Mish's Global Economic Trend Analysis

Posted: 30 Oct 2010 12:29 PM PDT

Ben from Australia has a wife who is wondering about the wisdom of staying in cash on the sidelines waiting for Australia home prices to decline.

With and Email header of Advice for an Aussie, Ben writes ...

Hey Mish,

Just wanted to say a quick hello. I love it every day when then email with your latest posts arrives in my inbox about 5:20pm each afternoon (Sydney time).

You are completely right about the property boom in Sydney and Australia. One of my best mates is about to buy a pretty average 3 bedroom unit in Sydney for about A$750,000. It is absolutely crazy. He plans to rent it out (the rent will cover less than half the interest etc) but he is sure it will go up 10-15% a year. "Why?" I always ask. "Because it always does!" he replies. I've stopped explaining my position to him. All my mates think I am uncle scrooge.

But my question – I have a young family and a growing business. I'm stashing everything in cash in the bank and waiting to buy a house when the RE market (inevitably) falls – although my wife is getting impatient. The Reserve Bank of Australia is a pretty conservative beast (that's a good thing in my book) with official interest rates at 4.50% and headed higher. But I look at China and your comments about Australia (and Canada) getting belted in the fallout. Would you suggest anything other than putting everything in the bank?

Anyway, hope you're having a good weekend. Just wanted you to know that your efforts are appreciated around the world.

Cheers,

Ben

Response to "Down Under"

Hello Ben, that home prices in Australia keep going up is all the more reason to wait. The bigger the bubble the bigger the crash when it happens. Home prices always revert to the mean. Australian home prices are standard deviations above the norm in terms of price-to-rent and price-to-wages.

The bubble will pop and the crash will be spectacular, no doubt as soon as every conceivable person on the sidelines is sucked in.

"No Bubble?" Don't Believe It

The central bank says there is no bubble. Don't believe it.

Moreover, I laugh when I read articles like No house price bubble: RBA

RBA deputy governor Ric Battellino said today house prices in Australia, relative to income, were reasonable.

"People feel that house prices in Australia are quite high and that's quite often because the ratio of house prices to income that are published for Australia tend to focus mainly on prices in the cities, and they are quite elevated,'' Mr Battellino said in response to a question at a business function in Sydney. ''But, if you look across the whole country, the ratio of house prices to income is not that different from most other countries."

What Battellino seems to be suggesting is to look across the Outback and average prices and there is no bubble. This is like suggesting there is no bubble in San Diego because there is no bubble in Danville, Illinois.

Well, there may not be a bubble in the central Illinois farm belt, but not many people live in widely dispersed small farm towns of a few thousand people each.

It makes no sense to measure prices this way. The bubbles in Australia are where the vast majority of the people live.

Ben Asked "But I look at China and your comments about Australia (and Canada) getting belted in the fallout. Would you suggest anything other than putting everything in the bank? "

His question is in reference to Misguided Love Affair with China; China's Massive Monetary Expansion and Crackup Boom.

One thing Australians have going for them is treasury rates of 4.5%. The second thing is they do not have to worry about currency fluctuations, something that carry trade investors do have to worry about.

Australia Dollar Weekly Chart

The Australian dollar has been on a tear. Yet, where to from here is of primary concern to carry trade players seeking 4.5% in interest but assuming the risk in the slide of the Australian dollar.

Australians have no such concerns, and that does open up another play. Instead of sitting in cash, Australians can consider buying longer term Australian Central Bank notes on the expectation that when the housing bubble bursts, the RBA will respond by lowering rates.

For someone living in Australia with expenses and wages in Australian dollars, long-term Australian Central Bank bonds looks like a very good opportunity.

Those are my thoughts as to what looks attractive from this side of the ocean where 5-year treasury notes yield a mere 1.17% and 10-year notes a paltry 2.6%.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Mad Dash Into Junk Sets October Record

Posted: 30 Oct 2010 12:56 AM PDT

The mad dash into junk bonds continues. Please consider Junk Sets October Record, Mortgage Bonds Rally

Sales of junk bonds in the U.S. set a record for October as returns topped investment-grade debt and more borrowers were raised than cut. Government-backed mortgage bonds may beat Treasuries by the most in at least 10 years.

Fortescue Metals Group Ltd. and Calpine Corp. led speculative-grade companies issuing $33 billion of debt this month, according to data compiled by Bloomberg. The notes have gained 2.32 percent on average in October, compared with a loss of 0.16 percent for high-grade securities, Bank of America Merrill Lynch Index data show. Not since March have high-yield, high-risk securities outperformed by such a wide margin.

Investors have driven relative yields down to the lowest in five months on confidence the Federal Reserve will flood the economy with money, allowing the neediest borrowers to access capital and refinance debt. The rally is robust enough to extend into next year, said James Murren, chief executive officer of Las Vegas-based casino operator MGM Resorts International, which sold $500 million of notes rated CCC+ on Oct. 25.

"The bond market will get better," Murren said yesterday in an interview at Bloomberg headquarters in New York. "People are going to start to have a more positive outlook toward 2011. They're going to be searching for yield and they're going to go down the rating scale and that's going to benefit companies like us."

U.S. junk bonds have gained 14.4 percent this year, compared with the record 57.5 percent in all of 2009. The 1.96 percent increase this month in the Bank of America Merrill Lynch Global High Yield & Emerging Markets Plus index exceeds gains on the Global Broad Market Corporate Index by 215 basis points, after outperforming by 233 basis points last month.

Global corporate bonds have lost 0.19 percent in October, after rising 0.22 percent in September and the worst performance since losing 0.4 percent in May. Year-to-date returns total 8.84 percent.

Lehman High Yield Bond ETF

S&P 500 Weekly Chart

Buy the Dip?

The last two downturns in January and May of 2010 were buying opportunities. Will buy the dip work next time? Fundamentally I see no reason it should, but that does not mean it won't.

I have been saying for 18 months that the stock market is unlikely to break hard as long as corporates are strong, but buyer beware, sentiment can turn on a dime.

Extreme Sentiment

We have a possible warning signal in that the corporate rally for the last two months has been US only.

We have another type of warning signal with the CEO of MGM Resorts International proudly proclaiming "The bond market will get better."

Will it? He does not know, no one does. Moreover, I see no reason to think it will.

Finally, we have Richard R.S. Smith, head of high-yield capital markets at Royal Bank of Scotland's RBS Securities unit touting "We've pushed many of our clients into what we view as a very attractive market from a refinancing standpoint. We think it's going to continue as long as the U.S. government maintains a 10-year treasury rate below 3 percent."

RBS just happened to pimp $500 million of MGM bonds rated CCC.

This is exactly the kind of sentiment it takes to make a top. However, please remember that sentiment, no matter how extreme, can always get more extreme.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

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Saturday, October 30, 2010

Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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