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Reasons to be hopeful
By Robert Gottliebsen
July 24, 2009
PORTFOLIO POINT: The stockmarket is telling us that problems in Europe and the US will be solved and that Australia will not slide back when stimulus packages are scaled down.
With the ASX 200 index now well above 4000 points and the Dow last night climbing above 9000, it's time to take stock of where the recovery is in the three centres that most affect our market: the US, China and of course Australia.
My assessment of each of these key regions will not be an economic one but rather I want to focus on the significant uncharted waters in the US, China and Australia that must be navigated to take the recovery to the next stage.
In all three countries governments have undertaken substantial stimulation packages and all three packages have worked to reverse the downturn and promote growth. In the US such growth signs are called “green shoots” and the bulls are hoping that these “green shoots” will blossom and reverse the great US recession.
For the bulls to be right, a significant American structural problem will need to be overcome and at this stage the Obama administration has not been able to make the required adjustments to achieve that structural change. In addition, in 2010 and 2011 President Obama will face the consequences of the huge debt burden the US now has – the prospect of higher interest rates.
US housing moratoriums
A friend of mine is intimately involved in the US mortgage business. Early this month he alerted me to the emerging problem of the vast number of household debt moratoriums that banks, local governments and others had engineered for those with problem home loans.
In essence, the moratoriums gave troubled home owner three to six months’ breathing space (sometimes longer) to get their affairs in order. These moratoriums are now coming to an end and, because in the main household finances have not improved, there will be foreclosures after the moratoriums expire.
Luke Mullins of US News.com has put some figures to the problem. He says there are nine million struggling home owners in the US and home foreclosures continue to rise at an alarming rate, often triggered by the end of moratoriums.
In the first six months of 2009, more than 1.5 million properties were the subject of a foreclosure filing – a 15% increase at the same time last year. In other words, 1.19% of American homes received a foreclosure filing in the six months to June 30.
Nearly three years after the peak the painful decline in home prices continues, although the pace of the decline moderated slightly in April. Home prices in 20 major metropolitan areas dropped 18.1% in April from a year earlier. More than 5% – or one in 20 – of American home owners are “under water”, which means they owe more on their mortgages than their property is worth. That’s an incredible figure.
Naturally, when somebody doesn’t have equity in their house and their loan is not secured on their non-house assets, as is the normal situation in the US, when there is a mortgage payment problem it is likely that the householder will walk away causing the house to be put on the market.
Obama tried to set up a rescue plan to change the status of about four million troubled loans. Unfortunately there are not enough qualified people able to undertake this work and the bureaucratic systems have been in chaos. Only about 325,000 of the four million troubled loans have found their way through the program.
Unless there is a quick and dramatic reorganisation, the opportunity to save these loans will disappear and the houses will be sold. I don’t think Australia has ever experienced a situation where one in 20 home loans were under water. The effect on consumer spending of such a catastrophe has to be severe.
In my view the American recovery will disappoint the stockmarket unless this problem can be solved and solved quickly.
China’s new stance
The Chinese stimulus package was very much concentrated on government activities, although there have been substantial bank loans to private enterprises. It is hard to determine how many jobs have been created but it certainly fostered a strong demand for resources, and the rise in metal prices and oil has played a big role in the recovery of our stockmarket.
Part of the extra demand for metals came from Chinese stockpiling, which is now abating. But so far metal prices have held well. In the past three months I have been a China bull (see Market wakes to a new dawn) because I believed that there was every likelihood that the China stimulus package would work.
But where I have been surprised is that there are now clear signs that China is taking a much more aggressive stance in the world. For the past 20 years China has been absorbing knowledge and capital and it still wants to do that but there is a clear toughening of its attitude. China wants to be treated at least as an equal but often it wants to be in control.
In Australia that attitude has been underlined by the arrest of Rio Tinto’s iron ore contract negotiator Stern Hu and his colleagues. But it was also reflected in the rejection of the Coca-Cola takeover and we are going to see it emerge in a whole raft of different ways.
The fact that President Hu Jintao left the G8 meeting because of problems at home was a tremendous loss of face for the Chinese leader but it reflects the fact that China's internal difficulties extend beyond western China; nobody can be sure of the outcome but longer term it may cause China to demand higher interest rates on its loans to the US.
The bottom line may be different from what the Chinese expect. I think that it is now going to be much more difficult for the Chinese sovereign enterprises to buy control of our resource companies. When there is a change in government attitudes of your major trading partner there are usually implications that nobody thought of. We need to watch this space.
Australia avoids the worst of it
Unlike the US and Europe, Australia went into this downturn with a solvent banking system. Even so, the government was required to guarantee bank deposits. In previous recessions governments have been slow to act but the Rudd government, along with its counterparts overseas, did not hesitate and embarked on a massive program of immediate, medium-term and long-term spending. At the same time the Reserve Bank slashed interest rates.
It is now clear that the process has substantially reduced the severity of the Australian downturn. Prime Minister Kevin Rudd and Treasurer Wayne Swan have every right to claim the credit. Of course, it is terribly important that the momentum does not fizzle out as the accelerator is released and the spending cut back.
I think there is a reasonable chance that the combination of the Australian and Chinese stimulus packages, plus the rise in the stockmarket, will turn Australian sentiment around and unemployment may not reach the 8% level forecast in the budget. The stockmarket also senses this and it is helping drive share prices higher.
But we are in uncharted waters. I don’t think any Australian government has acted so quickly to reverse a looming recession and it remains to be seen whether the actions will generate the follow-through to enable momentum to be maintained. The underlying inflationary pressures in the economy mean that it is unlikely interest rates will be cut again and because smaller banks can no longer gain deposit money from overseas (because the government charges them more than big banks for guarantees) there is intense competition for bank deposits, which is pushing up interest rates on bank deposits. The pessimists fear that all we have done is to delay the impact of the downturn. I am in the optimists camp but I recognise the danger.
Europe was more restrained in its stimulation and its bank problems were probably worse than other parts of the world and were not fully recognised. I think Europe is going to struggle for a while. The stockmarket is telling us that the Chinese change of administration strategy is not serious; that the US home foreclosure problem will be solved and that Australia will not slip back when the stimulation is scaled down. As the stockmarket rises further it becomes more important that all these forecasts are fulfilled.
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