Inflation set to miss again

Landmark speech?

The papers will be excited this week about auction results, and with some reason.

Source: CoreLogic

There's very little stock around and the clearance rate hit 100 per cent on Sydney's lower north shore. 

A lot patchier further from the city, though. 

Otherwise there's little in the way of domestic news this week.

Except there's potentially a very interesting luncheon presentation by the Reserve Bank governor on Thursday, on the subject of inflation targeting.

This may be a somewhat wonkish point, but economists have crunched the numbers for inflation in the June quarter and the calculators are spitting out some very low numbers again.

Here's Bill Evans, Chief Economist of Westpac:

Source: Westpac

Assuming it transpires a trimmed mean inflation result of 0.3 per cent could hold the annual reading down at 1½ per cent. 

In short there's a bit of inflation coming through in auto fuel, but very little inflationary pressure elsewhere.

And there's some deflationary pressure in consumer goods, with fruit & veg prices likely to be down in the June quarter. 

There's been a bit of conjecture about recent meetings between the government and Reserve Bank officials, so this could be an intriguing speech. 

Not all heroes wear CAPEs

Speculative fervour

It's sure felt like there's been a lot of speculative activity over the past couple of years, with the Bitcoin boom, a raft of borderline certifiable valuations for growth and tech stocks, plus a wide range of other soft indicators of a market nearing its peak (such as suspiciously flimsy-looking floats, and so on). 

But how to measure this in a single number, or a ratio?

Not so easy to do!

The traditional price-earnings (PE) ratio is sort of useful, but also has significant limitations, not least because the 'E' parts of the ratio (earnings) aren't exactly clear cut. 

As someone that spent way too much time in my professional career writing annual reports I'm painfully away of how easily profit figures can be manipulated, especially when market and stakeholder expectations are high.

Looking forward

And then there's the not-so-small matter of whether to use trailing or forward PEs. 

You can find historic earnings by looking at a company's most recent financials, but that's not much use for understanding the next year's outlook or for projecting next year's bottom line. 

Perhaps most critically of all, a PE ratio tells you nothing about the prospects for growth.

So a low PE might be a good signal...but it might not.

Sometimes analysts look at cyclically adjusted PE (CAPE) ratios as a popular proxy for calculating whether a market is overvalued. 

Adjusting for cycles

Now there's no foolproof way to measure whether a market is cheap or expensive, but one simple thing you can do is run a smoothed 10-year real earnings per share chart to iron out the bumps in company profits (which might well prove to be worse when the clouds form and the outlook takes a downward turn).

Plotted below is the Shiller PE ratio as at July 2019, which produces a far smoother chart than simply looking at current S&P 500 PE ratios for the US market. 

And the ratio has been running at over 30 lately. 

To put that in perspective, that's about the same level it was at just before the Black Tuesday Wall Street Crash and the ensuing Great Depression.

The Shiller PE ratio has been higher than this before, once (during the tech bubble).

And it's also crashed plenty of times before from much lower levels (Black Monday, global financial crisis, etc.).

Source: Shiller

Look out below.

This time...different?

Now you might argue that valuations have been pushed higher by low interest rates, quantitative easing, or other factors specific to this cycle, such as the strength of some technology companies.  

You might say that.

From looking at these figures I'd say that over the best part of a century-and-a-half such a level has never before been sustained. 

It doesn't so much matter what the specific grain of sand is that tips the scales, eventually something almost certainly will.

And if the US takes a tumble - which history says it will - Australia probably will follow suit too (although at least our stock market is arguably not so fully priced).

Dry powder

Now naturally I don't know anything about your situation, so there's no advice here.

But here's what I'm doing: 

(i) keeping a substantial sum of money in cash (actually in a mortgage offset account) as dry powder for when better opportunities come around; and

(ii) investing in some global ETFs in emerging and other markets where valuations have already plunged. 

Full disclosure: I am still invested in Aussie shares, but I also have some dry powder at the ready. 

I'm not suggesting it's a bad time to be invested in shares or anything like that - it depends on your age, your circumstances, and so on - just to be mindful of the cycle and to be clear about your strategy (and stick to it). 

Please hammer, don't hurt 'em

Hammer time

All the big guns are calling for big gains in the housing market as clearance rates in Sydney have soared to nearly 80 per cent. 

Volumes are very low at this time of year, of course.

Overall, the numbers look pretty patchy to me.

Some big results in the inner suburban markets, for sure, but overall median prices haven't been too dramatic.

Although, to be fair, clearance rates have previously tended to lead prices and then volumes.

Going forward markets will likely be led by sentiment as much as fundamentals.

Source: Shane Oliver, AMP

The housing market recovery will do what it does, and more so in some areas than others.

Rather than tediously focusing on this, I'm going to aim to explore some other ideas this week, starting with what the heck is going on with stock market valuations around the world.

Weekend reads (and podcasts!)

Must-see articles

Seriously low new stock listings in the housing market right now!

You can find all the details here at Property Update:

---

You can subscribe for the free newsletter here. 

Better still sign up the free podcast here.

I'll be appearing a couple of ripping episodes in the forthcoming weeks.

Have a great weekend!

Lower for (much) longer

Discount rates

Housing Minister Sukkar said this week advised first homebuyers they should take the chance to get into the market as housing prices are now likely to rise.

The government is introducing a first home loan deposit scheme, though it's not effective until 1 January. 

Decisions should as always be assessed on a case by case basis, though, and many would be understandably hesitant to look at new apartments right now.

Markets, meanwhile, are now expecting the cash rate to average less than 1 per cent for the next half decade.

