Housing, China put us at risk of economic ‘pneumonia’

By Lucy Dean

July 10 2018
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The confluence of Australia’s softening housing market and Chinese trade and stockmarket problems is the “fox in the henhouse”, a fund manager has warned.

Speaking in a recent insight, Grant Samuel Funds Management adviser Stephen Miller said Australia’s “remarkable run” of 27 recession-free years is facing challenges, mainly originating from a highly leveraged housing market. However, this same relationship means that if China sneezes, “Australia may well catch ‘pneumonia’”.

He explained, “The real ‘fox in the henhouse’ scenario is the potential for a China slowdown to afflict the domestic economy at the same time that household debt/housing excess was working its way through the system.

“The consequences would be a dramatically lower Australian dollar, an underperforming stockmarket and an extended period of low interest rates and bond yields.

“In other words, now may be the time for investors to think about a particularly challenging return environment from domestic financial assets!”

Noting that he’s not the first to make “dire prognostications” of housing and China risk, Mr Miller reminded investors that the boy who cried wolf did end up being correct.

He argued the headwinds coming from excessive household debt are “incontestable” and the cocktail of high household debt and high house prices has rendered the Australian economy “vulnerable to potential shocks”.

The next question is what could trigger a fall, Mr Miller said, pointing to curbs on lending and the risk of changes to investor incentives like negative gearing discounts.

“There are further negative feedback loops; the big four banks comprise approximately 20 per cent of the ASX200,” he said.

“Greater regulatory constraints, less lending activity and further (potentially significant) declines in house prices might further constrain bank profitability and create uncertainty around the sustainability of current bank dividends, leading to diminished holdings of bank stocks by the banks’ large retail investor base.”

These trends alone are unlikely to trigger a recession, however trouble in China could, Mr Miller warned.

Australia has China to thank for its 27 years of economic stability as it is “by far and away” one of the most highly leveraged to China. However, this same link could be its undoing.

“That leverage has come about from China’s extraordinary demand for Australia’s commodity exports, which has sustained Australia’s GDP and income growth through challenging periods. The downside is that were China to ‘sneeze’ then Australia may well catch ‘pneumonia’,” he said.

“Were this to occur when the consequences of housing excess were working their way through the system, then the 27-year dream run may well come to an end. In this context too, the recent emergence of diplomatic tensions between Australia and China may have adverse economic consequences.”

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