flongle, a mortgage contest, consumer-facing website where consumers can put their mortgage out to tender to banks, non-bank lenders and mortgage brokers, is now giving advisers the opportunity to do the same on behalf of their clients.

“A mortgage broker might have accreditations with many banks but most brokers mainly source a loan from three or four of them which means the best deals often fall through big gaps,” says flongle partner development manager, Daryl Smith. “Because of the nature of the flongle bidding community, the adviser will now be able to find the most competitive product for their clients, which may not necessarily be the one a mortgage broker will find. Lenders are discounting, and in many cases, broker firms offer cash back on commissions so it works better for the client.”

Mr Smith said advisers that are looking to offer comprehensive advice to their clients can now expand their service offering by adding ‘debt planning’ to their other planning segments. “By utilising the flongle system advisers can feel confident that their clients will receive a competitive lending product, resulting in a mortgage that suits their specific requirements.”

Currently, there is a risk when advisers outsource mortgage broking because larger mortgage aggregation firms are moving into the financial planning space, Mr Smith says. “flongle allows advisers to keep this process in house. It gives greater options and choice to clients and allows advisers to oversee the whole mortgage process and charge a fee which is in line with the service they provide.”

AdviceInnovation director, Michael Topper, says the addition of flongle to the hub of innovators was reflective of the growing demand for innovative services for advisers. “Advisers are coming to us really excited about what is new in the space and how they can better service their clients – it is something that is becoming more prevalent.”

Mr Topper says services like flongle are becoming more popular amongst financial advisers as they look to add more value to clients at a time when business models are changing to fee-for-service.

In order to lodge a contest direct an adviser needs to hold a credit licence, however other options are available for advisers who do not hold a credit licence.  Advisers pay for the flongle service on a casual plan or via a monthly subscription.

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The index is based on historic and recent consumer attitudinal data collected by Genworth and shows homebuyer confidence across Australia has dipped by 1.5% since September 2010 – the second consecutive fall since the launch of the index last year.

“This fall, despite Australia’s relatively strong economic performance was driven by decreased confidence in the natural disaster affected regions of Queensland and Western Australia (WA) coupled with growing concern amongst Australian homebuyers about the rising cost of living,” said Genworth CEO Ellie Comerford.

Natural disasters hit Western Australia and Queensland sentiment

Disaster-impacted borrower sentiment in Queensland and WA was the primary driver behind the index fall, without which the index would have risen by 0.8%.

Queensland was by far the worst affected, with one in three Queensland respondents impacted by the natural disasters in some way, compared to a national average of 14%.

Genworth Hardship data reflects this trend. Total Hardship requests in early 2011 increased by over 70% compared to the same period last year and nearly half (40%) of these requests were natural disaster related.

Most of those affected by the recent natural disasters were fairly optimistic about the recovery with 60% expecting to recover in two months or less. However, one in five believes they will be affected for more than six months.

Awareness of Government relief programs was strong with most homebuyers (78%) aware of relief initiatives. Borrower awareness of lender hardship relief measures was lower at 39%, but over 60% of borrowers using lenders hardship initiatives were more than satisfied with the service and support they received.

“Genworth has worked with lenders to deliver hardship assistance in the wake of natural disasters, and is pleased to find the majority of people that used these solutions were satisfied with the outcomes.

However, flood affected borrowers are telling us they expect to struggle for longer and we are working with lenders to introduce more relief to affected borrowers in the longer term,” Ms Comerford said.

Mortgage stress increasing – Rising costs of living the biggest worry

Overall, the report findings show that debt levels did not change between September 2010 and March 2011 with 27% of Australians putting half or more of their monthly income to paying off debt. However, more borrowers across Australia experienced mortgage stress at 21%, up from 15% in 2010.

The causes of mortgage stress have shifted over the last six months, with borrowers now seeing the rising cost of living as the biggest hurdle to meeting repayments rather than interest rate hikes at 66% compared to 51% respectively.

“Expectations for a relatively stable interest rate environment contrast with soaring food and petrol prices, moving the rising cost of living to the front of borrowers’ minds,” said Ms Comerford.

First homebuyers more anxious about repayment ability

Despite some concerns that first homebuyers had over-committed to high debt levels while generous first homeowner incentives were available, this segment is faring well with above average levels of confidence. However, this result masks the fact one in three first homebuyers spend more than half their monthly income on servicing debt, compared to only 27% of average homebuyers.

Also a concern is first homebuyer outlook for the year ahead, with 24% expecting to find it difficult to meet repayments over the next 12 months compared to the national average of 19%.

“Although first homebuyers are confident, they are most concerned about interest rate rises in the coming year. This reflects the trend of rising property prices forcing them to take on bigger loans to realise their dreams of home ownership,” Ms Comerford noted.

