Recession likely in Australia

AFR article
David Uren | March 7, 2008

THE economy is headed for recession next year, with a 50 per cent plunge in share values and a double-digit drop in house prices.

Do I have your attention?

While the Reserve Bank takes a largely benign view of the unfolding credit crisis, believing China's growth will insulate us from its worst consequences, others are less sanguine.

Morgan Stanley's chief market strategist Gerard Minack introduced a brief to clients last week saying, "I'm bearish - really bearish."

He argues that Australia will be dragged into recession by a slowing world economy, the tightening grip of the credit crisis, and the effects of the Reserve Bank's succession of interest rate hikes.

Economists are often trapped by the inertia of the moment, failing to see the magnitude of both booms and busts and being forced into constant revisions of their forecasts. This makes Minack, who takes a long view, worth listening to.

He argues that the market is coming to the end of its fifth bull run since the beginning of the 20th century.

As the chart (which adjusts the all-ordinaries index for inflation) shows, the bear markets that followed, produced falls in the region of 50 per cent and lasted for two to three years.

The problem is not that the market is overvalued, relative to earnings, but rather that earnings are themselves inflated and headed for a fall.

Based on profit figures back to 1970, earnings are 44 per cent above their long-term trend.

In the three recessions since then, real earnings per share fell by between 36 and 65 per cent from peak to trough.

"You've got to argue that earnings do revert to their mean. On almost every measure we've got for earnings, be it profit share of GDP, return on assets or margins, it looks unsustainable," he says.

Earnings have been inflated by spendthrift households running down their savings. While the Reserve Bank has argued that fears about housing debt are without foundation because household balance sheets are strong, Minack says the picture looks a lot worse when you look instead at household cash flow.

The latest annual national accounts show the household sector remains cashflow negative, with the deficit of 3.75 per cent of GDP accounting for half the current- account deficit.

Besides, he says, household balance sheets also looked fantastic in Japan in 1990, before its lost a decade of economic growth.

Minack is not persuaded by the proposition that Australia's housing market is somehow immune from the excesses of the US.

Australians have more leverage, are as reliant upon equity extraction and base their household balance sheet on a housing stock that is far more expensive than their American equivalents.

The household sector vulnerable to any reversal in fortune. The moment unemployment starts to rise, people will start defaulting on their housing loans.

The view that Australia will be saved by China and the resources boom underestimates the magnitude of the forces ranged against us.

China's growth may continue to require large flows of commodities, but commodity markets at present are being driven by speculative money that can flee as quickly as it came.

Base metals prices could fall by 40 per cent and bulk commodities by 15 per cent without heralding the end of the Chinese driven "super-cycle".
Commodity markets are facing not only the prospect of a recession in the US, but also the possibility of recessions in Japan and Britain, with a slowdown in Europe.

The long-awaited rise in the volume of mining exports will not save us, with Minack calculating it will raise GDP by, at most, 0.1 or 0.2 percentage points. The terms of trade, by contrast, has lifted GDP by about 9 per cent, while the increase in business investment caused by the resources boom has added about 3.5 percentage points.

"People react as though there is some injustice. Here we are with the market down 20 per cent, when our economy looks strong and China keeps growing," he says. "People miss the point that we're hugely wrapped up in the global credit crunch because we are one of the world's largest issuers of capital, with the most over-priced finance sector in the developed world and a rickety housing sector.

"People think we're Teflon coated because of links to China. I don't think that's true."


Hmmm - food for thought. I thought he was being negative when I read this last month, especially as all of our major banks are saying that they have little exposure.

Then ANZ announced $1bn in provision for bad debt last night - by any standards, that is an enormous provision and a sign that things are not what they seem with our banks.

AND - it's only on their half year results!

Time to revisit the mattress?
 
Anyone who has been keeping an eye on business news should have seen this coming. But what's the problem? I'm not retreating to my bunker. I kept the LVR fairly low in the last 3 years, partly because I thought the market was expensive. Now I have some nice equity lined up (some already in an offset). I'll be looking to buy some properties in anticipation of the next boom. Which may be in 5, 7, 10 years.
Alex
 
Recession with rising rents?

