Share markets have stalled since the turn of the year as they await indications that Donald Trump will come through with promised pro-business and growth policies. So far he has focused on immigration and trade barriers, both of which are of concern to the market. Behind the political noise things are starting to look rosier for shares. The US reporting season is in full swing with the majority of companies beating analyst estimates thus far. Locally the reporting season is just starting but the picture looks far more mixed. In particular there has been a number of high-flying mid or small caps being severely sold off following profit warnings or downgrades.
Commodities are holding up, with iron ore holding above 80 US dollars per tonne and oil keeping above 50 US dollars per barrel since the Organisation of Petroleum Exporting Countries (OPEC) announced its decision to cut production. This has boosted the Australian Dollar back to 76 US cents from about 72 US cents at the start of the year.
The Australian housing market continues to remain strong despite more stringent regulations put in place, and efforts by Chinese authorities to limit cash outflows. Readings for both home loans and private credit released in the past month have shown that Australian debt levels continue to rise despite employment continuing to be weak, with the unemployment rate rising to 5.8%. Although the rise was primarily attributed to more people entering the workforce (the number of employed people actually rose more than forecast), this indicates another problem for Australia’s economy – underemployment (where the participation rate is low because people are discouraged from looking for jobs).
The Reserve Bank of Australia (RBA) held rates and issued an upbeat assessment of the economy as the rebound in commodities spurred a big jump in Australia’s trade balance. Despite a weaker than expected inflation reading for the fourth quarter, the RBA believes that the commodity rebound will flow through the economy to boost business activity and eventually push inflation back towards their targeted 2-3% range.
The rest of the world continues to maintain positive momentum from the final months of 2016. Manufacturing and services data in the US, Europe and China all continue to indicate strong growth. US and European inflation continue to improve with the latest reading of US inflation now within their target range at 2.2%, while a reading of 1.1% for Europe is much better than the 0% readings at the start of 2016.
China also posted strong growth figures with GDP coming in at 6.8% for 2016, above the most recent estimates of 6.7%. Just a year ago many were doubting that China could maintain their minimum target of 6.5% GDP growth in 2016. As worries about growth abate, China has turned its focus back on reining in debt by raising a mix of different short and mid-term borrowing rates. Given Australia’s current debt levels, reining in debt looks to be an important local issue as well.
Australia’s burgeoning debt
On a variety of measures Australia’s current debt burden is higher than the US at the peak of the global financial crisis in 2008. The chart below shows Australia’s household debt to GDP (green line) is now higher than in the US (red line) in 2008. At 104%, the level of debt is higher than the value of goods produced in Australia.
We emphasise that while a large debt pile does not necessarily result in a crash like the one experienced in 2008, it certainly raises concerns. If the interest repayments can be made, the debt level will not eventuate into a crisis. The question here is, at what point do borrowers become unable to meet their obligations?
During the past few years, falling interest rates have made the rising debt manageable. In a falling interest rate environment, Australians were able to take out incrementally more debt while maintaining the amount needed to repay the debt. While the RBA cut interest rates twice in 2016, the low interest rate environment has seemingly reversed due to global yields rising. The rise in global yields will undoubtedly impact Australia’s lending rates because many Australian banks obtain funding from international markets – as evidenced by Australian banks recently raising lending rates.
Another key factor is that wages and employment rose strongly in Australia due to the resource investment boom and subsequently, the construction boom. This led to Australians having more money to make bigger loan repayments and take bigger loans, allowing the debt pile to grow ever larger. With the resource investment boom over and the construction boom fading, this support is no longer present.
As shown below, financial counselling services have received a flood of volume from people suffering mortgage stress and overdue or distressed debt has been rising gradually.
Although this raises concerns for investment markets in Australia, especially for the traditional big four banks, this does not necessarily spell a financial crisis. It’s important to recognise that distressed debt has been rising at a gradual pace along with the whole debt balance. This means the proportion of distressed debt relative to current debt levels is not as pronounced. Banks are also far more capitalised now compared to 2008 following the global focus on strengthening banks via the implementation of the Basel reforms.
What does this mean for Australia?
- Without a doubt, Australia will need to control its debt problem. Australian authorities have already moved to try to contain this by applying more stringent regulations around mortgages but the success of this is yet to be realised as mortgage levels have continued to rise.
- To facilitate a gradual and orderly reduction of debt, Australia requires a combination of higher wages, more employment and most crucial of all, a change of attitude to debt aversion.
- The current conditions certainly point to slack in the employment environment in Australia, which means that there is capacity for this to improve, provided that the Australian economy improves.
While the combination of acute awareness of the problem and capacity to contain or reduce the problem means that an economic or financial fallout may not eventuate, the current conditions definitely warrant a more cautious approach to investing.
It is important to remember that there are always opportunities in investing and the best opportunities often arise when worries are prevalent.
Want more information?
This month’s perspective highlights that market sentiment on all asset classes is constantly changing. It is important for us to quickly recognise any threats, to preserve your investment capital or to identify early investment opportunities to maximise any return advantages. At Partners Wealth Group we don’t get complacent with the current state of play and constantly monitor investments and your portfolios.
For more information on the above please contact your Partners Wealth Group advisor directly or on 1800 333 143.