Oct 14 2018Add to Favorites
The Australian equities market is experiencing volatility, with a 200 point drop last week in the S&P ASX index, the largest drop this year and potentially the result of sentiment surrounding geopolitical headwinds with the latest developments relating to the trade war between the USA and China.
Global bond rates remain low, and despite incremental increases, interest rates are too low to be attractive from an investment perspective.
Our national budget deficit was expected to be c. $18b as at May 2018, however, the Coalition improved on this forecast as at September this year to be at c. $10b, a huge improvement on the c.$34m 2016 deficit as a result of prudent economic management. One of the pullbacks in spending, to achieve this improvement, has been a reduction in aged care spending.
Record levels of immigration have stimulated our economy and housing market since 2008. It will be interesting to see how the anticipated $11b 2020 surplus is achieved if immigration levels are to be reduced.
Anticipated budget inflows are predicated on the collection of personal taxes. With immaterial wages growth and a significantly slower real estate market, meaning suggested stamp duty revenue losses of c. $1.5b per annum (according to Treasury reports), its unclear as to how a $10b deficit can become an $11b surplus by 2020 without continuing to increase the number of taxpayers via immigration.
Whilst pullbacks have been made with respect to aged care spending to create improvement towards surplus its unclear how the government is going to deal with the next major cost to Australia, which is our top-heavy aging population.
The expense associated with the support of the aging population and accommodating for that expenditure is an issue which is rarely addressed directly or succinctly. The primary issue being that the segment of the population that is aging is top-heavy and there is a diminishing ratio of the younger tax-payer base to support the ratio of elder.
Right now, as of August 2018, we have reached a population of 25 million, faster than forecast by the ABS, 14% is above the age of 65. Spending cuts have been applied to this segment in an effort to reach surplus.
When our population reaches 52 million, 25% of that 52 million will be over the age of 65 years.
Scott Morrisons latest Royal Commission into aged care will no doubt highlight that if we want to enjoy economic growth, a fiscal surplus and continued high quality of living for our aging population, inflows of taxpaying skilled migrants in continued high volumes to bolster government revenues is important.
Global ratings agency S&P has recently upgraded the outlook on Australia's AAA credit rating to "stable" and says it expects the combined federal and state budgets will return to surplus by the "early 2020s" thanks to a strong job market and high commodity prices.
S&P has had a negative rating outlook on Australia since July 2016, about the time APRA cooling measures commenced, constricting the availability of local real estate credit, which has cooled the market, causing price declines of c. 6% across Sydney and c. 3% across Melbourne, according to Core Logic.
A recent report by ANZ suggests this is an orderly and controlled decline, NAB and Macquarie mirror these sentiments. A recent analysis by JP Morgan suggests that residential prices could decline by as much as 15-20% from their peak, negatively affecting 2020 earnings for residential-heavy groups like Mirvac and Stockland. CBA economist Gareth Aird forecasts that house prices in Sydney and Melbourne will continue declining until the end of 2019, with the peak to trough being around 10% in Sydney and in Melbourne 8.8%.
Whilst the availability of credit, geopolitical issues, macroeconomic head/ tailwinds, and nuances are addressed in a lot of these assessments, none mention the crude underlying numbers. We have c.10m residential dwellings (Core Logic June 18) to accommodate a population of c. 25 million people, growing at c. 350,000 per annum. We also have an economy that appears to rely very heavily on immigration for buoyancy and growth, and a planning system which constricts new supply of accommodation.
A new attempt by the International Monetary Fund to comprehensively measure the health of government balance sheets has given Australia one of the world's top rankings, with only Norway having a stronger fiscal position according to the study.
Whilst our localised credit restrictions on housing and residential development cause the market to cool its heels for a moment or two, the upside of this is that our banks, as the primary pillars of our financial sphere are getting a dust and polish.
This makes Australia a more attractive global investment destination.
With increased NTA requirements and new responsible lending criteria across the board, requiring higher levels of rigour and transparency, the Australian banking system is undergoing a positive change.
The May 2018 budget talks about maintaining the planned trajectory to surplus in 2020-21, disciplined fiscal management and tax welfare integrity. Official ABS data confirms that Australia’s labour market delivered record jobs growth in 2017, with three-quarters of those jobs created being full-time positions. The 16 consecutive months of net job creation to January 2018 was the longest positive run since official records began.
