The banking royal commission's economic impact

[Music]

Hello and welcome to Talking Finance, I’m Alan Kohler.  This week of course it’s all about the banking Royal Commission, so to discuss the effects of that on the economy, on markets and politics, we’ve got Warren Hogan, the Industry Professor at UTS, Evan Lucas, Chief Market Strategist at InvestSMART and Michelle Grattan, Chief Political Correspondent for The Conversation, and of course there are other things going on as well so they’re talking about those things.  Also, we’ve got Tim Lawless, Head of Research at CoreLogic Asia Pacific to take us through the latest movements in house prices and where they’re going from here.

Listen to the podcast or read the full transcript below:

Now for his thoughts on the economy, here’s Warren Hogan, Industry Professor at UTS in Sydney.  Warren, what did you think of the Reserve Bank on Tuesday putting out a monetary policy statement in which the tightening bias was retained and the next day the Governor makes a speech in which he explicitly removes the tightening bias, what did you think of that?

Yeah, it was interesting.  I mean, it obviously caused a bit of volatility in the markets, but I think the point of the statement after the meeting was to continue on a path that expects the economy to expand, and therefore there’s no significant change in the short-term policy view.  In the speech of course, they have really outlined that a much weaker scenario could play out and is right in the middle of their thinking.  This is a case of procedure and structure to the way the RBA communicates versus the market’s need and often demand for uber-transparency.

Having read the speech, what’s your view now of interest rates in Australia?

I don’t think you can have a view, really.  I mean, you can have a punt.  Because I think the Governor’s got it right and the RBA – really, it’s quite an unusual way to go about it to say there’s two equally probable scenarios, quite a binary view of the world, but I think that’s right.  I think we either get the forces that are going to cause the economy to slow significantly start to play out in the next three or four months and that’ll be all related to housing and consumer spending and that’s seeping out into the business community and retrenchment of investment intentions and this sort of thing.  That could look like a recession and that could generate significant amounts of rate cuts in the next 12 months. 

But if we don’t reach that tipping point, if the economy does ride out this adjustment in what is essentially just a Sydney and Melbourne property market, then we may see the cash rate unchanged for another 12 or 24 months and of course we have the world economy doing all right through the next year or two, we could see a rate hike.  I think that’s the game plan and if you want to see a move in interest rates I think you’re more likely to get a cut in the next six to nine months and that’s going to be all about how the housing market performs and how the consumer responds in the next 3-4 months.  The next 3-4 months will be critical in my view. 

Do you think the Royal Commission will have an economic impact?

I don’t.  I think it already has.  I think the banks have already responded to the responsible lending issues that were raised in the first couple of hearings which is now sort of 9-10 months ago, and tightened up their lending standards, which the Governor of course noted in his speech.  There’s nothing in the final report which will give that more impetus, I would say.  I’d say the Royal Commission, you can sort of lay that to rest in terms of its macroeconomic effects.  The clear implication of that Royal Commission is that the people responsible for the misconduct now need to be pursued by the authorities and potentially through the courts.

One of the charts with the Governor’s speech on Wednesday showed their GDP forecasts, peaking at 3% this year and then declining again…

Yes.

Do you go along with that?  I mean, that suggests firstly that GDP growth is about to peak, secondly, that the peak is lower than the previous peak, which in turn was lower than the previous peak before that, and before that.  I was looking at the graph – for the past 20 years, every GDP peak has been below the last one.

Yes, and I think that’s going to continue.  I think we’re seeing this play out in places like Japan and Europe and we’re sort of headed in that direction whereby you have a lot less volatility in your economy, but you do get a lot of growth and that’s related to high debt levels, that’s related to demographics, and I think it’s also related to the emergence of the zombie economic entity.  In this post crisis world where there is absolutely zero appetite to try and put any financial pressure on the economy through tighter monetary policy – and this is in the United States, Europe, Australia – we’re seeing whole chunks of the business community operating simply because their funding costs are low.  I think the BIS estimates, it’s something like 12% of the world’s firms are zombie firms, and this isn’t just places like China or the emerging markets, this is The United States and Europe and I’d say here in Australia too.