Outlook

Despite an overall drop in borrower confidence and increased mortgage stress, more homebuyers are upbeat about the property market this year, with 38% of those surveyed viewing 2011 as a good time to buy a home (up from 25% in 2010).

However, homebuyers are pessimistic about their ability to repay their mortgages, with the rising cost of living and threat of future rate rises weighing heavily on their minds.

“Genworth will continue to provide the market with valuable insights into the attitudes and sentiment of homebuyers and would-be borrowers. We anticipate the effects of the recent natural disasters will continue to put downward pressure on borrower confidence over the coming six months,” Ms Comerford said.

Click here to download a full copy of the report.

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Unfortunately, if they miss the signal it can make a significant difference to their financial position when they retire, says Mr Jonathan Philpot, wealth management partner at accountants and advisers HLB Mann Judd Sydney.

“Missing out on a couple of years of savings and its compounding effects over ten to twenty years can make a huge difference to the amount they have saved.

“Different people will reach this ‘wealth builder’ stage at different times, so it’s difficult to say precisely what age this is, but for most people it will be some time in their 40s, when their income reaches a peak, their mortgage is down to 50 percent or less of the home’s value, and retirement planning strategies become a focus.

“Generally, one of the first signs is that there is more disposable income available in the family and it’s important to recognise this so that a decision can be made to put some of the extra funds into savings rather than spending it all on the family’s lifestyle.

“It’s the first time in our lives when we are in control of our financial situation and can make big decisions about how to manage wealth, and the choices made now can have a significant impact on our financial future.

“For younger people, much of their financial situation is ‘automated’ and inflexible – a set amount goes into superannuation, another set amount goes to pay off the mortgage each month, and there is little opportunity to vary this or put aside enough money to do anything else.

“For those in retirement, there is a good level of flexibility; however there are still rules and regulations governing, for instance, how much you are able to contribute to super, when you are allowed to commence drawing a pension; and a minimum amount that must be drawn down.  There is also the limitation that people in this phase of their life can’t afford to be too aggressive in their investments, and must therefore keep to fairly balanced or simple strategies.

“However in the pre-retiree years there are a number of tax-advantaged strategies that can be adopted – but how these can be applied will depend on how successful wealth accumulation strategies have been.

“It is therefore critical that people who have the opportunity to change gears and focus on building wealth ten to twenty years before retirement, start doing more than just repaying the mortgage and making superannuation guaranteed contributions.

“As it also coincides with the peak income-earning years, there should be additional money available that can be put towards building wealth,” he said.

Mr Philpot added that there are three main strategies that people should focus on when they become wealth builders.  They are: reducing the mortgage; increasing super contributions; and looking at appropriate gearing to diversify their wealth.

Mortgage reduction

Mr Philpot says that people should plan to be mortgage-free by the time they enter retirement.

“Therefore any wealth accumulation strategy should include reducing home mortgages as a priority, especially as the interest on mortgages is not tax-deductible.

“This strategy should start as soon as possible with mortgage holders looking at ways of always paying more than the minimum amount or making mortgage payments more frequently than required.

“Given that we are in a rising interest rate environment, this approach also builds in a buffer against future interest rate hikes.

“However, it should be only part of an overall strategy as your home is a “lifestyle” asset but doesn’t help build your investment wealth, which is what provides future income,” he said.

Super contributions

The simple fact is that people don’t start thinking about their superannuation early enough, according to Mr Philpot.

“It used to be at age 50 that people started worrying about building their super balance, but now, in light of the restrictive superannuation contribution limits, they need to start thinking about it much earlier, when they are still in their 40s.

“A desired retirement income of $50,000 is not extravagant; however it requires around $1 million in superannuation savings, which most people will not be able to achieve without making significant contributions above the superannuation guarantee levels during their 40s and 50s,” he said.

Gearing

Mr Philpot says that gearing can be a useful strategy, as long as it is not just into another residential property, and is not overly aggressive.

“Many people’s wealth is tied up in the value of their home, therefore residential property market moves have a large influence on their future wealth. If the residential property market has a flat period for five years, it follows that most people will see no change in their net wealth.

“Simply buying another residential property for capital gain is therefore a flawed strategy unless there is other diversification.

“Most people have some exposure to the sharemarket through superannuation, but given how low most superannuation balances are, it is relatively small.

“There can be real benefit in borrowing to invest in shares as you will diversify wealth and increase access to more assets.  These are key ingredients to building wealth over the long term,” he said.

However, Mr Philpot cautioned against excessive use of gearing and borrowing against the home to purchase shares.

“Gearing is not for everyone and should be considered very carefully.  It means taking on a much greater level of risk with leverage into shares.

“The borrowing should be interest only, as most of the spare cash flow should be directed towards the mortgage.

“On the positive side, with the dividend yield at close to 5% on Australian shares and interest rates between 7-8%, there is not a large cash shortfall in the cost of holding the shares.  Also, with the Australian equity market still subdued, it is a good time to be buying for long term gain.

