August 2024

Summary

Global share markets began the month of August with a sharp correction, before recovering to finish strongly, gaining approximately 1.8%.

The US Federal Reserve signalled that interest rate cuts are coming, and they expect to start in September. In the absence of a collapse in the labour market this is expected to be 0.25%. In Australia, the outlook is less dovish with the Reserve Bank remaining on hold.

Bond markets rallied in August as interest rate expectations fell. Major bond indices gained approximately 1% globally and in Australia.

Markets

Global equity markets rose by approximately 1.8% (in local currency terms) in August, recovering from a sell-off of over 5% earlier in the month. The US and Germany were the top performing markets, whilst China and Japan were the weakest. The sell-off was triggered in part by some weaker US employment data and an expectation that Japan would raise rates again after doing so in July. This triggered a liquidation of very large ‘carry trades’ where investors fund US dollar holdings by borrowing the lower yielding Japanese yen.

The S&P500 market volatility index, or ‘VIX’, jumped by the largest intraday amount in its history. The Japanese Nikkei index also fell almost 20% in the first few days of August before recovering most of those losses over the rest of August amid the Bank of Japan issuing dovish statements.

The US earnings season has been generally strong. Earnings growth for 2024 is expected to be around 11%. Notable gains were made in Financials and Healthcare, whilst IT remains the strongest sector (albeit dominated by Nvidia). The election appears to be a larger issue than potential recession based on mentions in earnings calls, notably around energy policy.

Australia’s share markets were marginally positive at around 0.5% with a weak resources sector acting as a drag. Iron ore and copper both remained weak. The Australian dollar strengthened toward US$0.68 as relative interest rates moved in Australia’s favour.

The SAHM rule, a recession indicator that measures deteriorating employment numbers, was triggered in August. It is not decisive at present but at a threshold that bares monitoring.

Data and events

Global GDP growth expectations have improved to above 3% at present. This is mixed with developed economies lower at under 2%, with some laggards such as the Eurozone tracking at less than 1% and Australia just above 1%. Global inflation continues to fall in most developed economies back toward targets. The US is now under 3%, whilst the Eurozone is heading below 2.5%. Australia remains stubbornly high at around 3%, hence the more hawkish tone from the RBA.

In the US, focus has shifted toward employment and growth. Unemployment moved upwards to 4.3% and along with other data prompted a pivot from the Federal Reserve that rate normalisation was now appropriate. US macro and surprise data are both negative at present suggesting a slowing but not a freefall economy. US manufacturing PMI’s have been below 50 for the last 4 months (above 50 signals expansion), adding to the case for interest rate cuts.

Eurozone growth data has been disappointing versus expectations and remains soft. The manufacturing PMI survey is still below 46, whilst surprise indices have dipped below 0 again, signalling data is not meeting expectations.

China continues to struggle economically with further deterioration in property prices. One measure of Chinese new commercial residential prices has fallen every month for the last 14 months. Most measures of demand, consumption and fixed asset investment look weaker this year from last, and although export growth is high it is also weakening. Despite that growth is still expected to be 4.8% in 2024 and 4.1% in 2025.

Australia’s Q2 trimmed mean inflation number for August came in slightly softer than expected. The headline inflation figure was in line with expectations. This allowed the RBA to stay on hold. Australia’s data remains soft overall with an uptick in unemployment, weaker job ads, mixed retail sales numbers and weak residential investment.   

Chart of the month

The US has around nine interest rate cuts priced by the end of 2025 whilst Australia has only about four. However, as Australia never raised rates as much, the path of future rates largely converges by the end of 2024. Australia has averaged higher cash rates than the US over the last 30 years and may end up with slightly higher rates again based on current expectations.

Market Implied Interest Rates

Source: Bloomberg

Some key themes and events

1. US election impacts

The US election in November is approaching and the entry of Kamala Harris as the Democratic candidate has evened up the odds for the presidency, Democrats are probably slightly ahead in the House and facing an uphill battle in the Senate. A Harris presidency would therefore most likely see a gridlocked government and more status quo. A Trump win would be somewhat more likely to see a sweep of both houses.

