The BFG Report

Welcome to the 2014 Summer Edition of the BFG Report.

Do International Property Prices Impact Our Economy ?

With many people having the majority of their wealth tied up in the value of their homes, house prices have a significant impact on an economy. While generally true globally, this is certainly the case here in Australia.

As we have seen in recent years, the outlook for residential and investment property can have a significant impact on a region’s economy. Low financing costs, low documentation loans and over supply contributed to a major correction in house prices which ultimately resulted in a severe credit crisis in the US. Since then, as demand catches up with supply, the US property market has been gradually recovering.

In China, average house prices are showing some weakness. Although prices in both Shanghai and Beijing have recently corrected, if Chinese house prices do not stabilise of their own accord, further government policy intervention may be required. While we are seeing restrictions being lifted in some regions, we anticipate more stimulus may be required at the national level. As new home sales slump, in a bid to reduce their inventories, there is evidence of developers slashing prices. Over the next couple of years, while this should help in rebalancing the supply/demand equation, highly geared developers may not survive.

While the Chinese banks are not immune to severe housing downturns, the Chinese household has relatively low debt levels, certainly much lower than that of Australians.

When it comes to measuring home affordability, there are a number of measures. One way is the ratio of house prices to after-tax incomes. On this measure alone, on a global basis, Australia appears to be very expensive, certainly more expensive than China.

The decline in property development also has a flow-on effect to iron ore prices. Steel is a major component in the housing construction industry and, with construction slowing as well as increased iron ore production, the price of iron ore has eased to a little under US $77 a tonne. As prices and demand weaken, the potential for iron ore surpluses also increases.

The prospects for Chinese economic growth are heavily influenced by government policy while consumer sentiment and behaviour (consumption) are impacted by house prices. Consumers tend to be more optimistic when house prices are rising and less so when they are falling.

While we cannot profess to know where real estate prices will go in China, we can observe that a sharp downturn in prices could have negative implications for the Chinese economy. The flow on effect to Australia (other than in lower iron ore prices) is less clear.

Our base case is that Chinese house prices stabilise (albeit potentially at lower levels) and the Chinese residential real estate market goes through a period of necessary, but manageable adjustment.

Perhaps the best hedge against a severe property downturn in China is not to have an
overexposure to resource companies and have at least part of your international
share exposures unhedged. In the event that a sharper slowdown in China
has a greater than expected negative impact on the Australian economy, this
would partially protect your portfolio of international shares.

So, what happens to house prices in the world’s economy really does matter.

Investment Market Review – Quarter Ending 30 September 2014

Asset Class – Australian Shares
Index – S&P/ASX 300 Accumulation index
1 year return – 5.73% p.a.
5 year return – 6.57% p.a.

With the fall in the price of iron ore recently, the outlook for Australian economic growth has deteriorated and resource sector investment spending is starting to decline significantly.

Asset Class – Listed Property Trusts
Index – S&P/ASX 300 A-REIT index
1 year return – 12.28% p.a.
5 year return – 8.55% p.a.

A-REITs posted impressive gains of 12.28% for the year, outperforming the broader market. The RBA kept the official interest rate at 2.5% which continues to be a tail wind for this sector.

Asset Class – International Shares
Index – MSCI World accumulation index (AUD)
1 year return – 19.89% p.a.
5 year return – 11.05% p.a.

International shares produced decent gains, despite global growth data slightly disappointing against market expectations. In the US, the S&P500 index hit new closing highs in each month of the quarter and breached the 2000 mark in September, but a weak finish saw its gains for the quarter pared back (+0.6%). Energy (-9.2%) was by some distance the weakest major group, hit by a falling oil price.

Asset Class – Fixed interest and cash
Index – Bloomberg AusBond Composite index (Previously called UBS Composite Bond All Maturities index)
1 year return – 6.02% p.a.
5 year return – 6.72% p.a.

Australian fixed interest securities produced solid returns over the quarter. The US 10-year benchmark Treasury yield ended the quarter little changed (-4 basis points). Stock market weakness helped bonds to end the quarter on a firmer note. Aussie bonds traced a similar path but performed a little better with the 10-year yield falling 6 basis points.

Asset Class – Cash
Index – Bloomberg AusBond Bank Index 0+Y (previously called UBS Bank Bill index
1 year return – 2.65% p.a.
5 year return – 3.87% p.a.

The RBA left the cash rate on hold over the quarter, at a record low of 2.5%, and the board maintained its outlook for a ‘period of stability’. Policy makers cited a lack of response of non-mining investment to low interest rates.

High Yielding Internet Savings Accounts

Financial Institution and Interest Rate

UBank – USaver Ultra – 4.02% p.a.

ING Savings Maximiser – 4.00% p.a.

St George – Maxi Saver – 3.85% p.a.

BankWest – Hero Saver – 4.00% p.a.

Westpac – ESaver – 3.71% p.a.

ANZ – Online Saver – 3.70% p.a.

Rates sourced from and are subject to conditions and change. Rates are correct as at 26/11/2014.