The Land Of Ockers
7th of October, 2019
I continually go on about how when researching Property Cycles every location will have its own specific drivers.
There are drivers related to specific locational advantages (and disadvantages) which will impact how the cycle manifests differently in each location.
For example, this impact can be felt due to a particular infrastructure project – think about the different impact that a new “transport hub”or “treatment works” will have on the houses that surround it compared to the city as a whole.
This can be anything including our very Australian “Ocker” attitude.
Photo by Dan Freeman on Unsplash
Our “Ocker” attitude
Australia is a unique country.
We have our own unique culture, attitudes and drivers specific to our economy.
I’m thinking here of things such as the tyranny of distance from our constitutional ruler, the Queen which impacts both our ability to import and export, with whom and at what price. Our geographical location can also give us an advantage in say exporting Iron Ore to China when compared to our competitors based in a country like Brazil.
Our rule of law is another competitive advantage over our neighbours. Just try to ascertain who owns the title to land in Indonesia or settle a legal dispute in Bahrain?
There are many things that make our country unique besides the abundance of green pastures that allowed us to grow fat off the sheep’s back and our insatiable appetite for prawns on a BBQ.
Besides, name another country that may have to choose between a Prime Minister called either “Scomo” or “Albo”?
As I keep saying, every location has its own specific locational drivers!
Photo by Markus Spiske on Unsplash
At Calnan Flack we know that the cycle will continue.
We know the process that has to occur. It is just hard sometimes to accept in the heat of emotional news reports just how the cycle can continue to manifest into a predictable repeatable event.
Our Calnan Flack Economic Cycle Action Plan says to expect the “Normalisation of Interest Rates”.
To us this means that market forces must eventually be allowed to set the price of money. That the intervention of the Central Governments will subside, and the market will once again set interest rates.
In the US we saw massive amounts of “Quantitative Easing” – a strategy the Fed used to dramatically increase the domestic money supply. The US was not alone in its use of “QE” to try and revive their failing economy and bankrupt financial system back from the cataclysmic edge of their terminal abyss.
Anyone remember the “Occupy Wall Street” movement that arose from the depths of the GFC?
The financial, economic and some argued the political and moral systems were all bankrupt. They argued that society as a whole was going to implode from the shenanigans of the GFC – that was until QE saved the day and restored the bankers’ bonuses…
We all know the story. And the ending!
But how quickly we forget the Occupy Wall Street Movement and the impact that it didn’t have on instigating social and financial change.
What did we do?
Here in Australia a different approach was taken, partly due to the strength of the commodity cycle that helped keep property prices buoyant and hence our banks’ bad debts low.
Our specific locational influences allowed our decision makers to manage things a little differently. The regulator APRA invoked stricter rules and regulations onto the Banks in an effort to sure up the local banks and help them build some fat back into their balance sheets (to ensure they could withstand any rising defaults).
- Banks had to assess a borrower’s ability to repay debt not at the prevailing interest rate but at a minimum of 7.25%
- Banks were to limit the flow of new interest-only lending to 30 per cent of total new residential mortgage lending
- Banks had to restrict the growth in their investors lending book to 10%pa and
- Australia’s biggest banks were required to increase their Tier 1 & 2 capital ratios
These restrictions were in response to a general concern for the continued growth in the housing market and to ensure our Aussie banks would withstand any repeat of the GFC.
At Calnan Flack we continually repeated that lending standards MUST relax. The cycle requires it to do so because the cycle as we describe it, is really a Credit Cycle, that must manifest itself into both the Property and Share Markets.
Lending requirements inevitably must become more relaxed, that’s what the last 200 years of cycles have shown us. (If you want a history lesson I can recommend you read Homer Hoyt “One Hundred Years of Land Values in Chicago” printed in 1933-the similarities to today are there for you to see …)
Credit MUST at some point, become easier.
Banks make money by extending credit! And this ensures the cycle will end with a CREDIT BUST…
Photo by Nathan Dumlao on Unsplash
What about inflation?
Inflation is a thing of the past. Or at least for the foreseeable future – that’s our view. See all the prodigious technological advancements and improved productivity gains are all driving low prices.
Technology is causing a lot of price deflation. Just look at the cost of TV’s…
It was only 40 years ago that the world was panicking about potential hyperinflation. Remember that?
The 70’s, cool cars and groovy hair it was the Nixon era.
Unfortunately for Nixon he was forced to resign before the completion of his impeachment process, thus denying him from joining the notorious list of Andrew Johnson and Bill Clinton as the only two US Presidents to ever be impeached….
It was also a time when inflation raged, out of control and gold became the asset of choice.
But things are very different today.
Its staggering to think that prior to 2009, the Bank of England (BoE) had never lent money to English banks below 2% pa interest rate. That’s to say the BoE had successfully navigated the Napoleonic wars, two world wars and way too many financial calamities to mention with rates above 2%.
