Australia & NZ Archives - Page 38 of 97

August 23, 2015

A bad case of the ‘nineties

The 1990s featured two significant upheavals in global financial markets. First, 1990 saw the Nikkei collapse from its high of 39000, reaching an eventual low of 7000 in 2008.

Nikkei 225 Index

The collapse followed strong appreciation of the Yen after the September 1985 Plaza Accord and the ensuing October 1987 global stock market crash. The Plaza Accord attempted to curtail long-term currency manipulation by Japan who had built up foreign reserves — mainly through purchases of US Treasuries — to suppress appreciation of the Yen against the Dollar and maintain a current account surplus.

Seven years later, collapsing currencies during the 1997 Asian financial crisis destroyed fast-growing economies — with Thailand, South Korea and Indonesia experiencing 40%, 34% and 83% falls in (1998) GNP respectively — and eventually led to the 1998 Russian default and break up of the Soviet Union. Earlier, rapidly growing exports with currencies pegged to the Dollar brought a flood of offshore investment and easy credit into the Asian tigers. Attempts by the IMF to impose discipline and a string of bankruptcies spooked investors into a stampede for the exits. Falling exchange rates caused by the stampede led to a further spate of bankruptcies as domestic values of dollar-denominated debt skyrocketed. Attempts by central banks to shore up their currencies through raising interest rates failed to stem the outflow and further exacerbated the disaster, causing even more bankruptcies, with borrowers unable to meet higher interest charges.

What we are witnessing is a repeat of the nineties. This time it was China that attempted to ride the dragon, pegging its currency against the Dollar and amassing vast foreign reserves in order to suppress appreciation of the Yuan and boost exports. The Chinese economy benefited enormously from the vast trade surplus with the US, but those who live by the dragon die by the dragon. Restrictions on capital inflows into China may dampen the reaction, compared to the 1997 crisis, but are unlikely to negate it. The market will have its way.

Financial markets in the West are cushioned by floating exchange rates which act as an important shock-absorber against fluctuations in financial markets. The S&P 500 fell 13.5% in 1990 but only 3.5% in October 1997. The ensuing collapse of the ruble and failure of LTCM, however, caused another fall of 9.0% a year later. Not exactly a crisis, but unpleasant all the same.

North America

The domestic US economy slowed in the past few months but increased spending on light motor vehicles and housing suggested that robust employment growth would continue. Upheaval in financial markets (and exports) now appears likely to negate this, leading to a global market down-turn.

The S&P 500 breached primary support at 1980, signaling a primary down-trend. The index has fallen 4.5% from its earlier high and presents a medium-term target of 1830*. Decline of 13-week Twiggs Money Flow below zero would confirm the signal but descent has been gradual, suggesting medium-rather than long-term selling pressure.

S&P 500 Index

* Target calculation: 1980 + ( 2130 – 1980 ) = 1830

The CBOE Volatility Index (VIX) spiked upwards indicating rising market risk.

S&P 500 VIX

Bellwether transport stock Fedex broke primary support at $164, confirming the primary down-trend signaled by 13-week Twiggs Money Flow reversal below zero. The fall warns of declining economic activity.

Fedex

Canada’s TSX 60 broke primary support at 800, confirming the earlier bear signal from 13-week Twiggs Momentum reversal below zero. Target for a decline is 700*.

TSX 60 Index

* Target calculation: 800 – ( 900 – 800 ) = 700

Europe selling

Germany’s DAX broke medium-term support at 10700. Expect further medium-term support at 10000 but reversal of 13-week Twiggs Money Flow below zero warns of selling pressure. Breach of 10000 would indicate a test of primary support at 9000.

DAX

* Target calculation: 10700 – ( 11800 – 10700 ) = 9600

The Footsie broke 6450, signaling a test of primary support at 6100. Reversal of 13-week Twiggs Money Flow below zero warns of (long-term) selling pressure. Breach of 6100 would offer a target of 5000**.

