Do the bulls hold the upper hoof or the bears the upper paw?

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Posted 5 months ago by Pope & Co. Mortgages

Article written exclusively for Pope & Co. Mortgages by Cameron Bagrie of Bagrie Economics

Is the New Zealand economy headed for a downturn and the housing market set to follow suit and head in reverse?

There are warning signs and risks to keep an eye on (particularly offshore and closer to home in Australia), and the Auckland property market is weakening, but the short answer is no. A pertinent danger is that we talk ourselves into a downturn though.

New Zealand is in reasonable shape. But there is a lot going on and the obvious caveats apply. A downturn could occur—I’m worried about the global scene, but it’s not the central scenario.

Let’s start with a glass half empty.

The economic bears hold the upper paw going by business confidence readings.

A huge 50 per cent of firms are pessimistic about the general economy according to the ANZ Business Outlook survey. That’s as bad as it was around the period of the global financial crisis. I ignore business confidence as an economic indicator. The correlation with economic growth is weak. There is a clear political bias. Businesses tend to be more upbeat under a blue hui as opposed to a red one. Business confidence averaged minus 18 between 2000 and 2007. The economy still did well.

The bad news is that some other economic indicators are showing a more sombre mood. This includes firms’ activity expectations for their own businesses, hiring and investment plans within ANZ’s Business Outlook Survey. When these indicators head to zero—which they have done—growth tends to do the same. Those indicators were weak in 2000. The economy came close to stalling.

Why are businesses nervous?

There are growing concerns over the international economy, though the United States—the biggest economy—is doing well. There are real fears of a trade war. New Zealand is an export dependent nation. A trade war wouldn’t be good for us. The global economy has more debt than prior to the 2008/09 financial crisis. Some emerging market economies such as Turkey are coming under real pressure. China (our largest trading partner) is being eyed nervously. Sydney house prices are falling, and people are speculating the same could happen in Auckland. Auckland prices are easing, but it’s been orderly so far.

The economy is 8 years into an expansion and people naturally look more nervously over their shoulders after such a period. It doesn’t feel like we’re 8 years into an expansion because there has been a lot to deal with over that period including recovering after the global financial crisis and earthquakes in Christchurch. The property market in the regions took a while to follow Auckland’s lead. Now Auckland is slowing but the regions are still buoyant.

It’s tough for the average household. Money disappears quickly. The household savings rate is negative; we spend more than we earn. New Zealand is not a cheap place to live.

Banks have become more conservative over lending. That’s not a bad thing but it’s still a change to manage and slows housing activity. Fuel taxes may be funding more roading investment, but it also takes money out of people’s pockets. Construction companies going bust or losing money does not help sentiment either.

Prospects for investment are being curtailed by access to credit, costs and lack of a sizeable domestic savings pool. Costs are rising faster than asset prices, which disincentivises investment. Firms tend to hold off investing when uncertainty is high. Migration is slowing.

People are pointing the finger at the new Government’s economic direction. Some criticism is warranted, and some is not. Businesses are being hit with a slew of rising costs. While issues need addressed in some sectors regarding what they are paid (i.e. education), there is a sense of catch-up about some of the wage demands and this will pressure firms’ profitability. Firms hire less and invest less when profitability comes under pressure. Some sectors are wondering if they are next after what has happened to the non-renewable sector.

There is nothing wrong with paying higher wages; we just need productivity to lift to validate it.

Farmers accept things need to change but are scratching their heads where climate change and environmental policy is taking us.

Where growth is going to come from is changing and people are confused.

We’re at peak cow, more mindful of the negative effects from non-renewables (i.e. coal), and surging house prices might be good for creating paper wealth, but it’s created housing affordability problems and has contributed to income inequality. We’ve relied on migration to drive growth for the past few years but that’s put pressure on infrastructure and housing.

New Zealand has achieved a lot of growth simply by leveraging up the balance sheet. There is nothing wrong with borrowing but eventually you hit constraints. We appear to be at that point now with household debt at 168 per cent of income. Debt can still increase, but in line with incomes and not in advance.

If we borrow less and the housing market is well behaved, the Reserve Bank will relax loan-to-value ratio restrictions to encourage us to borrow more and buy houses. But not too much more for fear of inflaming the property market! It’s a balancing act.

It’s a change that is needed but carries near-term costs. The economy is going to see less growth via the wealth effect (the boost to spending from surging house and land prices), and little growth from the dairy and non-renewable sectors over the coming years. Small businesses (who typically use house equity like an ATM) are going to find it more difficult to access credit if house prices don’t move a lot. More growth will need to come from other parts of the economy. The other parts will take time to step up.

People are asking “what are those other parts?”

But if you take out all the positives, of course you are left with something negative. 

The glass can be half full.

New Zealand is in reasonable shape, though growth is slowing. There are lots of positives. Opportunities will emerge as change takes place.

The equity market is performing well and reasonable earnings growth has just been reported. The government’s tax take is up; you don’t pay tax if you are not making money.

Interest rates are still low in New Zealand. There are growing expectations the next move in interest rates could be a cut. The market is pricing in 45 per cent chance of a cut.

Jobs are aplenty. Finding skilled staff is the biggest problem for firms. That’s a “good problem” not a bad one.

The New Zealand dollar has fallen, and this will help exporters, though it’s not great for retailers. New Zealand has one of the strongest fiscal positions in the western world. An orderly slowdown in the property market is a good thing as it lowers the risk of a bust. We are watching Australia closely though where the combination of falling house prices, tighter credit, high debt and lifts in interest rates is a worrying combination.

New Zealand dollar commodity prices are still strong, supporting rural incomes. The Government has the financial firepower to put more money into people’s pockets and invest more. Debt might go up, but we can handle it in the short term. Wages are lifting. Migration has slowed from 72,000 to 64,000 which is still a lot of people arriving. Tourism numbers are strong.

We have no shortage of work across the construction sector, just a shortage of workers. Normally at the top of the cycle we build too many houses. This time we can’t build enough. We can see some sectors such as gaming industry, pip-fruit and kiwifruit starting to step up.

I look at the economy through a set of traffic lights and structural indicators. When I see a lot of red lights I get worried and actively think about a downturn.

We have some red lights (high debt and excesses in Auckland), but many, such as low inflation, are still green for go.

All this does not preclude the potential for a hiccup. They do make hiccups more manageable. It’s when you have an array of red lights flashing (inflation, high debt, weak productivity, housing excesses such as bubbles, a blowout in the current account deficit) that downturns can be deep and hurt.

The economy is delicately placed. We should be okay. But economic theory is being challenged by reality and human nature as people eye a lot of change and risks.

The Wellington region is better placed than most. The Government is spending a lot of money and Wellington is a big recipient.

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