Australia: Good news and bad news

First, the good news from the RBA chart pack.

Exports continue to climb, especially in the Resources sector. Manufacturing is the only flat spot.

Business investment remains weak and is likely to impact on long-term growth in both profits and wages.

The decline is particularly steep in the Manufacturing sector and not just in Mining.

But government investment in infrastructure has cushioned the blow.

Profits in the non-financial sector remain low, apart from mining which has benefited from strong export demand.

Job vacancies are rising which should be good news for wage rates. But this also means higher inflation and, down the line, higher interest rates.

The housing and financial sector is our Achilles heel, with household debt climbing a wall of worry.

House prices are shrinking despite record low interest rates.

Broad money and credit growth are slowing, warning of a contraction.

Bank profits remain strong.

But capital ratios are low, with the bulk of profits distributed to shareholders as dividends. The ratios below are calculated on risk-weighted assets. Raw leverage ratios are a lot weaker.

One of the primary accelerants of the housing bubble and household debt has been $900 billion of offshore borrowings by domestic banks. The chickens are coming home to roost, with bank funding costs rising as the Fed hikes interest rates. In the last four months the 90-day bank bill swap rate (BBSW) jumped 34.5 basis points.

The banks face a tough choice: pass on higher interest rates to mortgage borrowers or accept narrower margins and a profit squeeze. With an estimated 30 percent of households already suffering from mortgage stress, any interest rate hikes will impact on both housing prices and delinquency rates.

I continue to avoid exposure to banks, particularly hybrids where many investors do not understand the risks.

I also remain cautious on mining because of a potential slow-down in China, with declining growth in investment and in retail sales.