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Leveraging into houses

Good morning! Lots happening in the world right now, from inflation worries and housing booms to herd immunity looking like it's the world's great white whale.

Market Wrap

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Note: Brent oil, gold bullion and iron ore prices are the second futures contract.

The tech-heavy Nasdaq fell 1.88% overnight after US Treasury Secretary and former Fed Chair Janet Yellen said: "It may be that interest rates will have to rise somewhat to make sure that our economy doesn't overheat, even though the additional spending [Biden stimulus] is relatively small relative to the size of the economy."

Higher interest rates = lower tech valuations. The more balanced S&P500 was down a smaller 0.67%, with gains in many commodity, financial and industrial shares offsetting the carnage in tech.

Inflation watch: Bank of America tracks mentions of the word "inflation" in earnings calls. In its analysis of March quarter earnings, it recorded the biggest jump in the use of the word since it started keeping track in 2004, with mentions up 800% from March 2020. On an absolute basis, mentions were the highest since 2011, which Bank of America says is "pointing to at the very least, 'transitory' hyper-inflation ahead". Yes, "transitory". 🤔

Risks rising: In a similar theme to the above, Mohamed El-Erian had a decent OpEd in the AFR yesterday, warning that "Indications of market froth are multiplying in an 'everything rally.' More companies are warning about rising input costs, with some signalling that this will be passed on to prices. The contrast between the Fed stance and all this is why policy risk has climbed up the ranks to be one of the major challenges that investors will be navigating this year... Ultimately, the Fed may be forced to slam on the monetary policy brakes, risking undermining what should be a long-lasting inclusive recovery".

RBA unfazed: The RBA left rates unchanged at its regular meeting yesterday, despite hefty upgrades to its economic forecasts. It now expects the unemployment rate to be 5% by the end of 2021 (previously 6%) and 4.5% by the end of 2022 (previously 5.5%). But still no rate hike until "2024 at the earliest"...

The rise of retail: According to JPMorgan Chase & Co. and Federal Reserve data going back to 1952, individual investors in the US are holding more stocks than ever before, accounting for 41% of their total financial assets in April. The previous high was 38% in March 2000, just prior to the dot-com crash.

Data Wrap

Leveraging into houses

More leverage, higher prices.
More leverage, higher prices. ABS

The Australian Bureau of Statistics (ABS) released lending finance data for March 2021, showing a 5.5% increase in housing finance, or a 55.3% rise year-on-year. Investor growth was even stronger at 12.7%, although from a much lower base (see chart above).

Debt is affordable: As we noted yesterday, even with incomes unchanged, "the 0.5 percentage point decline in mortgage interest rates since February 2020 effectively gave buyers an extra 14.5% in borrowing power". People have used that increased borrowing power, combined with COVID-19 restrictions limiting spending options (the saving ratio is still above pre-pandemic levels), to take on additional debt to buy more expensive houses.

It may end sooner than you think: Unless mortgage rates are reduced further or people's incomes and/or spending habits change, these rates of growth are a once-off. Greater debt also equates to heightened risk – if inflation were to increase and mortgage rates followed (most Australians are on variable rate mortgages), many people could suddenly find their larger mortgages difficult to service. Leverage can affect prices on the way down just as much as it does on the way up.

A double whammy: If the timing of rising mortgage rates were to coincide with a reversal of the fiscal impulse (the government's deficit-financed spending growth has to slow down at some point), it could prove to be quite the negative income shock.

The Wrap Up

  • Budget 2021-22: The federal government announced a $10 billion reinsurance pool to reduce home and business insurance premiums in northern Australia. So now we're actively subsidising construction in areas with frequent disasters, rather than just bailing them out when the inevitable disaster strikes. Sounds about right. 🤦‍♂️
  • Herd immunity may be impossible because "the virus is changing too quickly, new variants are spreading too easily and vaccination is proceeding too slowly for herd immunity to be within reach anytime soon". True, but vaccines significantly reduce the severity of any infections.
  • Incentives matter – Daily vaccinations in the US have fallen from a peak of ~3.4 million in mid-April to ~2.4 million, despite just ~31% of the population being fully vaccinated. In response, the state of Maryland announced a $US100 incentive for state employees to get a COVID-19 vaccine. In New Jersey, any resident over 21 years of age who gets their first dose of a COVID-19 vaccine in May will get a free pint of beer. That's more like it! 🍻
  • Iron ore billionaire Andrew 'Twiggy' Forrest reckons it's time for "a science-driven, risk-based approach" to quarantine, and that vaccinated Australians should be allowed to serve their time at home.
  • Something to hide? The Victorian Labor government spent at least $12.3 million on legal fees during the hotel quarantine inquiry, more than double the cost of the inquiry itself.
  • Clear – an app that enables quick identity verification at touchless, biometric security kiosks used in airports across the US – may soon be used at over 60 US stadiums and other venues as proof of vaccination. We're not super stoked about a closed source, proprietary subscription-based app having our biometric data, so...  next.
  • Nine reported that Stan Sport now has nearly 150,000 subscribers, with around half being new subscribers to Stan following its three-year, $100 million deal with Rugby Australia.
  • The Indian Premier League (IPL) was suspended indefinitely after its so-called biosecurity bubble was breached, with several players and non-playing staff members returning positive COVID-19 tests.