Interest rates are too low and house prices will fall further: T Rowe Price

The housing market is in the early stages of a correction and the Reserve Bank of Australia hasn’t equipped itself with effective tools to cushion the economy from the coming downturn because it lacks the policy space of previous cyclical downturns.

That’s the view of T Rowe Price’s head of Australian equities, Randal Jenneke, who says interest rates are too low for the current environment.

“I think it’s hard not to be in the ‘too low’ camp,” the fund manager said. “This year looks better as revenue growth has surprised on the upside, but that can change quickly. The cash rate is at 1.5 per cent.

“You can easily see the budget go back into quite a large deficit. We are not well-equipped for this downturn if it does turn nasty.” Mr Jenneke was referring to the present housing market decline.

Jenneke has a base case view sees house prices falling by between 10 and 20 per cent, but outside factors such as the ...
Jenneke has a base case view sees house prices falling by between 10 and 20 per cent, but outside factors such as the 2019 federal election could escalate the downturn.

Jessica Shapiro

The fund manager’s base case view sees house prices falling by between 10 and 20 per cent, but outside factors such as the 2019 federal election could escalate the downturn.

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“The Labor Party wants to change a lot of policies around negative gearing. That has the potential for another leg down in the housing market.

“The other thing to think about is that things can compound. So if trade and tariff [frictions] have a bigger impact and that flows through to commodity prices, then that could lead to another downward leg.”

‘Cautious’ approach

Bear case scenarios aside, the housing market correction is just getting started, Mr Jenneke said, as mortgage borrowers discover a more risk-adverse lending environment.

“A great example is offset accounts. Some of those are being changed or cut,” he said.

In his view, it will take two to three years for credit tightening to wash through the financial system. “So that makes us cautious on the housing market.”

The fund manager noted that housing activity was much higher last year than the long-term average of 140,000 dwelling starts, with about 220,000 dwellings built. “We could easily go back to 140,000.” In the first half of 2018, there were 114,000 dwelling units commenced.

He is reducing exposure to banks, domestic cyclicals, building materials companies, retailers and media companies in response to housing concerns.

“We are very underweight that part of the market,” he said, specifically 800 basis points underweight in bank stocks relative to the index.

“Investing is all about probabilities and what’s changing in my mind is that the probability of rate cuts is going up not going down,” the fund manager said.

Not many positives for growth

That stems from a view that the probability of slower economic growth, even recession, in Australia is climbing rather than falling, putting the chance of recession in Australia within two years at about 30 to 40 per cent.

“If you stand back and ask ‘what are the positive policies for growth in this country?’, it’s really hard to find any from either [political] party whereas you can clearly see a number of negatives.” Annual economic growth roared to 3.4 per cent in the June quarter.

The fund manager has little domestic exposure in his portfolio. He’s instead steering toward higher growth names where valuations are attractive after a heavy sell-off in October.

He’s been buying Reliance Worldwide Corporation, the a2 Milk Company, and has been topping up his Aristocrat position. “Even CSL. All of these stocks have become much more reasonable.”

But he remains cautious on some of the technology names, saying they haven’t fallen far enough, giving Wisetech as an example of one such stock.

Mr Jenneke is more cautious on the earnings outlook for some commodity names and is trimming his position in mining giant Rio Tinto. 

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