Canberra's dearth of oxygen

This week in Talking Finance it’s all about politics, the markets, the economy and house prices. 

• Michael Pachi, National Political Editor for Macquarie Media tells me about the dearth of oxygen going on in Canberra at the moment;
• Diana Mousina, Senior Economist at AMP Capital explains what’s going on in the markets and specifically whether she thinks we’ve had a double top;
• Su-Lin Ong, Chief Economist and Head of Australian Research at RBC Capital Markets runs me through this week’s economic news; and
• Tim Lawless, Research Director at CoreLogic reports on February house prices.

Hello and welcome to Talking Finance, I’m Alan Kohler.  This week in politics, the Minister for Jobs and Innovation, Michaelia Cash, was fooling around with an improvised explosive device in a Senate Committee hearing and the darn thing blew up in her hands with shrapnel reaching the PM’s office at the end of a tiring few weeks dealing with the now former Deputy Prime Minister’s tortured love life.  It’s all turned into an episode of I’m a Celebrity Get Me Out of Here, so we’ll check in with Michael Pachi, the National Political Editor for Macquarie Media about the dearth of oxygen going on in Canberra at the moment.

I also ask Diana Mousina at AMP Capital what’s going on in the markets and specifically whether she thinks we’ve had a double top.  Su-Lin Ong, Chief Economist and Head of Australian Research at RBC Capital Markets runs us through this week’s economic stuff.  And Tim Lawless, Research Director at Corelogic, reports on February house prices. 

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I’m joined now by Michael Pachi, the National Political Editor for Macquarie Media.  Michael, I guess the Michaelia Cash thing just continues to show how accident prone this government is?

MP:  Yeah, it was a really unfortunate comment that Michaelia Cash made on Wednesday during that parliamentary hearing when she was really bated by Labor and Doug Cameron to explain about staff arrangements in her own office and then she just basically said that she was going to reveal unspecified rumours about female staff members in Bill Shorten’s office.  She’s refusing to apologise for it even though Labor is putting a fair bit of pressure on her to apologise for the comments that she made.  She just simply withdrew the remarks but wouldn’t go any further than that. 

There is a new statement from Michaelia Cash’s office that is coming out saying she was under the belief that the opposition was simply just trying to probe into the personal details of her senior staff members and that’s why she made the swipe.  But whatever it is, the bottom line is, it’s basically robbed the government of more oxygen, in a week where they really did need to get their message out.

Well, after many weeks of Barnaby Joyce robbing the oxygen as well.  Where do you think that sits now?

MP:  It will be interesting to see what happens with Barnaby Joyce.  He’s now sitting on the back bench.  On Monday, as we know, the Nationals chose a new leader in Michael McCormack and it was a contested ballot in the fact that George Christensen also put his hand up for the job, not that I think he was ever going to get that role.  But it was interesting that the Nationals did have a contested ballot when they normally don’t have contested ballots for these leadership changes.  So, it’ll be interesting to see how Michael McCormack does work with the Turnbull government, I think he’ll be fine.  What I think is interesting about Barnaby Joyce, he held a quick news conference earlier in the week where he said that he doesn’t ever expect to come back to the National Party leadership, but he wouldn’t rule it out, because he basically said, you never know what can happen.  I do think what will be interesting with Barnaby Joyce is over the coming year is, if he doesn’t agree with government policy, whether or not he’s going to start making life a bit difficult for the government in speaking out against a government position on a certain issue and we know that he’s done that before and especially when he was a Queensland senator. 

Well, so is George Christensen.  I suppose you’ve got to wonder whether it matters.

MP:  Well, in terms of mattering, I suppose for the government it does matter in the sense, if they’re trying to push a policy position, they need to get legislation through, at the moment they only hold the lower house by that one seat.  If you start having national party MPs creating a bit of a ruckus in not supporting a government position.  Maybe certain bits of legislation may not get passed if you’ve got national members either abstaining or deciding to cross the floor, especially if the government can’t get any of the cross-benchers on board.

Do you think Barnaby Joyce is a chance to cross the floor?

