Australia’s newest duopoly

  • Biggest bubble in recorded history
  • What’s big business in Australia right now? Mortgage debt
  • Australia’s newest duopoly
  • End of the yield advantage

‘Australia’s domestic-oriented economy has hitched its fortunes to a real estate bubble.

My colleague in the US told me this over email last week.

It certainly has. The only thing holding up the Australian economy is property prices. And the only thing holding up property prices is the banks. And the only thing propping up the banks is property.

Our crazy house prices are a pillar of discussion everywhere you go, the same way sporting team references fill conversation holes.

However, this week is a special week. Why? Because two companies further cemented Australia’s love of duopolies. Before we get to that, let’s look at the markets.

Markets 

Overnight, the Dow Jones Industrial Average was up 143.95 points, or 0.68%. 

The S&P 500 was 21.31 points higher, or 0.88%. 

In Europe, the Euro Stoxx 50 was down 2.62 points. Meanwhile, the FTSE 100 dropped 0.63%, and Germany’s DAX index was down 0.19%. 

In Asian markets, Japan’s Nikkei 225 is up 879.57 points, or 0.40%. China’s CSI 300 is up 0.30%. 

In Australia, the S&P/ASX 200 is up 62.40 points, or 1.08%. 

On the commodities markets, West Texas Intermediate crude oil is US$44.99 per barrel. Brent crude is US$47.5 per barrel. 

Gold is trading for US$1,250.49 (AU$1,640.88) per troy ounce. Silver is US$16.95 (AU$22.18) per troy ounce. 

The Aussie dollar is worth 76.64 US cents. 

Biggest bubble in recorded history

Your housing market reminds me of the US housing market around 2005’, said my US colleague, Dan Amoss, back in November 2015. At the time, I was convinced the property price crash was only a few months away.

Two years later, there’s still been no significant fall in Aussie prices. In recent months, I’ve taken some time to read Phil Anderson’s extensive research. I’ve come to the conclusion that yes, property prices are insane. But his research and analysis has convinced me that a US-style property plunge is still a few years away.

Not so for my US co-worker though. Dan sent me an email just last week, pointing out that we are setting ourselves up for the ‘biggest bubble in recorded history’, writing:

Australia’s domestic-oriented economy has hitched its fortunes to a real estate bubble. By many measures, Australia’s bubble may be the biggest one in recorded history.

House prices in the hottest areas in Australia’s biggest cities have soared to many multiples of income. The bubble makes the US housing bubble of 2002-2006 look like child’s play.

Aussie house flippers have long been in the “greater fool” stage, wherein a flipper must find a greater fool to buy. In recent years, the greater fools have been Chinese oligarchs getting money out of China by any means possible.

But ever since Chinese authorities have cracked down on capital flight, the supply of greater fools has slowed to a trickle. Now, Australia’s inward-focused economy faces the likelihood of a severe housing and credit market downturn.

When you layer these factors on top of a struggling commodity export sector, you have the ingredients for a sharp downturn in Australia’s GDP, and a sharp decline in international demand to hold its currency.

Dan’s points are all valid. But is he just another outsider? One who doesn’t understand that Australia’s property prices are all part of a much bigger, global stock market cycle? Check out Cycle, Trends and Forecasts. Here, Phil will show you how our perceived ‘biggest bubble in recorded history’ is all part of a much broader trend…

What’s big business in Australia right now? Mortgage debt.

If you have any bank shares in your portfolio, you are a proud owner of Australian mortgage debt.

Right now, the focus on Australia’s mortgage debt and banking system is well and truly global.

In fact, our banks’ exposure to property-related debt was the key reason Moody’s Investors Service downgraded all four major Australian banks from Aa3 to Aa2.

On the back of Moody’s downgrade, Bloomberg came to the party, and put together three charts to show us just how out of control our mortgage debt really is.

Since March 2008, growth in interest-only loans has tripled.



chart image

Source: Bloomberg
Click to enlarge

Many international eyes will tell you that interest-only loans are ‘Australia’s subprime’. And that’s quite possibly true. Interest-only loans have encouraged far more buyers into the market. And it’s highly likely that the reduced monthly payments for interest-only loans — versus interest and principle — have encouraged people to take on more debt that they would’ve otherwise. 

It’s not just the level of interest-only loans that alarms international firms. The loan concentration of Australia’s banks compared to international banks spooks outsiders…



chart image

Source: Bloomberg
Click to enlarge

It’s easy to see why. Combined, the Aussie banks have an incredible 60%-plus exposure to our $1.6 trillion mortgage debt. The next highest country is Norway, but even then their banks have a total home loan exposure of 45%. A solid 20% less than us.

Look, I’m not about to call our property market unique. But it needs to be said: Our banks have so little avenues in Australia to make money. Aside from those dealing with bricks and rocks, very few Australian companies are seeking out loans.

In other words, the reason our banks are so exposed to home loans is because they’re one of the few reliable revenue sources in Australia.

