This Sector is on the Cusp of a Big Bear Market

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What was that, Ben?

I don’t think China’s economic slowdown is that severe to threaten the global economy.’

Hmmm. That’s a worry. He said the same thing about the US housing market in 2006.

I’m talking about Ben Bernanke, of course. He was speaking at the Asia Financial Forum in Hong Kong on Tuesday. No doubt he received a wad of money to maintain the impression — or charade — that China has things under control.

He received another bribe (what else is it, really?) to front a private event in Seoul and basically say the same thing in May 2015. This was just a few months before China’s central bank unleashed hell on global markets by devaluing the yuan.

As the Asia Times reported back then:

Speaking at a private-sector forum in Seoul on Wednesday, Bernanke said there’s no risk of a hard landing and that China’s economic slowdown shouldn’t worry the financial markets, Reuters reported. In addition, he said that the anticipated interest rate hike in the U.S. should be viewed as a positive sign for the world’s largest economy.

Clearly, the market digested Bernanke’s latest comments and went into outright panic mode.

Overnight, the Dow Jones index was down more than 500 points at one stage. A late day rally saved the situation though, with the Dow finishing down ‘only’ around 250 points, or 1.56%.

The Aussie market, or I should say Asian markets in general, kicked off the panic yesterday. After beginning the day in the green, selling quickly took hold, and the ASX 200 finished down 1.26%.

There were some big falls amongst former blue chip, household names. Santos [ASX:STO] lost another 7.5%. It’s now trading at a pathetic $2.50 per share and well below its recent capital raising price.

It’s still got a tonne of debt, and at current oil prices is losing money on its shiny, new Gladstone LNG project. The company will need to raise more capital at some point. But there’s a good chance the market won’t stump up again, which means they might have to look at more asset sales.

What a debacle…

Things aren’t much better over at Origin Energy [ASX:ORG]. The former fund manager favourite fell 9.5% yesterday, and now trades at just $3.50. That’s down from $13.50 in June 2015.

Both STO and ORG hit fresh lows yesterday. Both have invested heavily in new LNG plants. The steep share price falls suggest the market is concerned about the supply contracts these plants entered into. Customers could renege given the abundance of other forms of energy. This would be a disaster, but it wouldn’t surprise me.

Selling in the oil market is simply relentless. West Texas crude fell ANOTHER 6.7% overnight, to $26.55. Australia’s multi-billion dollar investment attempt to become the world’s largest exporter of LNG looks like a mal-investment of biblical proportions.

It’s a good thing we leveraged the future ‘gains’ from this investment into property…

Which begs the question…how is all this going to play out in the property market?

Vested interests will tell you stock market volatility is good for property. But they would say that, wouldn’t they? What they don’t understand though, is that there is a complex chain of events taking place. These events are slowly working their way into the housing market right now.

As I’ve written this week, you need to keep an eye on the banks and financial sector for clues to how this is playing out. I see the financial sector as a proxy for the health of rent seeking industries. Property speculation is at the heart of rent seeking, and many other financial related industries flourish from it.

Yesterday, the banks copped a beating. ANZ [ASX:ANZ] fell 4.4% to $23.50, the lowest level since late 2012. Westpac [ASX:WBC] lost 3.6%.

But, but…but what about the yield?

When you lose an annual yield in a few day’s trade, no one really cares about it. More to the point, market pricing suggests those yields won’t last. The share price action tells you earnings downgrades are coming.

Banks face a number of headwinds. More capital raisings (which means more shares on issue) rising bad debts (the cycle is at a low point) and importantly, a rising cost of capital.

What does that mean? Well, banks source around 40% of their funding from offshore. As the global economy continues to deteriorate (especially China) foreign creditors will charge our banks more to borrow. This will either hurt profits, or banks will pass it on via higher borrowing costs.

Higher borrowing costs means less demand for credit, less demand for mortgages, and falling house prices. If foreign creditors see falling house prices as a major threat to the economy, they will jack up our borrowing costs again. It will turn into a vicious cycle and there’s not much the RBA can do about it.

When you’re a large debtor nation earning income from just a few main export goods, you must march to the tune of your creditors. They’ve been pretty good to us over the years. They’ve basically stuffed money down our throats.

But these things can turn very quickly. In the same way that the mood of the market has gone from greed to fear in just a few weeks, so to can the fortunes of highly indebted sovereign nations.

And Australia is highly indebted. But it’s not the government up to its neck in debt, although that will come down the track. It’s Aussie households. A recent article in The Guardian, by Phillip Soos, points out that Australian households have the highest debt in the world relative to the size of the economy:

The results are in: Australian households have more debt compared to the size of the country’s economy than any other in the world.

Research by the Federal Reserve has shown the consolidated household debt to GDP ratio increased the most for Australia between 1960 and 2010 out of a select group of OECD nations. Australia’s household sector has accumulated massive unconsolidated debt compared with other countries. As of the third quarter of 2015, it now has the world’s most indebted household sector relative to GDP, according to LF Economics’ analysis of national statistics.

Much of that debt comes from foreign creditors. Maybe they’re beginning to wake up to the fragile nature of the Aussie economy? Maybe that’s why the banks look a lot like iron ore stocks did back in 2012? That is, on the cusp of a big bear market.

Greg Canavan,

For The Daily Reckoning

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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