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What we learned this week 5 Sept 14

04 September 2014  |  News

1. Big four banks ‘risky’learn

New data released during the week allows us to objectively lift the lid on the true level of risk in Australia’s banking system. Remarkably the evidence suggests the biggest banks have actually reduced tier-one “equity” capital and increased leverage over the past decade, which contradicts the consensus that our banks are more conservatively capitalised since the global financial crisis.

Information published by the Australian Prudential Regulation Authority (APRA), which should be carefully inspected by David Murray’s financial system inquiry, addresses several myths that investors and financial advisers have swallowed hook, line and sinker.

The $400 billion too-big-to-fail major banks are leveraged about 10 times, right? Wrong.

But they have more loss-absorbing tier-one equity capital and less leverage than competitors? Incorrect.

Well, they have absolutely boosted equity and cut leverage after the lessons learned during the GFC about the ease with which highly geared entities fall over? Wrong again.

Every quarter, APRA reports statistics on the “performance” of all deposit-taking institutions. While the big banks like to criticise comparisons of their capital and leverage with overseas peers – which are hampered by differences in measurement methods – APRA’s data is beyond reproach. It is the final word on Aussie banking risk, given it is calculated and published by the regulator that sets the capital rules banks must abide by.

2. Even the RBA is worried about property prices.

The baby boomer generation’s love of investment property could end in ­tears, according to the ­governor of the Reserve Bank of ­Australia, Glenn Stevens.

Mr Stevens, speaking after a speech that raised the prospect of a housing bubble, suggested property wasn’t the fail-safe investment many Australians believe it to be.

“We perhaps have been a little bit over keen on investment property as our retirement plan,” he said. “We may at some point be a little disappointed.”

The comments appear to be part of a carefully calibrated strategy by the central bank to dampen expectations about surging property prices, which by some measures have risen the most in the English-speaking world.

The comments were backed up by Aussie Home Loans founder John Symond, who said prices in Melbourne and Sydney have been “on fire” and could be unsustainable.

3. SMSFs big beneficiaries of $70 billion dividend bonanza.

Almost $70 billion has flowed to ­investors in dividends throughout 2013-14, keeping equities in favour and underscoring Australia’s love affair with companies which give back cash.

Dividends declared in the earnings season just ruled off takes the haul over the year to June 30 to a record ­$67.8 billion, up ­from ­$61.3 billion in 2012-13 for current ­members of the S&P/ASX 200, analysis by Credit Suisse shows.

Improved payouts from Telstra, Wesfarmers and Commonwealth Bank of Australia led the way, ensuring the S&P/ASX 200 Index held its gains through August in spite of only single-digit ­average earnings growth by Australian companies. Indeed, dividends rose by more than earnings.

The Reserve Bank of Australia revealed on Wednesday the economy grew at 0.5 per cent in the second ­quarter, slowing from 1.1 per cent in the first quarter, making the strength of ­dividends all the more remarkable. Annual gross domestic product growth was a more comfortable 3.1 per cent.

Shares closed at 5656.1 points, down 2 points at the end of the session.

“It is obvious that some of these ­massive dividend payments are coming at the expense of capex,” Credit Suisse equity strategistHasan Tevfik said.

“This is what investors want now, ­especially “selfies” [SMSFs] who are ­collecting more than $10 billion of ­dividends themselves. It is important to ­remember Australian companies are contributing a significant amount to our pension scheme.”

4. Australian economy could be in trouble as the China/iron ore boom comes to an end"The federal government’s former top resources forecaster says the economy faces a painful downturn in 2015 as a property crisis in China accelerates the biggest hit to Australia’s export income in more than two decades.

Speaking after iron ore plunged to a five-year low of $US85.70 a tonne, the former chief economist and head of the Australian Bureau of Resources and Energy Economics, Quentin Grafton, said the Chinese economy looked like it was “unravelling”.

He said falling prices for coal and iron ore, a slump in business investment, an overpriced housing market and high dollar had placed the Reserve Bank of Australia “between a rock and a hard place”. “Put all those things together and it could be a difficult ride for us,” he said. “This isn’t about doom and gloom – it’s about looking at the risks and numbers. There’s a clear and present danger.”