Whilst the details are too involved and uncertain to fully run through here, the general view is that if either side has a clean sweep, then the US budget deficit will continue to increase – Democrats through extra care spending, Republicans through full tax cut extensions.

Based on previous actions and policy platforms, a Republican sweep would appear beneficial to real estate, materials, energy, and financials. It would probably not be beneficial to emerging market equities, trade and export heavy US trade partners.

A Democrat platform (with gridlock) probably leans to the status quo which would imply health care and IT would benefit. Democrat gridlock would also be more likely beneficial to US bonds and wider asset volatility.

2. Australian earnings season

Australian earnings season has wound up with most results in line with expectations. Australian earnings growth is expected to remain flat to modestly positive in 2024 and 2025, which is well below global market levels.

Unlike the realised results, guidance from companies relative to market expectations was generally poor. Only 25% of companies upgraded expectations, while over 40% downgraded. Sectors dragging down the market include energy and resources. From the peak for 2024, expected earnings have been downgraded over 15% for 2024.  Australia’s PE valuation at 18X 2024 earnings looks high historically.

With Australian GDP growth languishing somewhat, and a central bank that is not yet ready to pivot to monetary easing, domestic catalysts for recovery in fundamentals appear lacking at present.

3. The Australian dollar

The Australian dollar doesn’t screen as the cheapest in terms of currency models. It is also a well-known underperformer at times of slowing growth and is especially sensitive to how well China is doing. On the other hand, Australia’s terms of trade seem OK despite weaker copper and iron ore prices, and the Australian government has one of the best budget balances across the developed economies.

Given that Australia was a laggard in raising rates and is now behind the curve in cutting them (relative to other major economies), it seems like the Australian dollar has an opportunity for a step higher providing growth holds up and our central bank is on hold, or at least a less accommodative stance versus global peers. It rose circa 4% against the US dollar in August.

4. Property prices

Australian commercial property prices have been under pressure for the last couple of years due to a combination of high valuations, Covid-19 impacts, higher interest rates, and selling pressure across the market.

As at mid-year, property prices have on average fallen by almost 20% with retail and office sectors around 26% each, and industrial sectors by around 10%.

Valuations now appear closer to their listed counterparts where trading is simpler and faster, and closer to simple valuation models. Whilst property valuations do not appear to be bargains just yet, and there is more selling in the pipeline due to fund redemptions, they are closer to fair value and absent a recession the worst looks over.

5. US recession watch

Several historically reliable recession indicators have been triggered in recent times (or not so recent) including inverted yield curves, SAHM rule employment rules, negative leading indicator indices (US Conference Board Ten leading Indicators), whilst in many other areas there are areas of tightness that have often preceded downturns such as US Loan Officer surveys showing tightening lending standards (although less so recently) or rising delinquencies in US credit card debt. Despite this, US GDP is still tracking at around 3% at present and is only expected to ease toward 2% over the next 12 month. US consumers also continue to spend.

The pandemic has distorted a lot of data and historical relationships, including the US labour market where supply of labour returning to the market may initially push employment numbers higher, however job losses and lower hiring rates are also real, and recession odds have risen even if the timing remains uncertain.

6. Bank valuations

Australian banks have returned over 30% to date this year whilst earnings growth is lacklustre. At face value their valuations appear to have driven performance, however historically they are still well within normal ranges. As a group they have a price-to-book value of just under two. Historically this is marginally above average, and relative to US banks it is about average. Without solid earnings growth it is hard to see banks continue to rise at this rate, and there are cheaper bank markets around the world, but they aren’t any overtly ominous signals as yet.

Market Return Summary

Source: AMP (index values from multiple vendors are received via external providers such as Factset, Bloomberg). Returns are shown on a total return basis as at 31 August. Past performance is not a reliable indicator of future performance.