The thing I can't figure out is if property values drop in the current situation where rents are rapidly rising due to a supply and demand situation, wont most of the market become positively geared very quickly?

And I also can't see the rents dropping if there is no increase in supply - people still need to live/rent somewhere?

So this is very good for investors.

Secondly, wouldn't most renters realise that it would actually be cheaper for them to just by a place and get a mortgage than to keep renting, which would then increase demand for buying properties and lift up property prices?

My wife and I have several IPs but have been renting on the lower north shore in an apartment. We are looking at buying our own apartment at the end of the year because rents are moving up to the point where it's not much more to buy our own PPOR (when we starting renting, rent was really cheap compared to buying).

I would imagine that the decision we have made to buy a PPOR would be repeated en masse in the market and keep property values up.....

Any thoughts??
 
What effect will the new coking coal prices have. Talk is that prices will jump 300% ...???

Iron Ore going up heaps.

There is a global copper shortage looming.

Soft commodities boom just getting started, and as Australia exports two thirds of it's food in a non drought time, that's got to be good for us.



I reckon there are enough bullish things going on to counteract the bearish, although you probably have to get out of the cities to see it all. I'm sure things would look crook in Western Sydney.

See ya's.
 
The thing I can't figure out is if property values drop in the current situation where rents are rapidly rising due to a supply and demand situation, wont most of the market become positively geared very quickly?

And I also can't see the rents dropping if there is no increase in supply - people still need to live/rent somewhere?

So this is very good for investors.

I don't know about becoming positively geared quickly, since yields are about 5% with interest in the high 8s. At least 2-3 years, and imagine what the media will be saying if prices drop for 3 years: property is a crap investment! It’ll never go up! The masses will overlook the fact that a positively geared property is much less risky than when it was negatively geared because of fear.

Secondly, wouldn't most renters realise that it would actually be cheaper for them to just by a place and get a mortgage than to keep renting, which would then increase demand for buying properties and lift up property prices?

I think that will be the start of the next boom, much like the late 90s. There might be a number of years of stagnant or falling prices between now and then, though.

My wife and I have several IPs but have been renting on the lower north shore in an apartment. We are looking at buying our own apartment at the end of the year because rents are moving up to the point where it's not much more to buy our own PPOR (when we starting renting, rent was really cheap compared to buying).

I find that hard to believe, since your PPOR interest is not deductible (neither is rent) so if you are comparing purely between the COSTS of renting and buying, you’d have to be paying rent at a yield of 8%+?

I would imagine that the decision we have made to buy a PPOR would be repeated en masse in the market and keep property values up.....

I’m not optimistic in the short term, because I think banks are not going to ration credit. I think increasing yields (from increasing rents and falling prices) and people shifting from renting to buying will happen over a number of years, and a boom will follow after that.
Alex
 
I reckon there are enough bullish things going on to counteract the bearish, although you probably have to get out of the cities to see it all. I'm sure things would look crook in Western Sydney.

This touches on something I have often considered - how regional variations in economic activity can mask a recession (or a boom for that matter).

According to Wikipedia, the population of each of the states and territories (in thousands of people) is:

Population in thousands (as a % of total)
ACT 340 (2%)
NSW 6900 (33%)
NT 215 (1%)
QLD 4182 (20%)
SA 1584 (8%)
TAS 493 (2%)
VIC 5205 (25%)
WA 2118 (10%)

Total 21,037 (100%)

Assume that their contribution to national GDP is in proportion to their population (as a % of national GDP).

Purely for the sake of example (based on my assumptions above) - the economies of ACT, NSW, NT, SA, TAS and VIC can each contract by 1%, but if QLD and WA continue to boom on the back of resources - say they grow at 10% each - then nationally GDP is up 2.29% and the economy is not in recession.

TC could well be right when he says the positives could outweigh the negatives, and that it may not look good in Western Sydney.

M
 

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Correction

Alex,

You are correct, I should clarify that we would not be buying an apartment in the lower north shore where we currently rent, but slightly further out (about 12 kms), down south where the apartments are cheaper and so my difference between rent and mortgage is not much at all, but then we have another property under our belts. (I know this mortgage is not tax deductible, but at least we're putting our previous rent money to use on an IO loan to hold another asset for whenever Sydney does finally move up).

