The market fall, and the future

By Robert Gottliebsen, Financial Commentator – InvestSMART

How the battle for future world leadership is affecting the average Aussie investor.

Summary: The trade war, and the slowdown of two global superpowers, is causing markets to fall. But Australia is experiencing the reverse of a pattern dominating US investment strategies.

Key take-out: What theoretically should happen to Australian bank shares in this environment is playing out as quite the opposite. This implicates Australian property investors. 

All of us remember at the start of the week, in the wake of the G20, markets around the world celebrated the possibility that the trade war between the US and China would start to fade away. It’s always difficult to predict the actions of leaders like China’s Xi Jinping and America’s Donald Trump but for the trade war to go away it would require a massive backdown from one of the leaders. Today the realisation hit the markets that neither was likely to back down.

In the case of China, Xi Jinping has a very clear agenda. He plans to build China into the world’s largest manufacturing centre, driven by the best technology he can get from the US developed using China’s internal resources. And we should not forget that his famous Belt and Road initiative is in part designed to make China much less dependent on Australia and Brazilian resources. At the moment, Xi Jinping is sending us a message about what is ahead by curtailing coal and iron ore imports.

On the US trade war front, it is highly unlikely the Chinese leader will give in to the American demands for technology protection because gaining western technology is what China is about. Conversely, President Trump has woken up to the Chinese strategy and is attempting to restore the American manufacturing base and retain its technology lead. Both sides are treating the trade war to the equivalent of throwing meat pies at each other via tariffs and other trade restrictions. It’s the surface manifestation of a deeper battle – future world technology leadership. China has vowed that it will never again give into western pressure and it is not going to.

The G20 agreement looked to me a little like the Christmas truces on the battlefronts in the First World War which were merely a temporary halt in the fighting. Initially the market saw it a different way, but now, the market better understands what is happening. We should not forget that both countries are experiencing a slowdown. The China slowdown has been happening for some time, now translating into lower orders of Australian coal and iron ore, as I mentioned earlier.

On the surface, the US is booming. But as we discussed last week, that boom is not uniform. Higher interest rates have started taking their toll on consumer behaviour. US companies are not investing at the rate that President Trump had hoped for. I picked out the icons General Motors and GE, and both companies were hammered in the fall. We saw the US 10-year bond rate fall below the indicator level of 3 per cent as investors rushed for the security of US dollar bonds in the wake of economic slowdown in the US and China and the problems in Europe. 

Accordingly, we are seeing a reverse in the pattern that has been dominating US investment strategies for the last year or so – that is, a continuation of higher interest rates that was pummelling long-term yield securities. 

The market is now telling us that interest rates are not going to rise at the same rate as was originally expected. That takes the pressure off Australian banks that have already experienced some increases in interest rates on their overseas borrowing. It is still possible there will be official rate rises in the US but the magnitude of these will slow. The fear of much higher rates will start to evaporate. 

Under normal circumstances, this would have boosted Australian bank shares, but as we all know, banks are controlling their credit and looking at a tougher environment that is less shareholder friendly. Meanwhile, the wider community is now appreciating that residential real estate is in a decline, potentially caused by the bank credit squeeze. Even in the Reserve Bank of Australia’s Martin Place bunker there is an understanding that, contrary to their statements of last month, there is indeed a credit squeeze, and it is having a considerable impact on residential property prices. 

And the simple fact is that, while the credit squeeze continues, property prices will continue to fall. 

Just this week I learned of a medium-sized property investor with lots of cash generation and internal wealth applying for a loan to fund the purchase of another unit as an investment. There is no way this person is a credit risk – but one of the big four banks took four weeks to give an answer, and as of today, there is still no answer. That sort of delay is plaguing all sorts of credit decisions, especially those linked to residential real estate. At some point the situation will change, however, it’s not easy to change because the tight credit is aimed at lifting the standard of banking balance sheets. The banking executives know if they take the slightest risk in a loan, they are likely to lose their job. And not taking a risk means making sure that every part of a form is filled in to suit the requirements of APRA. It is a time consuming and miserable process. Although house prices have fallen, those seeking to buy are seeing the amount of money they can borrow reduced, so they are not actually much better off.