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Early signs of the negative wealth effect

Early signs of the negative wealth effect

The negative wealth effect from falling residential property prices combined with the podium position for Australian Household Debt to GDP (120 per cent) and Australian Household Debt to Disposable Income (200 per cent) is starting to bite.

New car sales in December 2018 declined 15 per cent, year-on-year, and pressure on the Aussie consumer is further borne out by the cautious ASX announcements from Kathmandu Holdings (ASX: KMD), Costa Group (ASX: CGC) and Wesfarmers (ASX: WES) Department Stores business, which follow.

Kathmandu Holdings (3 January):

“In Australia and New Zealand sales during December have been below management expectations and prior year. Same store sales for the 22 weeks ending 30 December 2018 are below prior year by 1.0 per cent (at constant exchange rates)”.

Comment: Based on trading during the first 15 weeks of the fiscal year, 1H FY2019 profit was expected to be strongly above last year. It appears trading results in the final weeks of 2018 in both Australia and New Zealand were disappointing.

Costa Group (10 January):

“Subdued demand in a number of categories, namely tomato, berry and avocado during December 2018, and trading conditions in January appear to be slower than planned at this stage”.

Comment: While management does not view the immediate issues as structural and regards the conditions as a cyclic situation, the Company is, to a large degree, a price-taker. When a punnet of raspberries falls from A$3.50 to $2.50 and there is a genuine over-supply of tomatoes after good growing conditions, there is not a lot the Costa Group can do.

Wesfarmers Department Stores (14 January):

“For the 2019 half-year, total sales in Kmart (excluding Kmart Tyre and Auto) increased by 1.0 per cent with comparable sales declining by 0.6 per cent. In Target, total sales increased by 0.2 per cent with comparable sales increasing by 0.5 per cent”.

Comment: Weaker sales in apparel categories, particularly in womenswear and moderated growth in everyday products signals the consumer is curbing his or her expenditure.

High levels of Australian household debt have been accumulated in an environment of relatively lax lending standards. The recent move by Australian lending institutions to introduce stricter mortgage underwriting standards is playing a role in pricking the housing price bubble.  And we see early signs of households responding to this negative wealth effect by cutting consumption and increasing their savings, where possible.


Chief Executive Officer of Montgomery Investment Management, David Buckland has over 30 years of industry experience. David is a deeply knowledgeable and highly experienced financial services executive. Prior to joining Montgomery in 2012, David was CEO and Executive Director of Hunter Hall for 11 years, as well as a Director at JP Morgan in Sydney and London for eight years.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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  1. Brett Edgerton

    I just wanted to update one thing on what I wrote earlier, below, if I might.

    I inferred that I had used the weakness in stocks at the end of 2018 to buy into numerous Chinese stocks, and that I felt that the tough conditions ahead would benefit these companies to sharpen their competitiveness. I had done this, but I have now reversed full throttle and below I explain why.

    I have long felt that Chinese companies would be successful going forward – because of the size and growth of their own domestic markets, the way in which China was increasingly interacting with especially the developing world, and because of the Chinese-specific factors that everyone at least partly understands (ie the heavy hand of Government).

    As early as 10 years ago when I wrote a piece on the Australian property bubble, which Steve Keen posted on his website, I have been of the belief that there is no reason why that final point would ensure that it is all smooth sailing for the Chinese economy and their companies and markets. I had this in mind when I invested and accepted that.

    In recent years I have taken particular note of people who I admire greatly as investors and economic thinkers (eg Roger M, Charlie Munger, Grantham and others) in forming an opinion that I wanted to have a high weighting to Chinese companies for future growth potential. And last year’s falls created an opportunity to buy in at lower prices.

    However, I have to admit that there was an extra unease inside of me as I loaded up especially on Chinese tech and automobile (around EV and autonomous), tech infrastructure, industrials (plumbing goods), and education companies.

    I was fortunate to spend a month in China around 20 years ago, while I worked for the Australian federal Government, for an APEC training workshop. It was an interesting insight into the country that has emerged as our most important trading partner.

    At 30 I was one of the youngest workshop participants – some attendees were in their 50s – and the first night that we stayed out later than the “recommended” time for lights out it became clear that it was not a recommendation but an enforced curfew! The second time that we were late, around a week after the first time, we were walking back to our accommodation about 30 mins after “curfew” and it become clear that the short stocky man who was taking photos throughout the workshop, and was that night a pillion on the motor cycle of the junior staff member, was laying down the law to that staff member and was very, very cross with our “insolent” behaviour. (Imagine professional men ranging from 30 to 60 years of age constantly checking watches to ensure that we were not late for curfew!)

