How far will house prices fall?

Hello, I’m Alan Kohler, welcome to Talking Finance.  This week, Shane Oliver now thinks Sydney and Melbourne house prices will fall 20%, which would make it the biggest decline since the 70s and a big deal.  It might even mean the next interest rate move is down, not up.  That’s our lead item today.  Also, Tim Lawless of CoreLogic tells us what happened to prices in October and he reports that the decline is in fact, accelerating.  Kyle Rodda, Market Analyst at IG, explains why the US market went up last night after the mid-term election.  And, David Marr, Columnist for the Guardian, tells us about ScoMo – PM.

[Music]

Here’s Shane Oliver, Chief Economist at AMP Capital.  Shane, the Reserve Bank left interest rates on hold this week, as expected.  When the statement of monetary policy comes out tomorrow, what will you be looking for in that?  

SO:  The first thing I will be looking at will be the forecasts which are towards the back of the statement.  The reason I’ll be looking at that is because it’s a guide to how the Reserve Bank is seeing the economy, and the indications are that the Reserve Bank is starting to get a bit more upbeat about things, that they’re going to be revising their economic growth forecasts up for this year and next year, revising their unemployment rate down, probably to 4.75%.  Also, pushing up their inflation forecast a little bit for 2020.  They’ll be the things that I’ll be looking at and of course the commentary around that to see how strongly the Reserve Bank holds those views.  To me, that’s going to be the main focus.

If those things happen as you expect, will that lead to the markets changing their pricing for interest rates next year?  

SO:  It’s quite possible that if the forecasts are indeed upgraded and the commentary is more positive, then the market may increase the chance of a rate hike and increase the projected profile for interest rates.  I must admit, I’m a little bit sceptical because, yes, there are reasons for optimism on the economy, reasons to indicate that growth will continue, but I think the Reserve Bank to some degree is underestimating the negative wealth effect that will come from falling house prices and also the risks around the Chinese economy.  So, yes, I think we’ll see the normal kneejerk reaction in markets.  To some degree, you might argue we’ve seen a little bit of that.  The Aussie dollar’s got to its highest level in two months, partly on the indications that the Reserve Bank will upgrade its forecasts.

But my feeling at the end of the day is that growth will ultimately remain pretty constrained and as we go into 2019, I actually think growth will be more around the 2.5% to 3% level rather than around 3.5%.  I’m not quite as upbeat as the Reserve Bank is.  I think the Reserve Bank does rightly point out there’s bits of the economy that are doing pretty well and that’s why we’re not going to go plunging into a recession as many people like to tell us.  But by the same token, I think they’re probably just a little bit too optimistic, particularly with the housing downturn unfolding.  

Are you starting to get worried about the housing market?

SO:  The housing market does worry me.  I guess we’ve been hearing warnings about the housing market for many years, like the boy who cried wolf!  These rash predictions… In fact, I’ve been monitoring them ever since about 2004 when The Economist magazine referred to Australia as being America’s ugly sister, and the OECD and the IMF at the time were talking about house prices being 50% overvalued in Australia.  But of course, we’ve seen several occasions where the market just comes down 5%, 7%, prices come off and then of course, the Reserve Bank cuts interest rates and the housing market takes off again.  This time around, I think it’s a little bit different, which is why I’m a little bit more worried. 

Firstly, the overvaluation reached perhaps more extreme levels, particularly relative to people’s incomes.  It came with record levels of household debt and of course there had been some deterioration in the lending standards the banks had been employing and that there’d been very rapid growth in lending to interest only borrowers.  Of course, they’re now being told to switch back to principal and interest.  So, the risks going into this I think are greater and then of course, in the last year or so you’ve seen the banks tightening their lending standards, making it harder for people to get loans. 

Quite severe checks on income levels and expense levels and more importantly, as we go into next year with the start up of comprehensive credit reporting, banks will have access to any loans that you might have from competitors.  If you’ve got multiple loans across Westpac and ANZ and everybody else, then they might say, “Well this is taking your debt to income level to an area where we regard that as too risky and we’ll deny your ability to refinance or force you to finance with someone else.”  That, I think, will create problems for the property market.  On top of that, we’ve got the prospect of a change of government which is promising changes to negative gearing and capital gains tax, which will make life or investing in property less attractive for investors.

All of those things suggest that the risks are certainly greater than normal for the property markets and we’re expecting prices to fall 20%.  I must admit, looking at the auction clearance rates over the last weekend, I know Melbourne was distorted by the Melbourne Cup coming up on the Tuesday, but those auction clearance rates were, I think, indicating we’re starting to push below 40%, which could be consistent with an acceleration in the rate of decline in house prices.  The short answer is, yes, I am getting concerned about the decline in the property markets in Sydney and Melbourne, and therefore if I’m worried about that I have to be concerned about the impact on people’s perception of their wealth and the flow on of that to consumer spending.  

But, 20%, Shane, what are you talking about?  Are you talking about national price or Sydney and Melbourne only…?  And if so, what does 20% mean, is that recession territory?

SO:  20% that I’m looking at is a top to bottom fall in Sydney and Melbourne.  Nationally, that’ll be 10%.  The other capital cities haven’t had the boom, so they’re not going to have the bust and you could argue, well Perth and Darwin have been falling for several years no, so if anything, they’re getting close to the bottom.  It’s a fairly benign story I think for other capital cities, but they are vulnerable to some degree as credit conditions tighten.  But my numbers, top to bottom, 10% nation-wide, Sydney and Melbourne 20%.  That 20% fall, part of it’s already occurred.  Sydney has offered about 8% from its highs.  Melbourne is 4% or 5% down from its highs but there’s obviously quite a lot more to go and it will unfold over the next couple of years, which I think will start to impact expectations. 