The bit I meant about going positive probably should have some figures attached. Ok, here's a typical scenario of an apartment 10-15kms from Sydney CBD.

Purchase Price $325,000
Rental Income $350/week or $18,200 p/a
Yield (exlcuding outgoings/rates etc) on 100% lend is 5.3%
Yield (exlcuding outgoings/rates etc) on 95% lend is 5.9%

If the property value was to drop by 30% in a short timeframe, as Bill Zheng has apparently quoted, the following scenario would occur:

Purchase Price $227,500
Rental Income $350/week or $18,200 p/a
Yield (exlcuding outgoings/rates etc) on 100% lend is 8%
Yield (exlcuding outgoings/rates etc) on 95% lend is 8.4%

So the yeild has increased dramatically and provided the interest rate on your loan is less than 8.4% (and it's fair to assume that if we had a recession where property prices were dropping by 30% that rates would be dropping) then you could pick up one of these properties as positively geared 10-15kms from Sydney CBD.

If this would occur, every investor missing the good 'ol "Steve McKnight - positively geared property's growing on trees" days, would be buying like there's no tomorrow.

Also, any renters with half a brain would be buying instead of renting.

My theory is that with all the demand that a 30% drop in prices would create...well, there wouldn't be a 30% drop for very long!
 
Its not the 30% drop that people don't notice. Its the stagnation in property prices for a long period that people don't notice.

With rents increasing and properties falling behind inflation by 5% per year (a la 90 -98) in a few years most of the population have forgotten about property investment after being shaken out years ago.

This is the golden time for investors. I'm waiting for the equivalent of late 90s - early 2000s Sydney/Melb/Bris to roll round again.

I'm a timer of markets and don't subscribe to the 'buy any time and stay in the market' school of thought.

There have been/are a few sad examples of that thinking on the forum currently and recently that shows the result of buying at the wrong time.

I feel for those guys.

Also, lots of negative equity around at the moment on historically low yields. Not a good combination.

My theory is that with all the demand that a 30% drop in prices would create...well, there wouldn't be a 30% drop for very long!
 
I think that will be the start of the next boom, much like the late 90s. There might be a number of years of stagnant or falling prices between now and then, though.
Me too Alex,

That's basically my old tipping point hypothesis in a nutshell. i.e. Its all about rental yield relative the prevailing interest rate. I argued there's a small premium that buyers are willing to pay to secure a property of their own and the security that comes with doing so, that means the premium should never reach zero. But as it gets close, people start buying over renting and the next boom ensues.

Time will tell how long it takes to pan out. But with yields at 5% and the prevailing interest rates at 8.5% then it would take a 50% increase in rents to get that yield to 7.5% and approaching the prevailing interest rate today. But if a recession occurs in 2009, then the interest rates should drop and thereby bridge the gap a bit too.

I give it maybe 2-3 years before we start to see some solid price appreciation in Sydney. Sooner in some pockets (hopefully the Northern Beaches is one of these). But 2008/09 ain't going to be flash. Expect median prices reported to be falling due to the mortgage pain being felt in the west and the defaults to follow. But this median will hide the tale of two cities, the haves and the have nots.

I'm tightening my belt and riding this one out. I look forward to the back half of 2009 and what it means for property investors. Heck, if Mona Vale holds up and rental yields go up by even 20% then I'm neutral when developed (even at 8.5% mortgage rates) and a lot of equity built into it. Then I'll be able to look around with solid cash flow and a lot of equity just when yields are on the improve and property general looking like a good investment. Ride the wave from the "premium" properties out through the "fringe/aspirant" ones.

Ciao,
Michael
 
Also, any renters with half a brain would be buying instead of renting.

My theory is that with all the demand that a 30% drop in prices would create...well, there wouldn't be a 30% drop for very long!

The reason I don't see prices bouncing back that quickly is what is implied by a 30% drop. A 30% drop would usually imply that the economy is VERY bad. Which means while properties might be relatively cheap, people might not have the confidence (because of a fear of unemployment) or means (banks might not be as willing to lend) to buy. Properties were relatively affordable for years in the mid 90s, but it stayed there for a few years before the boom really hit. The key would be what you do for those couple of years (which will feel like a long time) while yields are going up, prices are going down and in fact demand is building for the next boom.

