Hong Kong offers a silver lining for Australian property, shares remain in a bubble
Hong Kong offers a silver lining for Australian property, shares remain in a bubble

Written by The Investor

13 July, 2020

Hong Kong offers a silver lining for Australian property, shares remain in a bubble

Last week Australians were warned by the Australian government that travel to mainland China could put them at risk of “arbitrary detention” by the Communist regime. “This law could be interpreted broadly. You can break the law without intending too. The maximum penalty under this law in Hong Kong is life imprisonment.”

This has sparked speculation of a mass exodus with both Australia and the UK being supportive of the HK refugees.

China, in their typical aggressive fashion has issued a warning via the Chinese newspaper Global Times reporting that a move to make it easier for Hong Kong citizens to settle in Australia would have a “huge negative impact” on the Australian economy and there would be “immeasurable losses” to Aussie firms.

Last week, Prime Minister Scott Morrison said the new law was “very concerning” and Australia was prepared to “step up and provide support” to Hongkongers, although he didn’t confirm whether that would include residency.

 The Global Times darkly warned the PM not to get involved.  “If the Australian Government chooses to continue to interfere in China’s internal affairs, it should be expected that the ‘safe haven’ offer will result in a huge negative impact on the Australian economy, making the issue much more serious than many people would have anticipated…and generating immeasurable losses to countless local businesses.”

While this scenario does not bode well for Australian economics it may present a silver lining for Australian property which is suffering from its worst quarter of rental growth in 15 years.

“For the past two years Sydney unit rents have tumbled annually as tenants benefited from heightened investor activity in previous years, as completed off-the-plan apartments add to supply,” Domain senior research analyst Nicola Powell said.

Between March and June advertised rentals surged by 13 per cent across Sydney, lifting by 43 per cent in the city and east and 29 per cent in the inner west, as a wave of short-term rentals converted to long-term as border closures stopped international tourism.

According to The Urban Developer “Deteriorating unit rents have now forced Sydney’s gross yields to a record low of 3.66 per cent.”

Property investors, struggling with falling rents and rising vacancies, now face a further cash flow crunch as the number of empty rental homes languish on the market.

Research by industry data provider Suburb Trends flags 60,000 rental properties that are sitting empty for over 21 days—a 46.1 per cent jump from May to June.

Homes typically listed for Airbnb have hit the rental market, further adding to supply.  It is estimated that approximately 120,000 Airbnb properties are available for rent across Australia and analysts expect around 30,000 properties to transition into the long-term market amid the lockdown.

Meanwhile shares continue to flirt with record valuations despite deteriorating fundamentals.  According to Nucleus Wealth “Stock markets have disconnected from fundamentals (and reality). The economic fundamentals are almost as bad as they have ever been. Stock market valuations are as expensive as they have ever been. But that hasn’t concerned markets for the past six weeks and, to be frank, it doesn’t look like concerning markets any time soon.  Thus, right now you have been given a rare second chance to sell stocks.”

Bloomberg reports “While much of the equity selling owed to the frantic pace of the recent rally, sentiment did sour as signs mounted that a possible second wave of the pandemic could be taking hold in some states. U.S. jobless claims remained high, underscoring the longer-term challenges caused by the pandemic. The report came out a day after the Federal Reserve provided a dour economic outlook. Treasury Secretary Steven Mnuchin said the U.S. shouldn’t shut down the economy again even if there is another surge in coronavirus cases.”

This rhetoric from the Fed is clearly now echoing President Trump and other politicians.  Time will tell if their gamble on the economy has been at the expense of health and wellbeing.

 

It seems ironic that these same politicians chose health over economics just three month ago

This Coronavirus has a tendency to surprise on the upside.  Even New Zealand, touted as a model for the world to follow and who declared that they had beaten the virus, is now battling new cases.  Australia is also lucky to also be an island.  Even here we are seeing Melbourne in full lockdown again and borders shut indefinitely.

Whilst there is less gravitas being placed on China’s claims of “no new cases for months” they too have been back in lockdown.  After weeks without a locally transmitted case, an outbreak linked to a Beijing food market spread to half of Beijing’s districts and to other provinces. In response the capital has raised its emergency level, suspended schools and cancelled hundreds of flights.

 

Is there a second wave or are these isolated pockets?

The latest Covid-19 infection data from the Southern States of the USA, India and Brazil has been disturbing on so many levels. The Beijing outbreak has highlighted another key food supply hub with risky practices.

“At present, the states in which the virus is growing rapidly (i.e. thousands of new cases per day) account for around 42% of US GDP, while 15% of GDP is generated by states with moderate rates of growth in C-19 cases and 35% of GDP is produced by states with low numbers of new cases. This makes it very hard to estimate just what impact the rising trajectory of total C-19 cases will have on the aggregate economy.” Says Hunt Economics.

Hong Kong offers a silver lining for Australian property, shares remain in a bubble

What does this mean for share investors?

Does the stock market seems to think there is an economic recovery in process or is it that the mass of liquidity that was poured into the bond markets made its way to share speculators?   According to Long Term trends stocks are in as bubble.  The following chart show the PE ratio calculated using historical earnings.

S&P 500. Price Earnings Ratio

Hong Kong offers a silver lining for Australian property, shares remain in a bubble

The next chart is the Shiller PE ratio.  Instead of dividing by the earnings of one year (see chart above), this ratio divides the price of the S&P 500 index by the average inflation-adjusted earnings of the previous 10 years. The ratio is also known as the Cyclically Adjusted PE Ratio (CAPE Ratio), the Shiller PE Ratio, or the P/E10.

The second charts reads as “extreme bubble”

Shiller S&P 500 PE Ratio Hong Kong offers a silver lining for Australian property, shares remain in a bubble

Interesting statement made by The Guardian

“… at this historic moment, we demand better. From the coronavirus pandemic and police brutality to the marginalisation of minority communities around the world, leadership is broken. Devoid of the humility and inclusivity we so desperately need, and given to narcissism, leaders are gambling with public health, safety and the future of younger generations. They unapologetically prioritise serving themselves over the people they were elected to serve. We have to make them raise their game.”

 

Thus the world continues to remain an uncertain place…

With second waves, closed boarders and significant trade wars in play the risks remain high for both share and property investors.  The fundamentals of both shares and property have deteriorated significantly since the beginning of the year.  Particularly property has seen a significant increase in supply as closed boarders have switched off tourists and short-term rentals have been converted to regular rentals. At the same time completed projects have also hit the market pushing up vacancies and pushing rents down.

One potential silver lining is the fleeing HK resident scenario which may trigger significant increases on the demand side as immigrants / refugees flee an increasingly dangerous landscape in HK / China.  This is purely speculation at present.

The reality is that shares are suffering from poor earnings and the property market is suffering from a supply glut. Yet prices are holding firm in a disconnect from fundamentals.  In light of these poor fundamentals and significant geopolitical risks the downside risks are high.

Australia is certain to encounter significant challengers in the short term as China flexes its muscles on the trade stage. Short term risks are to the downside for shares but ironically could be to the upside as the Australian government offers a parachute for property investors and Hongkongers.

 

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Please consult your advisor for specific recommendations.  This general advice does not take into account the client’s objectives, financial situation or needs as we do not and cannot provide personal advice.  Any views written about in this article are the views of the author who has no holdings in those companies or investments mentioned in this article.