“Borrowing against the house to purchase shares has benefits over taking on a margin loan, as borrowers are not subject to margin calls when shares fall in value.

“In addition, the cost of the loan is about two percent cheaper than a margin loan,” Mr Philpot said.

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Sailors and investors have come to fear extremes; both violent storms and utter calms can be deadly. A storm at sea can sink even the finest ship, or dash it against the rocks of an unforgiving coast. When becalmed, the ship, robbed of wind for the sails, is literally dead in the water as food and hope fade away. For long-term investors, the turbulence of extremely volatile markets can similarly destroy even the most well-crafted portfolio and markets that are too calm can starve a portfolio of yields and returns.

The world’s financial markets have recently begun to emerge from what has been one of the worst financial tempests of the last 60 years. The flotsam and jetsam of the investment industry are scattered as far as the eye can see. Some financial firms have capsized, while others were able to weather the storm and emerge, if not unscathed, then unsettled.

Plotting a course for 2011 will be an exercise that balances caution and opportunity, because, as Van Gogh alludes, the search for greater rewards inevitably involves taking incremental risks. However, much like experienced sailors have learned to deal with the perils of the sea through managing the variables they can control and respecting those they cannot, a focus on effective risk management is equally critical in the investment industry. In real estate, that means carefully evaluating the shifting tides of macroeconomic variables that affect the industry and examining the outlook for the four quadrants of U.S. commercial real estate.

U.S. MACROECONOMIC OUTLOOK

Despite policy uncertainty, a soft patch in the U.S. economy, and continued peril in the broader investment environment (with intermittent bouts of risk taking and risk aversion), we feel there are several reasons for optimism in 2011 and beyond. While unlikely to be accompanied by powerful economic tailwinds, we believe the following factors should collectively help provide further leeway for continued steady economic growth that gradually reduces unemployment rates and avoids a double-dip recession.

• Political rebalancing following the 2010 U.S. elections should result in reduced risk of unwelcome legislative initiatives and reduced corporate perceptions of an anti-business political climate.
• Stabilizing commercial real estate values should help unclog bank balance sheets through improved resolution of problem loans, freeing up lending capacity and improved credit formation for small businesses.
• Continued progress with household deleveraging and higher personal savings rates should lead to a more stable consumer base that is less likely to reverse course to a retrenchment mode.
• Corporate earnings in 2011 should continue their favorable tack in 2011.
• Asset reflation-friendly actions by the U.S. Federal Reserve (Fed) which, while clearly generating longer term risks of inflationary pressures, will likely buoy up asset values over the near-to-intermediate term and help the wealth effect.
• Markets should continue to see progress in a relatively orderly deleveraging of the commercial real estate market.

By and large, the cumulative impact of the above dynamics should prove helpful to both real estate space and capital markets in 2011 and 2012. The outlying years of 2013 and beyond do face the risk that a reversal of ultra-accommodative monetary policy and removal of quantitative easing could produce a material upward movement in Treasury rates, which would be generally unfavorable for cap rates, discount rates, and borrowing rates. The 2010 course correction in real estate pricing has been partially attributable to the macro forces of monetary policy. The asset reflation dynamics resulting from market anticipation of further Fed easing have contributed to the current round of cap rate compression in commercial real estate. While that has been positive for borrowing costs and real estate prices, Fed policy now potentially represents a form of future event risk that could halt or reverse cap rate compression as the economy improves. The Fed’s future actions imply that, while there will likely be material improvement in space markets before monetary policy is reversed, the subsequent trajectory of incremental property appreciation could be interrupted by rising Treasury rates. And the anticipatory nature of
the public bond markets means that those eventual forces could well blow ashore before improving space markets allow for a complete restoration of landlord pricing power. Indeed, because the recovery in space markets has thus far trailed the recovery in capital markets (especially for core real estate), it will be critical that space markets gain traction in 2011 and 2012 to catch up with the capital market recovery.

This is not to put a damper on a well-justified improvement in investor sentiment toward the U.S. real estate asset class. The two public quadrants have already provided investors with tremendous returns in just the few quarters since the recession ended. Sustained improvement in price recovery in the private equity quadrant appears to be in the offing and provides investors an opportunity for dollar-cost averaging by returning to the market at or near the bottom. A weak U.S. dollar will provide a further boost in real estate buying power for foreign buyers. We believe that attractive investment opportunities include not only highly sought after core strategies, but also selective value-add and opportunistic strategies. The latter two strategies entail less competitive bidding and in addition could perform well even in just a moderate economic recovery scenario if investors are sufficiently well capitalized and have strong leasing capabilities, providing a strong competitive advantage that facilitates taking tenant market share away from weaker, overleveraged competitors. Indeed, in some ways, while 2010 has seen the majority of capital pursuing core strategies in primary markets, we believe it is likely that 2011 will increasingly see that capital set its sights on selective non-core strategies and secondary markets.