FTSE 100

* Target calculation: 6450 – ( 6800 – 6450 ) = 6100 **Long-term: 6000 – ( 7000 – 6000 ) = 5000

Asia

The Shanghai Composite reflects artificial, state-backed support at 3500. Declining 13-week Twiggs Money Flow warns of long-term selling pressure. Withdrawal of government support is unlikely, but breach of 3400/3500 would cause a nineties-style collapse in stock prices.

Shanghai Composite Index

* Target calculation: 4000 – ( 5000 – 4000 ) = 3000

Japan’s Nikkei 225 appears headed for a test of 19000. Breach would test primary support at 17000 but, given the scale of BOJ easing, respect is as likely and would indicate further consolidation between 19000 and 21000. Gradual decline of 13-week Twiggs Money Flow suggests medium-term selling pressure.

Nikkei 225 Index

* Target calculation: 21000 + ( 21000 – 19000 ) = 23000

India’s Sensex is holding up well, with rising 13-week Twiggs Money Flow signaling medium-term buying pressure. Breakout above 28500 is unlikely but would indicate another test of 30000. Decline below 27000 would warn of a primary down-trend; confirmed if there is follow-through below 26500.

SENSEX

Australia

Commodity-rich Australian stocks are exposed to China and emerging markets. The only protection is the floating exchange rate which is likely to adjust downward to absorb the shock — as it did during the 1997 Asian crisis. 13-Week Twiggs Money Flow below zero warns of (long-term) selling pressure on the ASX 200. Breach of support at 5150 is likely and would confirm a primary down-trend. Long-term target for the decline is 4400*. Respect of primary support is unlikely, but would indicate consolidation above the support level rather than a rally.

ASX 200

August 18, 2015

Australia: Housing slowdown

From Westpac’s Red Book:

….the situation around housing does appear to be shifting. We highlighted a sharp fall in the ‘time to buy a dwelling’ index as last month’s most signiﬁcant development, warning that unless there was an equally sharp reversal in Aug it would likely mark the beginning of a further leg to the housing slowdown. The Aug update posted a solid but insufficient reversal. Home buyer sentiment does appear to be breaking lower and a further weakening in activity is now likely towards year end…..

August 16, 2015

CBA, ANZ, NAB and Westpac: The incredible shrinking big four banks | afr.com

Great article by Chris Joye:

Welcome to the world of that beautiful $140 billion behemoth, the Commonwealth Bank, which has inverted the axiom that there is a trade-off between risk and return. Years ago I highlighted a perversion embedded at the heart of our financial system: the supposedly lowest (highest) risk banks were producing the highest (lowest) returns. Normally it works the other way around.

…..contrary to some optimistic reports, the capital-raising game has only just begun.

The terrific news for shareholders is that this belated deleveraging will transform the majors into some of the safest banks in the world, which will be able to comfortably withstand a 1991-style recession, exacerbated by a 20 per cent decline in house prices.

In the past I have been critical of APRA’s failure to properly police Australia’s vastly-undercapitalized banking system but must now give them credit for their leadership towards creating a world-class system that will be able to withstand serious endogenous or exogenous economic shocks.

Shareholders face lower returns from reduced leverage but will benefit from improved valuations due to lower risk premiums and stronger, more stable, long-term growth.

July 20, 2015

APRA confirms further capital adequacy measures

From Robin Christie:

The Australian Prudential Regulation Authority (APRA) has confirmed that the country’s largest banks will face increased capital adequacy requirements for residential mortgage exposures – and hasn’t ruled out further rises.

The regulator made it clear yesterday that the new rules would be an interim measure based on the Financial System Inquiry’s (FSI) recommendations – and that it was keenly awaiting guidance from the Basel Committee on Banking Supervision before making any further changes.

The new measures, which come into effect on 1 July 2016, mandate that authorised deposit-taking institutions (ADIs) that are accredited to use the internal ratings-based (IRB) approach to credit risk must increase their average risk weight on Australian residential mortgage exposures to at least 25 per cent. According to APRA, the current average risk weight figure sits at around 16 per cent….

This is a welcome first step. Increases in bank capital will improve economic stability. Even at 25 percent, however, a capital ratio of 10% would mean that banks are holding 2.5 percent capital against residential mortgages. Further increases over time will be necessary.

