For a Real Correction to Happen, Aussie Banks Need to be Under Pressure

US stocks finished Friday’s trading session down marginally, leading to expectations of a flat open today for the Aussie market.

Last week’s correction of 1% caused a whole bunch of anxiety and hindsight analysis, but the simple fact is, from time to time, market’s simply correct. They breathe in, and breathe out.

There are always reasons to justify a market move, but the fact is that it just happens. In his new book, Unshakeable, Tony Robbins points out that on average, US stocks experience a correction of 14% a year.

Now, a 14% decline is hefty, and enough to make anyone reconsider how their portfolio is positioned. But it shouldn’t be enough to make you panic into cash…because it is nothing out of the ordinary!

The Aussie market, as represented by the ASX 200, is just a few percent off its recent highs. Maybe it continues to move sideways for a few more months before breaking higher. Or maybe the correction does continue and there’s more pain to come.

For the Aussie market to really have a decent correction though, you need the banks to come under pressure. There’s a risk of that happening of course, given the recent interest rate rises and potential slowdown in investor lending, but when you weigh up the factors, that risk is a small one.

Let’s check out the ASX 200 financials index. It’s dominated by the big four banks.

Source: Optuma
Click to enlarge

As you can see, the index enjoyed a strong rally in November and December, and is now in a consolidation phase. The moving averages (the blue and red lines) are moving higher, indicative of an upward trend, which is bullish.

But lately, the concern about the pace of house price rises in Australia and their effect on financial stability has increased considerably. The Reserve Bank and the banking regulator, APRA, are starting to panic…again.

Thanks to low interest rates, property investor loan growth is going ballistic. The banks, in a pre-emptive strike, have increased rates for investors and speculators paying interest only loans.

That’s a prudent move. Both for financial stability, and their own pocketbooks. But judging by the chart above, the market doesn’t think this will cause a major issue with the sector’s profitability. But it is causing fears (as always) in the mainstream media that a greater slowdown awaits. From The Australian:

But as rampant investor lending continues to come under closer scrutiny, a confluence of potential policy changes and market dynamics is threatening to derail the stability of the housing market.

Analysts argue rate hikes are piling more risk on to a system already stressed by possible changes to capital gains tax in the federal budget, the apartment “settlement bulge” in capital cities, low rental yields and toppy house prices.

As interest rates rise and house prices begin to cool, investors may no longer find economic sense in owning a property if costs are increasing at a time when the outlook for capital growth — the continued increase in prices — is flat.

“There is clear evidence that the macro conditions for Australian house prices are deteriorating,” said CLSA analyst Brian Johnson.

This is just conjecture though. Just because banks raised rates last week doesn’t mean that house prices will fall. There are plenty of non-bank lenders ready to step in and satisfy the demand that the banks are no longer supplying; lenders that aren’t regulated by APRA, and can do what they want.

As the Financial Review reports this morning:

Leaders of the non-bank lending sector believe additional restraints on the big banks that are designed to temper the housing market and ensure financial stability will boost demand for their shadow loans and reckon they have capacity to pick up some of the slack.

The bottom line is that the RBA and APRA have stuffed up. This issue has been going on for years. Two years ago pretty much to the day I wrote an article in Markets and Money titled ‘Australian Housing Speculation and Financial Stability’.

Back then, the RBA was concerned about the pace of investor loan growth, especially in NSW and Victoria. But it was OK, because APRA would help cool the market. They had just sent a letter (seriously) to the banks requesting they get investor loan growth below 10% per annum, or they would do something about it.

Naively, the RBA thought APRA’s measures would soon be effective. This is what I wrote on 26 March, 2015:

The RBA is probably the only one waiting for the effect of APRA’s ‘measures’ to flow through. Meanwhile, they’ll continue to feed the market sugar and then warn it about the risks of getting diabetes.

While not much of a consolation, at least the RBA understands the big picture risks of letting a housing bubble get out of hand, even if they don’t intend to do anything about it.

‘“…the main risk from the ongoing strong level of investor activity is most likely to be macroeconomic in nature. Heightened investor demand can amplify the housing price cycle, especially when it involves the use of leverage, and so increases the risk that prices later fall significantly; investors are more likely to engage in speculative behaviour than are owner-occupiers, and they face lower barriers to exiting when the market turns down.”’

Last week’s Bank for International Settlements quarterly report made this risk clear. It showed that asset price deflations, especially house prices, have a major impact on economic output.

Even though the RBA has a mandate to maintain financial stability, and even though history shows that house price booms and busts have a major impact on economic output (and therefore employment, one of the RBA’s other mandates) the central bank chooses to ‘sound warnings’ on the issue of financial stability, rather than do anything about it.

Instead of the RBA, APRA and the government working together to ward off what is shaping up to be a major threat to Australia’s economic future, there is a head in the sand mentality and classic arse covering taking place.

Current policy coordination is a joke, but the joke is on us.’

Two years later and the joke is, more than ever, on us. Investor loan growth is again out of control, and the RBA and APRA are threatening to ‘do something’.

If that is the case, heaven help us all.


Greg Canavan is a Feature Editor at Money Morning and Head of Research at Fat Tail Investment Research.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really 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. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

Read correctly, a chart contains all the information you need. It contains no opinions or emotion. 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 basic, costly 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 Money Morning 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:

Money Morning Australia