Two risks rising in the background

In Australia today, growth is forecast to be around 2.5%, commodity prices are stable, jobs are strong, and inflation is low and stable. But in the background, risks are rising, explains Chris Rands from Nikko Asset Management.

“The biggest risk that’s sitting there is the house price situation... The flow-through effect that housing can have on the economy is quite large… The second big risk facing Australia is what’s going on in China. The indicators out of China look like they’re slowing down from last year.”

Rands points out that the last time commodity prices fell heavily, the housing market was booming. The real problems arise when you combine a weakening housing market with falling commodity prices.

Hear his full take on these risks in the video below. 

What are the risks on your radar?

The biggest risk that is, I think, sitting there at the moment is obviously the house price situation. If you look at the house price indicators, there's probably still a little bit of weakness to come through there. Things like mortgage approvals, auction clearance rates, these types of things are still slowing down. It doesn't look drastic, but it's certainly not the market that it was two to three years ago. Now, the flow-through effect that housing can have on an economy is actually quite large, so a couple of examples can be in the retail sector, typically when you buy a house, you go and fill it with a lot of stuff, like furniture and fridge and whatever else you need.

So if the mortgage lending is slowing down, I would expect that consumption associated with those housing goods will also slow down. The problem being, retail is only growing at 3% at the moment anyway. So if you take that out of it, you kind of wonder "Well, how much can the Australian consumer actually continue spending?" Because their wages growth is only running at 2% at the moment anyway.

The second big risk that is looking at Australia at the moment is obviously what's going on in China. Now, the indicators out of China look like they're slowing down a little bit from last year. So if you look at things like fixed asset investment, the amount of liquidity that they're putting into the economy, things like industrial production, they've all slowed slightly. Again, it's not terrible, but it's not what it was 12 months ago.

Now for Australia, 30% of our exports go to China. A big part of the strong economy in 2017 was that export prices rose, and that was really about coal and iron ore. So if China's not growing as strong as it was, you would probably expect those commodity prices to ease off a little bit, and then that strong growth story from 2017 about rising exports, rising commodity prices, can potentially turn back the other way. Now, the risk, I would say, is the last time commodity prices rolled over, we had a very strong housing market. If you have a weakening housing market with weakening commodity prices, that's really when you get the problem. Now I think that's probably a low relative outcome at the moment, but the risk of those two things happening at the same time is probably growing.

What indicators are you watching on these fronts?

Two of the big indicators that I watch on housing is the mortgage approvals that go through the Australian system. They've slowed for investors, but are moving sideways for owner-occupiers, so that's kind of a neutral at the moment. The other one is auction clearance rates, that gives you a kind of a good feel of how much volume is going through the market at the moment. And again, that's slowing, but it's kind of sitting around the 50% level.

For China, generally I like to watch things like the money growth, so how much liquidity are they putting into the economy? I look at things like commodity prices. Where's copper? Iron ore? Steel prices? These types of things that they use in the industrial process are good to get a feel for what's going on in China, because they do so much manufacturing. They demand so many raw materials, you can use it a proxy for what's going on in that economy.

For further insights from Chris and the team at Nikko AM, please visit their website