Goodbye Summer, Goodbye Australia

Goodbye Summer, Goodbye Australia

In today’s Money Morning…the market is still bullish, but doubts are creeping in…imbalance in favour of property…the rise of Australia’s interest-only home loans…banks raising rates when the RBA won’t…and more…

Say goodbye to summer, folks. Today is the Autumn equinox. The sun is directly above the equator, on it’s way north. The northern and southern hemispheres get roughly 12 hours of sunlight each day today. Then it starts to shift. The north takes what we give up.

You’ll start to notice things cooling down in the next couple of weeks. Thank goodness. It’s been a long, hot summer for many parts of Australia.

Obviously global warming is to blame.

We just won’t mention the serious blizzard that dumped a huge amount of snow on New York last week. That’s hard to explain.

But money, not weather, is our beat. So let’s get to it. Markets continue to drift, just like the seasons. But there is no mistaking the fact that the general market outlook is bullish.

Have a look at the chart of the S&P 500, below:

Source: Optuma
Click to enlarge

The rally from the lows of 2016 has been relentless. There have been a few sharp sell-offs, but each quickly reversed, and the market went on to make new highs.

But was the early March high the top? After all, there is a lot of worry about rising interest rates and expensive valuations.

Which is kind of the point. Market’s don’t usually form major tops amid warnings about over exuberance. Sure, you’ll continue to see corrections from time to time (we’re ‘due’ for a decent one soon) but that doesn’t mean we’re heading into GFC Mark II

It’s quite normal for major stock indices to correct anywhere between 10-15% during a major sell-off. Selling out during these times of short term panic might make you feel safe, but it’s the wrong thing to do. Because you don’t normally have the nerve to buy back in, and then you miss the ensuing rally.

There is no ‘right’ answer on what to do. But you do need to have a system and a strategy to ensure it’s not your emotions making decisions on the fly.

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Aussie banks doing RBA’s job

While I don’t think it’s all plain sailing (it never is), I don’t see a major bust anytime soon. That’s in marked contrast with my mate Vern Gowdie. He sees the global stock rally as being on borrowed time.

More specifically, he sees serious problems with Australia’s economy. We agree on this point. I just don’t think it will lead to a stock market collapse. Not yet anyway.

As I’ve written to you before, the problem with Australia is our infatuation with property, and borrowing heavily to speculate on it. The RBA’s poor decision to cut rates twice in 2016, even though commodity markets had started to rally, just added more fuel to the property bonfire.

There’s no better representation of the speculation going on in the market than to witness the huge amount of interest only loans in the system. From last week’s Australian:

For the past six years more than half of new housing investor loans issued have been interest-only, a share that is rising towards 60 per cent. Over the same period, the share of even new owner­occupier loans that are interest-only has increased, from about a fifth to a quarter. Just think: swathes of working families not choosing to pay off the “family home”, the most sacred of assets.

These are rising shares of a rising flow too: total home loans in Australia rose 6.5 per cent to $1.64 trillion over the course of 2016.

The infamous low-doc loans that plagued the US financial system aren’t a problem in Australia. Only $1.5 billion of those were written last year. But more than $137bn worth of interest-only loans were granted, according to the latest APRA data. More than 40 per cent of Westpac’s outstanding mortgages, more than $390bn, were interest-only mid-last year.

What the?

40% of Westpac’s mortgages are interest only? Nearly 60% of all loans written in the last six years are interest only? That’s crazy.

APRA, the banking regulator, may have complied the data, but it would’ve been better served by putting a stop to it.

Interest only loans are great for banks, as they collect the interest income and the principle stays the same. But it’s not so good for the speculators when interest rates inevitably rise.

Only in a country where house price appreciation is so ingrained in the culture would you see such a large proportion of interest only loans.

Why build equity yourself (by paying down the principle) when you can let the market do it for you? That’s how you get wealthy in Australia.

But because we don’t have enough savings to satisfy our huge demand for debt, we have to borrow from foreigners. And interest rates are starting to rise globally. Not by much, but by enough to make our banks pass on some of the costs.

Last week, Westpac Bank [ASX:WBC] and National Australia Bank [ASX:NAB] raised interest rates on investor and owner-occupier loans. Given the banking industry is an oligopoly, it probably won’t be too long before the other two major banks lift rates too.

Although I bet that ANZ Bank [ASX:ANZ] will be the last to move. Given its retreat from Asia, the bank has a bit of catching up to do to build up its Aussie mortgage business.

NAB moved first last week by raising rates for owner occupier loans by 7 basis points, and 25 basis points for investor loans.

WBC followed with a tiny 3 basis point increase for owner occupiers, and 8 basis points for owner occupiers with interest only loans. Investor loans increased by 23 basis points, or 28 basis points for interest only.

The economy will no doubt be able to handle such a small rate rise. The risk — and it’s a big risk — is that inflation starts to pick up sharply and rates will keep on moving higher.

That will deal a major blow for Australia’s property market.

Maybe Vern’s ‘End of Australia’ thesis isn’t so far-fetched after all? If you want to know how to protect your portfolio in such a scenario, and pick up a cheap as chips copy of Vern’s latest book, click here.


Greg Canavan

Greg Canavan

Greg is the Managing Editor for Money Morning. He helps investors preserve their wealth over the long term using a method known as value investing. Lucky for Money Morning readers, he imparts some of this knowledge on them three times a week with editorial spots.
Greg Canavan is a feature Editor at the Money Morning and is the foremost authority for retail investors on value investing in Australia.
He is also the Editor of Crisis & Opportunity. An investment publication designed to help investors profit from companies and stocks that are undervalued on the market. Greg is the former head of Australasian Research for an Australian asset-management group and has appeared on CNBC, Sky Business’s ‘The Perrett Report’ and Lateline Business. He has written articles for The Sydney Morning HeraldThe Australian and Greg’s aim is to help you create a portfolio of stocks based on sound, proven, investing principles. His system for identifying stocks trading beneath their ‘intrinsic’ value combines a big picture understanding of the financial markets with a thorough valuation analysis of individual securities. Greg’s method of investing is not about taking huge risks and rushing into big positions. He investigates highly profitable companies trading at a reduced premium to their net asset value, or ‘equity’ value as he puts it – and passes that research on to his subscribers to incorporate into their financial plan as they see fit. With Greg’s help, you can implement a long-term wealth building strategy into your financial planning, be better prepared for the tough financial challenges ahead and stop making the basic, costly mistakes that most private investors make every time they buy a stock. To find out more Greg’s investing style and his financial worldview take out a free subscription to Money Morning here. And to discover what a company’s profitability reveals about its true value…and more importantly how you can use that knowledge to become a better, smarter investor, take out a 30 day trial to his value investing service Crisis & Opportunity here. Official websites and financial eletters Greg writes for:

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