MP:  I do think he’s a chance to cross the floor, I don’t know on what issue at this point in time, but I do think he’s a chance to cross the floor if there’s something seriously he doesn’t agree with and he thinks the government should be going in a different direction.  I think he’ll threaten to cross the floor as has George Christensen.  George Christensen’s threatened to cross the floor before and then the government has generally changed a certain policy or it’s done something to try and manipulate a policy in order to try and appease people like George Christensen and the same thing could happen with Barnaby Joyce. 

Maybe if he doesn’t agree with where the government is going on a certain issue, maybe the government may be forced to change a certain policy measure to ensure that it does go through and that the government is not embarrassed on the floor of parliament.  But at this point in time, people like Barnaby Joyce haven’t indicated they’ll be crossing the floor but if he will do it, I wouldn’t be surprised.  He could do it.

He could end up being more powerful as a backbencher than he was as Deputy Prime Minister.

MP:  Well that’s potentially true.  It’s not only Barnaby Joyce that you’ve got sitting on the backbench, you’ve also got Tony Abbott sitting on the backbench, so you’ve got a former Prime Minister and a former Deputy Prime Minister – two fairly outspoken leaders sitting on the government’s backbenches.  As we’ve seen with Tony Abbott especially in the last couple of weeks, he has started this whole debate about migration and about population and people have been talking about it.  Even though some of Tony Abbott’s colleagues, some senior ministers have tried to slap him down, in the end we have had a lot of people talk about it. 

I know that a lot of talk back callers have been really interested in dealing with this issue and saying that the government must do something to deal with this issue, if anything it’s created a debate point for people like Tony Abbott and the government even though the government may not like where Tony Abbott is leading the debate.

Michael, what is all this stuff sucking the oxygen out of?  What I mean is, what are the policy things that are going on behind the scenes that are just getting obliterated by all this political stuff?

MP:  The big thing that the government wants to be talking about is company tax cuts.  That’s the big issue that the government wants to be talking about.  Obviously, the other issue that the government wants to be talking about is putting the heat on Bill Shorten on a number of issues.  For example, one of the issues they did want to put some heat on Bill Shorten over was the Adani Coal Mine and Bill Shorten’s wavering view on the coal mine, in the sense that he’d tell some people in some electorates like the Victorian seat of Batman that a Labor government would potentially not see the Adani Mine go ahead, but then he’s telling mine workers or coal miners in Queensland that Labor would be more committed to the mine. 

So I think it’s that to-ing and fro-ing on the Adani Coal Mine by Labor and its leader is what the government would like to be concentrating on but it’s hardly getting any air time.  Of course, the issue of company tax cuts is the other big one.  That simply seems to be going through to the keeper, they’re not able to get any oxygen on those sorts of issues.  They obviously want to be talking about jobs and the general performance of the economy, but they don’t seem able to get those sorts of messages out. 

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Joining me now is Diana Mousina, Senior Economist at AMP Capital, she works with Shane Oliver.  Diana, the DOW fell 380 points this morning, we’re talking on Thursday, do you think we’ve seen a double top?

DM:  We think that the outlook for equity markets is still quite positive for the remainder of the year and that’s ultimately because we’re seeing earnings momentum or earnings growth continue to surprise to the upside, particularly in the US, and that in the near term should outweigh the increase in bond yields. 

I take it that means you don’t think it’s a double top, leading to a bear market?

DM:  That’s right.  We see equity markets continuing to rally this year.  We think that there’s more potential for upside in areas like Japan and the Euro zone where you’re still seeing quite strong earnings momentum but the valuations aren’t as high as they are in the US.  However, the positive impacts of tax reform, you can’t really outweigh.  There is still some more growth in the US, we just prefer to be overweight in markets that we think have been underperforming recently. 

Obviously, the US market in particular is soggy this week as a result of the statement by the new Fed chair, Jerome Powell.  What do you make of what’s going on there?

DM:  Well it looks like what Powell and the Fed is trying to manage is really trying not to get markets too excited about – or try and increase the fear in markets that inflation is going to run away.  I think his comments were quite considered in that the Fed’s still reiterating that they expect inflation to pickup but not a pace that would be unsustainable for the US economy or at a pace that would mean the Fed would have to hike rates too fast this year.  While his comments were quite positive and markets took that to mean we’ll probably get four hikes this year, I don’t think that his comments indicated that we’re going to get the Fed raising rates to the neutral level in the US which is probably at around 3% or so. 

