Smoke signals from the Fed – ‘send more paramedics’
Posted on 19 August 2010 | No responses
Hardly a vote of confidence in the recovery this return to quantitative easing – even if it is balance sheet neutral. Apparently, liquidity remains fragile.
Consider where the CBOE put-call ratio was at the start of quantitative easing proper – when global liquidity was truly in a catatonic state:
While the ebullience that marked the first half of the year has subsided somewhat, current conditions are hardly indicative of an all-out squeeze. It’s also interesting is that looking to the breakdown of the ratio, the volume in both puts and calls has fallen to levels not seen since Dick Fuld had the keys to the gym.
My sense is that it is wishful thinking to imagine that we have passed beyond the volatility that has characterised the last couple of years. Maybe fatigue is setting in – people have just lost interest? More likely we are passing through the end of one cycle and into another. The government inspired rally in risk expired some months ago, until the next round of stimulus money gets put to work, the pull of debt deflation will have its way. No wonder Treasuries have been pushing to new lows – even dragging lesser credits in their wake:
Chances are that the risk curve will splinter once the motivation for the move in long yields is recognised. A balance sheet recession is not good for anything but the most pristine of safe havens. Volatility is cheap around current levels…it’s just a matter of theta.
Australian unemployment –
Posted on 18 August 2010 | No responses
Suffering from bandwidth constraints hence the brevity of posts – but still let’s introduce a couple of charts on Australian labour force, for example headline unemployment:
Now given the mix of employment growth over the last decade (construction, services and retail with mining contributing strongly recently), the auspices suggest that the best of the unemployment numbers are behind us.
Which, given that CPI has been scraping along the bottom for a league or two, suggests that the best of days for the misery index are behind us:
For the uninitiated, the Misery Index is simply the unemployment rate plus the inflation rate. I’m yet to find raw long term data for Australia, but here’s the US experience (US data here) with the S&P500 in log form as an overlay:
Or to view it a little differently, following is the misery index with the performance of the S&P500 mapped as the percentage change in the last 12 months average against the next 12 months average. A cursory glance suggests that if you get your timing right on the misery index peaking, the next 12 month return is pretty attractive. We might come back to this….
Australian equities – in the bear zone
Posted on 17 August 2010 | No responses
Reflecting on the following chart via Pragmatic Capitalism (here) – got to thinking about how the same might apply to Australia:
So herewith is the log chart of the All Ordinaries price history since 1875:
Now you might argue about the choice of market cycles – I admit to liking the symmetry of ~27 year bull markets against ~13 year bear cycles. But the point remains that with 2007 ushering in the end of the global debt party it looks likely that we’ll be trading in the bear zone for some years to come.
ABS Housing Finance (Jun10) – home lending trending lower
Posted on 10 August 2010 | 3 responses
ABS Housing Finance figured were released yesterday (here) showing symptoms of rising damp:
The number of home loans continues to fall across all categories. With house prices at highs levels relative to income (see here and here), the odds are shortening that we are due a deeper correction both in the number and size of home loans.
If there was ever any doubt about the role of debt in driving house prices higher (there wasn’t), the ~8% compound growth rate that we have witnessed in the size of the average loan since the start of the 70′s is ample confirmation. We may be an island, but how sustainable is this when the world around us is in the throws of deleveraging from the same trend? At the very least we can question the potency of lower interest rates in stimulating domestic demand in an environment where the Australian consumer is already substantially leveraged. (Note that debt to disposable income has been rising pretty consistently since the 1970′s – from the mid 20′s to around 160% currently.)
Looking to the second chart, there have only been two major dips in average loan size across the available data set. The last occurred when the GST was introduced, and prior to that it was when interest rates climbed into the high teens. What does it take to create a new data point?
August OECD leading indicators tip into negative
Posted on 10 August 2010 | No responses
Latest OECD Composite Leading Indicators are out (here) – with the June data slipping into the red indicating according to the OECD “a possible peak in expansion”.
‘Possible peak’? Looks pretty much like it is a near certainty. With Europe yet to feel the effects of the communal belt tightening and the US struggling to come to terms with its deteriorating government balance sheet, the economic momentum is favouring the downside.
But perhaps it is not all gloom. It may be that the recent bounce in Chinese equities is reflecting a turn for the better in growth expectations:
While the leading indicator for China has been heading south for some time, it is still in expansion mode and by the looks of the rate of change in the CLI may be starting to find a base. The ‘rate of change’ in the CLI has proven to be a reasonably useful leading indicator of the stock market over the last couple of years – and over recent months its downward momentum has slowed. Okay – it may be a bit of a stretch to claim the second derivative of a composite leading indicator is looking good. Conclusion – don’t buy the bounce until there is confirmation that the CLI has turned up again – which would probably coincide with a change in tack in Government policy.