    After that incident, the next day the “photographer” entered the room and from 3 rows of desks in front of me took photographs with me in the centre of the frame. I covered my face acting as if in deep contemplation. The next day he came into the room again to take photographs, but this time squatted down immediately in front of my desk and made it clear that he would take a photograph of me if he so chose.

    The small family restaurant that we were frequenting to have one or two beers between supper and “curfew” received two visits from black limousines while we were there. Men in dark suits entered and spoke with the owners after shutters were pulled across to cordon off half of their restaurant.

    Also, when I worked in Thailand for a multi-national organisation under the auspices of the FAO I had an interesting and memorable conversation with a Chinese national colleague, who had quickly become a good friend, about Taiwan/Taipei.

    With these experiences, I have watched concerningly whenever the level of interference by China into our political system has become apparent.

    I also noted the changes that Xi made last year to prolong his stay at the helm, and I was particularly interested and concerned by Soros’ recent speech at Davos.

    The truth is that while I am no fan of Donald Trump as an individual, I do think that pushing back on China is long overdue, and I respect his administration for it. I think that I would feel far more comfortable with the world if the US continues what it has begun. I suspect it will happen because Trump’s administration has crashed through the “group think” that had prevailed on China. I certainly hope that China’s main advantage – short-termism for political expediency by western democracies – does not return to the US or allies over this issue.

    With that in mind, I not only think that we have begun a historic reframing of China’s engagement with our western allies, I very much want it to happen. As such I feel I cannot on the other hand seek to profit from China continuing to rise.

    Attempting to do so will throw up all sorts of conflicts and already did. For example, while researching one of the EV companies that I was invested in I learned that it also produced military vehicles!

    Now I realise that there are many western companies that at least partly depend on military sales.

    But I do think that increasingly, as this relationship is reframed, we are going to have to navigate the shifting ground carefully as individual investors and at a national level (certainly that many interested observers, like myself, now understand from newspaper articles what the “five eyes” means is indication of that). For me I would rather be early than risk being caught in a rush for the exits when the crowd realises how the environment has become much more complicated and volatile.

    I should also admit that my concerns were probably showing through in a question I posed on one of Roger’s posts at the end of last year when I inquired whether the Montgomery team was taking the opportunity to increase exposure to Tencent at cheaper prices or was concerned by a reframing of the wests relationship with China – and I have noted since in investment updates that exposure to Tencent has not been increased.

    Fortunately, coming to this realisation did not result in a financial penalty for my family – it actually yielded a fairly nice short-term return – but I do wonder whether this is a widely underestimated issue that will ultimately affect returns over the medium to long term. I guess I hope it does because that will mean that what I consider to be a dangerous drift in geopolitics will have been contained or slowed.

    I accept that these actions could be seen as an over-reaction – however, as a personal investor, not a professional with career risk at play, I am “allowed” to turn full circle on a dime, and it has usually worked out OK for me when I have done so. (If I wish to put a positive spin on it I would say that I tend to act decisively once I’ve decided, and am not afraid to admit if my opinion has changed, but hindsight is usually the best “judge” of that.) But I have to admit that while I was feeling good about buying into reasonably valued companies in the areas in which I have greatest conviction – as opposed to buying into mostly overvalued ones in developed markets – I do feel a whole lot better about my positioning now (which has resulted in me increasing cash weightings again to about 50%! – between September and December I had gone from less than 20% in equities to a high of close to 70%)

  2. David,
    Is anyone wealthy enough to shop at Kathmandu? It’s like deciding to do your weekly grocery shopping at the airport

  3. Brett Edgerton

    Exactly, David!

    It is basic common sense – when through regulation or general policy drift one sector of the economy is favoured over others, partly through co-option of the political and bureaucratic system, a smaller share of the pie must by definition be shared by the “others”. In this case the “others” were content to live with this while the pie was growing, but it was never sustainable to grow the banking/housing sector so out of proportion within the economy so that eventually the pie would shrink back and those proportionally smaller pieces of pie within a shrinking economy had to have serious consequences.

    My disappointment is greatest with the RBA. They have treated everyone like we are Nongs (my wife’s favourite derogatory term :) ) and have become confidence sellers – peddlers of hot air and baloney.

    For example, until recently they argued that there would be no negative wealth effect on the basis that there was no discernible positive wealth effect as price rose strongly in recent years. Another far more plausible, and I have to say rather obvious, discussion around the topic would highlight that earlier stages of the long process of almost continually rising house prices, and concomitant household leverage, since the late 90s/early 00s was accompanied by strong wealth effects, and that the latest period of strongly rising prices in Sydney and Melbourne was not is suggestive that the positive wealth effects from these very strong rises in prices were counterbalanced by the negative wealth effects from the stock of household debt. In other words the laws of diminishing returns were very much in play and the end of the debt cycle was nigh, and the risks that Mr Stevens discussed in his 2012 paper “The Glass is Half Full” have in fact come to the fore .