Disclaimer

The information in this document is current as at the time of publication of this document. This document is based on information obtained from sources believed to be reliable. While a reasonable care has been taken in the preparation of this document, AMP Research (on behalf of the licensees mentioned below) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. AMP Research accepts no obligation to correct or update the information or opinions in it. Opinions expressed and other information contained in the document are subject to change without notice. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, therefore, before making any investment or financial decisions, seek professional advice, having regard to their objectives, financial situation, and needs. This document is solely for advisers within the AMP Adviser network, including AMP Financial Planning (ABN 89 051 208 327 & AFSL No. 232706), Charter Financial Planning Limited (ABN 35 002 976 294 & AFSL No. 234665) and Hillross Financial Services Limited (ABN 77 003 323 055 & AFSL No. 232705) and must not be copied, either whole or in part, or distributed to any other person. AMP Research accepts no liability whatsoever for any direct, indirect, consequential or other loss arising from any use of or reliance on the information contained in this document, to the extent permitted by law.

Current as at September 2024

Managing your financial situation always involves tension between how you live your life now and preparing for your future – whatever that looks like.

The worry about not getting the balance right and making unnecessary sacrifices now – or not having enough money for the things you want to do in the future is a common and valid concern. You want to be living your best life now which means not living too frugally or worrying about your future. At the same time, you don’t want the choices you are making now in how you live your life to impact or make impossible the wonderful life you envision for yourself down the track.

Balance whatever your stage of life

We all have financial goals – whether you are saving for your children’s education, working towards that once in a lifetime round the world trip, freeing up finances for a gap year, or setting yourself up for a wonderful retirement. It’s important to balance your ‘now’ with your ‘future’ when it comes to spending, saving, and investing to make sure you can achieve those goals. You don’t want to regret your spending – or on the other hand live a frugal life and look back on opportunities you missed while you were squirrelling it away.

The tension between the ‘now’ and your ‘future’ with respect to your finances can be even more heightened when you have retired. It can be a strange adjustment suddenly not having a wage coming in and living off your savings, super and investments. It’s common, and quite understandable, to worry about not having enough to last the distance, particularly given that a 65-year-old today may live well into their 90’s and could spend up to three decades in retirement.ⁱ No one wants to outlive their savings.

How the balance changes over time

That balance is hard to hit. It is different for different people, and your approach to saving and spending will change at various stages of your life.

If you are paying off a difficult to maintain level of debt or in the final stages of scraping together a deposit for a home, making sacrifices now in the way you live life your life might feel OK. Equally if you have spent much of your life building wealth, letting loose the reins a little and going on that cruise might be something you are extremely comfortable with.

Certainty now and confidence in the future

Whatever your stage of life, achieving the right balance comes from having an in-depth understanding of your financial situation now, and establishing and maintaining a personalised plan that takes into account all aspects of your financials – your earning capacity, level of debt, assets and very importantly, the life you want to live today and your goals for the future.

The importance of receiving support with financial planning is reinforced in a recent report which indicated advised Australians are significantly more likely to say they feel confident in achieving their financial goals (71 per cent) compared with those who are not receiving support (55 per cent).ⁱⁱ

The same proportion said that they were living well now, stating their finances allow them to “do the things I want and enjoy in life.” And those receiving advice are also balancing the “now” with their future needs. Those accessing financial advice also indicated they were more likely to be financially prepared for retirement and have a higher savings balance.

This confidence that comes from receiving personalised advice also means being more prepared when people leave the workforce (and a wage) behind. Advised Australians are significantly more likely to feel very or reasonably prepared for retirement (76 per cent), than those without advice (45 per cent).ⁱⁱⁱ

The key to achieving a balance between living your best life now and being financially secure in the future is knowledge. If we know that tomorrow is shaping up well for us, we may worry a little less today, feel a little less guilty when we spend today and be less likely to have regrets about spending – or about missing out – further down the track.