The main issue is that renters won't buy unless they think property prices are going to go up. Sure, we think prices will eventually go up, but not everyone thinks like us: otherwise they would have bought already.
Alex
 
Alex,

As usual, I think you are pretty close to the money (excuse the pun!) on all of that. I agree that 30% drop means that the economy will be in bad shape and therefore not as many people keen on buying, but I still think 30% is a bit over the top. Sydney has dropped a lot since 2003 due to the losses against a period of strong inflation, so I wonder if the 30% figure is inflation adjusted? I think it's more likely that prices will remain pretty steady and maybe a minor drop of 5%, which is really about 9% in real terms if you take into account inflation.

I tend to agree more with Michael though, in that I don't think renters are thinking of waiting until they are sure prices will go up before they buy, in fact, I don't think they're considering prices growth at all. I'm pretty confident it's a purely emotional decision i.e. "for only $100 more a week than what we are paying in rent, we can afford our own place and we can hang our pictures on the wall and have security etc."

I think we all agree that Sydney in particular represents excellent, excellent buying and it's only a matter of time before we have a very lovely boom that I have been waiting a while for - and if it takes slightly longer, who cares because rents are going up all the time and reducing my holding costs!

For that reason I have a very bullish sentiment compared to all the doom and gloom going on around SS at the moment (which is starting to annoy me), because this is the time that investors should be dreaming about - opportunity abounds!!! yayayaya!!
 
For that reason I have a very bullish sentiment compared to all the doom and gloom going on around SS at the moment (which is starting to annoy me), because this is the time that investors should be dreaming about - opportunity abounds!!! yayayaya!!

You should be glad for doom and gloom. If an investors forum is feeling gloomy, imagine what your average man on the street must be feeling. That means they'll stay away from the market giving us time to buy in.
Alex
 
OK, here's a tad more doom and gloom, but this one with a silver lining:

http://business.smh.com.au/business-conditions-slump-to-5year-low/20080408-24in.html

Business conditions slumping to a 5-year low!

Which resulted in the NAB pulling forward their projection of the RBA cutting rates to early-2009 from mid-2009 (that's the silver lining).

So, lead indicators are all suggesting the economy is in trouble. No surprises there. And already there's talk of rates coming down. Well, no surprises there either. All just part of the normal economic cycle. Hold on to your properties (these are a great inflation hedge too) and ride out the slowdown. Then get ready for the big lift on the other side, but get in early when fear is still ruling the day.

Cheers,
Michael.
 
can we just get this "recession" over with already....?

so sick of hearing about it, people worrying etc.

if it's gonna happen, the cartel (sorry, i mean RBA) won;t have your interests at heart.
 
Some pretty bold predictions there mate, what model is your crystal ball? :) But good Luck with it all.

I remember reading in the paper in the late 90s that rental yields were at 10% in outer Sydney and still people didn't take notice. It wasn't for another 3-4 years the boom started in earnest.

I predict this current stagnation will last longer than 2-3 years. Probably double that or more.

I know properties on the central coast have dropped 20% - 25% in the last year.

Me too Alex,

That's basically my old tipping point hypothesis in a nutshell. i.e. Its all about rental yield relative the prevailing interest rate. I argued there's a small premium that buyers are willing to pay to secure a property of their own and the security that comes with doing so, that means the premium should never reach zero. But as it gets close, people start buying over renting and the next boom ensues.

Time will tell how long it takes to pan out. But with yields at 5% and the prevailing interest rates at 8.5% then it would take a 50% increase in rents to get that yield to 7.5% and approaching the prevailing interest rate today. But if a recession occurs in 2009, then the interest rates should drop and thereby bridge the gap a bit too.

I give it maybe 2-3 years before we start to see some solid price appreciation in Sydney. Sooner in some pockets (hopefully the Northern Beaches is one of these). But 2008/09 ain't going to be flash. Expect median prices reported to be falling due to the mortgage pain being felt in the west and the defaults to follow. But this median will hide the tale of two cities, the haves and the have nots.