The remarks add to doubts about the economy’s underlying resilience and the robustness of the government’s revenue expectations after this week’s national accounts showed income fell in 2013-14 and 2012-13, the first two-year decline since the early 1990s recession.

5. Global markets are set for period of instability.

"Australia’s largest asset manager, Colonial First State, says global markets could be set for a period of instability as a major policy divide emerges between the world’s major central banks.

Stephen Halmarick, the head of economic and market research at Colonial First State, believes the US Federal Reserve will raise interest rates for the first time in nearly seven years next June. By this time, he says, the US unemployment rate will be below the 6 per cent level, while the country’s inflation rate will be closer to 2 per cent.

In contrast, he says, the European Central Bank and the Bank of Japan have little choice but to opt for even more monetary stimulus.

“So we’re going to have this policy division in the next six to 12 months, and that is very different to the post-financial crisis period where all of the world’s major central banks pushed interest rates close to zero and then added more monetary stimulus through quantitative easing,” he said.

“In the next six to 12 months, this will change quite dramatically. The Reserve Bank of New Zealand has already raised interest rates four times, and I expect the Bank of England will push interest rates higher in the next six months."

“The US Federal Reserve will put rates up in June, and the Reserve Bank of Australia will put rates up around the same time. And the Reserve Bank of Canada will put rates up shortly after that.

6. Emerging markets show positive signs, however.

Emerging markets are making a comeback following a bumpy ride in 2013 and at the beginning of this year, as investors search for new shoots of growth.

Corporate earnings in the developed world have been fairly solid, but the story has been one of cost-cutting rather than revenue growth.

Developed markets have performed reasonably well in 2014 – not as strongly as last year but good enough to provide hope that companies will eventually begin to increase revenue streams.

Last week on Wall Street, the S&P 500 closed above 2000 for the first time, and it has added 8.4 per cent for the year. Locally, the S&P/ASX200 has added 5.1 per cent in the year to date, but corporate earnings season, which was acceptable, did not get rewarded by investors. The ASX200 slipped 0.1 per cent during August.

Investors in the developed markets will need a bit more convincing to take shares through their current valuations, which are looking a little stretched.

Instead, investors are once again turning their attention to emerging markets, as volatility lowers following last year’s sell-off.

7. There are a lot of bulls in the stock market.

The big news today isn’t coming from the economy or world events, it is the fact the number of bears in the US Advisors’ Sentiment Report came in at their lowest level since February 1987 at just 13.3%.

This matters because many use this poll as a contrarian indicator.  The thinking goes if there are no bears left, then we could be near a major peak as there is no one left to buy as everyone is bullish.  Lastly, this poll looks at what newsletter writers are thinking.  

Then the fact the last time the bears were beneath 14% was in 1987 and you have all the ingredients for an intriguing headline as well.  Now before you go out and sell all your stocks, remember the S&P 500 (SPX) gained +16.6% the six months after the late February signal in 1987.  Sure, we had the one-day crash of 20% later in October, but there were some spectacular gains to be had for a long time first.

8. Moody’s is warning about a credit bubble in Australia.

"Last Tuesday, the Australian Prudential Regulation Authority (APRA) released its latest statistics on Australian authorized deposit-taking institutions’ (ADIs) exposure to residential property, which showed an increase in the proportion of higher-risk loans underwritten by Australian banks, including investment loans, interest-only (IO) loans and loans written outside normal serviceability criteria. The increase in higher-risk lending is credit negative for Australian banks because it weakens the credit quality of their portfolios.

APRA’s data show three notable negative developments during the June quarter (Exhibit 1). The proportion of investment loans written by Australian ADIs as a percent of all newly written loans rose to 37.9%, compared with a 2008-14 average of 32.6%. Over the past 12 months, the total value of outstanding mortgages to investors increased by 10.9%, versus a 7.5% growth rate for loans provided to owner-occupiers. The proportion of newly written IO loans rose to 43.2% in the quarter, and now comprises 35.7% of all outstanding loans, the highest percentage on record. The proportion of loans approved outside normal serviceability criteria8 – where the lender makes an exception to its policy – rose to 3.7%, again the highest proportion in ARPA’s 2008-14 sample."




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