The price falls that we saw in Sydney, say around 2005 and then nation-wide around 2008 and 2012, they were short-lived.  By the time anyone realised that prices were coming off much, prices were starting to pick up again as interest rates came down.  This time around I think it will drag on for longer and therefore, start to affect expectations.  Would I call it a crash?  Probably not.  I think to get a crash you’d probably need a bigger price fall and for that to be spread nation-wide.  I don’t think it’s enough to bring down the economy, but it will have a dampening impact on the economy.  Of course, if the Reserve Bank raises interest rates prematurely or unemployment were to go up, then it will make things a lot tougher.  That could turn the falls that I’m looking at into a crash scenario, accelerating on the downside and before you know it, we’re down 30%.  But I’m hopeful that that won’t happen.  I don’t see the Reserve Bank raising interest rates any time soon and the labour market story so far has been reasonably positive. 

But I think it is going to be a much tougher environment than we’ve seen for housing over many years.  In fact, to get anything comparable, you’ve got to go way back.  I mean, we’ve been pretty lucky in Australia that price declines have been pretty mild.  The data we have that’s reliable really only goes back to the 1980s, so it’ll be worse than anything we’ve seen since the 1980s.  In real terms it might be comparable to what happened in the 1970s where for a while there prices went sideways but inflation was very high and so prices did come down in real terms.  The bottom line is, I think it’s going to be a pretty tough environment for home owners as they see their prices come down over the next couple of years.

Surely, the scenario you’re painting is one in which the Reserve Bank cuts interest rates rather than raises them?

SO:  That’s the big thing here.  I’ve been of the view that a rate hike is unlikely until late-2020 at the earliest, but I’ve recently been sort of shifting that view a little bit and sort of educated view that the next move could indeed be a cut.  Now, I must admit, if I read the Reserve Bank’s commentary recently, the fact that they revised their growth forecasts up, the fact that we have seen unemployment fall to 5%.  All of those things tell me the Reserve Bank at this point in time is a long way from considering cutting interest rates.  The scenario would unfold that prices come down, that starts to affect consumer spending, that keeps inflation lower for longer and the Reserve Bank starts to realise there’s a threat to ever meeting its inflation target, so in a year’s time or so, then they start cutting interest rates. 

That’s how that could unfold but at this point in time we’re a long way from that.  The Reserve Bank, I think, will just continue to reiterate that they still believe for the time being anyway, that the next move is more likely to be up than down.  But they’ll also probably say that right now there’s no need to move.  

Good to talk to you, Shane, thank you.

SO:  Thanks, Alan.

[Music]

Well, it’s the start of the month and that means it’s time to talk to Tim Lawless about last month’s house prices.  Tim Lawless is the Head of Research at CoreLogic.  Tim, the coverage of the October house price moves was generally along the lines that price declines were accelerating, but just looking at the per month declines, they’ve been 0.7% in Melbourne and Sydney per month for a while now.  Do you think it’s true that price declines are accelerating?

TL:  I think there’s two ways to look at this.  In one sense, we have seen some acceleration and declines over the second half of 2018.  If you look at just Sydney and Melbourne specifically over the first two quarters of this year, the values are generally falling at about 1% to 1.5%.  If we look at the movement in Melbourne, with the most recent three months or really since June we’ve seen that rolling quarterly rate of decline has picked up to around about 2% to 2.1% or so – a little bit higher in Melbourne now actually, so if anything it’s Melbourne that has accelerated in its decline.  But maybe a better way to describe this is, this downturn is becoming more broad-based now.  We are seeing the lower end of the marketplace showing some cracks at the lower values of properties, which was generally more resilient.  And we’re also starting to see regional markets slowing down, although generally still seeing some level of growth.  We have seen some momentum come out of the market.

Are you changing your view about the potential extent of the declines?

TL:  I think progressively as we see the market becoming a bit more broad-based in its downturn and we do see some of the more segments of the market that have been more resilient like the more affordable quartile, is showing some cracks now as well.  Then yeah, I think we probably are finetuning our outlook on the market.  Originally, we were looking at Sydney values, for example, down around 10% from the market peak through to the trough.  We’ve already seen Sydney values fall by 8.2% since they peaked back in July 2017.  A 10% decline at the moment in Sydney is looking quite optimistic and more realistically, probably more along the lines of say, 15%, if not a bit more than that.

Overall, do you think we’re looking at something greater than previous declines in house prices?

TL:  If you look at the previous downturns in some of our strongest markets, Sydney and Melbourne, once again, just focusing on these two markets, typically the largest downturn that we’ve seen historically for example in Sydney was back in the late 80s, early 90s.  And we saw dwelling values in Sydney fall by nearly 10% from peak to trough, debt go down by 9.6% over about two years.  Sydney is already about a year and a half into its downturn and we’ve seen values fall by 8.2%.  It does look like this downturn is going to be more substantial and potentially longer lasted than what we’ve seen historically.  That kind of comes back to the reasons or the fatness behind this downturn being very different as well.  This is very much a regulatory fuelled credit availability fuelled downturn rather than changes in interest rates or economic conditions.  

What impact do you think is it going to have on the broader economy?

