IT’S GOOD NEWS WEEK !!

IT’S GOOD NEWS WEEK !!

Applying clearance rates as a reliable barometer to assess the temperature of the property market is generally fraught with danger. One cold rainy day does not, in my opinion, constitute the true reflection of a property market (as was the case last Saturday). But what the heck, when you are on a deadline and you have to file, throw in an interest rate increase and we all know what to expect. The Sydney property market was heading south on Struggle Street and for all intents and purposes the wheels were set to fall off – so (as directed in the Sunday papers) please now assume the crash landing position. It could be said of course, that the writers of such doom and gloom are not (with respect) household names when it comes to real estate.

At exactly 3.40 pm on Tuesday this week, my perception of the market changed dramatically (you may be a subscriber to Eureka?). I received an email from a respected journalist who is pretty well known in business circles. More clues … well he is a former editor of the Australian Financial Review and The Age, former business and economics editor of the 7.30 Report, former Chanticleer columnist for the Financial Review and currently columnist for The Age and the Sydney Morning Herald. A finance presenter on ABC news and host of Inside Business on ABC TV each Sunday, his name is Alan Kohler and the email contained his latest weekly edition of the Eureka Report. It is a totally independent online e-zine (electronic magazine report) where a collective combination of Australia’s most respected journalists offer their thoughts on many economic issues www.eurekareport.com.au ( enjoy a free 14 day trial). Here is what Alan Kohler had to say about Struggle Streets in NSW – a far cry from the otherwise suggested crash landing position. Alan and I have since exchanged emails (he is a subscriber to “Virtual Realty News”) and he gave us permission to use quotes from his article. Being the typical agent I decided to quote the entire article as one of Australia’s most respected journalists stepped out of his comfort zone to make such a controversial prediction (given the weekly climate). I for one, would totally support the pedigree of this reliable source. You can draw your own conclusion !! Please read with interest.

PORTFOLIO POINT: As the sharemarket cools for the next couple of years, conditions are falling into place for a property boom, which will be strongest in NSW.

The implication of the punchline of Friday’s Statement on Monetary Policy from the Reserve Bank was, I think, widely missed. Here it is, in case you were wondering: “The Bank’s current forecast is that underlying inflation over the next two years will be around 3%.”

The point is the bank is forecasting that. There was no sign in the statement that it is actually worried about 3% inflation and would do something to prevent it. Considering that its job is to deal with excessive inflation, which means anything over 3%, if the RBA is forecasting that then it is, by definition, comfortable with it.

Here’s what I think this means:

* Rates will stay where they are for 12 months and then fall.
* The economy will slow but not go into recession.
* The sharemarket will have a “Fed pause” rally soon and then produce single-digit returns for a couple of years.
* The property market will boom again from next year, led by Sydney.

The stories over the weekend that rates will go up again are, in my view, misreading Friday’s RBA statement. Unless something changes in the economy — that is, it surprises everyone by continuing to accelerate despite higher oil prices and two rate hikes in 2006 — interest rates will stay where they are for 12 months and then, when the economy begins to slow next year, the next move will be down.

This is therefore the peak of interest rates in Australia, as it is in the US and Europe (there may more rate rises in both places, but it’s close enough to the peak).

History is really no guide to what we can expect from the sharemarket at this time, so to some extent we have to ignore interest rates, or at least look beyond the short term.

For example, in 1994 the cash rate was lifted from 4.75% to 7.5% in six months and the sharemarket began to rise the moment the peak was reached (December 14, 1994). But during 2000 the cash rate was raised from 4.75% to 6.25%; the sharemarket didn’t peak until June 2001, bottomed in February 2003 and didn’t regain the 2001 peak until March 2004, none of which had much to do with Australian interest rates.

Nor has the bull market of the past three years been even slightly affected by the fact that rates have steadily increased from 4.25% at the beginning of 2002 to 6% today. That’s because the course of the rate increase has been steady and restrained: the Reserve Bank under governor Ian Macfarlane did not panic about the so-called property bubble nor has it responded to record low unemployment by jerking interest rates higher.

The result has been a glorious boom on the stockmarket caused primarily by commodity prices but also the strength of the Australian economy and consumer demand. That economic boom will now slow because inflation has finally got to the top of the RBA’s target band, but the good news is that the bank is forecasting that it won’t go any higher than that, which means rates won’t either (unless the new governor, Glenn Stevens, changes the way the RBA operates, which is very unlikely indeed).

But that doesn’t mean it is a time to sell your investments and move your money into cash — far from it. For a start, the next asset boom will be property, possibly starting about now. Property trusts have already outperformed the market by 3.5% over the past few weeks.

Second, the economic slowdown may be small enough that corporations will be able generally to hold their earnings, especially given that next year is an election year and there are likely to be more giveaways in the 2007 budget.