The ABS figures also show on average over the past year more than 1,000 jobs were created every day, with the growth in employment broad-based across regions and industries. Whilst there has been flat wages growth, there appears to be a healthy employment and jobs market in Australia.
A discussion is starting surrounding populating regional areas with strategic inflows of skilled, tax-paying migrants.
NSW government has pledged $85b for the next four years to infrastructure to support growth from 7.7million people to c.11 million by 2036. QLD has committed $45b and VIC state government has committed $13.7b to infrastructure in the 12 months following April 2018. The May federal budget accommodated for a seemingly small c. $24b by comparison.
Whilst this infrastructure spend makes provision for a larger population, it also stimulates further job creation for that larger population.
The budget deficit, coming to surplus and the Future Fund.
Whilst Australia is getting gold stars and appears to have an enviable balance sheet as a nation, which is pleasing news, it's cash flow that is required to pay for and support the wave of the elderly population. Support for this segment cannot be provided by erosion of assets, as it’s an unsustainable strategy.
The Future Fund exists to strengthen the government’s long-term financial position. Founded under John Howards government after the 2004 election, the Future Fund suggests it will make provision for unfunded superannuation liabilities that will become payable during a period when an aging population is likely to place significant pressure on the Commonwealth's Finances.
However, what is unclear is if this fund will be shared with the greater Australian aging population, or if it's reserved just for ongoing superannuation obligations for government employees and public servants.
As at 30 June 2018, the value of the Future Fund was $145.8bn, with investment growth representing a real return of 6.6% pa.
Since 2006 when the Future Fund was established, investment returns have added over $85bn to the original contributions made by the government which was $60.5bn, principally starting with the proceeds of the Telstra sale. No contributions have been made to the Fund since 2008.
What is clear is that aged care spending cuts have already been made to improve on the existing deficit and if this is the case it would suggest that if we are struggling to support our c.14% of the older population with the existing c.80% tax-payer base. As this ratio of elderly increases to 25%, the younger, working diminishing taxpayer base of the population will need to be replaced.
We all want a prosperous and comfortable future which is predicated on sustainable economic growth and provision for the more vulnerable in our community.
Based on the indicators; the federal and state governments commitment to infrastructure spend, as well as the high correlation of economic performance and immigration, we believe in continued population growth over the long term, which is one of the key drivers of our investment decisions at MP Funds Management.
Whilst we see current real estate asset prices sharply priced, there is emerging opportunity with high-quality 'mis-priced' assets as a result of the restriction on credit in the residential space. We are focused on residual residential stock portfolio acquisitions in the short term and see longer-term opportunity around the new planned infrastructure nodes, such as the Sydney new airport at Badgerys Creek.
We continue to see opportunity in the development & construction lending space in pockets where fundaments are sound and downside protected, and with the view to holding the completed stock for the medium term as the base downside case.
Additionally, we continue to see opportunity in well-priced and well-located commercial office assets. We see longer-term opportunity in the evolving retail and shopping centre sector, driven by the influences of online, the shifting behavioral demographics with Millennials outnumbering the declining Babyboomer generation.
Our target returns are between 15-25% on a risk-adjusted basis and the bulk of our fees are performance-based, once investors have received their principal and return, which created good alignment with investors.
We really love retail property at the moment at MP Funds Management because we see opportunity in the disruption. Australia’s population is growing, our living is getting denser and whilst the advent of online shopping is creating change in the sector, human behaviour causes us to gravitate towards food and entertainment. Whilst some of the retail tenants may be outmoded or a centre underperforming as a result of this evolution, it’s fair to say that well-located and underperforming CBD- located centres, which have a strong demographical catchment area can be turned around with some TLC and well thought out repositioning.
November analysis released by both UBS and Macquarie Bank highlight that potential buyers have become very cautious and expect prices to fall further. Both reports highlight that whilst borrowing capacity has declined, most borrowers don’t borrow at their maximum. The RBA recently showed that relatively few households would have been constrained by the tightening in lending standards over recent years.
Each of the primary property investment sectors, residential, commercial office, industrial warehouses, retail shopping centres has an investment cycle and a market cycle. Its useful to have the ability to move across sectors so that when one isn’t performing so well, others which are performing better can be capitalised on. Also, investing across sectors can build up diversification.
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