TL:  When you look at housing markets, there is a real multiplier effect here as well as a wealth effect which is now in reverse.  The markets in a decent upswing, you see more sales transactions.  That obviously has flowed through to retail.  You see more people buying whitegoods and appliances, home furnishings and so forth, you see state governments getting their stamp duty revenue.  You see a lot of transactions around the property sale as well.  Real estate agents get the commission and banks write more mortgages and building and pest inspections and so forth.  There’s obviously seeing that in reverse now, particularly around state government stamp duty revenues.

But also, you can look at the wealth effect.  During the upswing of a housing market you see households generally very confident.  They’re basking in the capital gains.  They’ve seen good equity behind them which gives them confidence to make high commitment decisions.  But as the housing market starts to move into the downturn which we’re seeing at the moment, then we probably will see some reversal in that wealth effect and potentially a swing back to more saving, which we see in the household saving ratio back to where it was around the time of 2008 or a bit earlier.  That will probably bounce back a little bit higher.

Well, thanks very much, Tim.  Good to talk to you again.

TL:  Thanks very much, Alan, cheers.

[Music]

And now let’s hear from Kyle Rodda, the Market Analyst at IG Markets.  The US market went up a lot last night, is that because the Democrats won the House or because the Republicans won the Senate?

KR:  Well, I think it’s because it went all as expected, more or less.  I think in the markets there is a truism and I think it played out last night that often the expected outcome is the best outcome.  What we saw was what we had priced in and the real volatility came when, for a few moments there it looked like we were going to see some sort of red wave through the House of Representatives and the markets went into a little bit of a frenzy when it happened.  But low and behold, the pollsters were right this time around, we got what we expected and now we can focus on challenges going forward and other things and taking that risk off the table.  As a result, we saw a bit of a relief to the risk rally and that heightened risk appetite saw obviously the markets post some pretty solid gains in US stocks.  More or less, that looks like it’s going to carry through to the Australian session or the Asian session too.

But you would think, Kyle, if the markets had priced in what actually happened, then they wouldn’t move that much, but 2.6% on the Nasdaq, 2.1% on the S&P 500, those are quite big moves.

KR:  Yeah, they are.  My view is that you take risk off the table in these sorts of situations and particularly considering that 2016 really does ring still very much in the ears of many traders.  You never really want to overcommit yourself to a particular position, but I think the fact that we saw what we were expecting meant that traders felt comfortable on the back of that to be able to jump back into the market, re-establish positions and equities away from other safer assets, cash in particular, potentially, and put that to work a little bit more in equities whereas prior to the release, you’d want to see more of an outcome for certain before making that sort of a commitment. 

But because we did see what we were expecting, markets didn’t have to worry about any additional information, so they could get straight back on with basically moving forward and getting back into the market to try and put some money to work.  

The US market has now recovered a bit more than half of that October correction.  Do you think it’ll regain the September peak again?

KR:  The September peak?  I’d be reasonably sceptical.  I think there’s quite solid headwinds in terms of this and issues that were driving markets back then or throughout October and that’s what’s going to happen with interest rates in particular, and we’ve got the FOMC tonight which will be illustrative.  Also, the trade war, which we get speckles of positive developments there but it still hasn’t really come close to resolving itself yet.  To see new highs in this market would be quite extraordinary I think on that basis because those stories are going to continue to unfold and weigh on the market.  I do think though that we are in for a period and I think that higher action last night really affirmed this, that the October rout is probably behind us now, we’ve reversed that particular trade, if you will.  It does mean that seasonality will start to kick in from here, November and December tend to be fairly strong for equities, and we could see a push higher.  If we get to record highs again in US markets.  Again, I’d be fairly sceptical just on the basis of the fundamentals.  But there’s certainly interest for some upside from at least where we are from here, and some reasonable confidence that at least the worst of what happened in October is now behind us and you can start looking forward to some future gains.  I still think it’ll take something remarkable to get to new all-time highs again.

We can certainly conclude, can’t we, that October was a correction, not a crash, and certainly not the start of a bear market?

KR:  Yeah, definitely.  And again, ballooning back to what we saw last night, and if you’d watched the ASX today too, this 5930 level is a bit of a cross roads for me to indicate potentially that we’re out of the woods on that one.  But it’s certainly now looking like a correction and I think when you look at it sensibly, I think this is a great stat to come out of these sorts of situations is that, true definitive bear markets it tends to happen at around the times of economic recession.  If you look at what happened in ‘07/’08 and you go a little further back around the Dot-com bust, it did coincide with a period of economic flatness.  We have very robust fundamentals across the globe, really. 

I mean, obviously there is a little bit of a diversion to the global growth story, but Europe’s better than what it was.  The Australian economy, if you want to look locally, is in a pretty good state if you believe the RBA, and the US economy is still humming.  I think, on that basis, I think you can definitely see it as a correction, brought about too by the same risks that won’t go away, which is changing interest rate settings.  And that will continue to cause volatility in the markets as liquidity is chucked out of the system.  But in terms of whether that really points to a definitive bear market, I think you’d have to be very much on the extreme side of the equation to make that suggestion. 

Yes, there’ll be headwinds going forward.  Yes, there’ll be more volatility as rate settings change, but it does seem like what we saw in October is a clean out and investors are taking the opportunity to readjust now and move forwards to putting their cash back to work with a heightened risk appetite.  

Good on you Kyle, thanks very much.

KR:  My pleasure, thank you for having me.

[Music]

[Parliament audio clip]

And now one of my favourite political commentators, David Marr from The Guardian.  David, how do you think Scott Morrison is going with his ‘ocker bloke’ schtick?

