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  • Writer's pictureSkyward Financial

Finance Market Update - 7 June 19

Optimism has returned to the market since the election, and now that we have our first cash rate cut in almost three years, it looks set to continue. But let’s take a moment in this update to take stock of the real picture, of what could go wrong.

We got the cut we expected

When you talk to large investors and asset managers they often say one of the hardest things to do is to do nothing at all.

Dr Lowe, the governor of the RBA, has been carefully presiding over the longest stretch of monetary stability this country has ever seen, and that must have been difficult, to do nothing for almost three years and sit back and watch.

Now the decision has been made to reduce the cash rate to the historical low of 1.25% after the 25-bps drop, the hardest decision he will need to make is when to do that again.

An economics professor of mine once described the decision from central banks being like driving a car forward while only being able to see using the review mirror.

This is an elegant metaphor because central banks all over the world make decisions based on data, and often that data is old. For example, employment data or debt data might be from 3 months earlier than now when the central bank needs to make a decision now, based on that ‘old’ data.

They are looking at a small part of the road behind them to decide on how to drive forward.

Generally speaking the market has declared they expect another one or two 25-bps cuts this year, and may even expect the official cash rate to get as low as 0.50% in 2020.

This is not all-round good news.

Yes, mortgage borrowers will benefit from lower repayments and/or interest expense. We have already seen CBA and NAB pass on the full 25-bps, while Westpac gave 0.20 and ANZ only passing on 0.18-bps (which I correctly predicted would be the spread in the last update).

But, the economic conditions that ‘forced’ the hand of the RBA to wield the knife are serious and could potentially still tip us into a recession.

Before we dive into the negative stuff, I want to highlight the psychology of rate cuts here again from an update back in March. Because it is important to understand that the RBA wants you to spend and borrow more when they cut the rate, because that produces economic activity, which helps them achieve their inflation and other economic targets.

Its all the little things that add up

Sentiment has seen a sudden shift to positive after the Liberal’s won in a shock win federal election.

Auction clearance rates are bouncing up, real estate agents’ phones are buzzing again, banks are receiving more applications, reserve prices at auctions are being exceeded and open homes are getting busier.

This is a very positive shift from consumer points of view, and while I do not want to sound negative, it is important that we look at the wider context to understand the possible things that could put a stop to the optimism and economic goldilocks moment.

1. Apartment supply

At one point Sydney had more cranes than almost anywhere else in the world, and they were all there to help build apartments.

Because so many were built we are now seeing vacancy rates around ~4% which is the highest level in years. And while the number of new building approvals plummeted by around half at the start of the year, the estimates from Core Logic back in August last year saw Sydney alone get a whopping 9.3% increase in apartment supply over a two-year period to late 2020.

This means we already have high vacancy rates for apartments, and that could continue to rise as more are finished and either try to be rented out or sold.

This will put downward pressure on apartment values and rental yield for investors.

The majority of apartments (~50% in NSW) are owned by investors, they will need to keep lowering rents to get tenants in as it becomes a renters market, and if the investor cant service the mortgage, or are stuck like a mortgage prisoner or have negative equity, then that could result in repossession by the banks and the apartment being sold. Of course, the market it is being sold into has many other apartments for sale at the same time, they will compete on price and overall values will decline.

This could knock onto house prices and contagion to overall property values.

2. Wages

Have you or anyone you know got a decent pay rise over the past few years?

If your answer is no, then you are in the majority. Because we have been in a structural wage growth deficit for years now and it is seriously worrying the RBA. But it should also be worrying us, as living expenses continue to rise. This was one of the key drivers for the recent cut, the RBA is attempting to push down the unemployment figure which they hope will boost wage growth as employers throw money at people to get them into jobs.

They also hope this leads to greater household consumption. I’ve argued before that people would likely pay down existing debts than go out and spend big if mortgage rates go down, regardless the RBA wants to get inside your head and get you to spend.

3. Property prices

It is pertinent to remember that in Sydney we have seen a ~15% fall in property prices since the back end of 2017, so any price increases we start to see are part of a ‘recovery’ rather than ‘boom’ in prices.

At the end of 2018 I predicted that we would see the bottom of the market this year, and given the cash rate cuts, recent assessment rate changes and liberals coming to power this looks set to become true as the decline starts to reverse into growth and price recovery.

However, it will likely be a long road (12 – 18 months) of recovery till we see property prices back to peak parity. That is of course if we don’t see a drastic external shock like US/China Trade Wars sending our economy crashing before then.


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