When you don’t have that sort of cleansing of the system, then you get a very inefficient use of capital.  Add onto that that we’ve got these global tensions where the cost of security, the cost of protecting against this increased geopolitical tension is also acting as a headwind to productivity and performance of the economy and I just see a period for a number of years, if not a decade, where growth in this country is going to be doing really well to get to 2-3% and will probably average something more like 2%.  I think this will continue.

Great, good on you, Warren, thanks very much.

[Music]

And now to bring us up to date on the markets, here’s Chief Market Strategist at InvestSMART, Evan Lucas.  Evan, there’s been a fair bit of action from central banks lately, firstly for the Fed in the US and the Reserve Bank this week in Australia.  What sort of impact have those things had on the share market?

Yeah, I think that’s a really good place to start because we always talk about central banks and what they do from an economic point of view.  What it’s done for the market also has been actually seen as a real positive.  The best way to look at it is if we probably start with the first part of your question around what’s happened over in the Fed.  You can make the argument and I think it’s a fair argument that probably the US markets have almost forced the Fed’s hand to back away from its hiking strategy.  If you have a look, the Fed is very, very good at communicating what it thinks.  Every member has to put out on what we call a dot-plot, what they think where rates will be. 

If you look at what happened in December to where they are now, they’ve dropped right back.  If you look at market pricing, the market’s actually expecting that rates may go up one more time this year, but could actually be cut in 2020 or 21.  That therefore, the reason that’s so interesting from an equity perspective is that what has been causing particularly the angst through October to December, was that financial conditions globally were getting tight and therefore the pressure on balance sheets, the pressure on revenue, the consumer consumption story, all of that has been the macro picture that’s really hit equity markets quite hard. 

There’s no argument that equity markets particularly in the states have had a bull market, an unloved bull market at that, but they have been driven up.  Maybe the pull-back was also just fired in a little bit of healthy movement in markets that way, but the relaxation of their hiking strategy has certainly helped US markets.  January’s actually been the best start to a year in the States since 1967 and as we speak we’ve just snapped out of a five-day winning streak in the States, but in the main they are still continuing to move up quite nicely – and they’re only 2.5% away from recapturing where they were back on October 5^th when this all started.  Now, that’s not a record all-time high but it’s close to, so the States have moved quite nicely.

I note that Janet Yellen said last night that the next move by the Fed could be a cut.  If that happens, the markets will take off wouldn’t they?

Yeah, they absolutely would, and not only that, the other interesting thing that she’s probably been saying for about a month and a half is that they’re probably at what we refer to as the neutral cash rate, where it’s perfectly, evenly balanced, and yes, it would take off.  If you saw US interest rates being cut, so the federal funds rate dropping down, that would really see a bit of a rock and particularly under stocks that have been the most savaged in this period.  If you look at discretionary earners over in the states.  If you look at also some of the banks like Wells Fargo for instance have had a fairly volatile period over this time with the impact of those tightening financial conditions.  All of that would be a big positive.  I’m not sure you can see it yet because the caveat to all of this is that US growth through all of this has actually held up pretty well and again, the other caveat to that is that not including what happened with the US Federal Government shutdown, there is clear arguments the 1Q will be affected, but US equity markets are doing quite well because the next part of that is we are going through their quarterly earnings cycle and having a look at it, it’s weaker.  Earnings growth has dropped down ever so slightly, but if you look at if from the point of view of EPS growth beating consensus, at the moment – and we’ve still got a little way to go – but at the moment about 71% of companies have beaten expectations.  That also has certainly helped.  Expectations were pretty low leading into this earnings season in the states.  

What about in Australia, the earnings season here, is it on balance, positive or negative?

Very, very early days.  On balance it’s neural.  Now, what I’ll point very clearly, analysts here have been just as hard on Australian equities as they have been in the states.  The expectation, as the overall ASX 200, they had downgraded earnings expectations by 1.1%.  They downgraded net profit expectations by about 3%.  Pessimism is reigning, I can’t deny that at all.  Possibly the ability to beat might be a little bit easier and therefore the fact that we have had a fairly tumultuous period too – we’ve been caught up with it.  The ASX is dominated by financial services and we know what happened with the banking Royal Commission and although it was tough, maybe not as tough as the market had been pricing and that explains what happened on Monday. 

