Mark Williams

Three reasons to be cautious on Australia

Mark Williams

Mark Williams: Three reasons to be cautious on Australia

The Liontrust Asia Income Fund has had relatively little exposure to Australia since its launch, which to date has been a positive for the portfolio. Here we look at three of the main reasons for our cautious stance:

1. High household debt

Rising levels of private sector debt were cited by Moody’s Investor Service when cutting its rating on Australia’s largest banks earlier this summer, a move which struck some resonance with us given our longstanding concerns over household leverage.

Moody’s accompanying statement questioned ‘the resilience of household balance sheets and, consequently, bank portfolios to a serious economic downturn’ as they have not been tested while at such high levels. Investor scrutiny of Australian banks was further heightened by a subsequent announcement from the Australian Prudential Regulatory Authority that it was increasing the provisions required to be held against mortgage books.

To put things in context, Australia has A$1.5 trillion (approximately US$1.2 trillion) of mortgage loans, with more than 60% of its total loan book in residential property. This gives the Australian banks the largest property exposure in the world, about 20% above the next largest, Norway, and 40% above the UK’s own, heady market, which sits at about 20% according to the IMF.

As in the UK, much of the lending has gone to investors – buy to let – and the Australian Regulator has been proactive in curbing new loans, but its March 2017 target that less than 30% of new home loans should go to investment properties has yet to be met by the banks.

If looked at from other perspectives Australia also raises eyebrows. Borrowings of 6x household income make up half of Australian mortgages (in the UK, banks are only allowed to lend 15% of new mortgages at more than 4.5x borrowers’ income), and household debt in aggregate is 189% of household income, amongst the highest in the world.

We are not predicting a property crash in Australia, as central banks globally have proven remarkably adept at staving off such busts, but it makes us wary at a time when cracks are beginning to show. In Perth, Western Australia, and Darwin, in the Northern Territories, property prices are already falling. Both saw quarter on quarter price falls in March, taking them down 3.5% and 5.9% respectively over the year.

2. Falling mining investment

Another of the risks that we see in Australia is that the fall in commodity prices, going against the massive investments which were made to satisfy China’s expected insatiable demand, has removed much of the need for more mining investment. This does not mean that there is a failure of the mining industry, as shown by the country’s iron ore exports, which in 2016 were the highest ever and almost three times those of 2007, in the run up to Global Financial Crisis. It is mining investment that is struggling, with expectations for mining capital expenditure to fall 29.6% in 2016-17, with a further 21.7% fall currently expected in 2017-18. Although mining only makes up about 10% of the Australian economy, the multiplier effect is likely to be felt more strongly, in part accounting for the slowdown in Perth – the hub of the mining world – and adding to risks for equity investment.

3. Retail headwinds

Both of the previous issues, a shaky, leveraged residential housing market and weakness in mining services, lessen the outlook for another potential investment area, retailers.  Here there are also external issues that are hard to avoid. The first of these is the relentless rise of the internet. While Australians have been shopping online abroad for some time, things are likely to get worse with Amazon set to bring a physical presence to Australia. Last week it announced its first Australian fulfilment centre will be opened in the outskirts of Melbourne in a 24,000 square metre warehouse as it prepares to launch the Amazon Marketplace retail service in the country. This will remove a lot of the pain of current delivery, which in other countries has led to a significant rise in online shopping. Again, we are not calling for a huge market capitulation in the retail space, and many companies in other countries have thrived while competing with Amazon, but it gives us an additional headwind that we would rather avoid.

While we are able to identify high quality companies in Australia, we think they are operating in a difficult arena at the moment, and one that does not justify the market’s premium valuation at 15.9x forward earnings. We like the companies that we do hold there, but they tend to be more defensive than the Fund’s investments in the rest of the Asia Pacific region. Without a change in the Asia Pacific outlook it seems unlikely that we will be tempted to significantly raise our Australian exposure, despite the country having a higher aggregate dividend yield than the other markets that we look at. This reflects our ongoing rationale for the Fund: that we are looking for companies that can grow but which also pay dividends, not just seeking yield alone.

A version of this blog was first published in What Investment on 5 July 2017.


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Friday, August 11, 2017, 1:12 PM