The Four Quadrants of U.S. Commercial Real Estate

Publicly Traded REITs

Most real estate investment trusts (REITs) have made the transition from their defensive positions of early-to-mid 2009 and are now relatively well positioned to go on the offensive. REITs have been able to take advantage of very favorable credit markets to access debt capital through unsecured corporate bonds issuance and, in select situations, through the Commercial Mortgage-Backed Securities (CMBS) issuance market. Several REITs have also used secondary equity issuance to deleverage. As a result, the upcoming 2011 and 2012 loan maturities that confront the broader real estate market does not look all that threatening to U.S. REITs.

A confluence of low cost-of-debt capital, stabilizing credit ratings, the likelihood that acquisitions will be accretive to debt-capital costs, and the relationship of dividend yields to risk-free rates are additional positives. However, a lackluster economic recovery does bring into question whether REIT investors may be overly optimistic about the strength of rent recovery. Indeed, from a number of perspectives, REITs appear to be close to fully valued. A key question is how much additional pricing support a low Treasury-rate environment will give to REITs, especially since share prices continue to trade well above net asset value. Of course, part of this premium is an expectation that REITs will be able to grow earnings through accretive acquisitions, helped by access to the credit markets at low cost financing and indeed REITs have generated a considerable share of property acquisitions year to date.

Consequently, it is reasonable to expect REIT prices to remain somewhat range-bound pending additional clarity regarding the longer-term economic outlook. A sell-off also looks unlikely, given that REITs remain attractive because of high dividend yields, which play well amidst a growing investor desire for current income.

Commercial Mortgage Backed Securities

CMBS prices have rallied strongly across the risk spectrum in 2010, despite rising delinquency rates. Although seemingly counterintuitive, that is a function of the previous severity in decline of commercial real estate prices that was impounded into CMBS prices, and the degree to which that expected severity has since been favorably reevaluated.

Still, a high degree of watchfulness will be needed going into 2011. That is particularly true for junior AAA (AJ) tranches that continue to see a wide variation in pricing depending upon vintage and specific mortgage composition. Selectivity will also be important given how the amount of underlying mortgages in the CMBS universe that are below a breakeven debt-service coverage ratio.

Financial regulatory reform could still take the wind out of the sails of the burgeoning CMBS recovery, particularly when considering the uncertainty regarding what the final risk-retention provisions will look like, especially for banks that issue CMBS. The degree to which this will slow momentum of the issuance market is unknown, but banks have been one of the most active players to return to the CMBS issuance market in 2010.

On the margin, the strong rally in CMBS pricing has reduced its relative value compared to a year ago. The search for yield amidst the broader bond market rally has resulted in certain higher-rated CMBS bonds trading at prices well in excess of par–a major reversal for a quadrant that has consistently traded at a discount since the beginning of the credit crisis. Still, attractive buying opportunities remain, particularly for selective AAA mezzanine (AM) and AJ bonds, which offer attractive current spreads-to-swap rates with limited downside risks given generally sufficient subordination levels to absorb credit losses.

Private Debt

A sharp increase in lender appetite for commercial real estate mortgages has led to significant competition, especially among life companies and better-capitalized banks, to originate conservative loans on well-leased, high quality properties. While core mortgages remain attractive relative to corporate bonds, from a total-return outlook conservative mortgage loans perhaps offer the least relative value of any quadrant at this time, with investors most likely to utilize such investments as part of asset liability management strategies. Very low yields on senior mortgages are why most institutional investors in the private debt quadrant are seeking mezzanine or subordinate debt structures or higher loan-to-value (>70%) loans in search of yields that are more competitive with CMBS or core unleveraged equity. This subsector of the private debt quadrant reflects a gap in the mortgage market that could offer attractive risk-adjusted returns, especially if some meaningful amortization or substantial structure can be achieved in order to effectively navigate downside risks.

Given that the preponderance of private debt capital is seeking conservative, core loans, there is much less availability and higher cost-of-debt capital for lower quality properties, value-add properties, properties in secondary and tertiary markets, and vertical development/land acquisition activities. To some degree this simply reflects improved risk discipline and more appropriate pricing, but at the same time also provides an opportunity for investors to help fill a financing gap by selectively moving up the risk spectrum in search of higher returns.

Private Equity

As the markets traverse the fourth quarter of 2010, most pricing indicators for institutional quality, core real estate are signaling that, barring a double-dip recession or some other disruption, price corrections in U.S. commercial real estate have ended. Despite a longer and more severe recession in 2008 than was the case in the 1990s, core property value declines have not exceeded the severity of the 1990s.