Current as at September 2024

i https://www.aihw.gov.au/reports/life-expectancy-deaths/deaths-in-australia/contents/life-expectancy

ii https://www.netwealth.com.au/web/insights/the-advisable-australian/understanding-australian-advice-clients-better/

iii https://www.netwealth.com.au/web/insights/the-advisable-australian/understanding-australian-advice-clients-better

Introduction

Apart from “what will home prices do?” and “where are the best places to buy a property?” the main debate around the Australian housing market has been about poor housing affordability, occasionally interspersed with a scare that home prices will crash. The most recent example of the latter was on 60 Minutes last week with a call by US demographer & economist Harry S Dent that Australian house prices could fall “as much as 50% in the coming years”. But how serious should we take forecasts for a crash? And more fundamentally how do we fix affordability?

Basic facts on the Australian property market

The basic facts regarding the Australian housing market are well known:

First, after strong gains in home prices over many years, it’s expensive relative to income, rents & its long-term trend and by global standards.

Second, flowing from this, housing affordability is poor:

• The ratio of average dwelling prices to average wages (red line in the next chart) & household income (green line) has doubled since 2000.

Home ownership versus home prices relative to incomes

Source ABS, CoreLogic, AMP

• The time taken to save for a deposit has roughly doubled over the last 30 years from five years to more than 10 years.

Years it takes to save for a 20% deposit

Source: ABS, AMP

• The portion of income needed to service a mortgage has hit an all-time high, thanks to the combination of the high price to income ratio and the sharp rise in mortgage rates starting in 2022.

Third, the surge in prices has seen our household debt to income ratio rise to the high end of OECD countries, which exposes Australia to financial instability on the back of high rates and or unemployment.

These things arguably make calls for some sort of crash seem plausible.

Crash calls for Australian property are nothing new

US commentator Harry S Dent’s forecast for an up to 50% fall in property prices is nothing new. Calls for an Australian property crash – say a 30% or more fall – have been trotted out regularly over the last two decades.

• In 2004, The Economist magazine described Australia as “America’s ugly sister” thanks in part to a “borrowing binge” and soaring property prices. At the time, the OECD estimated Australian housing was 51.8% overvalued.
• Property crash calls were wheeled out repeatedly after the GFC with one commentator losing a high-profile bet that prices could fall up to 40% & having to walk to the summit of Mount Kosciuszko as a result.
• In 2010, a US newspaper, The Philadelphia Trumpet, warned: “Pay close attention Australia. Los Angelification (referring to a 40% slump in LA home prices) is coming to a city near you.” At the same time, a US fund manager was labelling Australian housing as a “time bomb”.
• Similar calls were made in 2016 by a hedge fund: “The Australian property market is on the verge of blowing up on a spectacular scale…The feed-through effects will be immense… the economy will go into recession”.
• Over the years, these crash calls have periodically made it on to Four Corners and 60 Minutes. The latter aired a program called “Bricks and slaughter” in 2018 with some predicting falls of as much as 40%.
• And Harry S Dent was regularly predicting Australian property price crashes last decade that didn’t occur.

Why a crash is unlikely?

Of course, a crash can’t be ruled out, but as I have learned over the last two decades the Australia property market is a lot more complicated than many “perma property bears” allow for.

First, the property market is not just a speculative bubble fuelled by easy money and low interest rates. Sure low rates allowed us to pay each other more for homes but the key factor keeping them elevated relative to incomes has been that the supply of new dwellings has not kept up with demand due to strong population growth since the mid-2000s and more recently with record population growth resulting in an accumulated shortfall of around 200,000 dwellings at least but possibly as high as 300,000 if the reduction in average household size that occurred through the pandemic is allowed for. This partly explains why property prices have not collapsed despite the threefold rise in mortgage rates since May 2022.

Home construction and underlying demand

Source: ABS, AMP

Second, the property market is highly diverse as evident now with strength in previously underperforming cities like Perth, Adelaide and Brisbane but weak conditions in Melbourne, Hobart and Darwin.