DM:  Not well.  It’s going to appeal to some people of course, but I don’t think it really has much general appeal in Australia.  I think Australians like a Prime Minister to look like and sound like a Prime Minister.  It’s something that goes way back with us.  I think one of the reasons people warmed so immediately to Kevin Rudd was, here was a Labor man who looked like a Prime Minister.  Part of that judgement is, how will people abroad think of our man or woman, and Rudd until he began to kind of fall apart, looked like a Prime Minister. 

Malcolm Turnbull, now there’s a man who looked like a Prime Minister and I think quite a bit of that initial enthusiasm for him was around the sense that this guy was Prime Ministerial.  It is not Prime Ministerial to spend day after day drinking beer at the races and I think the public is completely tired of those television sequences where our leaders get around in high-vis vests inspecting factories.  Morrison, by the way, has personalised high-vis vests, which kind of undercuts the democratic appeal of the vest a bit because it says, “The Hon. Scott Morrison” across the front. 

And he’s turned himself into ScoMo as well.

DM:  Oh, and ScoMo – and that name will evolve I suppose in the next few months while it’s still got some life.  But the looking like a Prime Minister, this intangible thing of inhabiting the role is also of course a problem that Bill Shorten faces.  He looks like a Premier, he doesn’t look like a Prime Minister.  Though I think his stature just slowly grows all the time.  I think ScoMo, the beer-scoffing bloke is a pretty dreadful image of a man that’s grasping at what he can.  

The other thing that Morrison has to do, I guess, is reconcile the moderate and extreme right factions of his party.  How do you think that’s going?  I’m particularly thinking – I think that there’s a blue coming up over Craig Kelly.

DM:  I reckon this is probably one of the key underlying political problems in this country.  The Coalition is highly factionalised, it’s a mess, the factions are at each other’s throats.  That’s usually the Labor situation.  Shorten has made sure it’s not.  Labor has never been more disciplined for decades than it is at the moment.  These conservatives within the Coalition, determined to impose a kind of policy purity on the party, regardless of the polls – I mean, they can read polls, they know what the polling is. 

The polling on Dutton in his own seat at a time when they were putting him forward as the saviour of the country.  That polling was diabolical for Dutton in his own seat.  The polls don’t seem to matter, which is kind of edging me to a strange situation of starting to look at these people as a bit like a cult within the liberal party.  Because they just don’t seem to be amenable to the ordinary political processes and unless the Liberals can become a party that actually represents conservative Australia, the real mainstream – to use a John Howard word – of conservative Australia, it’s just doomed and they don’t seem to care. 

The conservatives in there don’t seem to care.  They seem to have this notion that if they can only get the settings right, then we’ll power forward.  But where’s the evidence for that?

And speaking of conservative cults, what do you make of Mark Latham joining One Nation?

DM:  As tragic a fall from political respectability as I think I’ve seen in my 40 or so years as a journalist.  The One Nation Party is an openly racist party which plays on the fears of a small number of Australians to wedge its way into politics, and here is a man who once led the Labor Party, is going to fight an election, albeit for the Legislative Council in New South Wales, but he’s going to fight an election under their banner.  It’s tragic.  It’s a personal tragedy, but politically it’s just so shabby.  But he’ll get up.  You don’t have to be particularly well-known, you only need somewhere between 3% and 4.5% of the vote and you’ll get yourself a seat in the Legislative Council. 

He’ll do that, but I don’t reckon the marriage of One Nation will last far beyond him finding a seat.  That will be under his bum for eight years – eight years in New South Wales Upper House.  But what a shabby gambit, what a terrible outcome for him!

Well, I guess it’s a living though.

DM:  Ha!  It will be a living, and what’s more it will give him something else, it will give him parliamentary privilege to sound off with perfect safety against all of his enemies real and imagined, with the eloquent venom that’s part of the Latham brand.  He will be safe there, well-paid there and there’s not much work you have to do.

That’s right.  David, I can’t let you go without getting your reaction to the US mid-term elections?

DM:  Well, I think Trump’s done pretty well.  I mean, compared to the seat loss of Barrack Obama, he’s lost a bit of paint and of course he’s lost control and there are big problems for him that he might face there but all of those people – and I’m not one of them – who’ve been saying for years, he will inevitably become a cropper because he’s just such a bizarre figure and he’s just so insulting and he lies so much, all that kind of thing.  He has not come a huge cropper and he celebrated that, you will have seen by him firing his Attorney General.  Jeff Sessions has now been fired.  The most interesting run probably over the next year or so is going to be whether the House of Representatives sets out to impeach the man – a lot of drama, and, Alan, it will sell a lot of newspapers!

That’s true!  It’s good news.  Do you think we should tie together what’s going on in America with what’s going on here in terms of the problems on the right of Australian politics?

DM:  Look, yes and no.  There are lots of similarities of course, but look at the numbers and the numbers are crucial.  The United States, Trump has just got a hefty proportion of the country voting for him.  I don’t know what the exact figure is but it must be well over 30% - pushing 40%.  Pauline Hanson polls 6%.  Our politics is in much better shape than the politics of the United States for all its problems, the politics of the United States, of Britain and many countries in Europe – Pauline Hanson, who fancies herself as some ‘Donald Downunder’, she’s getting 6%, in some electorates she’s getting more, but she’s getting 6%.  Those native angry xenophobic movements in other countries, they’re getting 25, 30, 40%.  We are in better shape than them.

Thanks very much, David.  Great to talk to you.

DM:  Pleasure, Alan.  All the best.

[Music]

Happy Birthday Joni Mitchell, who turned 75 yesterday, and yes, I could drink a case of her and still be on my feet.

[Music]

That’s all from me, have a great week!

