Australia Heading for ‘Mother of All Hard Landings’: Pros
Australia is headed for the “mother of all hard landings,” according to Société Générale strategist Albert Edwards, who says the country’s “credit bubble” could burst if China’s economy suffers a sharp slowdown.
“(In Australia) We see a credit bubble built on a commodity bull market based on a much bigger Chinese credit bubble,” Edwards said in a report. “Of all the bubbles I have seen over the last 30 years in this industry, this one is even more obvious.”
Edwards reiterated his case for a hard landing for the mainland economy, pointing to the official Purchasing Mangers Index (PMI) of 53.3 last month, which he says is “the worst” April reading in years.
“We are likely to see the PMI trend lower from here and the case for further Australian dollar weakness is clear,” he said.
The health of Australia’s economy, which is largely driven by its resources sector, is closely tied to that of its largest export market China – the world’s biggest consumer of commodities such as iron ore, copper and aluminum.
The Reserve Bank of Australia on Friday separately lowered its growth forecast for 2012 to 3 percent from 3.5 percent. It also lowered its outlook for export growth, warning that a sharp escalation in Europe's crisis could have significant implications on Asian demand, which in turn would weigh on commodities prices.
Australia Has an ‘Obvious’ Credit Bubble
According to Edwards, the lack of volatility in the Australian economic cycle and the absence of any recession since 1991 has led Australians to have an “excessive” appetite for debt in the belief the “future will reflect the past”.
“But for us, suppressed volatility is merely storing up an even bigger crash further down the road,” he wrote in report published Thursday.
Paul Gambles, Managing Partner at independent financial consultancy MBMG, agrees that there is a large credit bubble in Australia’s banking sector, and a hard landing in China is going to be the catalyst that “pricks” the bubble.
Companies in the resources sector, which borrow large amounts to fund their projects, will struggle to repay their debt if commodity prices fall, he said.
“Commodities tend to be capital intensive and based on a long term business model. There has been a huge amount of additional investment in commodities sector since 2008 on the assumption that higher commodity prices would be sustainable,” Gambles said.
“Any reduction in commodity prices is going to devastate these companies…it doesn’t take a big change in commodity price or demand to destroy the viability of new projects,” he added.
He also points to the massive level of household debt in the country, which has been around 150 percent of disposable income since 2006, according to the Reserve Bank of Australia.
“Australia has a very leveraged consumer sector whose wealth is dependent on the performance of the housing sector, which I think is also in a bubble,” he said, adding that the real estate market is highly overvalued, by approximately 45-70 percent.
“Consumer debt, and debt from the resources sector is way beyond anything the Australian government is going to be able to manage if there is a recession or downturn,” Gambles said.
Short the Aussie
Like Edwards, Gambles says that the case for a weaker Australian dollar is clear, warning that the currency will fall below parity against the greenback to 70 cents over the longer-term.
“We think that the Australian dollar along with perhaps the Aussie banks and Aussie property are maybe the greatest shorting opportunity that we're going to see for a long time to come,” Gambles said.
While he doesn’t think the sharp fall in the Aussie is imminent because of the healthy margin it offers carry traders, further deterioration in the outlook for the economy could “terrify” investors and lead them to exit the trade.
“The 70s is not a floor for the Australian dollar. When the Aussie spirals it can be a very volatile currency,” he said. The last time the currency fell below the 70 U.S. cent level was in October 2008 during the global financial crisis.