I'm tightening my belt and riding this one out. I look forward to the back half of 2009 and what it means for property investors. Heck, if Mona Vale holds up and rental yields go up by even 20% then I'm neutral when developed (even at 8.5% mortgage rates) and a lot of equity built into it. Then I'll be able to look around with solid cash flow and a lot of equity just when yields are on the improve and property general looking like a good investment. Ride the wave from the "premium" properties out through the "fringe/aspirant" ones.

Ciao,
Michael
 
I predict this current stagnation will last longer than 2-3 years. Probably double that or more.
You could be right, but with demand/supply where it is you could equally be wrong...

I'm just crystal ball gazing based on what I feel is happening out there. Whatever actually happens, I will respond to it. For now, I want to hold my premium site and wait for signs of strength in that suburb before I develop it. Everything after that is fairy-land for now, but a prolonged 3-5 year supressed market in Sydney would not upset me one little bit. I could then take my built-in profits and via LOC put them to very good use.

For now its really a cash flow game, so that's where I'm focussing my efforts. I've got a nice buffer so should be OK, and my cashflow is improving daily as my initiatives come through. (detailed budget, rent up, s. 221D form, family tax benefit part b etc etc).

Lets just see what happens with prices hey? Whatever happens, I'll be taking full responsibility for my investment decisions today.

Cheers,
Michael.
 
hi all
not sure about a recession as I think alot of areas have had the hit the ones that haven't watch out.
there is going to be a correction again and even thou not going intotebunker I am buying and increasing debt and the shelving that cash flow into liquid assets that can be used if need be similar to stocking up on oil.
to keep warm just before winter.
there are still areas that are moving and to of those areas are comm and hotels.
comm started to move about 12 months ago and is at full steam and got into it in small way then and an still in it and hotels are at crisis levels and not enough room. so into to it also.
both are relatively liquid if the right product.
and now back into resi but into the areas that have been hit why
simple if tey have been hit and the market is depressed the people will want to live somewhere and there back garden is the best place.
as they get hit prices drop but rent rise as people wnat to live there and just got kicked out.
supply and demand.
in the areas I have looked at people are asking why buy here when everyone is defaulting.
simple they would not be defaulting if they rented the property out.
a 2 br in lakemba at 150k with a 210 income per week takes alot to default if the owners are living off site and this is an investment( not that I recommend lakemba thou it seem a good investment and yes it is there).
are we in for a rocky road
yes
is resi a good investment if you are getting a 8 to 9% return in sydney and you are 20% below market now thats not bad
and if you can refinance and have cash flow there all the better and then hold for 5 years.
michael I agree your view but not sure what else is still to come.
so stock pile and if the rate move down release the stock pile into the next fallen market.
evand
my crystal ball is not very clear but 4 years is a very long time and I could not see the current demand for housing and the lack of to rent properties coupled with the increase in people comming in be able to take that time frame.
there will need to be done something a bit quicker then that.
the markets are getting very polar with resi defaults up and more to come.
comm is red hot for lack of supply and it getting hotter.
the hotel market is going to be red hot for the same reason(plus the land that the hotels is on is comm land so the developers are pulling down and redoing as comm as thats where the money is today)(just move the problem along)
so 4 years thats a very big call and I hope that our boys in canberra are not using the same crystal ball or we are in for a very rocky road.
good for me as my rents will sky rocket and my floor space value will go with them. but not sure about the other ducks in the pond
 
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can we just get this "recession" over with already....?

so sick of hearing about it, people worrying etc.

if it's gonna happen, the cartel (sorry, i mean RBA) won;t have your interests at heart.

if only it were that easy Blue Card! the stuff I have been reading lately is saying that the US recession is going to be bigger and uglier than most people would like to admit, making 1990 look like a picnic. regardless of how well China and India have been going it is hard to see us escaping this gloomy vortex.
 
I predict this current stagnation will last longer than 2-3 years. Probably double that or more.

In Canberra it lasted almost 10 years during the 1990s. I don't think it wil last that long this time, but strongly suspect it will last at least 5 years, potentially 8. I plan to buy in at about 3 IPs per 4 years over the next 8-10 years anyway, so I'm not so concerned.
 
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