But also that the impact on some financial services may not be as hard as first forecast and therefore an okay number and an outlook statement that suggests they can get through the changes would probably also help the ASX considering that’s 45% of the market.

Thanks, Evan.

Thanks, Alan.

[Music]

As always, there’s a bit going on in politics.  To discuss that, here’s Michelle Grattan, the Chief Political Correspondent at The Conversation.  Michelle, two things to talk about the politics of the Royal Commission and the Phelps Bill on Medical Evacuations of Asylum Seekers.  If we can just start with the second one.  I’ve read the Phelps Bill, it looks pretty straightforward to me, sure if somebody needs medical attention, they can’t get on Nauru or Manus Island, they should be brought to Australia.  But apparently, according to The Australian this morning, ASIO has advised the government that it’s a threat to national security.  Where do things stand with that?

I think this shows that the government really is pulling out all stops to try and avoid a defeat in the House next week.  It tried the softly, softly approach earlier in the week when, also through The Australian, it announced that it would set up a medical committee to review cases.  Now, it’s brought a bigger weapon to its cause with this ASIO advice.  It’s very bad, I think, for ASIO that the government’s done this, just as a side point.  People feared when ASIO was put under the Department of Home Affairs that it would be used politically, and this is an example.

On the issue itself, I think that the government is totally overestimating any dangers in this Bill.  There are provisions for the Minister to intervene on security grounds.  The government says that the definition of ‘security’ which ironically comes from the ASIO legislation, wouldn’t stop criminals coming in.  If criminals did get through the net, and remember most of these people are refugees, so they wouldn’t have got that status if they had serious criminal backgrounds, but if anyone did go through the net they’re detained automatically when they come to Australia anyway.  They can only be let into the community with the Minister’s permission, so there are plenty of safeguards there.

One way to avoid being defeated on the floor of the House over this Bill would be to vote for it.  Why don’t they just do that?

Well, of course, that would be a total going back on everything they’ve said and would be very embarrassing in itself.  They’ve really drawn the line in the sand on this, but it’s also interesting to note that Scott Morrison has made it clear this week that they’re not in any sense taking this as a matter of confidence, which of course, it’s not, but it’s not going to lead to a premature election.  There’s started to be speculation that that could happen and he wanted to cut that off.  But the importance of this Bill and the importance of trying to avoid a defeat is just so very obvious in the level of intensity the government is bringing to its lobbying.

Yeah, so in the end it doesn’t matter really.  Whether it gets defeated or not the election will still happen in May, as it was always going to?

Well that’s right and remember that the government has a budget on April 2 which is designed to frame that election, so running off to a premature election would be a disaster.

What about the Royal Commission, obviously the Labor Party is trying to attack them on having voted against it 26 times.  Morrison is sort of saying, well yes, but at least we did appoint it.  Where do you think they stand on the politics of that?

I think this is interesting.  Of course, people have been saying this will be a big issue in the election.  I have my doubts about that.  I think that obviously the government has taken a big hit on this already over quite a long period because it did vote against it so many times, because it did hang out against appointing a Royal Commission, when clearly the evidence has showed that one was needed but nevertheless now that’s all factored in.  Basically, both the government and Labor are leaving themselves a bit of wriggle room both embracing the recommendations by and large.  There’s a slight difference, of course, on the question of who pays mortgage brokers but I think in the end the people will see a fairly united approach on what to do and will really probably move on to other issues.

Now one thing that Labor is trying to do is get the numbers to pass the motion saying parliament should be recalled to sit a couple of extra times so that they can deal with legislation out of the Royal Commission.  But I don’t know how that’s going to go in the House.  It will depend on Bob Katter, who’s totally unpredictable on everything, but I think that there is a strong argument for saying, well, that’s not a very good course because this is complicated legislation to draft, there would be no time and it’s something that is best left ‘til after the election.

Great, Michelle, thanks very much.