Finally, a quick look at the CLI for Australia:
Looks suspiciously like Australia also has “a possible peak in expansion”.
Australian house prices – still up?
Posted on 6 August 2010 | 2 responses
The ABS released its Eight Cities House Price index yesterday (here) – according to the ABS:
- Preliminary estimates show that the price index for established houses for the weighted average of the eight capital cities increased 18.4% in the year to June quarter 2010.
- Annually, house prices rose in Melbourne (+24.3%), Sydney (+21.4%), Canberra (+19.6%), Darwin (+14.6%), Perth (+13.0%), Adelaide (+11.6%), Hobart (+10.8%) and Brisbane (+8.5%).
Going to the chart, we can see the volatility in established house prices – they declined 5.5% from a peak in March 2008 to their low in March 2009, and have now gained some 23% from this level. Australia’s GFC was a benign affair.
As we have discussed previously (here), it’s reasonable to assume that growth in national income is the ultimate (ie. long run) arbiter of house price growth. If prices have accelerated beyond the 3.2% annual growth in GDP (or, if you prefer, Gross National Income) that Australia has enjoyed since 1986, then it has been a function of debt (ie. bringing forward that GDP). Without the assistance of further increases in debt, the liklihood is that house prices will gravitate towards the long run trend in our country’s income growth. A drop of 25% to 35% tomorrow would do it – more likely prices flatline for a year or five.
The oft quoted rationale for the maintenance of current house price levels is the forecast excess of demand over supply. Consider, for example, the following chart from the National Housing Supply Council (or more specifically Saul Eslake, Economist at ANZ):
What does it mean to have a housing shortage? Clearly, the suggestion is not that there will be 400,000 households living al fresco. Rather this is a model of what the cumulative demand and supply balance would look like if current trends persisted. It’s one of those non-sensical extrapolations. Apart from the actual homeless in our number, the rest of us are by definition going to be living in a dwelling of some sort.
Consider the major variables for housing demand and supply:
Demand = underlying population growth divided by the persons per dwelling
Supply = new additions to housing stock (net of demolitions) less vacant dwellings
If the population is growing at a given rate then housing stock must increase at a commensurate rate, or housing density will increase to compensate. It’s notable then that housing density has recently turned from a century long trend to fewer people sharing the same dwelling:
As house prices climb relative to income there are ever fewer of us that can afford the hacienda of our dreams. We modify our expectations – stay at home longer, move in together – in short, we share our houses. Demand for housing changes to meet supply.
This is not to say that changing demographics in households will undermine prices. Rather that the argument that house prices will keep going up because of excess demand is deeply flawed. In other words, demand for housing is sensitive to prices.
If you subscribe to the theory that our living standards are likely to pullback in the absence of access to more credit cards, then it makes sense that housing density will creep higher – particularly in an environment where house prices are historically high relative to income. This is a major variable that is generally assumed away by our housing market forecasters.
Conclusion
On current numbers I figure that Australia’s housing market is pretty close to a demand and supply balance. Net migration for this year will be well short of last years record – I’m assuming net population growth closer to 400,000, or roughly 150,000 in new dwellings as a baseline demand number. The current run rate on housing approvals is around 170,000, which after allowing for demolitions and vacancy, will deliver around that exact number. I reckon that the top is in for house prices – just a matter of time before the ABS agrees.
The limits of growth – biology versus technology
Posted on 5 August 2010 | No responses
The following chart plots the relative running speeds for men over various distances from 100m to the marathon. The red line is based on those world records that stood at the time of the London Olympics in 2008. The blue line represents current world record times. It’s startling to think that we humans have improved our performance this much over the last 100 years (and even more startling to think that a modern marathon runner can sustain 20 km/h for 2 hours!).
Most of the improvement can probably be put down to diet and training. Some might be attributed to a bigger pool of contestants. A smidgeon might be attributed to some condensed version of evolution – the impacts of the environment across generations (eg. we are getting taller). But – and here’s the point – we are approaching the boundary of these ‘easy’ gains. Future gains are more likely to come from acceptance of the virtual – whether it be prosthetic limbs, tighter shorts or performance enhancing supplements (‘drugs’ for those of us born before 1999) – than from better training techniques.
Why is this relevant?