Hello, I’m Alan Kohler, welcome to Talking Finance.  This week, Shane Oliver now thinks Sydney and Melbourne house prices will fall 20%, which would make it the biggest decline since the 70s and a big deal.  It might even mean the next interest rate move is down, not up.  That’s our lead item today.  Also, Tim Lawless of CoreLogic tells us what happened to prices in October and he reports that the decline is in fact, accelerating.  Kyle Rodda, Market Analyst at IG, explains why the US market went up last night after the mid-term election.  And, David Marr, Columnist for the Guardian, tells us about ScoMo – PM.

[Music]

Here’s Shane Oliver, Chief Economist at AMP Capital.  Shane, the Reserve Bank left interest rates on hold this week, as expected.  When the statement of monetary policy comes out tomorrow, what will you be looking for in that?  

SO:  The first thing I will be looking at will be the forecasts which are towards the back of the statement.  The reason I’ll be looking at that is because it’s a guide to how the Reserve Bank is seeing the economy, and the indications are that the Reserve Bank is starting to get a bit more upbeat about things, that they’re going to be revising their economic growth forecasts up for this year and next year, revising their unemployment rate down, probably to 4.75%.  Also, pushing up their inflation forecast a little bit for 2020.  They’ll be the things that I’ll be looking at and of course the commentary around that to see how strongly the Reserve Bank holds those views.  To me, that’s going to be the main focus.

If those things happen as you expect, will that lead to the markets changing their pricing for interest rates next year?  

SO:  It’s quite possible that if the forecasts are indeed upgraded and the commentary is more positive, then the market may increase the chance of a rate hike and increase the projected profile for interest rates.  I must admit, I’m a little bit sceptical because, yes, there are reasons for optimism on the economy, reasons to indicate that growth will continue, but I think the Reserve Bank to some degree is underestimating the negative wealth effect that will come from falling house prices and also the risks around the Chinese economy.  So, yes, I think we’ll see the normal kneejerk reaction in markets.  To some degree, you might argue we’ve seen a little bit of that.  The Aussie dollar’s got to its highest level in two months, partly on the indications that the Reserve Bank will upgrade its forecasts.

But my feeling at the end of the day is that growth will ultimately remain pretty constrained and as we go into 2019, I actually think growth will be more around the 2.5% to 3% level rather than around 3.5%.  I’m not quite as upbeat as the Reserve Bank is.  I think the Reserve Bank does rightly point out there’s bits of the economy that are doing pretty well and that’s why we’re not going to go plunging into a recession as many people like to tell us.  But by the same token, I think they’re probably just a little bit too optimistic, particularly with the housing downturn unfolding.  

Are you starting to get worried about the housing market?

SO:  The housing market does worry me.  I guess we’ve been hearing warnings about the housing market for many years, like the boy who cried wolf!  These rash predictions… In fact, I’ve been monitoring them ever since about 2004 when The Economist magazine referred to Australia as being America’s ugly sister, and the OECD and the IMF at the time were talking about house prices being 50% overvalued in Australia.  But of course, we’ve seen several occasions where the market just comes down 5%, 7%, prices come off and then of course, the Reserve Bank cuts interest rates and the housing market takes off again.  This time around, I think it’s a little bit different, which is why I’m a little bit more worried. 

Firstly, the overvaluation reached perhaps more extreme levels, particularly relative to people’s incomes.  It came with record levels of household debt and of course there had been some deterioration in the lending standards the banks had been employing and that there’d been very rapid growth in lending to interest only borrowers.  Of course, they’re now being told to switch back to principal and interest.  So, the risks going into this I think are greater and then of course, in the last year or so you’ve seen the banks tightening their lending standards, making it harder for people to get loans. 

Quite severe checks on income levels and expense levels and more importantly, as we go into next year with the start up of comprehensive credit reporting, banks will have access to any loans that you might have from competitors.  If you’ve got multiple loans across Westpac and ANZ and everybody else, then they might say, “Well this is taking your debt to income level to an area where we regard that as too risky and we’ll deny your ability to refinance or force you to finance with someone else.”  That, I think, will create problems for the property market.  On top of that, we’ve got the prospect of a change of government which is promising changes to negative gearing and capital gains tax, which will make life or investing in property less attractive for investors.

All of those things suggest that the risks are certainly greater than normal for the property markets and we’re expecting prices to fall 20%.  I must admit, looking at the auction clearance rates over the last weekend, I know Melbourne was distorted by the Melbourne Cup coming up on the Tuesday, but those auction clearance rates were, I think, indicating we’re starting to push below 40%, which could be consistent with an acceleration in the rate of decline in house prices.  The short answer is, yes, I am getting concerned about the decline in the property markets in Sydney and Melbourne, and therefore if I’m worried about that I have to be concerned about the impact on people’s perception of their wealth and the flow on of that to consumer spending.  

But, 20%, Shane, what are you talking about?  Are you talking about national price or Sydney and Melbourne only…?  And if so, what does 20% mean, is that recession territory?

SO:  20% that I’m looking at is a top to bottom fall in Sydney and Melbourne.  Nationally, that’ll be 10%.  The other capital cities haven’t had the boom, so they’re not going to have the bust and you could argue, well Perth and Darwin have been falling for several years no, so if anything, they’re getting close to the bottom.  It’s a fairly benign story I think for other capital cities, but they are vulnerable to some degree as credit conditions tighten.  But my numbers, top to bottom, 10% nation-wide, Sydney and Melbourne 20%.  That 20% fall, part of it’s already occurred.  Sydney has offered about 8% from its highs.  Melbourne is 4% or 5% down from its highs but there’s obviously quite a lot more to go and it will unfold over the next couple of years, which I think will start to impact expectations. 

