"Despite the recent falls in the Australian equity market, coupled with Australian dollar (AUD) weakness – the AUD has fallen by over 10% versus the US dollar between 10 April and 18 June this year(1) – we continue to hold a constructive view on the Australian economy, market and currency" Frost said
The size of the AUD move did surprise us and, after having moved so quickly, we believe such a shift is overdone,” he adds.
Advance Australia bears
“We are well aware of the bears’ arguments on the AUD and while we do not disagree with all of them, we believe that there is a degree of market overreaction at play.” He continues, “One example is the argument of reliance on mining exports to China; we realise that Chinese demand for commodities is declining, and that commodity prices have fallen, however, we would argue that Australian exports are relatively flexible in terms of both end destination and commodity – it is more than simply iron ore exports to Chinese steel mills. In particular, we think the impact of liquefied natural gas (LNG) exports in the coming years is underestimated; from 2012 to 2020, LNG exports are expected to grow from 1% of GDP to 3.5%2 . Some estimates have this number closer to 6%, depending on the potential projects included. If the construction related to these projects is factored in, GDP estimates will be further boosted,” explains Frost.
Solid foundations
“The housing market is another area where we would say that consensus is too negative. We have been following the increase in house prices over the last decade but feel that foreign investors, in particular, are too concerned.” He continues, “Just because the housing market cracked in the US does not mean the same will be the case in Australia; the circumstances are very different. For example, immigration is a natural support in Australia, while the interest-rate cutting cycle that began again in 2011/2012 should have a similarly positive effect as it did in 2008/2009.
Furthermore, it is worth pointing out that most homeowners have substantial equity in their homes; during the rate-cutting cycle in 2008, a lot of people maintained their absolute dollar level of mortgage payments, despite falling rates, in order to pay down more. Indeed, Australia and New Zealand Bank’s chief financial officer, Shayne Elliot, recently told us that 59% of the bank’s borrowers were ahead of their payback schedule,” he adds.
“There is another key difference between the housing markets in the Australia and the US; borrowers can’t walk away from their mortgage when they are failing to meet the payments.” Frost explains, “Mortgage insurance is compulsory for any homeowner with less than a 20% deposit, and such insurance is very costly, which acts as a deterrent against excess leverage.”
“On another note, although Australia is in a rate-cutting cycle (we would expect at least one more cut this year, possibly two), the interest rate differential to other developed economies is still significant, with the headline rate currently at 2.75%3. On top of this, the AUD is an ‘asset-backed’ currency with the country’s commodity reserves huge in relation to a population of 24 million. Against this backdrop, we do not feel that the rise of the AUD over the last five to10 years was unjustified,” he adds.
Election bounce
“With the Australian election confirmed for 14 September this year, we believe that a change of government would be welcomed by the business community,” says Frost. “This is not just in terms of a potentially more business-friendly government, but also the simple matter of having a government with a workable majority; something Julia Gillard’s Labour government does not boast. We would expect a clear election outcome to give financial markets a boost,” he concludes, “much like the market reaction in Malaysia following the re-election of the incumbent government in early May.”
1 Bloomberg as at 18 June 2013
2 Newton as at 18 June 2013.
3 Bloomberg as at 18 June 2013.