That kind of environment is still generally positive for the economy.  But the Fed is moving at a faster pace than what we’ve seen in the last two years.  It means that bond yields have to ultimately rise and especially with the US Federal Reserve also normalising its balance sheet, we think that yields are headed towards 3% for the 10-year in the US.

Do you think that what happened this week in fact was the share market moving from pricing three rate hikes this year to now pricing four?

DM:  We think the market has further to go in terms of pricing more rate hikes.  The latest pricing that I’ve seen indicates about three to four hikes this year and perhaps two or so in the following year.  We think that there’s more upside to go.  The risk that we see anyway is that the Fed might have to hike five times this year and that’s if you get the inflationary stimulus from the fiscal changes that you had in the US and also from the taxation changes.  But it’s probably just too early to see exactly how strong those inflationary pressures will be on wages and on the economy.  But I’d say that the risk is that that Fed goes more than what the market’s pricing.

I take that what you mean by saying there’s more to go is that the share market has more downward adjustment to go?

DM:  Well the important distinction for the share market in the next few months will be whether the momentum in earnings growth can outweigh inflationary risks and move higher in bond yields.  For the next three months or so we think that earnings momentum is very strong and that it will be able to outweigh any inflationary risks, but as we move further through the year and inflation picks up as we expect it to, towards that 2% level that the Fed’s targeting, we think that equities might come under a bit of pressure in the second half of the year.

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Joining me now is Su-Lin Ong, the Chief Economist for Australia and New Zealand for RBC Markets.  Su-Lin, the capital expenditure data out today, did that make you change your view about GDP growth?

SO:  No, it doesn’t.  The actual headline fall in capex was a bit disappointing, it was a bit below market expectations.  We were looking for a slightly softer outcome any way.  The key component, the plant and equipment spending, was actually up and that maps a little bit better into GDP.  We are leaving our GDP forecast unchanged at the moment.  It’s at 0.6, that is about 2.5% year on year.  We’ve got a couple of other partials early next week and we’ll finalise our numbers but right now we think the economy was travelling at a fairly modest pace into the end of 2017. 

Talk about the handover or the transition from mining to non-mining investment in Australia, is that sort of intact still?

SO:  Very much so.  I think the story there is a really encouraging one.  It’s a trend that’s been underway for a while now over the last 12 months.  But I think more recently it’s picked up somewhat.  You can see continued growth in non-mining capex and more importantly, the spending plans to non-mining capex remain quite solid too.  I think it’s pretty clear that business investment outside of mining is strengthening.  I think that’s consistent very much with very high levels of business confidence and business conditions and so that’s a really encouraging story. 

In terms of the mining capex, the drag on activity continues to abate.  It looks like from the forward estimates that we may see a little bit more weakness but we look like we’re coming close to the end of this major drag on activity from the completion of resource related projects.

And what is the non-mining investment that’s going on, is it residential construction or something else?

SO:  It’s across a range of industries.  It is predominantly in the service sector.  It is your standard plant and equipment type investment, upgrading of capital stock, hopefully expansion as well.  And for us I think that’s a really positive sign, it tells you that businesses are facing rising capacity utilisation rates, that to lift output they need to invest more and I think that looks to be going on and should continue as the year unfolds.  We think as well, that that stronger non-mining capex story is part of a stronger global capex cycle and we see it in other parts of the world.  The US is a prime example, Canada, even in the UK despite all the Brexit concerns.  I think Australian businesses are part of this stronger global capex cycle and that’s a really positive thing.

I suppose the main problem is that it’s not turning into wages growth at this point?

SO:  No, it’s not at this point.  I think that the discussion around wages and the outlook remains a fairly complex one.  It is a combination of both cyclical and structural factors.  We know that there are a number of headwinds to wages growth, some of which are not unique to Australia and in particular we’d have to argue that on the cyclical side, the fact that there is still substantial spare capacity in the labour market means that wages growth remains fairly modest all around.  It’s hard to see significant upward momentum any time soon, we really need to absorb that slack in the labour market and that’s going to take some time. 