The price falls that we saw in Sydney, say around 2005 and then nation-wide around 2008 and 2012, they were short-lived.  By the time anyone realised that prices were coming off much, prices were starting to pick up again as interest rates came down.  This time around I think it will drag on for longer and therefore, start to affect expectations.  Would I call it a crash?  Probably not.  I think to get a crash you’d probably need a bigger price fall and for that to be spread nation-wide.  I don’t think it’s enough to bring down the economy, but it will have a dampening impact on the economy.  Of course, if the Reserve Bank raises interest rates prematurely or unemployment were to go up, then it will make things a lot tougher.  That could turn the falls that I’m looking at into a crash scenario, accelerating on the downside and before you know it, we’re down 30%.  But I’m hopeful that that won’t happen.  I don’t see the Reserve Bank raising interest rates any time soon and the labour market story so far has been reasonably positive. 

But I think it is going to be a much tougher environment than we’ve seen for housing over many years.  In fact, to get anything comparable, you’ve got to go way back.  I mean, we’ve been pretty lucky in Australia that price declines have been pretty mild.  The data we have that’s reliable really only goes back to the 1980s, so it’ll be worse than anything we’ve seen since the 1980s.  In real terms it might be comparable to what happened in the 1970s where for a while there prices went sideways but inflation was very high and so prices did come down in real terms.  The bottom line is, I think it’s going to be a pretty tough environment for home owners as they see their prices come down over the next couple of years.

Surely, the scenario you’re painting is one in which the Reserve Bank cuts interest rates rather than raises them?

SO:  That’s the big thing here.  I’ve been of the view that a rate hike is unlikely until late-2020 at the earliest, but I’ve recently been sort of shifting that view a little bit and sort of educated view that the next move could indeed be a cut.  Now, I must admit, if I read the Reserve Bank’s commentary recently, the fact that they revised their growth forecasts up, the fact that we have seen unemployment fall to 5%.  All of those things tell me the Reserve Bank at this point in time is a long way from considering cutting interest rates.  The scenario would unfold that prices come down, that starts to affect consumer spending, that keeps inflation lower for longer and the Reserve Bank starts to realise there’s a threat to ever meeting its inflation target, so in a year’s time or so, then they start cutting interest rates. 

That’s how that could unfold but at this point in time we’re a long way from that.  The Reserve Bank, I think, will just continue to reiterate that they still believe for the time being anyway, that the next move is more likely to be up than down.  But they’ll also probably say that right now there’s no need to move.  

Good to talk to you, Shane, thank you.

SO:  Thanks, Alan.

[Music]

Well, it’s the start of the month and that means it’s time to talk to Tim Lawless about last month’s house prices.  Tim Lawless is the Head of Research at CoreLogic.  Tim, the coverage of the October house price moves was generally along the lines that price declines were accelerating, but just looking at the per month declines, they’ve been 0.7% in Melbourne and Sydney per month for a while now.  Do you think it’s true that price declines are accelerating?

TL:  I think there’s two ways to look at this.  In one sense, we have seen some acceleration and declines over the second half of 2018.  If you look at just Sydney and Melbourne specifically over the first two quarters of this year, the values are generally falling at about 1% to 1.5%.  If we look at the movement in Melbourne, with the most recent three months or really since June we’ve seen that rolling quarterly rate of decline has picked up to around about 2% to 2.1% or so – a little bit higher in Melbourne now actually, so if anything it’s Melbourne that has accelerated in its decline.  But maybe a better way to describe this is, this downturn is becoming more broad-based now.  We are seeing the lower end of the marketplace showing some cracks at the lower values of properties, which was generally more resilient.  And we’re also starting to see regional markets slowing down, although generally still seeing some level of growth.  We have seen some momentum come out of the market.

Are you changing your view about the potential extent of the declines?

TL:  I think progressively as we see the market becoming a bit more broad-based in its downturn and we do see some of the more segments of the market that have been more resilient like the more affordable quartile, is showing some cracks now as well.  Then yeah, I think we probably are finetuning our outlook on the market.  Originally, we were looking at Sydney values, for example, down around 10% from the market peak through to the trough.  We’ve already seen Sydney values fall by 8.2% since they peaked back in July 2017.  A 10% decline at the moment in Sydney is looking quite optimistic and more realistically, probably more along the lines of say, 15%, if not a bit more than that.

Overall, do you think we’re looking at something greater than previous declines in house prices?

TL:  If you look at the previous downturns in some of our strongest markets, Sydney and Melbourne, once again, just focusing on these two markets, typically the largest downturn that we’ve seen historically for example in Sydney was back in the late 80s, early 90s.  And we saw dwelling values in Sydney fall by nearly 10% from peak to trough, debt go down by 9.6% over about two years.  Sydney is already about a year and a half into its downturn and we’ve seen values fall by 8.2%.  It does look like this downturn is going to be more substantial and potentially longer lasted than what we’ve seen historically.  That kind of comes back to the reasons or the fatness behind this downturn being very different as well.  This is very much a regulatory fuelled credit availability fuelled downturn rather than changes in interest rates or economic conditions.  

What impact do you think is it going to have on the broader economy?

