Australia As An Investing Opportunity – Stocks, Bonds And Real Estate

The article looks at Australia’s three key investment markets to find lucrative opportunities.

The three key investment markets in Australia are stocks, bonds, and real estate. The course of each is shown graphically in the charts below.

Stocks

Stocks have been trading in the same range since 2020. A breakout upward is overdue and likely to take place over the next two years driven by the last and most explosive phase of the real estate cycle. This is discussed in more detail below.

Bonds

Bond yields have been rising in step with the central bank interest rate. The face value of bonds issued before 2022 has fallen sharply over the last two years of the central bank rate increase regime.

An opportunity that presents itself in the bond market is to buy the latest bonds at par value and offer yields upwards of 4%. When the central bank decreases the interest rate the face value of these bonds will rise over the purchase price and offer an opportunity to sell them before maturity in the secondary market while collecting a strong 4% coupon while waiting.

An example of newer bonds trading on the secondary market that are now over par value is shown in the table below toward the end.

Another opportunity is to buy the 2022 and older low-yielding bonds in the secondary markets at below-par prices as these will rise in value when the central bank starts to lower interest rates again. This would allow for an early resale of the bonds in the secondary market at a higher face value. The present low face value in the secondary market makes the yield attractive relative to the subpar purchase price.

An example of subpar bonds that one can buy on the secondary market that would rise in value when the central bank lowers the interest rate is shown in the table below.

There is little risk in trading such bonds because if one waits long enough they get redeemed at par at the end of their maturity no matter what.

Real Estate

Australian real estate in residential property prices are exiting a phase of lower prices and look to be accelerating back upwards.

Real estate prices tend to move in twenty-year circles and we are now reaching the final and most explosive part of one of these cycles as the chart below shows.

On the above chart, the stylized diagram lists the start, midpoint, final boom, and then bust years of the last four cycles going back to 1955.

The chart below focuses in detail on the current land cycle and shows where we are now and what is likely to happen out to 2028.

The author of this chart has this to say about the upcoming termination of the current land cycle in his latest book.

Fred Harrison is an economic forecaster and policy analyst. Ten years before the financial crisis of 2008, he alerted governments that house prices would peak in 2007, which would trigger a banking crisis and economic depression. They failed to take defensive action. Applying the same methodology, the author has assessed the impact of Covid-19 and he predicts that house prices will peak in 2026. Our world is on course for a global catastrophe, unless nations mobilise the democratic consent that is needed to adopt the financial reforms that would mitigate the looming disasters.

Harrison, Fred. #WeAreRent Book 1: Capitalism, Cannibalism and why we must outlaw Free Riding (p. 183). Land Research Trust. Kindle Edition.

Australia is noteworthy in that its land cycle tends to peak and boom and bust twelve to twenty-four months after the US land cycle. The US leads and the rest of the world follows with the smaller Western satellite economies peaking and falling some time after the US in a cascading effect.

To move forward asset markets need to be driven forward by liquidity. Financial balances and aggregate demand need to rise and one must look to the source of this liquidity, which can come from three possible sources.

The three sources are federal government spending, the current account balance, and bank credit creation. Each of these will be looked at in turn below.

1. Federal Government Spending.

The chart below shows federal government spending from 2014 to 2022 expressed as a percentage of GDP. The federal government has been deficit spending in that it has generally been adding more money to the economy than it has taxed out thus causing financial balances in the private sector to rise. After the large COVID-related spending in 2021, the spending pattern has contracted to levels normally seen before COVID.

The chart above forecasts future federal spending going out to 2026. The forecast shows that spending is likely to fall initially, though remains as a net injection, and then rise into 2025 and 2026.

Forecasts of this sort can be made as much of the federal spending is mandated spending and can be forecast forward based on demographics.

2. The Current Account

The chart below shows the current account from 2021 to 2023. The chart shows positive surplus bars. Australia is enjoying rising financial balances in the private sector due to trade surpluses.

The chart below forecasts the current account forward to 2025. The data is reported in quarterly intervals and shows that the next three quarters are likely to be in surplus

The chart above shows the cash rate, GDP, exports, and AUD/USD movements for Australia.

3. Bank Credit Creation

The chart below shows credit creation for commercial banks from 2019 until 2023. Bank credit creation has been quite strong and when converted to a percentage of GDP works out to 2.3% of GDP for 2023 and is the second strongest of the three liquidity flows. Most of this credit is created as mortgages to enable people to buy Australia’s rather expensive real estate.

The forecast chart above shows that bank credit creation is expected to rise into 2024 and 2025.

All three of the sources of liquidity that drive asset markets forward are positive and rising.

One can calculate the private domestic sector balance (P) by adding the government sector (G) and the external sector (X) as a percentage of GDP for the next years as follows. For 2023:

P = G + X

P = 1.5 + 4.8

P = 6.3 % of GDP.

With a GDP of US$1692, this works out to an increase to private sector financial balances of US$106.5B

One can track the sectoral balances using the tools at FRED and the chart below can be tracked in real-time using this link.

To get an estimation for aggregate demand and therefore the financial demand for investment assets we must add the result for bank credit creation to the private domestic sector balance.

Bank credit creation is C.

The equation for aggregate demand (AD) is:

AD = G + X + C

So for 2023, the result is as follows:

AD = 1.5 + 4.8 + 2.3

AD = 8.6% of GDP.

This is a strong result. Financial balances in the private sector rose by US$145.5B.

Using the data to forecast for 2024.

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The forecast results for 2024 are weaker than for 2023 however show that all three liquidity sources are adding to total liquidity and are still quite strong and will cause financial balances in the private domestic sector to rise and drive asset market prices upward.

My opinion is that the official forecasts are unduly gloomy and given that we are in the last and most explosive phase of the real estate cycle they will surprise to the upside, as they will in 2025.

The second half of the real estate cycle normally sees the USD weaken against the AUD. It was a rocky ride but at the end of the last real estate cycle in the depths of the market crash phase after 2007 and between 2010 the AUD rose to over USD$1.1.

So it could be that if you are holding Australian assets during the final bust phase of the real estate cycle (cash, gold, and bonds, and not stocks and real estate) denominated in AUD you will get a free ride upwards in USDs due to the foreign exchange rate swings.

The chart below shows that even short term the trend to a higher AUD is emerging.

In the chart above the AUD – USD 10-year bond spread leads the AUD/USD by about five months and the yellow USD/AUD line tends to move in the direction of the blue bond spread line.

An investor wishing to trade these asset market movements could do so using the following Australian ETF funds that mirror the broad stock market and currency.

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Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.