    From an investment perspective, I firmly believe that we have a deleveraging process that will go on for much longer than anyone would predict. A search for the truly long-term data on real house price movements in Herengracht provides sobering reflection…

    I wrote the following to two mates in early May last year:

    “FYI – obviously this ppt [presenting data on of shop/restaurant closures in my near vicinity in Brisbane] is just for your eyes… don’t think it’s anything earth shattering, but I am convinced on this now and an effective* recession within 1.5-2 years is now my base case… It would be better if I was wrong, but I thought what I saw last November was a precursor and it continues to play out along those lines… I am sure that there will be policy thrown at the problem – and increasing the committed liquidity facility (to 250 billion) will stop the banks from going under and mean that we should not suffer a current account crisis (our own form of QE) – but there is a lot of vulnerability built into the system now (which the RC is addressing all too late) and the Government just has much less ammunition than it did 10 years ago (the AAA will be stripped, banks then downgraded, more sceptical voters so not sure first home buyer bribes, etc will work)… it’s going to be a long tough period for many over-leveraged Australians in my opinion…

    Yes I have been bearish for a while… but the only reason to be bullish has been a belief in “too big to fail” and Government intervention which just leads to more and more moral hazard in markets… that’s hardly a reason to be confident over the medium to long term – well for anyone who is trying to build wealth through investing over their life time as apposed to those concentrating on earning a fat bonus from clipping the ticket of fund flows… there will be a time when Governments can not kick the can down the road for future Governments and taxpayers to deal with… And I rather suspect this is it for us…

    I honestly look forward to one day being bullish :)

    * “effective” because high immigration and increasing volumes of gas exports might prevent the technical definition from occurring – eg most business people here consider 2000/01 was similarly an unrecognised recession – but I think it’s going to get pretty bad so I think the definition will be met”

    • Thanks for your thoughts Brett. The crucial point is that if the consensus view believes residential property will decline over the 2018-2020 period by neatly more than 20 per cent, to what degree does that get front-ended loaded into the valuations of those listed companies most vulnerable to this headwind? I suspect some good opportunities will surface later this year.

      • (Revised)

        Good point, David. Though for businesses depending on discretionary spend I suspect a donut structure will be most rewarding – those targeting the zero or lesser leveraged cohorts in the young and the retirees, and the hole being the very highly leveraged in the middle. It will have to be a truly extraordinary business to do well in the middle because, in my thought process, house prices in Sydney and Melbourne relative to wages will fall for a decade or more if nominal price falls are capped at 20%. (Of course greater nominal house price falls will speed up the adjustment but that does not improve the investment case.) Eventually wages growth will do some of the heavy lifting on that but nobody believes that will be any time soon unless we get truly reformist or even radical (eg universal basic income). Based on the performance of our political/bureaucratic/business leaders over the last 2 decades, I can’t see how we can sustainably/enduringly avoid anything other than a long hard grind ahead in the middle… (I know it’s depressing, but I was amused to read – perhaps on your site – that depression has been shown to be an advantage in investing… the author said they aimed to be miserable at work and jubilant at home… unfortunately it can’t be turned off and on :) – but at least it’s not too challenging/confronting to accept depressing conclusions )…

        Over the next 10 years or so there may well emerge one or two extraordinary businesses that do target this “middle” demographic… (in fact there is a case to make that tough conditions will produce exceptional businesses – like rugged ground and challenging conditions will produce exception wines – part of the reason why I am not deterred from investing in Chinese companies at present with growing headwinds of slowing growth within a changing economy within a changing global context)… I would suggest, though, that when analysing candidates, given these headwinds, it would be prudent to “lengthen the yardstick” and thus widen the margin of safety…

        Just trying to add value to discussion – hope I haven’t overstepped :)


      • Thanks for the good read David and Brett, it looks like we are in for a very long grind lower in many local assets, and you can bet your bottom dollar the government will be doing everything it can break the property markets fall, instead of facing the hard reality and just admitting it was stupid to base large parts of the economy on an asset bubble, which they did with loose money for a very long time, and now they find them selves trapped like every other central bank world wide.
        I’ve noticed a lot of talk about infrastructure upgrades coming out of governments lately, including adds on the radio etc, this next round of the centrally planned economy could be worth a look if one can pick the winners.

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