Tuesday, December 05, 2006

A cautionary tale

The impressive resilience of equity markets has surprised Macro Man and dented the monthly P/L. Following on from Friday afternoon’s late rally, the S&P 500 put in a truly impressive rally yesterday, confounding expectations that “recessionary” data would submarine risk assets. In fact, today’s non-manufacturing ISM is markedly more important than Friday’s number, given the weight of services in the US economy. We’ll see if the market notices.

Today, Macro Man has a story to tell. It is the story of a nation that is a consumption based society. The country routinely runs current account deficits in the mid-single digits as a percentage of GDP. It is a country where housing is no longer affordable to the common man; the latest Demographia survey of Anglo-Saxon housing markets reckons that this country is the most unaffordable in the survey. It is a country that is in the midst of a bust in housing activity, and that has sustained a significant deleterious impact from changing weather patterns in recent years. For some reason, however, the central bank in this country has insisted on putting up rates this year, despite all of the above factors clearly signaling that recession is around the corner. Yet somehow, the stock market in this country has rallied 14% in 2006- clearly a sign of either paramount foolishness or blatant market manipulation. Surely it will all end in tears! The name of the country is, of course...


As the chart below demonstrates, building approvals have fallen more than 25% over the last three and a half years; surely the type of long, drawn-out retrenchment in building activity that the entire world fears for the US.

Sure enough, Australian consumption did sag in 2004-05, enough to put the RBA on hold but not enough to foster a rate cut. Over the past year and a half, however, consumption growth has picked up smartly, despite the lack of rebounding in building activity. Indeed, the economy has recovered to the degree that the RBA has hiked rates 0.75% this year, despite a horrific drought that is taking nearly a percent off of annualized GDP growth over the next several quarters.

As the chart below suggests, the Demographia survey suggests that Australia is THE most unaffordable Anglo-Saxon housing market (the rating represents the cost of a home as a multiple of median income.) The US, while clearly expensive in aggregate, is the second most affordable country in the survey, behind Canada.

Source: Demographia

What this masks, of course, is the dichotomy between the coast (the most expensive markets in the entire study) and the interior (the most affordable markets in the entire survey, and affordable in an absolute sense.) A clearer sign that there is no unified “US housing market” would be difficult to find.

Source: Demographia

Does all of this mean that the US is guaranteed to avoid recession, or that Australia is guaranteed to slide into one? Of course not. Macro Man brings up the parallels simply to suggest that the US housing story is not, after all unique (other than the fact that most mortgages are fixed rather than floating rate), and that a period of subtrend growth resulting from a housing market adjustment does not necessarily produce either recession or even rate cuts.


Anonymous said...

Dear MM,

Thanks for bringing to notice the sad state of AUS....

but I am surprised at your confusion on the S&P bullishness. Don't you think the world is awash with USD and every asset class is inflated now ? (US equities, Emerging market equities and real estate, heck even Japanese Equities)

What significance do you give to the money supply growth seen in USA and ASIA (China and India running M3 of around 15- 20%)

Macro Man said...

Money supply growth is being driven by the reserve accumulation policies of the Asian CBs. As you note, M3 growth in China and India is running at a rapid clip.

At least some of this money finds its way into time and eurodollar deposits in the US, Europe, and UK. Unsurpisingly, Europe and the UK are showing very rapid broad money growth....while the Fed has quit even bothering with M3.

Conspiracy theorists in the US believe that this is to disguise a rapid printing press operation to prop up the stock market. Macro Man prefers to believe that they have simply recognized that they have lost control of M3, so there's no point tracking it. Narrower monetary aggregates in the US have demonstrated a fairly tepid grwoth rate, meanwhile.

Anonymous said...

I believe that MZM is a better indicator of money supply , and the prime reason that the Fed stopped following M3 is that CB's and Hedgies "distort" the M3 numbers by the shear size of their macro investments ..... of course , the Tin Foil Hat brigade and "big picture " types don't understand that --- it's always easy to come up with a conspiracy

Anonymous said...


what are your thoughts on London real estate ? I read a few tidbits here and there , but you may have better nuggets of info or research that you follow

Macro Man said...

I would concur that MZM or base money is the appropriate monetary aggreate to watch. Too many distortions in braod money these days, most of which dont require any conspiracy theory to justify. The Big Picture is a fine, fine blog, but it does attract a bit of a lunatic fringe IMHO.

London real estate is doing fine and should continue to appreciate. City bonuses will by all accounts set another record, which should provide a further boost to house prices. Estate agents are already positioning properties to benefit from buying interest from 'City legends.'