The unemployment rate of 5.5% is probably a good half a percentage point above full employment, and probably more importantly there is additional supply, we know, because underemployment levels still remain very elevated.  Until that slack is really absorbed it’s really hard to see substantial upwards momentum in wages growth.  We think we’ve hit the lows, we’re seeing a modest improvement, but annual wages growth around this 2% mark looks likely to linger we think for much of this year.

What are your colleagues saying about the US economy and in particular, what the Fed’s likely to do this year?

SO:  We remain pretty upbeat on the US, following the tax cuts and their implementation, our US team lifted both their GDP and inflation numbers for 2018 and 19 by about a quarter of a point for each year, so we expect growth this year to be pretty close to 3%, well above trend and core inflation to head a little above 2%.  It’s a fairly upbeat outlook for the US, it is being driven by a very strong consumer, the underlying consumption fundamentals are strong all around whether we look at the labour market, an emerging pickup in wages, confidence as well as wealth creation.  The consumer is a real driver there, but like I said, we’re also seeing strengths in terms of business investment, housing and so it’s a really positive story. 

As the labour market tightens further in the US and the wages picture continues to firm and inflation rises, we expect the Fed to continue normalising rates.  We’ve long held four rate hikes in our profile.  The Fed this year, we expect the Fed to shift its dot plots fairly soon from three hikes to four, which would be very consistent with the view we’ve had for a while.  The team is pretty upbeat and I think more importantly, they’re looking for further increases from the Fed in 2019.  I think consensus is very much shifting to our view for ’18, but further hikes in ’19 is probably fairly non-consensus at this juncture.

That’d probably be a big moment for markets, if the dot plot shifts or when it shifts?

SO:  Yeah, look I think market expectations are shifting already have been for some time.  It probably started earlier in the month with that unexpectedly strong wages number.  We’ve seen the testimony from the new Fed chair, Jerome Powell, also err on the more upbeat and hawkish side.  Expectations are shifting more towards four hikes and whether dot plots will move.  I think, I’m not so sure it will come as that much of a surprise when it happens.  I think we’ve started to move in that direction already.  It’s very consistent with what’s happening in asset markets more broadly.  Yields generally continue to rise, equity markets are now starting to wonder what that means for them and the dollar’s finally finding a little bit of support.  We’ll see, I guess, when the timing is, but increasingly the markets are speculating about four hikes from the Fed this year.

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I’m joined now by Tim Lawless, the Research Director at Corelogic.  Tim, 0.1% national decline in February, fifth in a row for the month.  I suppose we could say that the real estate bear market now is well underway?

TL:  Well, five months of declines would certainly indicate that but I suppose one thing in defence of the bulls is that the clients have been easing off a little bit.  The last couple of months we’ve seen values fall by about 0.3% in November/December/January, and to see a 0.1% decline suggests that the rate of falls is just easing off a little bit, but you can still see the most of this downward shift is just coming out of Sydney.   Values were down by 0.6% over the month and still Darwin also looking quite shaky with values down by nearly 1% over the month.

In fact, as you pointed out, Sydney’s rate of decline was 0.5% for the year, which was the first time we’ve seen that for quite a while.

TL: That’s right, we’ve seen Sydney slip into negative annual growth now and negative annual change.  The first time we’ve seen a negative annual movement in Sydney since 2012.  It really does highlight that momentum has left the Sydney market.  Remember, values peaked back in July last year in Sydney and since that time they’ve fallen by a little bit less than 4%, they’re down 3.7% from that peak through to the end of Feb.

Can you run us just through the other cities?

TL:  Of course, Melbourne has been much more resilient to a downtrend than Sydney has but we’ve seen three months where Melbourne values have slipped a little bit lower.  Virtually they’re flat, they’re down 0.1% over the month in Melbourne and since they peaked late last year we’ve seen Melbourne values fall by only 0.4%.  Every other capital city is still looking like reasonably flat conditions to slightly negative.  Brisbane was down by 0.1% continuing a fairly soft run, Adelaide values were flat over the month, Perth was down by 0.2%.  The real standout here is Hobart where we continue to see a reasonably strong rate of capital gain.  Values are up by 0.7% over the month of February and over the past 12 months there up a little bit more than 13% in Hobart.

The other thing that stands out from your report is that regional Australia values are holding up pretty well, in fact, haven’t declined.