Yet in 2016 UK rates found themselves down as low as 0.25% and are still under 1%
Photo by Pixabay from Pexels
How quickly we forget
It amazes me how quickly we forget. And if we don’t forget, we certainly remember historical events differently to how they actually occurred.
Throughout 2014, at our Calnan Flack Investment Club events we continually tried to convince people that the fallout that was happening in Greece, although terrible for the Greek people, really had NO bearing as to how the Economic cycle would playout.
Yet the whole world was obsessed with the Greek melt down that was occurring. Petrified that the Greek economy would be the template for all developed economies post the GFC crisis.
Do you remember the fear you felt?
The chart below is an interesting one with some great learning as well. It shows the difference in interest rates being paid by US Treasuries v Greek Treasuries since 2010.
In 2012 the US Government would have paid you about 2.5%pa for the pleasure of gaining the use of your funds. However, at the same time the cash strapped Greek government would have paid you over 30%pa. This massive (risk) premium was due to the risk of default and impending civil war that appeared to be breaking out.
Those silly enough to invest in Greek Bonds needed to be paid a massive incentive to do so.
But now some 7 years later, everyone has forgotten about the riots, forgotten about the debts, bankruptcies and foreclosures and investors now view Greek Bonds as having about the same level of risk as those of the US. You see they are both now priced at about 2.5%!
At the height of the Greek Crisis, who would have ever thought this would occur?
Investor memory, it’s such an interesting thing.
Negative rates – WTF?
And now negative rates are the norm across half the developed world. How does that work?
It’s a fairly complex topic this one.
The idea is that negative rates is like a tax on holding money encouraging consumers to spend it and banks to lend it.
When a negative interest rate policy is adopted, financial institutions will have to pay interest for parking their reserves with the central bank. This means that the central banks actually penalise the financial institution for holding on to cash in hope of prompting them to increase lending thus leading to increased output, consumption and hence growth. Or at least that is the theory.
In response to the negative interest rate policy that’s been adopted many European banks have restructured their reserves so that they are holding the positively yielding US Treasuries. This is because countries like Denmark, Sweden, Switzerland, Hungry and the Euro Zone are all penalising banks for holding cash.
Many lenders who are offering zero or negative rates are charging other fees and charges to borrowers to ensure that the lenders are not left out of pocket.
Negative interest rates also have the added effect of lowering the currency making it more competitive to export goods and services and hopefully increasing production at the same time.
Will it work? Will negative rates actually result in economic growth? I don’t know. But what I am certain about is that just like Nixon in the 1970’s, its likely to end very differently from how its currently envisaged.
The result is likely to be financial chaos.
How long will it be before this chaos hits our financial markets?
Now that’s an interesting question, one that I’m sure the cycle will answer for us.
Will these negative interest rate shenanigans unravel at the end of the cycle or will it be a major cause of the looming mid-cycle slowdown…? Time will tell!
So how are we travelling?
It’s safe to say that this cycle is just like the one before it. And the one before that, and before that….
This cycle is NO different to previous cycles.
Sure, its manifestations are a little different but that just helps ensure no one see the similarities.
A recent directive from the regulator APRA has allowed the banks to reduce the assessment rate they use before they can lend money. This means that instead of using an interest rate of 7.25% to see if you can afford the loan repayments they can now assess serviceability of 2.5% (or more) above the loan’s interest rate, resulting in more borrowers being able to afford more credit.
Yeah, what could go wrong?
The Caps on the growth of the bank’s loan books have also been removed. This means that the banks can be more aggressive in their lending appetite leading to further credit and bigger profits.
Yeah, what could go wrong?
And we have the Reserve Bank of Australia continually slashing official interest rates. It’s the first-time Australian official rates have started with a 0!
0.75% we are now down to, and its unlikely to stop there.
OK, something could go wrong!
Time to blow the Trumpet!
Without blowing our Calnan Flack trumpet too loudly, those who attended our first CF Forecasting Conference in Feb 2014 will recall that we made the outrageous call for interest rates to fall to 0.5%.
At the time this seemed like a ludicrous forecast – one that we copped a fair bit of flack over. But time has proven us almost perfectly correct!
We can’t expect to get every forecast correct – but it’s fair to say we’re building a fairly comprehensive record of correctly forecasting markets.
So, what does all this mean
All this tells me is that the cycle is alive and well! Each cycle must differ from the last and this is exactly what we have been seeing here.
Low interest rates are having a material impact on the way this cycle is manifesting by influencing both investor behaviour and economic activity.
At Calnan Flack we are still excited about what this cycle holds. Heaps of investment opportunity but not without a kink or two. But hey, that’s part of the cycle….
If you need some help navigating and interpreting the cycle, we’d love to help you – just get in touch with us.