Most investors are focused on core properties, especially high-quality assets in primary markets. However, despite (or possibly because of) reduced debt and equity capital availability, higher-quality, value-add properties in primary markets may offer somewhat better relative value opportunities within the private equity quadrant. This is especially true for well-capitalized investors that can buy properties on an all cash basis, have strong leasing capabilities and plenty of capital readiness for tenant procurement costs due to an opportunity to take leasing market share away from overleveraged competitors. In addition, green or sustainable buildings (especially in the office sector) will be increasingly important in order to maximize tenant bandwidth. The ability to acquire quality value-add assets at relatively steep discounts to reproduction costs can make select value add opportunities appealing, particularly in sub-markets with a multitude of undercapitalized competitors from which to potentially lure away tenants.

The post The Principal Real Estate Investors 2011 Outlook appeared first on AdviserVoice.

Almost half of Australians won’t pay off their mortgages before they retire, a nationwide debt and savings survey by RaboDirect, Australia’s online savings and investments bank, has found.

The National Saving and Debt Barometer found 49% of respondents with a home loan would be 60 or older before they had finished paying it off and more than two in five of those people aged over 40 have 20-plus years outstanding on their home loan.

The National Saving and Debt Barometer surveyed more than 2,000 financial decision-makers aged between 18-65 years across Australia on their attitudes and behaviours towards debt and savings in October 2010.

The survey found that three quarters of those who are likely to take their home loan into retirement are concerned they may not be able to sustain their standard of living through this period. More women (54 per cent) were concerned about this than men (41 per cent), the survey found.

“What we are seeing is a significant proportion of Australians who will carry their mortgage into their golden years, a time when they should be financially free and enjoying themselves. This significant household debt becomes a legacy of their lifetime of hard work,” RaboDirect General Manager Greg McAweeney said.

“It reflects a picture of hard-working Australians with their heads down, not seeing the future potential impact of ballooning personal credit card debt, insufficient budgeting and inefficient savings.

“Consumers need to understand the full financial picture; get back to basics such as setting a personal budget and a regular savings plan; and think twice before spending on the plastic.”

Consumers should also be regularly checking that key financial products, such as mortgages, transaction and savings accounts, insurance and any credit facilities, genuinely suit their needs and offer the best value.

“About half of those who responded to the survey think low-interest ‘transaction’ accounts are ‘savings’ accounts. This highlights that we’re in the dark when it comes to financial foresight. If you were to move your funds to a high interest savings account you could earn valuable interest that can be used to pay off that burdensome mortgage,” Mr McAweeney said.

The post Till debt do us part appeared first on AdviserVoice.

• The Reserve Bank Board has left the cash rate at 4.75 per cent at its final meeting for 2010. The next meeting is on February 1 2011.
• The Reserve Bank Board notes that lending rates are now a little above average and believes that this tight policy is “appropriate for the economic outlook.”

Click here to download this document (pdf)

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Headline developments of the past week

• While there was good news at the start of the week in terms of Ireland agreeing to accept a bailout from the European Union and the IMF, the worry list for investors actually expanded. It now includes worries about whether Ireland will deliver on its austerity package, concerns that Portugal will need a bailout too, an insider trading case in the US, ongoing issues with US mortgages, renewed tensions on the Korean peninsula, worries that China will tighten too much and concerns that rising inflation in emerging countries will become a problem. With this list of worries its little wonder investors are skittish.
• However, there are some positives worth noting. Firstly, the flow of economic data in Europe tells us that Germany and other core European countries are providing an offset to the weakness in peripheral countries. And at least Europe is now moving quickly to provide assistance to troubled countries. Secondly, US economic data is looking healthier. Thirdly, while North Korea is an ongoing worry, over the years it has a habit of doing provocative acts only to settle down again. Fourthly, while we are seeing almost a daily flow of news regarding tightening measures to combat inflation in China there is nothing in any of this to suggest that the Chinese authorities are going to crunch their economy, particularly with the pick up inflation essentially due to weather related food prices increases. Similarly, higher food prices accounts for most of the rise in inflation rates in other emerging countries and so is not a reason for aggressive monetary tightening. And finally, investors would be wise to remember the old saying that “shares climb a wall of worry”, in that its often when the worry list seems the longest that shares do their best, because invariably some of the worries start to fade which then prompts investors to close shorts and/or buy shares.
• In Australia, RBA Governor Glenn Stevens indicated that once allowance is made for the additional increase in bank lending rates and the strong Australian dollar, the current level of the cash rate is appropriate for the “period ahead”. This is pretty much in line with market expectations that rates are on hold for now. However, the Governor’s assessment that the medium term risks to inflation are that it will be too high on the back of only modest amounts of spare capacity and the need to accommodate a huge expansion in mining investment indicate the Reserve retains an inclination to continue raising interest rates next year. This was reinforced by the Governor’s observation that growth in labour costs is now rising. Our view is that the cash rate is likely on hold until March, but that it will rise to a cyclical peak of 5.5% in a year’s time.