The key to how deep the slowdown will be is the level of household debt in Australia (now approaching $1 trillion), offset by interest-earning assets of $400 billion (and non-interest-earning assets — mainly family homes — of $5 trillion, but that’s another story).

I simply do not buy the idea that the high level of debt will, on its own, cause a crisis: there would be serious problems only if unemployment rose substantially.

The ANZ Bank’s chief economist, Saul Eslake, estimates that last week’s rate rise will cost household borrowers another net $1.5 billion per annum, in total, in higher interest payments — on top of the $1.5 billion net cost of May’s increase.

He says: “The rise in petrol prices over the past few months is costing households a further $1 billion per annum (according to Access Economics). But adding all this up still falls well short of the nearly $9 billion per annum boost to household incomes from the tax cuts that took effect on July 1, which helps explain why the May rate increase has had so little impact thus far, and provides one reason why the Reserve Bank now perceives a need to raise rates again.”

Which is why, of course, the Prime Minister’s straight-faced denial that the 2006 tax cuts had anything to do with last week’s rate hike was pure sophistry.

Anyway, it will happen again next year too and might lead to another rate hike, which will once again be swamped in its effect by the next lot of tax cuts and hand-outs.

The main risk to my scenario of a very soft landing for the economy next year is not a collapse in consumer demand caused by high debt but a drop off in business investment. As Gerard Minack of Morgan Stanley pointed out last week: “GDP growth has been supported by a huge investment boom. Over the year to March, business investment contributed 2.8 percentage points to GDP growth. In fact, business investment has, on average, added 1.7 percentage points to GDP growth in each of the past four years. The leading indicators of investment spending are now pointing to a significant slowdown.”

This suggests that the outlook for share prices looks subdued over the next couple of years, after one last rally when it becomes clear that the Fed has stopped raising interest rates. That will happen sometime in the next few months.

But by far the most interesting investment market at the moment is residential property, where conditions are emerging for another boom.

The fact is that the Australian housing market, apart from NSW, has had a very soft landing over the past few years, and continues to surge in WA and northern Australia because of the resources boom. Demand for dwellings has remained steady at about 160,000 a year and was boosted by the Federal Government’s decision last year to increase the skilled migrant intake by 20,000 a year.

After three years of rough balance between supply (approvals) and demand, housing approvals have fallen sharply lately and are now running at an annual rate of about 135,000 a year — well below underlying demand. Last week’s rate rise is likely to cause another fall in approvals.

More importantly, a rental shortage crisis is looming. The residential rental vacancy rate is now just above 2%, well below the long term trend of 3.1%.

For the past 30 years property cycles have been driven almost entirely by interest rates; the most recent one by the fact that the cash rate was below 5% between April 2001 and November 2003. But that wasn’t always the case. The property booms of the 1950s and 1960s occurred with interest rates as stable as they are now and were caused by fundamental demand factors from the baby boom and immigration.

Once again interest rates are stable, and probably peaking, there is a sort of baby boom going on and immigration is high, and demand has been added to by the first home buyer’s grant. And there is already a shortage of rental accommodation.

The best looking property market, in my view, is NSW, which has suffered most over the past couple of years. Median house prices have fallen nearly 10% from their peak and approvals have fallen 40%. According to ANZ Bank, NSW needs 46,000 new dwellings a year, yet there is currently an annual completions rate of 26,400 and already dire shortages of rental accommodation.

There is an extraordinary level of pent-up demand for housing in NSW, which I believe is likely to come to a head next year. It’s true that affordability has been a big issue in NSW, and an important reason why house prices fell, but the main reason has been the dismal performance of the state economy.

As John Edwards of HSBC remarked in my Inside Business interview with him yesterday, NSW has been in virtual stagflation lately because of its near-recessed economy and the fact that its inflation rate is the same as those states that are booming.

But net migration out of NSW has been slowing lately and employment has been picking up there.“

On the whole, I reckon that investing in NSW right now is like buying a great blue-chip stock while it’s going through a temporary bad patch … like BHP Billiton three years ago, or the banks 10 years ago. Sydney is Australia’s prime real estate market and the conditions are in place for a big recovery.

Personally, I loved the introduction “If you can see the bandwagon, it’s already too late,” said the late great global investor Sir James Goldsmith. Today Eureka Report makes a big call: property is ready to rebound. If you want to be ahead of the bandwagon, don’t miss today’s lead article.

Another classic example that sometimes we can read too much into the market – however, you should never rule out the smart authors of the market and in my humble opinion Alan Kohler is a brain that at this point in time does not warrant us to get in crash mode. Your choice and call .. plenty of cement in the property market. Cheers ^__^

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