It’s an important counterpoint to the ‘demographics defines growth’ argument – eloquently stated by George Magnus in his article published by The Boeckh Investment Letter (here).
While I whole-heartedly accept the point that the changing nature of a society’s population will shape the way it accumulates or spends its wealth, it is also important to recognise the role of technology in changing that society’s productivity. The demographics of the baby-boomers may not be growth friendly across the next few decades, but the accelerating nature of technological change may well be.
Need convincing – have a wander around my favourite mad scientist’s website (Ray Kurzweil here), he has charts a-plenty mapping the exponential evolution of our various technologies. Singularity or not, it seems foolhardy to use the straight edge of a ruler to extrapolate expected productivity gains.
And to complete the circle, there is even a recent article by David Despain on “How to prevent an aging crisis” (here).
RBA commodity price index (Jul10) – recovering lost ground
Posted on 5 August 2010 | No responses
The RBA’s commodity price index continues to push on into the hill climbs of the Pyrenees:
According to the RBA (here), the key drivers were:
Preliminary estimates for July indicate that the index increased by 2.7 per cent (on a monthly average basis) in SDR terms, after rising 2.2 per cent in June (revised). The largest contributors to the rise in July were increases in the estimated prices of iron ore and coal. The price of wheat also rose, while the price of gold fell.
If economic growth has been driving industrial commodities higher, then the question is why is the ratio of base metals to gold languishing at multi-decade lows:
The continued outperformance of gold undermines the thesis that we are slowly but steadily pulling through the crisis. If world growth is going to struggle for the balance of the year, then the liklihood of the ratio tipping back towards its long term average is going to rely on some serious weakness in gold.
And to reinforce the point that world trade has been fading at the margin, the baltic dry index has had a torrid couple of months. While it has recovered some poise over recent days, in isolation it is still underperforming the ASX materials index.
And to place that underperformance in further context, following is our composite indicator for the materials sector – it blends the performance of the BDI, the RBA base metals index and the Shanghai stock market to get a proxy for commodity price and volume demand plus risk appetite in our largest customer. This index has lagged the ASX200 materials index all the way from the bottom – with the spread widening over recent months. If the relative performance argument holds, then the ASX materials sector should struggle to run higher from here without a commensurate move up in Chinese equities and/or the BDI.
Australian building approvals (Jun10)
Posted on 3 August 2010 | No responses
The ABS released the latest building approvals data today (here) – concluding that:
- The trend estimate for total dwellings approved fell 2.7% in June 2010 and is showing falls for four months.
- The seasonally adjusted estimate for total dwellings approved fell 3.3% and has fallen for three months.
Looking to the original data, building approvals continued to expand as measured by the change in the 12 month rolling average, but at a slowing rate.
Seems reasonable that building approvals should be plateauing given that the current annualised run rate is around 170,000 – which is broadly sufficient to meet demand.
Building approvals around these levels are a net positive for the domestic economy. The trick will be to see if this level can be sustained for any meaningful length of time – as has proven difficult time and again over recent decades.
Returning to earth – risk markets back to business as usual
Posted on 3 August 2010 | 5 responses
Nothing like being trapped in a tin can 10,000 metres above sea level to get a little perspective on things. Couple that with the a month long break, and here’s hoping that it’ll be a little easier to ignore the trees…
When we last looked (here), the stage was set for a relief rally into July. For mine, we are at least a couple weeks short of completing this rally – more time spent filibustering around 1150 (Jan10 highs) would see this consolidation out.
From there, I’m favouring the downside. The playbook that makes most sense to me is the one that says follow the ebbs and flows of government stimulus, and the leading indicators are suggesting that the ebbs hold the floor. With a softening macroeconomic picture, now being reflected in drifting earnings expectations, a move substantially higher would require something else – something that could kickstart a contraction in risk pricing. While not out of the realms of possibility, the odds are against it.
Consider US credit spreads – looks suspiciously like they are trading towards the lower end of a ‘new world order’ trading range – 100 to 150 bps rather than the 50 to 100 bps that prevailed during the credit boom years.
In this environment, the insouciant recovery in equity markets is likely to trip up. Sovereign risk in its many guises will resurface periodically – and will act as a catalyst for such risk aversion trades. If credit spreads are widening, then the risk curve will be getting a whole lot steeper – and equities will trade lower.
In this respect, keeping an eye on those currencies that rise and fall with the wash of liquidity may prove useful – as we’ve noted before the Asian Dollar index is useful in this regard, it’s rallied consistently over the last 8 weeks…
Click on icon to subscribe
