14 Dec November Market Commentary
While valuation is not a timing signal or an effective indicator of short-term performance, over longer periods it is absolutely the most important determinant of portfolio outcomes.
We will focus our initial comments below on the Australian economy, including the extent to which we are managing the transition between phases of the mining boom, and more importantly the transition between mining and non-mining sectors. This necessarily leads us to also revisit and update previous discussions about the property market and the significant exposures we have to the banking and financial system via both Australian Equities and Income Securities. Unfortunately the imperative to communicate with you in a timely manner precludes us from knowing next week’s economic growth number; however we do know that the consensus estimate is for an annual increase in Australian GDP of 2.3%, which would represent a pick up from Q2’s 2.0% – a number which caused some consternation. It is also worth noting that while these are merely forecasts, the consensus view is that growth will then pick up over the balance of 2016 to around 2.8%.
These growth rates are considered below long term trend rates, and the informed view is that these are likely to prevail for the medium term of the next few years. In fact over the course of this somewhat tepid recovery, we have seen much consideration given to the question of whether expecting a return to previous trend growth in the mid 3% to 4% range is likely to prove optimistic. Most recently this was in the form of a speech1 from the Deputy Secretary to the Treasury outlining the macroeconomic outlook. Predictably, but still disappointingly, the media coverage of the speech focused on this line: “Australia is now in a prolonged period of below-par growth, the likes of which we have rarely seen outside of a recession.” In reality, it is admirable that we are still growing at even these sub trend rates, whereas other commodity exporting economies like Canada and Brazil are contracting. Furthermore, there is much detail about which we can be optimistic with regard to our economic outlook.
The October jobs report showing 58,600 positions added was a very strong number, though it is a volatile data series and was accompanied by some skepticism on its release. If though we focus on the rolling sum of the last twelve months (red line) we can clearly see the strength in the relative labour market. That said, there still remains slack to be taken up as estimates of full employment are equivalent to an unemployment rate of 5%, rather than the most recent reading of 5.9%. Treasury observes that “the flexibility and resilience of the labour market through this period of adjustment is particularly encouraging” while noting the benefit of past policy reforms that decentralised wage setting.
Building activity is an integral part of the economic transition, and recent data remains historically high. Any casual observer of the property market has also seen lately that the exuberance in Sydney residential prices, and to a lesser extent Melbourne, has started to dissipate. Just as rising prices were an early signal of the strength to come in areas such as construction, retail sales, durable goods orders and labour, so too we should be vigilant to these reverse effects as price growth cools. This chart shows the difference between annual price growth and the rate of monthly growth annualised for the major capital cities. Clearly, prices are not growing as they once did, though they are still growing.
One area of the residential market that drew attention from the prudential regulator was the growth in loans to investors, and there has been an immediate reaction with an 8.5% decline in loan approvals to investors in the September data. Of course, the major banks have also increased their mortgage rates by between 0.15% and 0.20% out of cycle with the RBA, also helping to cool activity in hot markets. Anecdotally we are hearing that rather than becoming loose as is expected in a bubble environment, lending standards have been tightening, and this is supported by data from the regulator. APRA has reported that new mortgages with a loan to valuation ratio (LVR) of greater than 90% represent just 9.4% of new loans by value, down from more than 22% in 2009. So called ‘low-doc’ loans represent only a trivial amount of new borrowing, though there has been a marked increase in interest only lending, however in many cases this is matched with an offset account.
Finally, since our last quarterly update we have had reports from three of the four major banks which include details on their latest regulatory capital position. The requirement for banks to increase their capital has been a fixture of this sector in the years following the financial crisis, and our major institutions are comfortably ahead of their obligations. This stronger capital position increases the comfort with which we hold the bank issued income securities, and even after allowing for lower expected returns on equity (ROE), the bank equity exposure still looks to represent very good value in our long term forecasts.
We have focused this discussion on the areas in which we are most exposed in the portfolios, and will use our final long form monthly commentary for December to provide more detail on developments in other regions. As usual, this will be published in time for you to read early in the New Year.
About Reuben Zelwer
Reuben Zelwer established Adapt Wealth Management in 2011 to help time poor clients achieve financial freedom. For over 15 years, Reuben has helped professionals, executives, business owner and those approaching retirement make the most of their circumstances by making good financial decisions. Reuben’s professional practice is complemented by substantial voluntary work, which has included setting up financial literacy and savings programs in the local community.