Many investors are worried about the housing market slump in Australia, and whispers of a recession have been doing the rounds.
Investors are worried the negative wealth effect of falling house prices could lead to a cut in consumer spending as Australians feel poorer. They’re also concerned a fall in housing construction will directly impact economic growth.
We agree the housing market is going to be a big drag on Australian economic growth, taking one to one and a half per cent off growth, and causing growth to be subpar.
Growth will almost certainly be well below what the Reserve Bank of Australia (RBA) has been looking for, and that will ultimately lead them to cut interest rates a few times in 2019; I’d say by the end of the year we’re looking at a cash rate of around one per cent.
But by the same token we don’t see the Australian economy heading into a recession, as many fear.
There are five reasons for that:
1. Mining drag ending
There will be a drag from housing, but the big drag we have seen over the last five years or so from falling mining investment is starting to fade.
2. Infrastructure boost
We have a very strong infrastructure investment pipeline, mainly coming from State Governments.
3. Business investment rebound
Business investment outside of mining is starting to pick up – albeit slowly. So there are other sectors in the economy beginning to take over and pick up some of the slack.
4. Reserve Bank ammunition
The RBA can still cut interest rates – the cash rate still has a long way still to go to get to zero. There is a lot of debate about whether banks will pass on interest rate cuts to their customers, but since 2008 the RBA has been the main driver of interest rates, and it determines about 65% of bank funding costs. So the reality is that if you have got a mortgage and the RBA cuts the cash rate, the majority of that will be passed on.
5. $A stimulus
Finally, the $A will go down. We see it heading into the $US0.60s. It’s already come down from a year ago when it was about $US0.80, and from back in 2011 when it was well above parity ($US1.00).
So as the Australian dollar comes down that provides support to the Aussie economy.
Positive share market returns
For those five reasons we don’t see the Australian economy going into recession - even though we do see sub-par economic growth of around two and a half to three per cent and this will be weak enough to drive lower interest rates.
If the economy keeps growing at a reasonable rate, that will support profits and, ultimately, we see the share market heading higher by the end of 2019 and ending higher than it is today at around 6000.
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