In fact, mortgage debt is such important business for Australia that two major real estate websites have each acquired a mortgage brokering firm.

Australia’s newest duopoly

The markets don’t know it, but Australia’s newest, and perhaps most powerful, duopoly was officially created overnight.

And guess what? It is all based on increasing home loan debt.

Earlier in the week, online real estate search engine realestate.com.au acquired an 80% stake in mortgage brokering firm Smartline, for $67 million. Smartline has over 300 brokers working for it, and settles around $6 billion in loans per year.

REA Group [ASX:REA], the owner of realestate.com.au, says the revenue from Smartline — net broker commissions — will add $26-30 million to full 2018 financial year results.

Meanwhile, Fairfax Media Limited [ASX:FXJ] had its own announcement this morning. Late last night, Fairfax’s own real estate search engine business, Domain, entered into a joint venture with online broking firm Lendi. Together, this new business will be called ‘Domain Loan Finder’.

Now, two business that are trying to sell you houses can also sell you loans.

Why the sudden rush into the mortgage brokering business? According to Domain Chief Executive Anthony Catalano, there’s more money in selling debt to suckers helping Australians find the right home loan. Catalano pointed out that the mortgage brokering industry is a $2 billion sector, and that the average loan nets a broker $5,000 in commissions. That’s more than four times the average amount ($1,200) Domain or REA Group gets for listing a property.

It’s funny how businesses work out where the big money really is. Both companies have built their success on the back of Australia’s obsession with property. Now, they are moving into another venture that piggybacks on the back of our obsession with home loans.

End of the yield advantage

And what would a Thursday be if I didn’t prattle on about a central bank?

Today, we have John Edwards, a former Reserve Bank of Australia board member, kicking around ideas on when the RBA should start raising rates again. As Bloomberg wrote:

The Reserve Bank of Australia is probably already considering a program of rate increases given its forecasts for inflation returning to target and economic growth to accelerate to 3 percent against a stronger global backdrop, Edwards said in a column on the website of the Lowy Institute for International Policy, where he is a non-resident fellow.

Theorizing that the long-term cash rate is about 3.5 percent — lower than the 5.2 percent average over the past two decades — and the RBA wants to start tightening in 2018 and reach its goal within two years, that would require four quarter-point increases each year, he said. Rates have been on hold at 1.5 percent since last August.

“It seems to me that something like eight quarter percentage point tightenings over 2018 and 2019 are distinctly possible, if the RBA’s economic forecasts prove correct,” said Edwards, who was on the bank’s board until July last year. “It’s possible the tightening could start earlier, or if not the tightening itself, at least the signalling which should precede it. We may be seeing a little of that now.”

I’ve been watching the mainstreams press react to Edward’s theory throughout the day. Most of them have shut the concept down.

Back in March this year, futures markets were tipping a 50-50 chance that the RBA would raise rates this year. As of this month, the markets now suggest there’s a one in four chance of a rate cut coming from the RBA.

To be honest, I’ve claimed all year that the RBA will cut rates this year. My view was that official inflation figures are so low, there’s no way the RBA will do anything to prevent inflation rising.

However, if the RBA doesn’t start raising rates soon, the Aussie economy will be faced with yet another hurdle.

The US Federal Reserve began its rate ‘tightening’ policy back in December 2015, when it rose the cash rate by 25 basis points. Then it spent all 2016 warning the markets that another rate increase was coming. The Fed finally jacked the rate up again in December last year. Then again in March and June this year.

In less than two years, the Fed’s cash rate has moved from 0% to 1%. The minions inside the Fed are talking to the market, ensuring that everyone knows the ‘grand plan’ is to get that base rate up above 3% again by 2019. Then the Fed can cut rates once more to save the US from a recession.

Ludicrous, I know. But that’s the plan.

Now, here’s the problem for us folks Down Under. Our cash rate is sitting at 1.5%. Official inflation data nudged 2.1% last quarter. But wage growth is historically low at 1.9%, and underemployment is at a record high. Nobody is spending money in the shops, and our economy sputtered out a total growth figure of 0.3% for June.

To boot, our rocks and dirt aren’t worth as much as they were a year ago.

In other words, our economy has the strength of a kitten fighting its way out of paper bag. It’s weak, and stuck in the same place.

But one thing we do enjoy is a ‘yield advantage’ against the US. At least for now. Australia having the higher interest rate compared to the US is one of the few reasons we are able to attract foreign capital.

However, if the Fed raises its cash rate higher than the RBA — and before our central bank has a chance to do so — our yield advantage disappears.

If this happens, the Aussie dollar is likely to drop well under 70 US cents. That will make our commodities more attractive to overseas buyers, but risk importing rampant inflation. At the same time, our economy will become less attractive to foreign capital.

Edwards might not be putting out the crazy ideas the mainstream are claiming. In fact, there’s a chance he just wrote his ‘I told you so’ thesis.

Kind regards,
Shae Russell