TL:  When you look at housing markets, there is a real multiplier effect here as well as a wealth effect which is now in reverse.  The markets in a decent upswing, you see more sales transactions.  That obviously has flowed through to retail.  You see more people buying whitegoods and appliances, home furnishings and so forth, you see state governments getting their stamp duty revenue.  You see a lot of transactions around the property sale as well.  Real estate agents get the commission and banks write more mortgages and building and pest inspections and so forth.  There’s obviously seeing that in reverse now, particularly around state government stamp duty revenues.

But also, you can look at the wealth effect.  During the upswing of a housing market you see households generally very confident.  They’re basking in the capital gains.  They’ve seen good equity behind them which gives them confidence to make high commitment decisions.  But as the housing market starts to move into the downturn which we’re seeing at the moment, then we probably will see some reversal in that wealth effect and potentially a swing back to more saving, which we see in the household saving ratio back to where it was around the time of 2008 or a bit earlier.  That will probably bounce back a little bit higher.

Well, thanks very much, Tim.  Good to talk to you again.

TL:  Thanks very much, Alan, cheers.

[Music]

And now let’s hear from Kyle Rodda, the Market Analyst at IG Markets.  The US market went up a lot last night, is that because the Democrats won the House or because the Republicans won the Senate?

KR:  Well, I think it’s because it went all as expected, more or less.  I think in the markets there is a truism and I think it played out last night that often the expected outcome is the best outcome.  What we saw was what we had priced in and the real volatility came when, for a few moments there it looked like we were going to see some sort of red wave through the House of Representatives and the markets went into a little bit of a frenzy when it happened.  But low and behold, the pollsters were right this time around, we got what we expected and now we can focus on challenges going forward and other things and taking that risk off the table.  As a result, we saw a bit of a relief to the risk rally and that heightened risk appetite saw obviously the markets post some pretty solid gains in US stocks.  More or less, that looks like it’s going to carry through to the Australian session or the Asian session too.

But you would think, Kyle, if the markets had priced in what actually happened, then they wouldn’t move that much, but 2.6% on the Nasdaq, 2.1% on the S&P 500, those are quite big moves.

KR:  Yeah, they are.  My view is that you take risk off the table in these sorts of situations and particularly considering that 2016 really does ring still very much in the ears of many traders.  You never really want to overcommit yourself to a particular position, but I think the fact that we saw what we were expecting meant that traders felt comfortable on the back of that to be able to jump back into the market, re-establish positions and equities away from other safer assets, cash in particular, potentially, and put that to work a little bit more in equities whereas prior to the release, you’d want to see more of an outcome for certain before making that sort of a commitment. 

But because we did see what we were expecting, markets didn’t have to worry about any additional information, so they could get straight back on with basically moving forward and getting back into the market to try and put some money to work.  

The US market has now recovered a bit more than half of that October correction.  Do you think it’ll regain the September peak again?

KR:  The September peak?  I’d be reasonably sceptical.  I think there’s quite solid headwinds in terms of this and issues that were driving markets back then or throughout October and that’s what’s going to happen with interest rates in particular, and we’ve got the FOMC tonight which will be illustrative.  Also, the trade war, which we get speckles of positive developments there but it still hasn’t really come close to resolving itself yet.  To see new highs in this market would be quite extraordinary I think on that basis because those stories are going to continue to unfold and weigh on the market.  I do think though that we are in for a period and I think that higher action last night really affirmed this, that the October rout is probably behind us now, we’ve reversed that particular trade, if you will.  It does mean that seasonality will start to kick in from here, November and December tend to be fairly strong for equities, and we could see a push higher.  If we get to record highs again in US markets.  Again, I’d be fairly sceptical just on the basis of the fundamentals.  But there’s certainly interest for some upside from at least where we are from here, and some reasonable confidence that at least the worst of what happened in October is now behind us and you can start looking forward to some future gains.  I still think it’ll take something remarkable to get to new all-time highs again.

We can certainly conclude, can’t we, that October was a correction, not a crash, and certainly not the start of a bear market?

KR:  Yeah, definitely.  And again, ballooning back to what we saw last night, and if you’d watched the ASX today too, this 5930 level is a bit of a cross roads for me to indicate potentially that we’re out of the woods on that one.  But it’s certainly now looking like a correction and I think when you look at it sensibly, I think this is a great stat to come out of these sorts of situations is that, true definitive bear markets it tends to happen at around the times of economic recession.  If you look at what happened in ‘07/’08 and you go a little further back around the Dot-com bust, it did coincide with a period of economic flatness.  We have very robust fundamentals across the globe, really. 

I mean, obviously there is a little bit of a diversion to the global growth story, but Europe’s better than what it was.  The Australian economy, if you want to look locally, is in a pretty good state if you believe the RBA, and the US economy is still humming.  I think, on that basis, I think you can definitely see it as a correction, brought about too by the same risks that won’t go away, which is changing interest rate settings.  And that will continue to cause volatility in the markets as liquidity is chucked out of the system.  But in terms of whether that really points to a definitive bear market, I think you’d have to be very much on the extreme side of the equation to make that suggestion. 

Yes, there’ll be headwinds going forward.  Yes, there’ll be more volatility as rate settings change, but it does seem like what we saw in October is a clean out and investors are taking the opportunity to readjust now and move forwards to putting their cash back to work with a heightened risk appetite.  

Good on you Kyle, thanks very much.

KR:  My pleasure, thank you for having me.

[Music]

[Parliament audio clip]

And now one of my favourite political commentators, David Marr from The Guardian.  David, how do you think Scott Morrison is going with his ‘ocker bloke’ schtick?