[Music]

And now our monthly look at the housing market, here’s Tim Lawless, the Head of Research CoreLogic.  Tim, the housing market is playing out as you predicted, another 1.6% down in Melbourne in January another 1.3% in Sydney.  What you’re reporting is that peak to trough, Sydney is down 14.6% I think, Melbourne is 13.8%.  I suppose the question is, does it feel to you like there’s another 5% left in these markets or are we nearing the trough?

Put it this way, Alan, we’re not seeing any turnaround in the market just yet.  In fact, if anything, we’re seeing some momentum gathering in this downturn.  The last three months up to the end of January were the largest falls we’ve seen in Sydney and Melbourne on a rolling three-month basis, since the series kicked off back in 1980.  Sydney values were down by 4.5% over the three months ending January, and Melbourne was down by 4% and it looks like the market is really gathering some pace here on the back of very tight finance as well as some growing negative sentiment in the market place and potentially as we approach the election, that could potentially grow.

That suggests the answer is yes, that there is more to go, that’s what you seem to be saying?

Short answer, absolutely and our view on the market in terms of how far we think there is to go in Sydney and Melbourne is probably by at least 18-20%.  As you mentioned considering Melbourne’s down by nearly 9% now, Sydney is down by close to 13% since the market peaked, getting to see an 18-20% decline isn’t really that far off when you consider the trajectory of decline is quite steep at the moment.

What’s your sense of the impact of the Royal Commission on it?  When I talk to economists, they say the final report out this week probably won’t have much impact because the Royal Commission’s already had its impact.  Do you agree?

I do agree with that and I think we’ve already seen the credit tightening, but in the same sense, we’re certainly not going to see credit loosening up from here.  I don’t think it’s going to get any tighter, but we’re in the midst of a new normal here.  We’re seeing credit close very slow, we’re seeing investment credit is virtually flat in terms of credit growth and I think that’s what we have to look forward to and probably also an ongoing shift towards more owner-occupier participation of the market at least proportionately relative to investors.  We’re seeing investors continuing to become a smaller part of market activity.

What about the other markets apart from Melbourne and Sydney?  I note that Perth was down 1.1% in January and the only market to go up was Canberra.

That’s right.

Up just a little bit, but everything seems to be falling now.

There is quite a bit of diversity here.  The broad theme is clearly weakness.  Even though there’s a lot of focus on Sydney and Melbourne for obvious reasons, these are very large markets and they tend to push the dial around.  We’re still seeing Perth values falling, as they have been since the middle of 2014.  Darwin values are still trending lower, in fact, they’re down by a bit more than 25% since they peaked out.  But the markets where value growth has been what you might describe as more sustainable, think of say, Brisbane and Adelaide, where over the past decade or so we’ve only seen dwelling values rising at about the pace of inflation of both those cities, we have seen the trend rate of growth slowing in those markets.

In fact, Brisbane, over the past 12 months, has seen an absolutely flat market, values are unchanged from where they were a year ago, and you mentioned Canberra.  That seems to be one of the bright sparks at the moment.  Canberra dwelling values over the past 12 months were up by 3.8%, so still a pretty mild result and you’ve still got Hobart shooting the lights out with a 7.4% rise over the past 12 months.  But even though those figures are still very strong they are clearly losing some steam.

Are there any parts of the property market in Australia that you would call a buy?

Well if you look at some of the areas around regional Victoria and regional Tasmania, we are seeing some momentum building in those markets.  If you look at markets like Ballarat, Bendigo just outside of Melbourne, they do seem to have some good momentum about them.  Launceston is really benefiting from a ripple of demand moving away from Hobart probably due to the very affordable prices and the strong lifestyle demand in the market.

Some of the mining areas around the country have moved out of what’s been a very large and quite dramatic downturn, following the mining boom, markets like the Pilbara, Bowen Basin in Queensland, saw values fall by nearly 60% but since they bottomed out in early 2018, they’re up by about 13-15%, so for those speculators there’s some opportunities there.  But broadly conditions are generally quite soft in the major centres.

Good on you, Tim, thank you.

Thanks, Alan.

[Music]

Happy Birthday Carol King, who turns 77 on Saturday, and yes, you’ve got a friend in us here at the Constant Investor and InvestSMART.

 [Music]

That’s all from me, have a great weekend.

[Music]