July 19, 2015

Why negative gearing is not a fair tax policy

Interesting view from Antony Ting, Associate Professor at University of Sydney:

Is negative gearing in accordance with well-established tax rules? A fundamental principle in the tax law is that a taxpayer should be able to deduct expenses only if the expenses have been incurred to generate assessable income.

This is why an employee can only deduct expenses that are sufficiently related to work. For example, a funeral director at tropical Queensland would be able to deduct the cost of his black jacket (but not his black trousers) because the ATO believes that no rational person – except a funeral director – would wear a black jacket in such a hot place.

Should mortgage interest on an investment property be deductible? Investment properties generate two kinds of income: rental income and capital gains (if any). As capital gains on investment property can enjoy a 50% tax discount if the property has been held for at least a year, strictly speaking only 50% of the interest expenses related to the capital gain should be deductible.

……Many countries resolve this issue by quarantining losses on investment properties. It means that losses generated from negative gearing cannot be used to offset against other sources of income, for example, salaries or business income. Instead, the losses can be carried forward to future years to offset against income from the investment properties.

Quarantining losses seems fairer than limiting deductibility of losses to the 50% discount normally available on capital gains. But the situation gets more complicated when the property is sold. Can accumulated losses never be deducted against gains on other assets or should they be offset against any capital gain made on disposal of the property? And if the result is a net capital loss should this be allowed to be offset against gains on other properties? We need a system that is fundamentally fair.

July 15, 2015

Could a new property tax save the economy?

Interesting article by Robin Christie | 16 Jul 2015

Property levies could be the key to fixing state and territory budgets, and could raise as much as $7 billion a year, the Grattan Institute has claimed.

Grattan’s ‘Property Taxes’ report…..explores how imposing a broad-based property levy could help Australia’s state and territory governments to boost their deteriorating budgets.

According to the report, a levy of just two dollars for every $1,000 of unimproved land value would raise $7 billion a year.

…….While it accepts that property taxes can be unpopular because they are highly visible and hard to avoid, it states that they are also both efficient and fair. In addition, it argues that property taxes don’t change incentives to work, save and invest.

“Our proposal is manageable for property landowners, and protects low-income people,” said Daley. “Low-income retirees with high-value houses could defer paying the levy until their house is sold.”

Key points

According to the paper, other key arguments in favour of property taxes include:

Unlike capital, property is immobile – it cannot shift offshore to avoid taxes.

Over the last 25 years, taxes on property and property transactions have been the only significant growth taxes for states, with revenues keeping pace with the economy.

Shifting from stamp duty to a property levy would provide more stable revenues for states, and add up to $9 billion in annual GDP.

“Concerns about the risks of multinational tax avoidance, the increasing mobility of capital around the world, and the increasing value of residential property relative to incomes, should make property taxes a priority in any tax reform,” states the paper.

“Higher property taxes could also be used to fund the reduction and eventual abolition of state stamp duties on property. Stamp duties are among the most inefficient and inequitable taxes available to states, and their revenues are inherently volatile.”

Abolition of stamp duties would remove the temptation for State governments to restrict land release, driving up prices in order to increase stamp duty revenue. But high prices act as a deterrent for young families to purchase their own homes. Land taxes instead would create an incentive for states to release new land for development, widening property ownership and their tax base.

July 14, 2015

Bank share prices tipped to decline

Chris Joye at the AFR warns that increased capital requirements could cause an 18.5 percent fall in bank stocks:

….APRA warns that because the report makes several assumptions that are unrealistically favourable to the majors, and the majors’ CET1 ratios have fallen behind global peers since June 2014, it believes they “are likely to need to increase their capital ratios by at least 200 basis points … to be comfortably positioned in the fourth quartile”.

In dollar terms, UBS’ No. 1 ranked analyst Jonathon Mott estimates that this represents a CET1 shortfall of about $24 billion today, accounting for the extra equity the majors have started sourcing since June 2014 (the short-fall would otherwise have been $30 billion). That’s consistent with the lower bound of estimates I previously canvassed here.