Thirdly, Australian households with a mortgage have proven far more resilient than many including myself would have expected in the face of the rate hikes in 2022 and 2023. This is evident in still relatively low mortgage arrears (of around 1% of total loans). This may reflect a combination of savings buffers built up through the pandemic including in mortgage pre-payments and offset accounts, access to support from the “bank of mum and dad”, the still strong jobs market allowing people to work extra hours & an ability to cut discretionary spending (suggesting definitions of what constitutes mortgage stress may be overstating things). Of course, arrears are starting to rise as these supports recede, so the continuation of this resilience should not be taken for granted.

Finally, the conditions for a crash are not in place. This would probably require a sharp further rise in interest rates and/or much higher unemployment. Sharply higher interest rates from the RBA are unlikely as global inflationary pressure is easing and global central banks are now cutting. Our inflation & rates went up with a lag versus other countries & are likely to follow on the way down. Higher unemployment – with jobs leading indicators pointing to less jobs growth – is the biggest risk though.

So, a property price crash is a risk, but would likely require a deep recession. Our base case for average home prices remains for modest growth ahead of a pick-up after rates start to fall.

What can be done to boost housing affordability?

Of course, a house price crash would improve housing affordability – but it’s also a case of “be careful of what you wish for” because a crash would likely also come with a deep recession and sharply higher unemployment which could see many lose their homes along with a hit to incomes. However, improving housing affordability is critical as its long-term deterioration is driving excessive debt levels and increased mortgage stress and contributing to a fall in home ownership (the blue line in the first chart). Of course, other factors have also driven falling home ownership since the 1960s including people starting work and family later in life, a decline in perceptions that owning a home is necessary for security & growth in other forms of saving beyond housing. But worsening affordability is likely a big contributor and falling home ownership due to this is something we should be concerned about as its contributing to increasing inequality and if it persists it could threaten social cohesion.

So, beyond crashing home prices, what can be done to boost housing affordability? My shopping list includes the following:

• Build more homes – relaxing land use rules, releasing land faster and speeding up approval processes, encourage build to rent affordable housing and greater public involvement in provision of social housing.  The commitment by Australian governments to build 1.2 million homes – backed up by incentives and strong moves by at last NSW and Victoria over five years starting from this financial year is a welcome and big move down the path to boost supply. So far though approvals and commencements running at around 160,000 to 170,000 homes annually are well below the implied 240,000 target.
• Refocus on building more units – we will need more units (which are lower cost) than houses in the mix. The only time we consistently built more than 200,000 homes per annum was in the unit building boom of the 2015-19 period. Back then unit approvals were around 50% of total approvals whereas they are now about one third.
• Slow down infrastructure spending – home builders are now regularly complaining about the difficulty in building apartments. Apart from issues around approvals, much of this relates to cost blow outs and labour shortages and beyond the disruption caused by the pandemic an ongoing driver is the competition for resources from booming public sector infrastructure projects.

Australia Total Construction

(Building and Engineering)

Source: Macrobond, AMP

• Match the level of immigration to the ability of the property market to supply housing – we have clearly failed to do this since the mid-2000s and particularly following the reopening from the pandemic, and this is evident in the ongoing supply shortfalls. Of course, we need to be careful to not over-react with the crackdown on student visas and numbers risking a lasting negative impact on our education sector which is our biggest export earner after iron ore and energy.
• Encouraging greater decentralisation to regional Australia – this should be helped along with appropriate infrastructure and of course measures to boost regional housing supply.
• Tax reform – including replacing stamp duty with land tax (to make it easier for empty nesters to downsize) and reducing the capital gains tax discount (to remove a distortion in favour of speculation).

Policies that won’t work, but are regularly put forward by populist politicians as solutions to poor affordability, include: grants & concessions for first home buyers (as they just add to higher prices); abolishing negative gearing (which would just inject another distortion into the tax system and would adversely affect supply), although there is a case to cap excessive use of negative gearing tax benefits; banning foreign purchases altogether (as they are a small part of total demand and may make it even harder to get new unit construction off the ground); and a large scale return to public housing (as a major constraint to more units is excessive costs and delays, and just switching to public housing won’t fix this).

Dr Shane Oliver – Head of Investment Strategy and Chief Economist, AMP

Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.