07 May

Pink diamonds are no one’s liability

It’s been another positive week for Australia in the fight against coronavirus, with more restrictions on businesses and social movements being eased, sporting codes preparing to recommence their seasons, and even talk about a resumption of international travel between Australia and New Zealand.

Despite this, financial markets have begun the month on a volatile note, with the ASX recording a 5% fall on Friday 1st May. After such a big rally in April (the ASX was up almost 10% for the month), a pullback of this nature was to be expected, with many respected commentators stating that they think equity markets will re-test the lows seen in late March in the months ahead.

This would make sense to us, as whilst things do look like they are getting better in the fight against coronavirus, they’re almost certainly getting worse in the economy.  The latest data from the Australian Bureau of Statistics (seen in the chart below) suggests the number of jobs, and total wages paid in Australia dropped by 7.5% and 8.2% respectively in the month to mid-April.


Changes in employee jobs and total wages indexed to the week ending 14 March 2020

Changes in employee jobs and total wages indexed to the week ending 14 March 2020

Source: Australian Bureau of Statistics

Given this backdrop, it is impossible to see how aggregate demand in the economy can hold up, with even the Federal Treasurer stating that the economy is bleeding to the tune of $4 billion a week whilst we remain in quasi-lockdown, with economic output likely to drop 10% this quarter.

For as long as this continues, companies are almost certain to see a massive hit to their sales figures, and to their profits, which can’t help but weight on share prices going forward.

As a result, investors are rightly looking at alternative asset classes to protect and grow wealth, and whilst some will inevitably look at real estate (you can’t go wrong with houses right?) we think pink diamonds are a far safer bet.

Property Becoming a Perpetual Liability

Ever since we started producing ‘In the Loupe’ market updates, we’ve warned our readers about the risks in the property market, noting the world beating household debt levels in Australia, the lack of real wage growth, and the oversupply of apartments, particularly on the East Coast.

None of that has gone away, though we’d add that the Federal Labor party’s recent decision to champion more limited immigration going forward will add to the downside pressure on house prices, as by definition it means less demand.

More important than that though, our biggest concern regarding the outlook for Australian property comes from recent media coverage suggesting that state governments in both Victoria and NSW are looking to do away with stamp duty (a one-off hit paid when buying a property), which in all likelihood means it would be replaced with a land tax, that would be paid annually.

Property spruikers have been quick to jump on this, arguing it’s bullish for house prices, as according to them, the money you ‘save’ not paying stamp duty can just be spent on the house itself.

Whilst there is a basic logic to this, it ignores two, much larger realities

  • Banks in the future will need to account for this annual tax that a borrower has to pay to the government when working out how much to let them borrow.
  • A policy move like this would turn property into a perpetual liability, as owners will be hit with a bill each and every year that they own a place.

From our perspective, those two negatives outweigh the short-term boost one may see if this policy is implemented.

More troublingly, given property is a big immovable asset, the temptation will be to raise this tax over time, as property owners will be loathe to sell their home. In short, they’ll be easy targets for any cash-strapped governments.

It could also add to the weakness seen in any property market correction, as who will buy a house with a permanent liability attached if prices are falling? If in the past you’d been hoping for a 10-15% pullback, then knowing there is a liability attached you might instead wait for a 25-30% pullback.

Add this all up and from our perspective, we think it’s far more sensible to diversify, protect and grow wealth with pink diamonds. Not only are they not reliant on perpetual debt growth like housing is, but they are genuinely rare, and they are discrete.

They are not and will not ever be a liability.

Banking on Trouble

As a final comment on the Australian property market, we’d note that the big banks offer investors a forward indicator on how much risk there is this asset class, with NAB, ANZ and Westpac all announcing disappointing results in the last week or so, with the share prices of all three now down over 30% for the year.

Across the board, profits have fallen rapidly, dividends have been reduced or delayed, and in some cases, capital raisings have been announced, as the banks look to bolster their balance sheets.

That the banks are taking these steps is highly instructive, as over 60% of their lending books are directed toward Australian residential property.

Trouble is clearly on the horizon, reinforcing the need to protect and diversify wealth with hard tangible assets.

As always, we hope you’ve enjoyed this week’s edition of “In the Loupe” and look forward to any questions or comments you may have.

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