Yet this number may be a low-ball for two reasons. First, APRA has yet to respond to the FSI’s recommendation of introducing a minimum average residential mortgage “risk-weighting” of between 25 per cent and 30 per cent. Second, the majors are likely to be slugged with higher risk-weights on their non-residential assets as a consequence of the new Basel 4 rules.

UBS’ research implies that the combined impact of this will be another $16 billion in CET1 on top of the $24 billion shortfall, which gives a total CET1 capital deficiency of $40 billion.

The Australian Financial Review’s Chanticleer column says the majors will only be given 12 months to boost CET1 in response to APRA’s looming decision on residential mortgage risk-weights, which the regulator says it will make “shortly”.

Bank share prices tipped to decline

From a shareholders’ perspective, higher equity means lower leverage and associated returns. Whether that translates into a fall in the majors’ valuations is an open question and depends on whether reduced returns on equity are offset by repricing of deposits and loans and cheaper overall funding costs. As I have explained before, there are arguments for and against. My base-case is that we see a 200 basis point dilution in returns on equity from current world-beating marks that results in a circa 18.5 per cent reduction in major bank valuations.

I would expect APRA to soften the blow by phasing in increased capital ratios and risk-weighting of residential mortgages over time. The impact this will have on valuations depends on several factors. Lower perceived risk could lead to lower cost of funding as well as higher earnings multiples. Also, a BIS study has shown that banks with stronger balance sheets are likely to experience stronger growth — which would again raise the earnings multiple. But I agree with Joye that we are likely to witness some softening of major bank stocks.

July 13, 2015

APRA considers two per cent capital adequacy increase

by Robin Christie | 14 Jul 2015

The Australian Prudential Regulation Authority (APRA) has stated that the major banks would need to increase their capital adequacy ratios by at least two per cent to meet Financial System Inquiry (FSI) recommendations.

APRA has been comparing the capital position of the Australian major banks against a group of international counterparts, and the results of this study, released today, have led to the two per cent figure being mooted.

The study was implemented as a direct response to the FSI final report’s first recommendation, that APRA should “set capital standards such that Australian authorised deposit-taking institution [ADI] capital ratios are unquestionably strong”. This would mean making sure that Australian ADIs sit in the top quartile of internationally-active banks in capital adequacy terms.

….the statement adds that APRA is committed to ensuring that any capital adequacy requirement improvements occur “in an orderly manner”. This process would take into account Australian ADIs’ ability to manage the impact of any changes “without undue disruption to their business plans”.

While APRA hasn’t made a decision on whether it will go as far as mandating a two per cent increase in capital adequacy ratios…. it has stated that Australian ADIs should be well placed to accommodate its directives over the next few years – “provided they take sensible opportunities to accumulate capital”.

Bear in mind that capital adequacy ratios are measured against risk-weighted assets, where asset values are adjusted for the perceived risk of default. Australian banks have historically used risk weightings as low as 15% for residential mortgages compared to 50% in the US. That means that a bank with a capital ratio of 10% would only hold 1.5% capital against residential mortgages. And a 2% increase, to a capital ratio of 12%, would only increase capital cover to 1.8%. Revision of risk weightings is more important than an increase in the capital ratio, especially given Australia’s precarious property market.

July 8, 2015

Australia: Rising foreign debt

The most worrying aspect of rising Australian debt is that most of it is coming from offshore.

Foreign Debt

Domestic borrowing is fairly benign, but an increase in international liabilities suggests the country is living beyond its means. Has been for a while.

July 8, 2015

RBA strategy: Fight fire with gasoline

This is just plain wrong.

Bulk Commodity Prices

The Australian economy is sitting atop an enormous housing bubble caused by credit expansion from 1995 to 2007. To counter the end of the mining boom, the RBA lowered interest rates to stimulate the economy. While this may be necessary to relieve pressure on borrowers, what we don’t need is another credit expansion. That would simply make the economy more unstable and increase the risk of a crash. Banks are moving to curb lending to speculators, with lower LVRs, but not fast enough in my view. We can’t afford a credit contraction, but the RBA needs to impose sufficient discipline to keep credit growth at/below the inflation rate — so that it gradually declines in real terms as the economy grows.