Major global economic releases and implications

• US economic data came in on the positive side on balance. Data for home sales were weak and house prices also fell in September, but against this, weekly mortgage applications for new homes rose strongly suggesting that there is some light at the end of the housing tunnel.  While durable goods orders fell in October this may reflect a seasonal distortion. On the clearly positive front though, September quarter GDP growth was revised up, manufacturing surveys in the Richmond and Kansas areas both rose solidly, consumer sentiment rose and there was another sharp fall in weekly unemployment claims taking them to the lowest level since July 2008. The basic message from the flow of US economic data is that the recovery is continuing.
• European economic data was also mostly positive with rises in consumer confidence and business conditions. Germany remains a standout with business conditions rising to their highest level on record according to the IFO survey. Business confidence also rose in Belgium, France and Italy.
• In China, we saw more signs of tightening, including indications that banks will have to wind down lending in the last two months of the year in order to stay within the Government’s 7.5 trillion Renminbi target for new loans this year, given that so far 6.9 trillion has been lent out, indications that this target will be wound back down to 6.5-7 trillion RMB for next year and indications from the central bank that it will “normalise” monetary policy after running stimulatory monetary policy for several years. However, even if the new lending target is wound back to 6.5 trillion RMB this will still see credit growth of around 14%% & because monetary conditions are coming from very easy currently we remain of the view that such moves won’t crunch the economy.
• Across Asia, growth rates have slowed from the double digit pace seen earlier this year as activity bounced back from the GFC, but are still around 5 to 10%. Moderation is necessary to avoid overheating.

Australian economic releases and implications

• Australian economic data was somewhat mixed. Construction activity unexpectedly fell in the September quarter due to a fall in housing activity. While business investment rose in the September quarter, intentions for 2010-11 were scaled back. However, it’s worth noting that based on long term realisation ratios investment is still expected to surge by around 20% this financial year, which compares to the Governments forecast for an 8% rise. The scaling back from a previously implied rise of 25% may simply reflect capacity constraints rather than any loss of confidence. Mining investment looks like rising around 45%.
• An agreed large increase in pay for aviation workers secured by the Transport Workers Union averaging around 4.5% pa over three years has added to concerns about upwards pressure on wages. This will no doubt serve to maintain the Reserve Bank’s inclination to raise interest rates further next year.

Major market moves

• Share markets had another volatile week, initially being affected by the North Korean attack on South Korea and ongoing debt concerns in Europe, but settled later in the week after positive economic news out of the US and Europe lifted spirits.
• Commodity prices rose on the back of stronger global economic data, but the Australian dollar slipped back on softer than expected economic data in Australia and RBA comments that rates are appropriate for the period ahead. The euro also weakened further against the $US.

What to watch in the week ahead?

• In the US, key to watch will be the ISM manufacturing conditions index (due Wednesday) which we expect to remain solid and employment data (Friday) which is expected to show another 150,000 gain in payrolls but unemployment remaining high at 9.6%. Consumer confidence data (Tuesday) is likely to show a small improvement as are pending home sales (Thursday) and the ISM non-manufacturing index (Friday) is likely to remain solid. Against this house price data (Tuesday) is likely to show further weakness lagging the earlier fall in housing activity indicators. The Fed’s Beige Book of anecdotal evidence on the economy will also be released.
• In China, the official and HSBC PMIs, or business conditions indicators, (due Wednesday) are likely to remain solid but show a small fall back after recent strong gains.
• The European Central Bank meets on Thursday but is likely to leave interest rates on hold at 1%, and may signal a slower exit from its liquidity boosting measures given public debt problems in Europe.
• The week ahead in Australia will see an avalanche of data releases. The main focus will be on September quarter GDP growth (due Wednesday) which is likely to show growth of around 0.5%, or 3.4% year on year after an unexpectedly strong rise of 1.2% in the June quarter. Consumer spending is likely to be a key driver, with flat business investment and a fall in dwelling investment. Other data to be released includes: profits, inventories and new home sales (all due Monday), building approvals (Tuesday) which are likely to show a bounce after a sharp fall in September, private credit (Tuesday) which is likely to remain soft and retail sales (Wednesday) which are expected to show growth of around 0.2%. A couple of speeches by RBA officials, including Governor Stevens, will also be closely watched.

Outlook for markets

• It’s too early to say whether the share market correction we have seen since early November is over or not. However, we continue to expect solid gains in shares into year end and through next year. Shares are cheap, particularly relative to government bonds, the run of better than expected economic data globally is continuing suggesting that the global recovery remains on track, the global liquidity backdrop is highly favourable underpinned by QE2 in the US and the corporate sector is cashed up which is likely to result in a further pickup in merger and acquisition activity, share buybacks and dividends. The period from US Thanksgiving to May is normally strong for shares, particularly December and January.
• Notwithstanding normal bumps along the way, the $A is likely to head higher as the $US and the euro remain under downwards pressure, interest rates in Australia continue to trend up, and commodity prices resume their rising trend. It’s likely that the $A will settle around $US1.10 in the year ahead.
• Deflation worries, along with central bank government bond purchases in the US and elsewhere, are likely to keep bond yields low in the short term. However, medium-term returns are likely to be poor, reflecting low yields and excessive public debt levels in many developed countries.