TL:  That’s right.  I suppose in some sense the regional markets don’t have a high base to fall from but we are seeing some real solid performance from many of the satellite cities.  The strongest regional market around Australia was actually Geelong, just outside of Melbourne and we saw values rise by nearly 10% over the past 12 months across Geelong, Newcastle, Lake Macquarie.  Values are up about 9% in the past 12 months in the Southern Highlands of New South Wales, up about 9% as well.  We are seeing some pretty strong performance around those markets fringing the major capitals, but the other key highlight in the regional areas would be the lifestyle markets, the Sunshine Coast for example has seen values rise by nearly 6% over the past 12 months, we are seeing this real migration and sea change phenomenon driving values up in those coastal lifestyle markets.

But the other thing about those regional markets, particularly for investors, is that the yields there are much better than in the cities.

TL:  That’s right and I think to some extent that’s partly a pay off of higher risk.  You find in some regional markets you should get some compensation in terms of a higher yield.  Generally, when you look around markets outside the capital cities where yields particularly in Sydney and Melbourne are just off record lows, are just rising a little bit now, but you’ll find most regional markets are showing yields which are a couple of percentage points higher than what you’ll find in their corresponding capital cities.  I think that will become more and more attractive to investors particularly as lenders really scrutinise serviceability.

Yeah, I’m not sure that’s right about the risk, I mean I’m sure that’s what the market says but the riskiest market in Australia has been Sydney and Melbourne.  They’re the risky markets.  The regional areas, as the evidence shows, have been pretty secure.

TL:  Well, you’re exactly right, Alan.  They have been pretty solid.  Some classic mining towns, for example, clearly the risk profile is very high but I think many of the regional markets, they do see relatively consistent rates of capital gains and also higher yield profile.  Your total return adding up your capital gain plus your yield generally tracks fairly healthily.  As you say, Sydney and Melbourne, I think the risk profile is certainly heightened considering the past five and a half odd years of very strong capital gains now suggesting these markets are probably over-valued.

Just back to the cities – the decline in values that occurred in 2015-16 were stopped by rate cuts by the Reserve Bank in 2016.  That’s not going to happen this time and I think you’ve said before to us that the typical decline in the real estate cycle would suggest something like 10% possibly, maybe a bit more, maybe a bit less, but that’s the sort of typical decline you’d expect.  There’s still a fair way to go, isn’t there?  Particularly considering that there’s unlikely to be a rate cut to rescue the market.

TL:  If those historical averages are anything to go by, then yeah, we should see value slipping lower for some time.  Remember, Sydney’s down a little bit less than 4% since the values peaked in July.  Going back to your original part of the question, what really drove the rebound back in 2016 into early 2017 was absolutely lower mortgage rates but also some loosening of credit policies as lenders met their new APRA benchmarks which was the 10% limit on investment credit growth.  We could see some relaxation in lending policies.  To be honest with you, we’re seeing banks now tracking well under those APRA limits. 

Investment credit growth annualised over the past three months was only around about 2%, so well below that 10% limit and interest only lending is only about 17% of originations and the benchmark there is about 30%.  Theoretically, the banks could open their purse strings a little bit for investment, but we’re absolutely not going to see the catalyst of lower mortgage rates like we saw back in 2016.

I’m not sure that investors are going to be piling into the market taking advantage of easier credit conditions, by the way.  The investors have to think that they’re going to get capital gains now that the returns were there, but maybe this time they won’t be.

TL:  That’s kind of interesting based on housing finance data.  We’re still seeing investors in New South Wales, for example, a little bit more of 50% of mortgage demand and they peaked at about nearly 65% back in 2015.  But even at 50% it’s still well above the long term average which is just a little bit below 40%.   It looks like investors are still active.  Yields are generally low in most asset classes and I think Australians certainly have had a love affair with housing for a long time and it looks like they’re not really giving up on that just yet. 

Today’s birthday song is Coldplay’s Chris Martin, one of Phoebe’s favourites – actually, her absolute favourite in the past.  He’s 41 today, this is the song we played at Phoebe’s 21^st which seems like only yesterday, it’s The Scientist.

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That’s it for Talking Finance, you can share your thoughts by emailing hello@theconstantinvestor.com and I’d love to hear from you.  I’m Alan Kohler, do have a Constant week.