Bubbles don’t ever…ever…happen in the same way. After all, Australia’s banks are loaded with mortgages because they are so ‘safe’. No one thinks it is possible to lose money on mortgages. This is exactly the sentiment that created the US housing monster.
What is remarkable about Australia is that it avoided the down cycle that the rest of the world’s real estate markets had to endure from 2006 to 2010.
By the way, the movie portrays those that saw what was coming as visionaries. It’s true, they were, especially Mike Burry. But there were plenty of others who knew too. And you’ve got access to one of them here…
Phil Anderson, editor of Cycles, Trends and Forecasts, predicted the US market would bust in his book, The Secret Life of Real Estate and Banking. He said the bottom would occur in 2010. The prediction was bang on the money.
But Australia, the lucky country, avoided the bust. After all, as property types will tell you, even if they don’t know how exactly, Australia is different.
Personally, I think that’s a terrifying argument. The simple fact is that Australia avoided getting caught up in the US cycle because China dragged us into its orbit. Instead of falling in unison with the rest of the world’s real estate markets, Australia went the other way.
Does that mean that our real estate fortunes are tied to China, and no longer the US?
That’s a question only hindsight can answer for sure. But there is evidence to suggest that is the case. Australia’s interest rate settings reflect our relationship with China. Our ability to attract foreign capital reflects our relationship with China.
These two factors have a huge impact on real estate prices. If China’s credit boom turns to bust (which it seems to be in the process of doing) then it will bust Australia’s housing market too.
The initial signs are already here. The squeeze on Chinese capital coming into the country will begin to impact prices at the margin. From the Financial Review:
‘One of Sydney’s top real estate agents said Chinese buyers are finding it increasingly difficult to get money out of the country, as Beijing tightens foreign exchange controls in a bid to support its weakening currency.
‘Lu Lu Pallier from Sotheby’s International Realty, who is focused on buyers from mainland China, said she had heard in recent weeks clients were having difficulty moving money offshore.’
This is just the start of things to come. A slowdown in Chinese capital flows is a precursor to a slowdown in foreign capital flows in general. And given that Australia’s housing market rests on a foreign debt pile of approximately $1 trillion dollars, THIS is the crucial point that no one seems to get.
To make it clear, our foreign creditors ultimately control the rate of interest we pay on mortgages, not the RBA. As China moves closer to a credit bust, foreign creditors will freak out and increase Australia’s cost of capital. That will bust our housing market. It’s just a matter of time.
For Markets and Money