Fair value uplift

Discounted cashflow analysis seldom (i.e. never) throws out good numbers for capital city housing in Australia.

But if yields and prices follow historic patterns this unprecedented shift in the discount rate could see housing markets revalued radically higher through the coming cycle. 

Markets had begun to price in Labor's proposed changes to negative gearing and capital gains tax before the election, but these changes were binned by the electorate. 

It's always interesting to debate the minutiae of housing markets, but it's impossible to anticipate them.

The big picture is that after four or five years of tightening the credit pendulum has begun to swing back in the other direction, with half a dozen of the main lenders announcing a lower floor rate over the past week or two. 

My base case is now that a rudderless Labor will lose the next election - they've removed their proposed negative gearing reforms from their now website anyway - and well-selected properties will perform handsomely over the next six years. 

Any holder of a remotely positive outlook tends to be dismissed as permanently Panglossian these days, but that's not so in my case.

Before the election I co-authored a report forecasting sharp declines in housing prices as a result of prospective tax changes, but then Labor wiped out at the polls and mortgage rates were cut hard - to record lows. 

---

If econometric housing market models rather than gut feel are more your thing, then the below research paper (Tulip/Saunders, RBA Research Discussion Paper) puts some numbers on it.

Recall that not long ago Lowy's John Edwards projected that the RBA could hike nine or ten times over the following couple of years; whereas in the event rates have been cut and cut again, with financial markets pricing for further easing.

Some models show markets as being more sensitive still to interest rates, but remember that the real rate of interest is the key metric to watch.

Labour force swells

More jobseekers

New South Wales wages growth has only been running at about 2.3 to 2.4 per cent.

And that's despite a very low unemployment rate of just 4.6 per cent. 

The labour force has swelled by more than 200,000 this year as more Aussies come back in search of work.

Some 106,000 of that increase has been in New South Wales alone. 

This is great news for the Federal Budget bottom line, and we should see a Budget in surplus fairly soon. 

But it does mean that full employment is probably getting further away rather than closer.

For example, at the beginning of the year there were 666,500 unemployed persons, and now there are 711,500, for an increase of 45,000 for calendar year 2019 to date. 

So it's a mixed bag of news, and financial markets are still pricing in further easing.

Sally Auld of JP Morgan thinks we'll get two more rate cuts by 2020, with a risk that they come sooner still. 

More renting as home ownership falls

Cost of living

There was something for everyone in the ABS housing occupancy figures for 2017-18 this week.

Home ownership rates were still high in international terms at 66 per cent, but were down from 68 per cent in 2015-16.

In 1997-98 the home ownership rate was as high as 70 per cent. 

Over that time the share of homes owned outright also declined from 40 per cent to 30 per cent. 

The figures were a bit contradictory, in some cases showing very little movement in median rents over the past decade. 

More than three quarters of us still pay less than 25 per cent of our gross income towards housing costs, and in 2017-18 there was a small improvement in those paying 30 per cent or above. 

What is clear, though, is that there are more renters, while more Boomers are seemingly taking a bit of debt into their later years, resulting in fewer homes owned outright.

We'd probably expect to see more mortgaged homes and renters going forward, too, if Australia continues to pursue the high immigration/high population growth path. 

On the other hand there's been a significant affordability dividend for existing homeowners, with mortgaged owners seeing their housing costs at multi-decade lows as a proportion of their income (even before the recent rate cuts and double-digit housing correction).

Note that these are averages, and may be distorted lower by, for example, older owners borrowing equity.

The lowest housing costs as a proportion of income for mortgaged owners? Sydney at 14 per cent. 

And the highest? Melbourne at 16.9 per cent. 

I'd thought that we might see the median number of households per dwelling come down with all the high-rise units going up, but instead that number was steady at 3.2 (a huge share of households have more bedrooms than they need). 

The median number of persons per dwelling also stabilised at 2.6. 

One inescapable conclusion from the stats is that for low income households housing costs chew up a high proportion of income, making it tough for this cohort to get ahead. 

A fifth of households owner more property other than where they live, but most only owned one additional dwelling. 

Only 5 per cent owned four or more properties. 

Two out of three ain't too bad

More capacity

Nearly two out of three Aussies are now participating in the labour force.

For 16 to 64 year-olds the ratio is nearly up to four in every five. 

This is great news, but it's also making it darned tricky to get the unemployment rate down as capacity has increased. 

Not the result policy makers would have been hoping for today, then.

Employment was flat in June 2019, which took the annual rate of employment growth down from 2.89 per cent to 2.36 per cent. 

There was a bit of mean reversion at play this month for New South Wales and Victoria after a storming run (even now NSW employment is up 47,000 over the past quarter). 

Unfortunately if full employment or NAIRU is thought to be about 4½ per cent (or perhaps below) then we aren't demonstrably getting any closer to that.

The unemployment rate increased from 5.19 per cent to 5.24 per cent this month, and is up from under 5 per cent in February 2019 to now sit at a ten-month high. 

High participation and a strong rate of full-time jobs growth are both good news, but around the country and away from Sydney and Melbourne unemployment rates are often far too high to be ideal. 

Hours worked decreased in June, marginally, and the trend is also decelerating.

The wrap

Overall, not much here to suggest that the unemployment rate is going to fall as desired. 

In fact, senior economists at Westpac, ANZ, and elsewhere expect to see the unemployment rate drifting up to around 5½ per cent by the end of the year. 

Yesterday's figures suggested that much of the increase in debt (and supposed financial stability risks) relates to Boomers taking a bit of debt into retirement. 

With another soft inflation print looking to be locked in for the end of the month markets are looking for one further interest rate cut in H2 2019.