CONCLUSION: We see further weakness in the Australian economy over the intermediate-term TREND as well as a growing number of key questions regarding Australia’s long-term TAIL growth potential. As such, we are reiterating our TREND-duration bearish fundamental call on Australian equities and the Aussie dollar – barring incremental accommodation out of the Fed over the immediate term.
In lowering its Benchmark Cash Rate -25bps (to 3.5%) overnight, RBA Governor Glenn Stevens reminded the world that the intermediate-term outlook for Australian economic growth leaves much to be desired. In fact, reported growth down under is poised to slow here in 2Q12E and, assuming no incremental headwinds, should start to flatten out in 3Q12E. On the inflation front, our models have the slope of Australian CPI slowing at a slower rate here in 2Q12E and flattening out in the following quarter.
The net result of this analysis is that the RBA’s current monetary easing cycle, which has amassed 100bps since NOV ’11, may in fact be nearing its end. Glenn Stevens, who has proven to a both data dependent and cautious on both sides of the policy spectrum over the past 3-4yrs, may need to see an incremental deterioration in Aussie economic growth and an incremental bout of disinflation from here to warrant cutting rates further.
This speculation is consistent with our own research view and gives us the confidence to reiterate our TREND-duration bearish fundamental call on Australian equities (initially published MAR 26). Moreover, a wait-and-see approach out of the RBA is not currently priced in at the current juncture; even after today’s cut, various rate markets are still pricing in 50-100bps of cuts over the NTM – far more aggressive action than what we expect Stevens to signal as necessary over the intermediate term.
That’s bad news for the Aussie consumers, who boast an > 60% homeownership rate with 90% of mortgages being of the variable rate variety; banks had already been lowering mortgage rates less than the central bank has cut the benchmark rate in this cycle (-70bps vs. -100bps), due to NIM pressure from rising wholesale funding costs and heightened competition for domestic deposits.
Looking to the risk management setup, Australia’s benchmark All Ordinaries Index is firmly broken on our TRADE and TREND durations.
We would caution against shorting them in the immediate term, however, given the preponderance of many market participants to speculate on additional accommodation out of the Federal Reserve. Key TRADE-duration catalysts on this front include: JUN 7 – Bernanke testifies to Congress on the US economic outlook and JUN 20 – FOMC Rate Decision.
If the Fed disappoints growing expectations for further monetary easing in the immediate term (our base-case scenario), you’re likely to see another leg down in Australian equities. For US-based investors who chose to go short, that return is likely to be supplemented by further weakness in the Aussie dollar relative to the USD over the intermediate term – a core fundamental view we’ve [generally] held in the currency market since APR ’11.
Two other key catalysts that give us incremental confidence in reiterating our bearish fundamentals bias on Australian equities here are an incremental deterioration in China’s TREND-duration economic outlook and Deflating the Inflation of Bernanke’s Bubbles. Refer to the following research notes as well as our APR 16 2Q12 Macro Themes presentation for more details here:
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As it relates to China, we are of the view that increased bearish sentiment in/around the Chinese economy will act as a wet blanket over Australian equities and the AUD/USD exchange rate over the intermediate term. China is Australia’s largest trading partner at 25.1% of total shipments, per the CIA Factbook.
But the story isn’t simply about China; slower Chinese demand for Australia’s exports merely alludes to a broader trend taking place within Australia's economy. Further declines across key commodities markets pose a material risk to Australian exports (raw materials account for ~60% of the total; Australia produces ~20% of the world’s iron ore, ~7% of its liquefied natural gas and ~6 percent of its gold), which, then, pose a material risk to Australian job growth – which has become increasingly driven by CapEx and other operations stemming from Australia's natural resources industries.
For additional color, it would be an understatement to say that Australia has become a two-speed economy, with growth increasingly hampered by what economic historians refer to as “Dutch Disease”. If Australia’s A$456B mineral resources projects come under risk of being delayed or canceled on the margin, we would expect Aussie GDP growth to slow incrementally.
We’d be remiss to not point out the fact that Gillard’s government expects to reap A$6.5B from its mining tax in its latest budget, which was designed to return the nation to a slight surplus in spite of increased social spending. The nation also expects to rake in A$25.7B from the carbon tax coming into effect JUL 1 – a large component of which to come from heavy polluters like the mining, petroleum and gas industries.
The main takeaway here is that both the Aussie central government and central bank are anchoring on continued rapid expansion of Australia’s resource industry to deliver on promises of fiscal tightness (a key political issue down under) and continued employment growth, respectively, with 2012-13 GDP growth estimates in the range of 2.5-3.5% each.
To the aforementioned point regarding lower commodity prices, BHP Billiton Ltd., the world’s largest miner and Australia’s largest company, recently stated that it would fall short of its $80B CapEx guidance over the next five years due to declining commodity prices. Rio Tinto, Australia’s largest iron-ore producer, has made similar statement(s) over the past few weeks as well.
Net-net-net, Deflating the Inflation is bad for the Australian economy – particular given some core assumptions being baked into growth estimates at the highest levels.
From a TAIL-duration perspective, our TREND-duration fundamental view of the Aussie economy poses a fair amount of key questions – particularly on the housing front due to what has the potential to morph into a structural decline in Aussie employment growth. With Aussie housing prices up +89.2% since comparable data began in 1Q03, there’s a lot of dispute on both the buy and sell sides as to whether or not this market is A) a bubble and B) poised to enter a structural decline. While we prefer to let the market decide for us, a few noteworthy metrics lend a fair amount credence to both sides of the debate:
- Per the central government’s annual State of Supply report, Australia has a 178.4k unit shortage of homes on a population of 22.3M (Bloomberg);
- Per an independent study by tax-reform advocate David Collyer, commentator Kris Sayce and academic Steve Keen, Australia actually has an excess of 256.3k homes, having built new homes at a rate of 2.32 per person over the past 15yrs (Prosper Australia);
- Home ownership rate of 60% vs. a US peak of 69.2% in ’04 and 65.4% currently (RP Data);
- Household debt-to-disposable income of 184% vs. 141% in Spain, 118% in the US and 98% in Greece… Australia’s current ratio is > than the ’07 peaks in those countries’ ratios and that of the UK (OECD);
- Owner-occupied home loan growth holding at an all-time low growth rate of +5.3% YoY in MAY (Bloomberg);
- Prime mortgages default rate of 0.61% vs. 5.32% for the US (Fitch);
- Mortgages account for 59.4% of all bank credit in Australia (Bloomberg; Hedgeye calculations);
- An Unemployment Rate that has declined -630bps over the past ~10yrs to 4.9% (90bps above an FEB ’08 all-time low);
- The existence of a first-time homeowner grant introduced in JUL ’00 and doubled in OCT ’08, which caused Aussie home prices to jump in the year following each implementation by +10% and +13.6%, respectively;
- Direct and indirect taxes account for ~42% of the cost of new home in Sydney – Australia’s largest city (Australia Housing Industry Association); and
- Australia has the second-least affordable homes in the developed world (behind Hong Kong) with metropolitan dwellings costing 6.7x median income on average (Demographia).
All told, we see further weakness in the Australian economy over the intermediate-term TREND as well as a growing number of key questions regarding Australia’s long-term TAIL growth potential. As such, we are reiterating our TREND-duration bearish fundamental call on Australian equities and the Aussie dollar – barring incremental accommodation out of the Fed over the immediate term.