DM:  Not well.  It’s going to appeal to some people of course, but I don’t think it really has much general appeal in Australia.  I think Australians like a Prime Minister to look like and sound like a Prime Minister.  It’s something that goes way back with us.  I think one of the reasons people warmed so immediately to Kevin Rudd was, here was a Labor man who looked like a Prime Minister.  Part of that judgement is, how will people abroad think of our man or woman, and Rudd until he began to kind of fall apart, looked like a Prime Minister. 

Malcolm Turnbull, now there’s a man who looked like a Prime Minister and I think quite a bit of that initial enthusiasm for him was around the sense that this guy was Prime Ministerial.  It is not Prime Ministerial to spend day after day drinking beer at the races and I think the public is completely tired of those television sequences where our leaders get around in high-vis vests inspecting factories.  Morrison, by the way, has personalised high-vis vests, which kind of undercuts the democratic appeal of the vest a bit because it says, “The Hon. Scott Morrison” across the front. 

And he’s turned himself into ScoMo as well.

DM:  Oh, and ScoMo – and that name will evolve I suppose in the next few months while it’s still got some life.  But the looking like a Prime Minister, this intangible thing of inhabiting the role is also of course a problem that Bill Shorten faces.  He looks like a Premier, he doesn’t look like a Prime Minister.  Though I think his stature just slowly grows all the time.  I think ScoMo, the beer-scoffing bloke is a pretty dreadful image of a man that’s grasping at what he can.  

The other thing that Morrison has to do, I guess, is reconcile the moderate and extreme right factions of his party.  How do you think that’s going?  I’m particularly thinking – I think that there’s a blue coming up over Craig Kelly.

DM:  I reckon this is probably one of the key underlying political problems in this country.  The Coalition is highly factionalised, it’s a mess, the factions are at each other’s throats.  That’s usually the Labor situation.  Shorten has made sure it’s not.  Labor has never been more disciplined for decades than it is at the moment.  These conservatives within the Coalition, determined to impose a kind of policy purity on the party, regardless of the polls – I mean, they can read polls, they know what the polling is. 

The polling on Dutton in his own seat at a time when they were putting him forward as the saviour of the country.  That polling was diabolical for Dutton in his own seat.  The polls don’t seem to matter, which is kind of edging me to a strange situation of starting to look at these people as a bit like a cult within the liberal party.  Because they just don’t seem to be amenable to the ordinary political processes and unless the Liberals can become a party that actually represents conservative Australia, the real mainstream – to use a John Howard word – of conservative Australia, it’s just doomed and they don’t seem to care. 

The conservatives in there don’t seem to care.  They seem to have this notion that if they can only get the settings right, then we’ll power forward.  But where’s the evidence for that?

And speaking of conservative cults, what do you make of Mark Latham joining One Nation?

DM:  As tragic a fall from political respectability as I think I’ve seen in my 40 or so years as a journalist.  The One Nation Party is an openly racist party which plays on the fears of a small number of Australians to wedge its way into politics, and here is a man who once led the Labor Party, is going to fight an election, albeit for the Legislative Council in New South Wales, but he’s going to fight an election under their banner.  It’s tragic.  It’s a personal tragedy, but politically it’s just so shabby.  But he’ll get up.  You don’t have to be particularly well-known, you only need somewhere between 3% and 4.5% of the vote and you’ll get yourself a seat in the Legislative Council. 

He’ll do that, but I don’t reckon the marriage of One Nation will last far beyond him finding a seat.  That will be under his bum for eight years – eight years in New South Wales Upper House.  But what a shabby gambit, what a terrible outcome for him!

Well, I guess it’s a living though.

DM:  Ha!  It will be a living, and what’s more it will give him something else, it will give him parliamentary privilege to sound off with perfect safety against all of his enemies real and imagined, with the eloquent venom that’s part of the Latham brand.  He will be safe there, well-paid there and there’s not much work you have to do.

That’s right.  David, I can’t let you go without getting your reaction to the US mid-term elections?

DM:  Well, I think Trump’s done pretty well.  I mean, compared to the seat loss of Barrack Obama, he’s lost a bit of paint and of course he’s lost control and there are big problems for him that he might face there but all of those people – and I’m not one of them – who’ve been saying for years, he will inevitably become a cropper because he’s just such a bizarre figure and he’s just so insulting and he lies so much, all that kind of thing.  He has not come a huge cropper and he celebrated that, you will have seen by him firing his Attorney General.  Jeff Sessions has now been fired.  The most interesting run probably over the next year or so is going to be whether the House of Representatives sets out to impeach the man – a lot of drama, and, Alan, it will sell a lot of newspapers!

That’s true!  It’s good news.  Do you think we should tie together what’s going on in America with what’s going on here in terms of the problems on the right of Australian politics?

DM:  Look, yes and no.  There are lots of similarities of course, but look at the numbers and the numbers are crucial.  The United States, Trump has just got a hefty proportion of the country voting for him.  I don’t know what the exact figure is but it must be well over 30% - pushing 40%.  Pauline Hanson polls 6%.  Our politics is in much better shape than the politics of the United States for all its problems, the politics of the United States, of Britain and many countries in Europe – Pauline Hanson, who fancies herself as some ‘Donald Downunder’, she’s getting 6%, in some electorates she’s getting more, but she’s getting 6%.  Those native angry xenophobic movements in other countries, they’re getting 25, 30, 40%.  We are in better shape than them.

Thanks very much, David.  Great to talk to you.

DM:  Pleasure, Alan.  All the best.

[Music]

Happy Birthday Joni Mitchell, who turned 75 yesterday, and yes, I could drink a case of her and still be on my feet.

[Music]

That’s all from me, have a great week!