Three months into 2012, let’s have a look at:
- The current situation in Europe
- The Share market and Sydney house prices
- Changes to super contribution caps
It would be nice to have a year without a Greek tragedy. Unfortunately that’s still not the case, with Greece back in the headlines again with another bailout package. With its economy in tatters and social unrest on the rise, it’s natural to wonder if at some point Greece and maybe Portugal and Ireland will opt to default and leave the euro. Or alternatively, given it’s impossible to expel countries from the euro, a group of strong countries might decide to leave.
What is the current situation with Greece? The Greek debt crisis has been in the media for the last 3 years. My view is simple Greece is broke, they have no economy so at some stage they will raise the white flag and leave the euro. The new Greek currency will fall dramatically, there ill be public riots, but very shortly it will pass into history. The same may happen for Portugal. The European Union (EU), the International Monetary Fund (IMF) and the European Central Bank (ECB) are really focused on getting Spain and Italy to grow their economy so a default by their neighbours will not have a knock on effect. In other words Greece seems to have had a broken economy all my life and this looks like continuing.
So I am asked if Greece defaults and the world ends in Europe what will happen in Australia. While we don’t think this will happen it is always possible. The advantage that we have in Australia is that we have a strong economy, meaning low unemployment, economic growth and relatively low government debt. If a major crisis does occur some of the events may look like this. We would get a freezing of banks lending to each other like in 2008, global trade will stall for a few months, the Australian dollar would fall from $1.05 to $0.60, oil prices will fall and interest rates will drop and the government will start some short term stimulus programs. This means several months of worry, petrol will be cheaper, interest on mortgages and loans will reduce, our companies that are struggling with a high Australian dollar will get some reprieve and the government will give us some money to spend all generating growth. So a short term shock and potential quick rebound.
If we look at the share market in Australia it is lagging the US in recovery. It had the large drop in 2008 with the GFC and is about 15% lower than early last year. This says to me that the share market has factored in 1 ½ GFCs so is somewhat priced at the lower end. On the other side we also need to look at the other main asset we hold that is our houses. Sydney house prices have been relatively stable over the last few years but on average have not grown much since 2003 and on a global scale are expensive. 2003 was when they just got too expensive – and they are still priced as if the GFC did not happen.
We see from the graph below, comparing share market performance with Sydney house prices over the last 25 years, that we now have a significant gap in performance in recent years. What this means is that on historical valuations the Australian Share Market is either underperforming or the Sydney housing prices are over performing or a combination of both.
The next question is what is likely from here. The Reserve Bank reduced interest rates late last year and many pundits believe that this will drive up house prices. If you look at history, this tends not to happen. In the early 1990s after the “recession we had to have”, interest rates on mortgages dropped from high teens to about 7% over a very short period of time; however we did not see this translate into house price movement for about 5 years. Remembering from then, the next 5 years was about us getting comfortable that the rates would stay lower for the longer term.
Similarly we all now have our own austerity program. For most this means tightening of our belts and paying off the mortgage. While this is occurring houses won’t go up in price. On the other hand, as the share market is priced for fear and as we become more immune to bad news and believe that we are in good shape, we can expect the share market over the medium term to return to more normalised values and go up.
To sum up we do not think Europe will collapse but Greece and Portugal will be in the sin bin on a regular basis for the foreseeable future and things in Australia are actually good.
In our newsletter late last year we advised changes to super contribution caps starting from July 2012. However with all the noise in Canberra we still haven’t seen anything further from the government. Some of the proposed changes will require legislation of which we still have not seen a draft.