The post Weekly market & economic update – 26 November 2010 appeared first on AdviserVoice.

Key points

• Australian housing is not in a bubble but it is very overvalued, and combined with high debt levels leaves Australian households vulnerable should anything significantly threaten house prices. It is a reason for the RBA to tread carefully in raising interest rates.
• Poor and worsening affordability will likely lead to soft house prices over the next year or so. Key factors to watch for in terms of the risk of a substantial housing slump are a collapse in China leading to much higher unemployment, excessive tightening by the RBA and a big increase in the supply of housing. None seem likely in the short term, but are worth keeping an eye on.

Introduction

Australia has come through the global financial crisis in good shape. However, there is one nagging concern – what I have long called Australia’s Achilles heel – and that is the excessive level of house prices and associated household debt. Lately the debate has focussed on whether Australian housing is a bubble, with some saying it’s expensive and therefore must be a bubble, which will burst with disastrous consequences.

This view is epitomised in a recent article in The Philadelphia Trumpet (a US newspaper) that warned “Pay close attention, Australia. Los Angelification (referring to the 40% slump in LA house prices) is coming to a city near you.” The counter view is Australian housing may be expensive but not dramatically so & can be justified by a severe undersupply.

Is Australian housing in a bubble?

It is natural for those in the US to look at Australian house prices and see a bubble. Australian house prices have left US prices for dead over the last two decades.

Source: Case-Shiller, Nationwide, ABS, AMP Capital Investors

But is it really a bubble? An asset bubble is thought to require: overvaluation, easy money fuelling price gains and speculators buying on the basis that past price gains will continue amidst euphoric investor psychology. In terms of overvaluation, Australian housing gets a tick. On most measures Australian housing is very expensive. Australian house prices are running around 35% above their long term trend (see the next chart). According to the OECD the ratio of house prices to incomes is about 36% above its long term average and the ratio of house prices to rents is 58% above its long term average, both of which are at the top end of OECD countries.

Source: ABS, AMP Capital Investors

But other signs for the presence of a bubble are absent.

• Housing credit is only growing at about 8% pa (well down from the 20% pace seen about seven years ago).
• Only 39% of housing finance is going to investors (compared to more than 50% seven years ago).
• There is no sense anymore that buyers are rushing in for fear of missing out.
• Weekend auction clearance rates have slumped.

Source: Australian Property Monitors

• The Australian housing market hasn’t seen the same deterioration in lending standards that occurred in other countries over the last decade: loan to valuation ratios for new dwellings are little changed over the last decade; homeownership rates haven’t increased – in fact they have fallen for the typical first home buyer age group; and non-conventional loans (eg sub prime loans, option ARMs, etc) have never had a strong foothold.
• Most of the increase in mortgage debt over the last few decades went to older and wealthier Australians.
• There is little evidence Australians are struggling with their mortgages. Non-performing housing loans are less than 1% of the total and have been around this level for years. In the US the comparable figure is 8%.

And finally, Australia does suffer from a shortage of housing. In contrast to the US which saw a huge supply surge during its period of strong price gains into 2006, the supply of housing has been subdued in Australia, particularly relative to the expansion in the population, which has been faster than in India over the last five years. As a result, according to the National Housing Supply Council there is now a cumulative net shortfall of about 200,000 dwellings. And on current trends this is set to get much worse. The undersupply is reflected in continuing low vacancy rates in rental housing – currently averaging 1.6%.

Source: National Housing Supply Council

Outlook

While Australian housing is very overvalued, it’s not inevitable it will have a bust. Many of the tell tale signs of a bubble are not present and just because house prices are overvalued doesn’t guarantee a bust. For example, the Bank for International Settlements found that of 16 housing booms studied over the 1970 to 2001 period only six ended in a bust. However, there is little doubt the intersection of high house prices with high household debt levels leaves Australia vulnerable. Key potential triggers for a bust would be a big increase in the supply of new dwellings, a big rise in unemployment perhaps on the back of a collapse in China or a big rise in interest rates. Right now none of these seem likely. There is no sign of any imminent large land release from state governments, China is trying to cool down a food driven increase in inflation but is not likely to tolerate a sharp slowdown in growth and the RBA is likely to tread carefully in raising interest rates, particularly after banks added more to the last rate hike.

The most likely outcome is an extended period of constrained range bound house prices as average income levels catch up. To some extent this is what has occurred in Sydney over the last six years. After strong gains into early this year, house price gains have since been flattened by a return to poor affordability. With mortgage rates rising sharply in November, and more increases likely next year, a further deterioration in affordability is likely and this could well see prices fall slightly over the year ahead. While the shortage of housing should prevent a sharp fall in prices, a rise in mortgage rates (currently around 7.8%) to much above 8.5% could prove to be a big dampener on house prices next year.

Source: Commonwealth Bank/HIA. REIA, AMP Capital Investors

Is housing a good investment?

After allowing for costs, residential investment property and shares generate similar long term returns. This can be seen in the next chart, which shows an estimate of the long term return from housing, shares, bonds and cash.

Source: ABS, REIA, Global Financial Data, AMP Capital Investors

Over the long term, the returns from housing and shares tend to cycle around each other at similar levels. In fact, both have returned an average of 11.5% pa over the last 80 years or so. While housing is less volatile than shares and for many seems safer, it offers a lower level of liquidity and diversification. The bottom line is once the similar returns of housing and shares are allowed for, and these characteristics are traded off, there is a case for both in investors’ portfolios over the long term. For the time being, with housing looking expensive and offering a net rental yield of around 1.5%, shares are probably a better bet as they are cheap on most valuation measures and offer a more attractive dividend yield of around 5 to 5.5% once allowance is made for franking credits.

Concluding comments

At this stage a housing bust in Australia seems unlikely. Key things to watch for though would be a surge in supply, much higher levels of interest rates and anything that sharply pushed up unemployment. In the meantime a lack of supply should prevent sharp falls in prices, but on the flipside, the continuing drip feed of higher interest rates will likely serve to weaken prices slightly over the year ahead.

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The world’s largest bond manager, PIMCO, has forecast a positive investment outlook for Australia, due to its fiscal and monetary policy flexibility and its relatively clean banking sector, which differentiates it from most of its developed world peers. This comparative advantage is set to continue and in this climate quality Residential Mortgage Backed Securities (RMBS) stand out as offering attractive relative value, according to Rob Mead, PIMCO Head of Portfolio Management, in the fund manager’s 6-12 month cyclical outlook.

“The comparative advantage between Australia and its developed world peers has been enhanced over time, especially as fiscal positions in the developed world are forecast to diverge further, with Australia expected to be comparatively better off,” Mr Mead said.

As a result, Australia has presented more of a credit opportunity than an interest rate opportunity for most of 2010, and only recently have opportunities reappeared in Australia’s interest rate structure, he said.

“Having already raised rates by 150 basis points (1.5%) since the crisis lows, the Reserve Bank of Australia retains its mild hawkish tone.

“PIMCO continues to believe the RBA will raise rates towards 5%, implying a tightening bias, versus a New Normal neutral rate expectation, which would be approximately 4.75%. However, with the Australian dollar trading close to parity with the US dollar, near-term pressure for the RBA action is reduced slightly,” Mr Mead said.

“As global credit markets have rallied strongly, carefully selected Australian residential mortgage backed securities continue to stand out as offering potential attractive relative value, especially when considering the majority of Australian RMBS naturally de-leverage over time and are self liquidating as mortgages are paid down.”

“While some commentators have claimed Australian housing has become a bubble, various RMBS features provide downside risk mitigation against potential house price volatility. In particular, increased subordination on current vintage RMBS securities provides a cushion for investors while declining loan to value ratios in older vintage RMBS securities provides further protection,” Mr Mead said.

Advice for investors

Mr Mead said investors should look to generate real investment returns with manageable levels of risk using active management.

“Given the RBA’s inflation management credibility, which has realised a CPI rate of approximately 2.5% for the past 15 years, Australian investors have an excellent opportunity in the current markets to earn real (net of inflation) returns of 3%-4% via Australian bonds or global bonds hedged to Australian dollars.

The investment landscape is also expected to remain volatile, which provides active managers with significant opportunities to obtain alpha for investors through both top down and bottom up drivers.

“Investing passively in this environment or with too narrow a focus could result in lower return expectations,” Mr Mead said.

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The Bank has also launched a new Basic Package made up of the Basic Variable Rate Loan with
100 per cent Mortgage Interest Offset Account and a Basic Fixed Rate Loan.

The Basic 3 year Fixed rate is 6.99 per cent per annum – 15 basis points below the standard 3
year Fixed rate.

AMP Banking Head of Sales and Marketing Steve Craig said a growing number of customers want
to combine variable and fixed interest rate loans to provide peace of mind against rising interest
rates.

“This new Basic Package gives our customers a simpler, more competitive, value for money
product with the choice and flexibility they want.

“Our Basic product range has a high degree of functionality for the price, offering borrowers real
value and making AMP Bank a competitive alternative to the major banks,” Mr Craig said.

The changes are effective immediately for new customers.

AMP Banking customers can visit www.amp.com.au or phone 13 30 30 for further information.

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